Trane Technologies plc (TT) — Q2 2017 Earnings Call Transcript

Thanks, operator. Good morning, and thank you for joining us for Ingersoll Rand's second quarter earnings conference call. This call is also being webcast on our website at ingersollrand.com, where you'll find the accompanying presentation. We are also recording and archiving this call on our website. Please go to Slide 2. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our SEC filings for a description of some of the factors that may cause actual results to differ materially from anticipated results. This presentation also includes non-GAAP measures, which are explained in the financial tables attached to our news release. The participants on today's call are Mike Lamach, Chairman and CEO; and Sue Carter, Senior Vice President and CFO. With that, please go to Slide 3 and I'll turn it over to Mike.

Thanks, Zac, and thank you, everyone, for joining us today. Our first half results continue a strong track record of performance and position us well for the balance of 2017 and beyond as we look ahead to the 2018 to 2020 targets that we laid out in May at our Investor Day. First half performance is running ahead of our initial expectations and gives us confidence in raising our full year revenue guidance to approximately 4.5%; raising our adjusted continuing EPS guidance to approximately $4.50, which is at the high end of our previous range; and maintaining a strong cash flow guidance of free cash flow equal to or greater than 100% of net income. Today, I'll start by discussing how focused execution of our strategy is delivering sustainable high levels of performance. I'll also provide comments on how our key end markets are shaping up for 2017. Sue will discuss our second quarter performance in more detail and address some topics we know are on the minds of investors and I'll then close with a brief summary before we take your questions. Our overall strategy remains straightforward and we believe our people and culture are a source of competitive advantage. First, our business model is rooted in anticipating and addressing all the trends that impact the way we live, work and move. We focus on delivering outstanding products and services in durable growing markets. In our case, it's an orientation toward the importance of sustainability, enabled by technologies growing at exponential rates that will create new business models and sources of productivity in a world that will increasingly value the conservation of resources. We excel in delivering energy efficiency and reducing greenhouse gas emissions, reducing food waste, preserving natural resources and generating productivity for our customers. It's what we do; that's what we're known for. We maintain a healthy level of investment in our businesses to sustain leading brands, which are #1 or #2 in virtually every market in which we participate. Second, we excel at delivering strong top line, incremental margins and free cash flow through our business operating system. Our business operating system is continuously improving and underpins everything we do and enables us to constantly generate high levels of free cash flow, which powers our dynamic capital allocation strategy. Our strategy once again served us well in the second quarter. We followed our business operating system to achieve outstanding organic revenue growth of 7% and adjusted continuing EPS of $1.49, an increase of 8%. We also expanded adjusted operating margin 40 basis points and generated $414 million in free cash flow. Our very strong revenue growth gives us great optionality to balance ongoing business investments for the long-term with meeting or beating our more near-term 2017 financial commitments. The larger categories in this investment include channel, infrastructure and new product development that position us in a way to continually improve our competitive position. In the second quarter, the company delivered strong top line and bottom line results. We realized continued strength in the Climate segment, which reported an organic revenue up high single digits. Residential and North American Commercial HVAC led the company's growth and, as expected, we're also seeing steady system improvement in our Industrial segment, which saw positive revenue growth and delivered strong margin expansion and order growth. This was the second consecutive quarter of organic revenue growth for Industrial. It was also a quarter marked by the launch of several product offerings. Compression Technologies and Services, for example, launched another model in the next-generation R-Series compressor family this quarter and its variable speed offering is up to 35% more efficient than the industry average. We just recently received external recognition with the Environmental Leader Product Award for its advances made in energy efficiency with the next generation R-Series line of the compressors. This is one great example out of 16 new products we launched in the quarter that demonstrate the kind of innovative, advanced offerings we offer our customers to build on our leadership position for the long run. We enable our customers to be both environmentally responsible and productive at the same time so customers are no longer obligated to choose one or the other. Moving to Slide 4. We changed our format a bit from our traditional market view to a midyear update that provides insights on how we're seeing the markets and our businesses now versus where we saw them when we provided our initial guidance in January. Based on the questions we've received leading up to this call, we believe you'll find the approach to be valuable. I'll touch on the primary areas that we've highlighted here as areas to watch so I'm going to keep it focused. It's not intended to be an update on every cut of the business here where we're seeing any element of change. So if we don't hit something here, we'll cover it in the Q&A session. The first topic is volume and revenues, which have been stronger than expected. The North American and China Commercial HVAC and our North American Residential HVAC markets exceeded our initial expectations. Our North American Commercial HVAC Building Services business, for example, achieved record performance in Q2 with its highest revenue recorded and 9% revenue growth. Combined with the market share gains we enjoyed based on our product and service leadership and sales excellence in all critical components of our business operating system, we're seeing very strong revenue growth. While we see the potential for growth to moderate in the second half of the year, we forecast that we will continue to exceed our initial plan for the year. On an equally positive note, with Industrial, we're tracking to exceed our annual revenue plan there, too. The next topic is the price to material inflation spread. Well before 2017 kicked off, we highlighted that we expected 2017 to be in an inflationary environment that, historically, we've been able to achieve a positive price material inflation spread of about 10 to 20 basis points. As we moved through the first quarter, the environment became increasingly inflationary, but still looked manageable to a 10 basis point positive spread if cost and pricing held steady. As we moved through the second quarter, material cost inflation has continued to persist and it's moved beyond steel and Tier 2 materials to all metals and into refrigerants. Because our volumes have exceeded our expectations, which we're pleased about, we're purchasing a higher percentage of commodities at current prices versus locked prices resulting in more inflationary headwinds. We did achieve a positive price to material inflation spread in our Industrial segment and within our Residential business as well as in Transport in the second quarter. Our price to material inflationary headwind was in our Commercial HVAC business and mainly this was centered in the Asia, Middle East and Latin American regions. Looking forward, it's important to note that we continue to expect to get positive price as we did in the second quarter. In fact, we expect to realize higher pricing as compared to last year and we believe this will continue through the balance of the year. However, we are planning around the assumption that price realization will be below our prior forecast in the second half. We believe it's prudent to plan for a negative price to material cost spread similar to what we saw in the first half of the year and this is built into our updated guidance for approximately $4.50 a share. The fourth topic is relative to our Transport business. At the beginning of the year, we indicated we believe the durability and diversity of the business would enable us to maintain modestly down revenues and margins based on expected declines in the North American trailer market and this has not changed, but the way we believe we'll get to the same result is a bit different. We're seeing modestly better results in North American trailers and softer results in our European trailer business as well as strong auxiliary power unit bookings as well as truck unit bookings and revenue. So in all, this is netting out to a relatively unchanged outlook for the Transport business. The next topic is foreign exchange. Generally speaking, the dollar has been weaker than we originally forecasted, which is largely closing the gap between our reported results and our organic results, which is a benefit to us. It's meaningful to remember that operating margin currency translation historically flows through the P&L at a rate approximately half of what we pull through from operations. So overall, this is creating a modest impact to our leverage rates primarily on euro-based revenues. Netting out all these updates, strong revenue and share gain combined with positive price and productivity, has enabled us to not only cover the cost to material inflation and other inflation, it's also enabled us to maintain high levels of investment in our business, which helps us maintain our momentum over the long-term. We expect that we will grow our business and expand margins again in the back half of the year, which gives us more confidence to raise our full year guidance to the high end of our previous range, with the same expectation on generating cash equal to or greater than net income and returning significant cash to shareholders via dividends and share repurchases and pursuing accretive M&A where we can create value. The future is very bright and we're excited about the opportunities that lie ahead in 2017 and beyond. I hope that this has given you some important insights into how our outlook has evolved through the midpoint of the year. And now I'd like to turn the call over to Sue to discuss the first quarter in more detail.

Thank you, Mike. Please go to Slide #5. I will begin with a summary of the main points I'd like you to take away from today's call. As Mike discussed, we have exited the first half of 2017 on a strong note with continued strong financial and operational results. First half bookings growth, organic revenue growth, adjusted operating margin improvement, adjusted earnings per share growth and free cash flow are all on track or ahead of expectations at this stage in the year and give us confidence in raising our revenue growth, adjusted earnings per share and free cash flow guidance. Our bookings and revenue performance were strong, with growth in both segments. Climate organic bookings and revenue were up 3% and 8%, respectively. Residential HVAC led the way with high-teens growth in bookings and revenues and improved operating margins. Commercial revenues were also healthy, up mid-single digits. Our Industrial segment continues on the path of steady improvement with strong bookings growth, revenue growth, and a 250 basis point improvement in adjusted operating margin. Excluding capitalized costs related to new product engineering and development of $8 million or 1.1 percentage points that were reclassified to the income statement in the second quarter of 2016, margins expanded by 140 basis points. These solid results give us further confidence in our full year guidance for the segment. In January, we laid out our capital allocation priorities for 2017, including spending approximately $410 million on dividends and an additional $1.5 billion on a combination of share buybacks and acquisitions. Year-to-date through today, we've spent $667 million on share buybacks and $205 million in dividends. We've also spent approximately $65 million on acquisitions. We are continuing to follow the dynamic capital allocation plan we announced in January. Please go to Slide #6. Focused execution of our business strategy underpinned by operational excellence drove strong year-over-year financial performance. Net revenues increased 7% organically, adjusted operating margins improved 40 basis points, and adjusted earnings per share was higher by 8%. Robust revenue growth, positive price, and productivity enabled us to more than offset increased material inflation pressures from metals and refrigerants while maintaining a healthy business investment. Please go to Slide #7. Organic orders were strong in the second quarter, up 4%, with increased activity in both our HVAC and Industrial businesses. We do a particularly strong growth in Residential, up high-teens, driven by a robust market and continued market share gains. Organic Commercial HVAC bookings were down low single digits, impacted by a tough comparison to the prior year when we booked a very large order in the North America Commercial HVAC Contracting business. Excluding this order, North America bookings would have been up 4% in the second quarter. Outside of North America Commercial HVAC, organic bookings were broad-based with high single-digit growth in EMEA and Asia. Transport organic bookings were up low single-digits with gains in North America, EMEA and Asia. Our diversification strategy enabled us to offset the decline in trailers through growth in worldwide truck, aftermarket and APUs in the quarter. Industrial organic bookings were up 5% in the quarter led by strength in Compression Technologies and Fluid Management. Regionally, North America and Europe were flat while we had strong growth in China, India, and the Middle East and Africa. Please go to Slide #8. In our Climate segment, organic revenue was up low-teens in both North America and China. Applied was up high single digits and unitary and aftermarket were both up mid-single digits. In our Industrial segment, overall organic revenue was up 2% led by high single-digit growth in North America and low single-digit growth in Asia. In our Compression Technology business, North America was up low to mid-teens in both equipment and parts and services and Asia also delivered strong equipment growth, up high single digits. Overall, North America revenues were up low-teens and international revenues were flat netting 7% organic growth rate for the enterprise. Please go to Slide #9. Q2 adjusted operating margin improved 40 basis points primarily driven by strong volume, productivity and price, partially offset by material and other inflation. We continue to invest in the business. For Q2, approximately 40% of our investments were in new product development, 40% in channel optimization programs, and 20% in OpEx on process and productivity-related projects to further improve our long-term competitive positioning. Please go to Slide #10. Overall Climate performance was strong in the quarter, with organic revenues up 8% and an adjusted operating margin of 16.8%. Strong revenue growth in both Commercial and Residential HVAC was partially offset by modestly lower Transport revenues. Climate adjusted operating margin was down slightly year-over-year. Significantly higher revenues, productivity, and price were offset by headwinds from material inflation and a lower product mix of higher margin Transport revenues. Please go to Slide #11. Our Industrial segment continued to show steady improvement in the second quarter. In addition to organic bookings growth of 5%, the business also drove organic revenue growth of 2% and adjusted operating margin improvement of 250 basis points. Our continued focus on improving the fundamental operations of the business through commercial focus on aftermarket, Operational Excellence initiatives and cost reduction measures is delivering tangible results. Please go to Slide #12. Free cash flow was $414 million for the second quarter driven largely by strong profit. Working capital as a percent of revenue for the quarter improved 50 basis points versus the second quarter of 2016. Year-to-date free cash flow is $340 million. Our guidance for free cash flow has been raised to approximately $1.2 billion, which is the high end of our previous range, reflecting continued expectations for free cash flow to be equal to or greater than net income. Additionally, our balance sheet continues to strengthen, which provides optionality as our markets continue to evolve. Please go to Slide #13. Continued strong cash flows in 2017 enable us to drive a dynamic capital allocation strategy, employing capital where it earns the best returns. In January, we laid out our 2017 capital allocation priorities and they remain unchanged. Our first priority is continuing to make high ROI investments in our business. These include investments in innovation and in strategic growth programs. These ongoing investments are at the heart of our innovation, growth and margin expansion story and our performance demonstrates our strategy is delivering results. The second area is maintaining a strong balance sheet. We're BBB-rated today and believe this is the appropriate structure for the company at the present time. The third area is our commitment to paying a highly competitive reliable dividend that grows at or above the rate of earnings growth over time. We've paid an annual dividend for 106 years and have consistently raised this dividend over the years. In fact, the compound annual growth rate of our dividend is 20% over the past 5 years. The fourth priority is strategic acquisitions and share repurchases. In January of this year, we committed to spend $1.5 billion between these 2 areas and year-to-date we've spent approximately $667 million on share repurchases and approximately $65 million on acquisitions. We intend to spend the balance of the $1.5 billion during the remainder of 2017. Our pipeline of actionable and available acquisitions is approximately $300 million to $500 million at any given point in time. We will continue to create long-term value for our shareholders through a dynamic capital allocation strategy as we have consistently done for years. Please go to Slide 15. Our strong first half financial performance gives us confidence in raising our 2017 adjusted continuing earnings per share guidance to the high end of our previously communicated range of approximately $4.50 per share. We have also raised our organic revenue guidance for the year from approximately 3% to approximately 4.5%, reflecting very strong revenues in the first half and expectations for continued healthy market growth and share gains in the second half. By segment, we expect Climate organic revenues to be up approximately 5.5% and Industrial organic revenues to be flat, both reflecting improvements versus our prior guidance. Please go to Slide #16. This slide lays out our updated guidance versus our prior guidance in more detail. I'd note that our free cash flow guidance has been raised to approximately $1.2 billion, which is the high end of the previous range, reflecting continued expectations for free cash flow to be equal to or greater than net income. Please go to Slide #18. We've received positive feedback on the section covering key topics we know are of interest to you in our prepared remarks, so I'll cover a few such topics on the next couple of slides similar to what we've done in recent quarters. The first topic is the expected impact of currency on our 2017 guidance. For the full year, we have been expecting roughly a $0.10 impact from a strengthening dollar primarily against the euro. At this point in the year, we're not expecting the dollar to strengthen as much as previously forecast, which has improved our currency impact from negative $0.10 to about a negative $0.02. We also expect currency to have a minor impact on revenues, which is reflected in our revised guidance. The next topic is our second quarter Climate segment leverage, which was lower than you might expect on the strong revenues we delivered. The primary factors impacting leverage in the second quarter in the Climate segment were persistent material cost and other inflation, unfavorable product mix from a lower mix of Transport revenues which carry relatively higher margins compared to the other Climate business and lower overseas margins than expected primarily tied to lower revenues. It is important to note that we continue to expect to see margin expansion in Commercial in the second half of 2017 and this is embedded in our guidance. Please go to Slide 19. The last topic for today is the noncash, noneconomic negative discrete tax item of $33 million or negative $0.13 earnings per share we laid out in our earnings release this morning. This charge is related to the impairment of deferred tax assets, primarily net operating loss carryforwards in Latin America. It is important to note that while these assets are impaired, the net operating loss carryforwards remain available for future use if profitability exceeds our current projections so there's no current or future cash or economic impact to the company.

Thank you, Sue. So in closing on Slide 20, we are executing our 2017 plan and building a thriving, more valuable Ingersoll Rand. I'm proud of our employees who successfully executed our strategy and delivered another strong financial and operational quarter for the company. We expect to see continued top-tier revenue and operating margin improvement in the back half of the year. Our robust revenue and booking performance gives us the optionality to make continued investments in the business to further improve our competitive positioning for the long run while, at the same time, raising our financial targets for 2017. To summarize, our Climate segment remains strong, led by our Commercial and Residential HVAC businesses, which are focused on growth areas with equipment, controls and service. Our Transport Refrigeration business is diverse and agile and will execute their strategy as they typically do. Our Industrial business is on track and is delivering steady, consistent improvement. We have a tremendous depth of talented people, and our culture remains as strong as ever. And taken together, I'm confident that, with this formula, we'll continue to deliver top-tier financial and operating performance. And with that, Sue and I will now be happy to take your questions.

So the tone on price cost definitely changed since the mid-May timeframe at EPG. So I'm wondering, has there been deterioration in the price environment? I understand you talked about rest of the world commercial, but has there been deterioration in the pricing environment since that point? And on that topic, are you building a Section 232 impact in the second half of the year into your guidance?

I would like to start by saying that regarding pricing, the most competitive pricing is occurring in regions like China, where there is an overcapacity of OEMs, or in areas facing economic challenges such as the Middle East or Latin America. This has created a more difficult scenario. We have seen inflation continue, particularly impacting refrigerants into the second quarter. Our delivered volumes were significantly higher than our forecasts, leading us to engage more in the spot market than we initially anticipated. Consequently, our outlook for the latter half of the year resembles our outlook for the first half. We expect a negative spread of around 40 to 50 basis points. We're not foreseeing any additional price increases, maintaining a similar price level as in the first half of the year while adopting a conservative stance regarding inflation predictions. We plan to improve margins in the latter half of the year while continuing to invest in the company. For instance, Climate would be an excellent example, as the rate of investments in the second half will be about double that of the first half, despite the price material inflation spread remaining consistent. Thus, our strategy focuses not only on managing price material inflation but also on investing in growth and productivity, which is an ongoing priority for us.

And Nigel, if I could add just a few things to what Mike said and then I'll get to your follow-up question. So the answer to your question on whether we've seen more inflation in commodities than what we expected for 2017 is a definite yes and that inflation has come from steel. It's come from copper, turning from what we thought was a slight deflation for the year to an inflationary metric. Aluminum has been slightly inflationary and refrigerants have also been inflationary for the year and, in fact, refrigerants represent about 10% of our inflationary pressure for the year. Another thing that I would tell you though is that with the volumes that we've had in 2017 to date, the increase also reflects some of the volumes that we've had where we've had to go out and buy it at spot. So it's a good problem and it's a great thing, but it has caused us increased inflationary pressure. And I would add just one more point on what Mike talked about with the Commercial HVAC regions where we're seeing not only pricing pressure, but also inflationary pressure with Asia, the Middle East and Latin America. These are some of our best businesses at managing the total P&L and productivity. So while these businesses are causing us some pressure on price cost, they also do a pretty good job of delivering their commitments by working the entire P&L, and I think that's what we'll continue to do as a total company for the remainder of the year.

Okay. Great. That's helpful. And then, as a follow-on, just the North American Commercial, I think we understand the comp issue, but maybe just dig into the verticals in terms of where you're seeing the underlying strength and weakness. And specifically, we are picking up some signs of a slowdown in light commercial activity, maybe on the tendering side. Are you seeing that, Mike?

First, Nigel, we've got to answer your 232 question and just really quickly on that. Steel prices, for us, are fairly well set now for the balance of the year. So between inventory and pricing that's out there, that rolls through the balance of the year. You would think we've got steel fairly well set in terms of our outlook for the balance of the year. Now going to markets, our view all along is that, at some point, you would see a positive but declining growth rate in the overall unitary market, particularly as it relates to commercial buildings. And I think that is definitely store outlook for the back half of the year, but offsetting that, we still think that we're sort of more in the early innings of the Applied business in the institutional markets and still have a nice pipeline moving through 2018 in that regard.

Mike, so Industrial order growth was plus 9 in Q1, plus 5 in Q2. Revenue growth was also positive in both quarters. We know you want to be conservative, but why would organic growth and growth for the year just be flattish? I think we understand that some of the orders you're getting are for your large longleaf compressor that won't impact '17, but is there something else you're seeing in the Industrial business that keeps you conservative about your forward forecast?

Well, for me, no. It's really about analyzing those large orders and their timing, as well as customer deliveries. We experienced a pleasant surprise in the first half of the year, as the book-and-turn business performed better than we had expected, with positive results across the Power Tools, Fluid Management, and even the consumer vehicle and Club Car segments. If the book-and-turn continues at this pace, there could be some potential upside, but what truly drives our significant revenue are the larger projects, which we have scheduled quite tightly.

Okay. That's helpful, Mike. And I wanted to follow-up on the Commercial HVAC orders that Nigel talked about. What was your internal expectation for the quarter? And then, how are you thinking about orders for the rest of the year? You've mentioned the improvement in Applied. Does that sort of accelerate as the year goes on? How should we look at that?

Yes, we performed very well this quarter. If you reflect on last year, our bookings growth was in the double digits, so we are building off some challenging comparisons. Last year at this time, we secured a contract worth over $100 million. We have similar opportunities in the pipeline, but their timing is unpredictable. Our business strategy isn't dependent on these contracts; we don’t shape our cost structure or investment timelines around their arrival. However, the market conditions are strong and continue to be favorable across all product lines, especially in Service and globally. We are pleased with our progress, and we have invested in growth which we believe is paying off. I feel as optimistic as I did at the beginning of the year regarding the second half for our Commercial HVAC business.

So maybe touching on pricing for a second, the 50 basis points of negative price cost that you expect to occur in the second half of the year. I guess, one question is what constrains you at this point from pricing further in order for that to narrow into the second half knowing that commodity prices have increased?

The challenging aspect here is that, while we have announced price increases, we are also facing inflationary pressures. We anticipate continued cost pressures in regions such as China, the Middle East, and Latin America. We don’t expect these issues to resolve, nor do we expect to make changes because our steel and most of our copper supplies are secured for the latter half of the year. Thus, we will not be able to alter this overall situation. Our approach for the back half of the year will focus on managing the entire profit and loss statement, enhancing productivity as we demonstrated in the second quarter, and managing our costs effectively.

Yes, Joe. Remember, too, that every single part of the company with the exception of Commercial HVAC had price that exceeded material inflation. If you focus solely on Commercial HVAC, it's much easier to maintain that price cost relationship in the unitary business than it, say, would be in the Applied business. We're at pricing today, 6, 9, 12 months out into the future. So if inflation shoots up dramatically in case of refrigerants as an example, which are used extensively in great volumes in applied equipment, you're going to see that you didn't cover it. So it's really isolated to that Commercial HVAC business and, again, to the markets that are most competitive and into a larger equipment where you sometimes have a hard time getting in front of it when it moves up dramatically for really no reason.

That's helpful color. I guess, maybe following up on that, Mike, you mentioned that price was positive really kind of across the portfolio with the exception of Commercial HVAC. If you were to maybe kind of give us a little bit more color on 2Q specifically around the incremental margins within Climate, so specifically on Commercial HVAC, Residential and Thermo King, just how did the incremental margins look for those different pieces of the business within the quarter?

We saw the highest margins in Residential, where we are significantly expanding, and the lowest in the Commercial HVAC sector, which faced some growth challenges in certain regions like China and parts of the Middle East. In the TK business, there was a mixed situation, with most of the growth in Europe occurring in Eastern Europe rather than Western Europe, leading to some regional disparities that negatively impacted results. Sue, do you have anything to add?

Yes, I think that's accurate. The greatest incremental leverage came from the Residential business, followed by Commercial North America and EMEA, with some areas experiencing price-cost challenges. Additionally, regarding TK, we did see a mix decrease primarily due to TK's sales, which typically have higher margins compared to other Climate businesses, alongside some lower-margin sales from Europe. This was not in the truck and trailer segment where we maintain high margins, so it was just a temporary mix decrease in TK.

Joe, it's interesting to note that the Parts business is growing, though at a slow pace, just slightly above low single digits. There is a significant increase in replacements on both the Residential and Commercial sides of the business, where the high margin Parts business is clearly seeing more replacements than repairs. This trend is also evident across the entire portfolio.

If you look at the Commercial HVAC orders over the last 12 months, they are in the mid to high single-digit range. I understand there has been some slowing, and considering that some of these bookings in Commercial HVAC might take longer, can you provide any insight on whether this quarter represents a true shift in the trend? Should we anticipate returning to a range of 4 to 5, possibly mid-single-digit orders in the third quarter for Commercial HVAC, especially since the third quarter may have an easier comparison due to a significant deal, though it's unclear if that was indeed the case?

Yes. I think the market is actually going to grow in that mid-single-digit range so that's the market in North America. As it stands, I mean, I think, Steve, slower unitary growth and accelerating Applied growth with the wild card being these larger energy services projects that we do at times that can impact the data.

We did have one of the contracting bookings in the third quarter of 2016 as well. It was about half the size of the one in Q2, but it was still considerable, so you'll experience a slightly challenging comparison. However, as Mike mentioned earlier, we will face tough comparisons on the Commercial HVAC bookings throughout the year.

Right. But the quoting activity is holding up okay, I guess, is the messaging?

Particularly on the Applied side, institutional side, absolutely yes.

Okay. So if you look at the margin bridge for the second half, you mentioned that the remainder of the year will resemble the second quarter, resulting in an increase of approximately 40 basis points during the back half of the year. Is that the correct perspective?

Yes, that's exactly right.

In the fourth quarter, the margin performance wasn't stellar, as there was a decline and some inflation impacted the results, creating a 40 basis point headwind. Why wouldn't that comparison become a bit easier, or is it just the timing of raw materials arriving? Additionally, why aren't you able to secure more pricing increases in the second half? You've mentioned you're planning to introduce some adjustments; are the markets in international Commercial just too challenging?

Second half investments are about twice the rate of the first half investments we're making and really trying to set up 2018 and beyond, Steve. So really on the margin side, yes, we could certainly squeeze more leverage out if we took that down, but we think we've got ideas and good projects to do that. Sue, the other part of the question, anything you want to add there?

Yes, you're correct, Steve. As we enter the fourth quarter, the comparisons on price cost begin to reflect previous periods because that was when we first noticed the negative impact in 2016. However, for the entire year, as outlined in our prepared remarks, we still anticipate a decline of about 40 basis points based on our observations from the first half and our projections for the second half.

Just a question on the productivity and other inflation line within the margin bridge. Maybe just give us a sense of sort of where you stand on the outlook for that. That had been a very big margin driver, 2014 and '15, sort of flattened out last year, back to being a good tailwind this year. So is that sort of 60, 70 bps range what we should expect in the second half? Or are you thinking about trying to step that up to offset potentially a price material headwind that could last some time into next year?

Yes. Total productivity steps up in the back half of the year for sure and that's programmed in, so those are projects that are in flight. So I feel that's pretty near in for us, a quarter or 2 out, to go look at that and that's certainly part of how we're trying to ensure that we still grow operating margin in the back half of the year and, again, sort of 30 to 50 basis points for the full year as well. But that's a good pick up, Julian. That's exactly right.

I have a follow-up question about the Industrial business. The strong margin performance in the first half suggests that we might see a leveling off in the second half. Were there any significant timing issues related to productivity efforts or specific favorable mix factors in the Industrial sector during Q2 or the first half that might not continue into the latter half? Alternatively, is the margin guidance in that division primarily cautious, considering the challenging years prior, and aimed at not getting overly optimistic about margin recovery?

Price volume mix performed better than expected, which is definitely a positive. Over the past 18 months to 2 years, there has been significant productivity work in our business, leading to some of the highest productivity levels we’ve seen. This improvement includes restructuring and changes to our business model. Overall, it has been an excellent performance so far, and we anticipate it will continue. However, what remains uncertain is where we expect volume to settle in the latter half of the year, specifically regarding how much we can ship during that period.

And we did, Julian, in 2016, we did see the margin start to improve in the back half of the year in Industrial. So again, the first half comparisons are going to be a little bit easier than the second half comparisons. But as I look at every line item for the business, they're continuing to improve in the second half of the year, all the way down the P&L. So I think the business is doing exactly what we expected and want it to do in 2017.

And I've got a lot of just personal confidence the way that, that team is executing through, Julian. They're delivering on exactly what was committed to on our May Investor Day. And it said through the operating reviews, you just see the cadence there and the delivery has been commensurate with that.

Yes, I wanted to get a better understanding of the volume mix in the second half. When I consider the tax benefit for that period along with your comments on pricing, it appears that foreign exchange will offset most of the pricing impact. I'm looking for clarity on the operating leverage in the second half. You mentioned some uncertainty around volume; is that the main factor behind it, or are you just being cautious about operating leverage? I’d like to understand this better.

Well, I mean, the leverage is not that different in the first half. It's marginally better in the back half than the front half, but the largest difference really is in the investments area where, again, it's about twice the rate as the first half.

Got you. That makes sense. And just a question on pricing. I think one of the themes this earnings season was that some deflationary pricing and distribution channels from online. I know that online is starting to make inroads on the Residential side. What has been your experience with pricing on the Residential side in the U.S. as online is growing?

So far, so good. If you remember in May, we talked about one of the things that consumers really asked for was more transparency in pricing. And so we launched and we're first to launch now, nationally, a model where we've worked with our dealers to be able to give homeowners a fairly tight range of what an installed system would look like. And we're seeing uptake on that from the web. We're seeing close rates that are well above what they were sort of in the conventional way. So look, I think that simplifying the consumer experience and being more transparent around that is a good thing and it's something that we intend to lead and/or participate in with other leading companies that think that way.

Just a follow-up on the price question. I understand the international dynamic in Applied, but why not go for a midyear price hike in Resi, especially since the market there seems so strong?

Well, Resi is covering material inflation and expanding margins and we're growing share. I mean, I wish we would have got 20 basis points more growth. We could have said it was 20%. So I mean, we had a heck of a good quarter. I don't think we need to do anything different there other than continue to do what we're doing and execute the way we've been executing. So I feel like that's in good shape and I think the industry is in good shape. Just like that, we could manage the whole income statement to deliver on the commitment we gave at the beginning of the year. So we're halfway through the year. We're now at the top end of our guidance range, which is a good thing. And as long as we've got good investments for the long run, we're going to make those investments. So I think it's happened to us before where the fourth quarter has rolled around and there was an opportunity to do something good for the business in the long run and we've done that. So we're not going to sacrifice a quarter to make a consensus number, that's for sure, but we are going to go deliver on the commitments we've made, which we're doing this year and, hopefully, we can top those.

And Robert, I would add that one of the things that, I think, we do a good job of and are putting some tools into actually continue to improve on the investments is we look at the investments versus the financial criteria and the returns that they're going to give to us, not necessarily their impact. It does factor into the P&L and we're very conscious of that, but we're looking at each of the projects for how it fits into the strategy and what kind of returns it's going to bring over the 2020 guidance that we gave at our Investor Day. So I think that's something we do very well and we're very conscious of how that all fits together, but it isn't just a look at the P&L. It's also a look at strategy and the longer term plan that goes along with that. So I think we do that pretty well.

I just had a clarification and then a question. Just on the share repurchase and the acquisition activity, the $1.5 billion that you talked about for this year. I just wanted to clarify that only the year-to-date numbers are actually in guidance?

Yes. As of today, our share buyback stands at the year's progress. The acquisition amount is $65 million related to the buyback, and we remain committed to a total deployment of $1.5 million. We are still considering actionable and affordable M&A opportunities estimated between $300 million and $500 million. Despite some changes in the pipeline, the estimate remains the same. If I were to assess the situation today compared to last quarter, I would say our focus leans more towards the $500 million side than the $300 million. That is the update I have for you. Thermo King is a diverse business, and right now we are seeing excellent growth in areas such as auxiliary power unit bookings, the total aftermarket, and the overall truck business. It's important to remember that Thermo King is not just involved in the trailer sector but also in the Class 3 to 7 truck market, which has seen a significant increase for us. Additionally, we have segments including bus, rail, and air that contribute positively as well. In terms of market performance, North America is slightly better than we anticipated, while EMEA, particularly Western Europe, is a bit weaker than expected, but Eastern Europe has outperformed our expectations. Overall, we are slightly above our initial projections for the year.

I will skip the breakup question since you've had enough of that topic. However, I’d like to provide some context regarding bookings. You have effectively re-triggered the presentation this quarter, but let's focus first on the Commercial bookings for the first half of this year. Can you explain the overall growth and makeup of those bookings? I understand that last year's first quarter presented a tough comparison due to remarkable growth, so I would appreciate some clarity on the first half bookings to highlight the continued strength in that area.

In the first quarter, we saw high single-digit growth in global Commercial HVAC bookings. In the second quarter, we secured a $111 million contract, resulting in a 4.5% growth for that quarter. Looking ahead, the outlook for the remainder of the year remains strong despite facing challenging comparisons.

Yes. I mean, 1Q '16, I mean, you had pretty explosive Commercial bookings as I recall. I mean, it was kind of in that 15% to 20% range, if memory serves right, in North America.

In the first quarter of '16, North America experienced a 12% growth compared to the second quarter of last year.

Yes. Well, no. I mean, I think good performance on very tough compares. And then, could you just like comment a little bit about the kind of volume assumptions you did have with respect to commodities? I mean, how did you outperform there in terms of what your volume assumptions were for the quarter versus what actual volumes were? Any kind of complexion around that?

Yes, Robert. It would be challenging to cover the entire business on this call, but we did not anticipate around 20% growth in the Residential HVAC sector this quarter. Additionally, we did not expect the Commercial unitary business to perform at the levels it did. Our strategy is working well in that area, and the North America Commercial unitary business experienced double-digit growth again this quarter. We were not forecasting such growth after already seeing double-digit increases in the previous year. Overall, the market conditions are strong and exceed our expectations. What excites me is our ability to effectively execute our plans and manage the increased volume with our suppliers while achieving significantly higher revenues than we had projected. The only downside was needing to source steel, copper, and aluminum from the spot market, but that is a minor issue.

Looking ahead to 2018, considering the levels of investments you've mentioned this year and the challenges posed by material costs, even though you're not providing guidance today, could we discuss the factors that might indicate what to expect regarding returns on the Climate side of the business if growth continues and spending increases? Additionally, could you provide insights on your R&D and overall investment spending plans for 2018 and whether you anticipate them stabilizing?

The long-range plans for the business extend over three years, capturing the year 2020. On the growth side, driven by product road teams, we continually ask how we can simultaneously increase our market share and improve margins. Projects that meet these criteria and are executed well will be approved. Looking at growth, our incremental investments will resemble those of the past three years, and we still have solid ideas to implement. On the productivity front, we are ensuring that our investments are adequate to outpace inflation, including wage and labor increases. This approach forms our operating model. As we plan ahead, our strategy remains consistent: we will make incremental investments for growth and productivity to counteract inflation. Additionally, pricing for materials constitutes a separate aspect of our operations. This year will be challenging and somewhat atypical, but I believe that in the long term, we will not remain in a disadvantageous position.

Lots of ground to cover here. Just a couple of things. Mike, the growth in building services, does that reflect the beginning of the execution of the big profits you booked last year? And whether the answer is yes or no, are you building backlog in that business?

The main area of growth was in all other service areas, including planned service, break-fix, and smaller turnkey contracting. This reflects the return on investment for our personnel in the field and all the service technicians we have added. In North America, we have increased our number of technicians by 200 to 300 year-over-year, possibly more. We are experiencing industry-leading revenue and margin per technician. This continues to be a strategic focus for the business, with ongoing investments in these higher-margin areas.

So on the bigger projects, you're not really starting to see revenue from those, correct?

Yes. They are lengthy in nature and follow a fairly linear execution process. Typically, for an 80-building project, it's completed in phases, which causes it to gradually reflect in the income statement. Some of these projects span 24 to 26 months, or even longer, meaning they unfold over a period of 2 to 2.5 years.

No. Actually, it doesn't. What it really reflects is our in-region, 4-region strategy. So in other words, your cost and your revenues are largely in the same currency. And so what that means is, is when you translate out the revenues that you're really translating the income at the operating income level. So it includes the cost side of that versus just at the gross margin level. So a bit of a nuance, but nothing more than straight math.

I guess, first question, Mike, on some of the big performance contracting orders that you booked last year that set up a tough comp, I'm to understand those are fairly lower margin relative to the base business. Does that show up in an easier margin comp somewhere along the way that we should keep in mind as well?

Well, it shows up in lower gross margins. It should show up in the contribution margin being about the same. So you tend to have all elements of cost set against that particular contract. So there's very little incremental, meaning the commissions and the sale are part of the cost structure of the contract. So we look at those to be accretive to the overall margins on a contribution basis, but it would put pressure on your gross margins for sure.

Is that something we lap here in the second half? Or is that just spread over multiple quarters?

In response to Jeff's question, when you secure contracts worth $100 million, it can significantly impact your bookings in a single quarter. However, if those projects extend over 24 to 30 months, the profit and loss effect is spread out over that time frame. This results in a diluted effect on the income statement as it reflects over time. Does that clarify things for you?

Yes. That's helpful. And I guess, just a follow-up on another one of Jeff's questions on the currency front. A lot of companies we've seen have gotten pretty decent pricing over the last couple of years in a stronger dollar environment. Is that some of what's going on with the tougher pricing environment internationally, just maybe it's tougher to price your inflation given that you've already priced through currency? Is that dynamic playing out at all for you? Or it's because it's purely translational, that doesn't show up?

So we tend to produce and sell in-region at those currencies. We do very little sort of exporting around the world in various currencies. The only exception to that is there's some Middle East orders that will come out of the U.S. as an example, but generally speaking, you're operating in the same currency. So to us, it's much, much more translational than it would be transactional.

Right. I believe that, Josh, when considering the current global situation, we will encounter a competitive pricing environment in certain areas, which is expected. Additionally, we will be sourcing our raw materials locally, whether in China or other countries. This means we are experiencing both sides of that dynamic, depending on the region. Therefore, it is not simply a matter of translation or foreign exchange effects. If you are manufacturing within the region, you will experience the complete cost implications alongside the total revenue aspects.

Great. I'd like to thank everyone for joining us for today's call. We'll be available in the coming days and weeks for any follow-up calls that you might have. And we look forward to connecting with many of you soon. Have a great day.