Trane Technologies plc (TT) — Q2 2018 Earnings Call Transcript

Thanks, operator. Good morning, and thank you for joining us for Ingersoll Rand's second quarter 2018 earnings conference call. This call is 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. Mike?

Thanks, Zac, and thanks to everyone for joining us on the call today. Please go to Slide 3. I'd like to begin with a brief review of the fundamental elements of our business strategy that drives long-term value creation for shareholders. This is often a helpful starting point for those of you listening who may be less familiar with the company. First, our global business strategy is at the nexus of environmental sustainability and impact. The world is continuing to urbanize while becoming warmer and more resource-constrained as time passes. We excel at delivering energy efficiency and reducing greenhouse gas emissions, reducing food and other waste of perishable goods and generating productivity for our customers, all enabled by digital and other exponential technologies. Our business portfolio positioning creates a platform for the company to consistently grow above average global economic conditions, aided by the strong secular tailwinds that I've outlined. Second, our business operating system is designed to excel at delivering strong top line growth, incremental margins and free cash flow. Our business operating system underpins everything we do and enables us to consistently generate powerful free cash flow, which, when combined with our dynamic capital allocation strategy, drives strong returns for shareholders over the long term. And finally, over the years, we've built an experienced management team and a high-performance winning culture, which gives me confidence in our ability to deliver strong results that are sustainable for the long run. Having a strong winning culture takes years to build and cultivate, and I believe this is one of the things that the market may underappreciate about Ingersoll Rand. As we consistently execute our strategy, we continue to build a stronger company that delivers reliable and consistent financial performance for shareholders over the long term. Moving to Slide 4. Midway through the year, we continue to execute well against our long-term strategy and 2018 is shaping up to be a very good year for us. Our end markets are healthy, and we are executing well, as evidenced by the strong growth we're delivering in bookings and revenues in both our Climate and Industrial segments across virtually all products, services and geographies globally. Our Industrial segment continues to perform well with broad-based bookings and revenue growth and significant margin expansion. We're effectively managing inflation and tariff headwinds. We delivered a 10 basis point positive price versus material inflation spread in the second quarter, which reflects strong pricing discipline and efficiency. Our China growth strategy is performing well against our expectations, with continued strong revenue and bookings growth and improving margins. As we look forward, we expect our end markets to remain healthy, with consistent execution of our business operating system, which gives us confidence in raising our full year guidance for revenues, EPS and free cash flow. Please go to Slide #5. In the second quarter, we delivered strong growth in organic bookings and revenue across the board, as indicated by the positive signs on the chart. Enterprise organic bookings and revenues were up 15% and 9%, respectively. Climate led the way with organic bookings and revenues of 17% and 9%, respectively. And Industrial was also very strong, with organic bookings and revenues up 8% and 9%, respectively. These results represent continued healthy end markets and consistent execution of our strategy. A couple of points to highlight. First, we did not see a significant impact from revenue pull-ins ahead of price increases or tariffs in the quarter, and Sue will discuss it in more detail later. And second, we didn't have any large performance contracting orders to call out in the quarter that would have skewed our results. The 1 minus on the chart was in small electric vehicle bookings, where results were only modestly lower. Golf was down, with utility and consumer vehicles showing bookings growth as expected. Please go to Slide #6. This slide provides insight and color into the key drivers behind the chart on Slide 5 and how we're thinking about the outlook for the year. In commercial HVAC, we're seeing sustained growth globally in both bookings and revenue, with good growth in both equipment and services and particular strength in Asia. North America growth remained solid, with gains in equipment, services, contracting and controls. Institutional growth was particularly strong, led by education. And Industrial HVAC strength was also notable in the quarter. Europe, the Middle East and Africa commercial HVAC remained strong with solid growth across the board in equipment and after-market, and we saw additional growth in services from our rental services business. China continued to have very strong growth in the quarter, led by the execution of our China direct sales growth strategy. Our outlook for total commercial HVAC remains healthy for 2018, and key economic and market indicators largely support our view. Turning to residential HVAC, bookings and revenue growth were also very strong, particularly against tough growth comps versus 2017. The replacement markets, where the majority of our sales are derived, showed very good growth in the second quarter, and this is expected to continue through 2018. Our transport solutions business continues to be a diversified, resilient business, and the improving market conditions for North America refrigerated trailer have been a positive. North American trailer order growth was strong in the quarter and revenues were up as well. The Americas Commercial Transportation Research Company, also known as ACT, has taken up their forecast for North American refrigerated trailers to approximately 5% growth over 2017. However, industry capacity by trailer OEMs is constrained, so it's not clear how much the industry will actually grow at this stage. Auxiliary power unit growth remained strong, with good growth in both refrigerated and non-refrigerated segments. We're also seeing continued solid growth in Europe, the Middle East and Africa truck, which is a meaningful business for us. Overall, the transport market should be stronger than we originally expected in 2018, primarily led by improvement in the North American trailer market. Compression Technologies is seeing the continuation of an industrial recovery, consistent with industrial production and other key leading indicators. In the quarter, we delivered good growth in bookings and revenues in both equipment and after-market. All major geographies were solid, with particular strength in Asia. For 2018, we expect to see solid growth broadly across key products, services and markets. Small electric vehicle revenue growth was strong, driven largely by successful market penetration of our consumer vehicle, and we expect that to continue through 2018. We also delivered strong growth across our Industrial Products business, which is comprised of tools, fluid management and material handling. We expect to see continued good growth in our Industrial Products businesses in the second half of the year. And now I would like to turn over to Sue to provide more details on the quarter and to discuss our 2018 guidance increase. Sue?

Thank you, Mike. Please go to Slide #7. As Mike highlighted, strong momentum from the first quarter continued through Q2. Revenue growth in both our Climate and Industrial segments is outpacing our initial guidance expectations. Margins and leverage are improving and the pull-through to EPS growth has been strong. As we look forward to the second half of the year, we continue to see good opportunities for growth broadly across our end markets. We expect sustained strong execution of our business operating system to enable us to deliver financial results that meaningfully exceed our initial full year guidance for revenues, earnings per share and free cash flow. Looking at our second quarter results in more detail. Bookings and revenue performance were both strong, with robust growth in virtually every major product category and geography and in both services and equipment. We delivered record Enterprise bookings and revenues with organic bookings up 15% and organic revenues, up 9%. Climate led the way with organic bookings and revenues up 17% and 9%, respectively. Industrial organic bookings and revenue were also strong, up 8% and 9%, respectively. After-market growth outpaced equipment growth, up 12% and 11%, respectively, as we continue to focus on building out a greater mix of high-margin, sustainable revenue and margin streams over time. There's been a fair amount of discussion on the street recently regarding the impact of customers' pre-buying inventory ahead of announced price increases or the anticipated implementation of tariffs, so we wanted to spend a moment addressing this question with respect to Ingersoll Rand. While it is difficult to determine a precise number due to a number of factors, we are confident this was not a substantial factor for us in the second quarter given our channel structure, and the visibility that we do have. We would estimate an impact of between $80 million and $100 million on orders, spread primarily between commercial HVAC, residential HVAC and transport refrigeration. As best we can call it, this would translate into 2 to 3 percentage points of the 15% bookings growth in Q2. The impact of revenues was likely a fraction of this in the quarter and de minimis to the full year. Through the second quarter, we have continued to execute a balanced capital allocation strategy. Our first priority is always reinvesting in high ROI projects in our business. As we outlined in our original guidance for the year, we also have a number of high ROI capital expenditure-related projects in 2018. These projects are aimed at simplifying our business through footprint optimization and at innovation through new product development-related projects. We've invested in a number of these higher ROI projects through the first half. We have also maintained our commitment to a strong and growing dividend. We announced a quarterly dividend increase of 18% in the second quarter and have distributed $222 million to shareholders in the first half of 2018. Share repurchases have also remained a good investment for us as our shares have continued to trade below our calculated intrinsic value. Through June, we have repurchased $500 million at an average price of $88.53. On the acquisition front, we closed on the Trane-Mitsubishi Electric JV, which is now up and running, and our acquisition pipeline remains active. Through the second quarter, our total cash spend on M&A is approximately $280 million, including the ICS Cool Energy acquisition and the Trane-Mitsubishi JV, which were previously announced. While it is still early days on the Trane-Mitsubishi JV, we're already seeing good returns on the ICS Cool Energy acquisition. Please go to Slide #8. As we've highlighted, Q2 was a strong financial quarter top to bottom. We delivered 9% organic revenue growth, 50 basis points of adjusted operating margin expansion and EPS growth of 24%. Our operating leverage also significantly improved to approximately 20%. Please go to Slide #9. Focused execution of our strategy in Operational Excellence drove strong core business operating income contribution from both of our business segments, which combined for approximately $0.25 or the majority of the $0.36 of EPS growth in the year-over-year quarter. Lower share count from significant capital deployments towards share repurchases in 2017 and 2018 drove another $0.07 improvement. We also had modest positive contributions from lower interest expense associated with the company's debt refinancing earlier this year. Additionally, we benefited from a slightly lower effective tax rate year-over-year on higher pretax earnings. Please go to Slide #10. Strong execution drove 50 basis points of adjusted operating margin improvement in the quarter. Pricing discipline delivered greater pricing efficiency than we anticipated when we gave guidance at the end of the first quarter. Price versus material inflation improved 50 basis points sequentially in the second quarter to a positive 10 basis point spread. Higher revenue drove 80 basis points of margin expansion, and investment spend was consistent with our targeted levels of approximately 40 to 50 basis points of incremental investment per year. Productivity versus other inflation was flat in the quarter but improved sequentially. We expect productivity to continue to improve in the back half of the year and particularly in the fourth quarter as programs and initiatives continue to ramp. We expect total productivity in 2018 to exceed 2017 levels. Please go to Slide #11. Our Climate segment demonstrated strong improvement in the quarter with flat adjusted operating margins, which was a 50 basis point sequential improvement from the first quarter, driven primarily by volume, pricing and productivity. We are successfully mitigating persistent Tier 1 and Tier 2 inflation, freight costs and the known impacts of the tariffs that have been implemented to date. As you know, the majority of inflation impacts are to the Climate segment. Our China direct sales strategy continues to perform well against our expectations, with continued strong growth and improving margins as we move through the year. Please go to Slide #12. Our Industrial business delivered another strong quarter with organic revenue growth of 9%, and adjusted operating margin improvement of 170 basis points. The restructuring and productivity actions in prior years are providing operating margin growth in 2018, and we continue to take further actions in 2018 that will benefit future years. Please go to Slide #13. We remain committed to a dynamic capital allocation strategy that consistently deploys excess cash to opportunities with the highest returns for shareholders. We maintain a healthy level of business investment in high ROI projects, which is helping to drive our strong growth in both our Climate and Industrial segments this year. We have also increased our capital expenditure investments that will have strong returns through new product development and footprint optimization. We maintain a long-standing commitment to paying a strong and growing dividend and have increased the dividend at a 20% compound annual growth rate over the past 5 years. In the second quarter, we announced a quarterly dividend increase of 18%, which reflects our ongoing confidence in our ability to drive sustained high levels of cash flow in the future. We will continue to make strategic investments in value-accretive M&A that drives long-term shareholder returns. We maintain a strong balance sheet that continues to improve through high-quality operating income growth, which provides us with significant optionality as our markets continue to evolve. We also continue to invest in share buybacks when the shares trade below our calculated intrinsic value. Over the past 1.5 years, we've spent $1.5 billion on share repurchases and have reduced our outstanding share count by approximately 5%. Please go to Slide #15. As we touched on earlier, our strong first half financial performance gives us confidence in raising our 2018 guidance for organic revenues, adjusted earnings per share and free cash flow. Adjusted earnings per share guidance moves up significantly to approximately $5.50. Organic revenue guidance is more than double to a range of between 7% to 8%, reflecting very strong revenues and bookings in the first half and expectations for continued healthy end market growth and continued share gains in the second half. The strength is also broad-based. By segment, we expect Climate and Industrial organic revenues to each be up 7% to 8%, essentially doubling our prior guidance for revenue growth for each business segment. Please go to Slide 16. This table lays out our updated guidance versus our prior guidance in more detail. We've talked to most of the data points on the slide, so we've included the table in the presentation for your reference, and it includes some of the modeling-related questions you'll want to have. Bottom line is that we expect 2018 to be a strong year for Ingersoll Rand. Please go to Slide #18. Moving on to our topics of interest section, we have one primary topic to cover: tariffs and inflation mitigation. The main takeaway is that we have incorporated all known direct and indirect impacts into our guidance from the section 232 tariffs and the section 301 tariffs related to the first $50 billion that went into effect in July. We're evaluating the potential impacts from the additional $200 billion in proposed Section 301 tariffs, which are indeterminate at this stage. To be clear, we have seen a significant uptick in inflation from the direct and indirect impacts of the known portions of the section 232 and 301 tariffs. At the same time, however, with the pricing effectiveness we're seeing and expectancy going forward, we believe we can maintain a flat price versus material inflation equation in the back half, as we previously guided. We expect the better pricing we are seeing to offset additional inflation and tariffs in the back half of the year. Beyond the known tariffs, we continue to closely monitor the tariff proposals and discussions taking place globally in order to react quickly if and when additional tariff pressure comes into play. First, our global integrated supply chain team is continuously monitoring tariffs from the time they are proposed. Second, we are rigorously addressing the cost increases across the portfolio working through our supply chain team. And third, we are utilizing our business operating system to actively manage our pricing and productivity actions and pipeline throughout the enterprise. We anticipate that additional tariffs would be met quickly by pricing action across the industry. Now I'd like to turn the call back to Mike for closing remarks before we take Q&A. Mike?

Thanks, Sue. Please go to Slide 19. We believe the company is extremely well positioned to deliver strong shareholder returns over the next several years. Our strategy is firmly tied to attractive end markets that are healthy and growing profitably. Our products and services portfolio is at the nexus of global energy efficiency and sustainability megatrends, which provides a tailwind for growth above average economic conditions over the long term. So unless you believe the world is getting less populated, cooler and less resource-constrained, these secular megatrends will continue to create growth opportunities for Ingersoll Rand. We have experienced management and a high-performing team culture that incorporates Operational Excellence into everything we do. Culture is so fundamental to a company's success, yet it is often underappreciated in the short term. For us, it is a sustainable competitive advantage that we invest in heavily to cultivate and maintain. And lastly, our business model generates powerful cash flow, and we are committed to dynamic and balanced deployment of capital. We have a strong track record of deploying excess cash to shareholders over the years. And with that, Sue and I will be happy to take your questions. Operator?

Impressive performance for sure. I just wanted to come back to a couple of things. One is, I guess, the order pull forward and the second one is on Climate margins. On the order pull forward from Q3, could you give us a little more color around that, and how we should expect that to materialize over a kind of time frame? And do you think this is just a 1 quarter phenomenon? Or do you think there's going to be a little bit more of this? Just anything on that front would be helpful.

Yes. Steve, so half of it would have been really in commercial HVAC and then a small portion would have been residential, a very small balance being TK for the most part. So that would total something in the $80 million range. What I'd say to you is that, and I don't necessarily talk about sort of third quarter, but I will say we looked at what was happening with bookings in the first few weeks of July very carefully, and they came in very strong. So I don't think that there's going to be an issue there for us with any hiccups in the quarter.

Okay. That's helpful. Can you provide more details on the factors influencing the Climate margin performance? I know you discussed some of the price cost inflation dynamics, tariff impacts, and other considerations. It would be beneficial to understand investment, inflation, and the existing pricing to help us grasp the flat margin performance moving forward.

Yes, for the full year 2018, I expect Climate margins to improve by about 10 to 20 basis points overall. The pricing has already been accounted for, and productivity is a focus for us. We always assess the health of our pipeline, aiming for 125% of our needs each quarter. This assessment breaks down into a monthly and quarterly view, which supports our productivity goals. With bookings at their current level and strong end market conditions, along with good pricing performance, we are achieving the price levels we targeted. The productivity timeline looks favorable as well. Overall, I anticipate a 10 to 20 basis point improvement for the full year, indicating a solid second half.

All right, that's helpful. And I could just sneak one more in, on the Trane-Mitsubishi JV that launched, what kind of financial impact are you thinking about on that as you move forward?

In 2018, it hasn't been particularly significant for the company. However, the early stages have been outstanding and exhilarating, with the teams starting off strong. They are actively engaging in the market and performing as expected. Everything is on track and looking positive in that regard.

Yes, can you hear me now?

Got you.

Great. Sorry, yes, I don't think I was on mute. The guidance suggests that there may be some slowdown in the expansion of industrial margins following some very strong results. Is there any mix impact or anything similar expected in the second half?

Actually, we think Industrial remains strong. Everything is pointing forward. We're looking at probably a 2-year high now in terms of Industrial productivity. We're seeing strength across the world. We're seeing services grow at about the rate of equipment. So no, I think, for the most part, we see sort of steady as she goes in Industrial.

Is there any reason why price or cost would slow down in the second half if these price increases are occurring? Is inflation significantly worse in the second half?

Well, you've got a little bit of that first $50 billion in tariffs coming through in July and August, on those 2. So I think that the safe view of that, at this point, would be the original guidance we have, which is a flat back half. We saw great price effectiveness in the second quarter. It was beyond what we thought, but I think we need to pace ourselves based on the changes that happened with tariffs, and the dates of implementation and how those lists might change. But we think that we're managing it really effectively and that we've got a plan and contingencies around how to manage changes that we would get on the tariff front. By the way, it's not just tariffs, it's inflation. We really have a region-for-region strategy. And so if you think about the impact we're seeing, it's not so much on the actual tariff, it's on the derivative effect of commodities in the region increasing because they can as a result of tariffs.

Got it. One last quick question on residential. What are your thoughts on the market? Lennox was up 9 percent, and Carrier had mid-single digit growth. It seems like the market is somewhat inconsistent at the moment. How do you expect the market to evolve after the second quarter for residential?

Yes, I think the market data was released already, Steve, so we grew share in the quarter. We know that. And if you look across the board, and I know you'd love the detail on this, but let me just tell you that on the Climate segment itself, when you think about the revenue growth rate for the segment, we didn't have more than 1 point of variance globally across HVAC or transport or residential. So it was a really good uniform performance. And then North America specifically, when you look at applied unitary and service, everything there was, say, 15%, 16% plus growth. And so that was really strong across the whole range which probably tells you what you're asking, I think, at that point.

Mike, just a little bit more color on price. I think earlier in the year, there was a lot of optimism you could get it in the U.S. but a lot of doubt or certainly less certainty about the rest of the world. Your results here do suggest that price is moving up pretty nicely now in those markets, but could you give a little bit more color on kind of the geographic differences around price? And if you're maybe still playing a bit more catch up outside of the U.S.?

There is not a lot of variability around price effectiveness around the globe for us at this point, Jeff. And that's part of, if you will, the surprise here. So the margin improvement in China is going really well, and that would have been the points we would have been talking about a couple of quarters ago. But that's going really well and there's not enough differentiation globally to really kind of point out here in that space. Now I mean clearly, we are covering and have been covering material inflation in every business, with the exception of our global commercial HVAC business, and what we're seeing there is that, that gap is flattening and improving with the increases that have been put out in the marketplace.

And how about capacity, Mike? In a good news result in a year like this, I would assume you're sweating the assets a little harder than you thought. Any material change in investment or anything that you need to do to keep up with this?

Jeff, we're ready to build and ship more, so send us orders and we'll get it to you. Yes, no, it's a good time, and we need to make hay when the sun shines. We all understand that and that's what's happening. So we don't have any capacity issues at this point in time.

I'm sorry, just one other quick one, maybe Sue has calculated this number. But if you're at price/cost parity, how much margin pressure, just arithmetically, does that create?

I'm not sure I understand.

Well, revenues will be higher because of price but profits not up because you're neutralizing cost with price. So there's an arithmetic margin headwind. If you haven't done the math or you don't know it, that's fine. Just curious.

Yes, I haven't done the math. But what I would say, Jeff, is when we think about this through the entire P&L is we're not just working off of that equation, we're working off of all the different elements. And so as we point out to you on productivity, we're continuing to put productivity projects into the pipeline because there are other elements that are inflationary and moving around in the P&L, too. So we can certainly come back to you on that answer. But my general overall answer is, I'm going to manage everything that is on the P&L to get to the guidance that we've provided and that we're going to hit for 2018.

Jeff, a good example is that this has been one of our better years for gross productivity, possibly the best in terms of absolute dollars. Even though the bridge indicates flat results, it's factoring in 20 basis points of unplanned freight costs, which will slightly affect pricing. This situation, as Sue noted, is fluctuating between pricing and productivity, and we expect improvement in the latter half of the year. We'll follow up with you on the detailed calculations.

Mike, obviously your intention in China has been to accelerate growth through moving to the direct sales model, and you did mention that one of the highlights of your overall growth this quarter is China HVAC. Can you give us a little bit more perspective on the growth in the region, maybe how much of it is coming from your own initiative here versus what the HVAC market is doing over there?

Yes. The market is growing something in the 5% range, so we're growing in multiples of the market there. And it's in the areas that we would expect, which is the applied systems and some of the larger infrastructure projects and in some of the geographies that we weren't covering as deeply as in the past. So that is a strategy, that's what's being executed. It's being executed very well, and the margin profile and linkage to service continues to improve. So it's been a great success. It's probably one of the greatest successes we've had in the past year or so has been that whole strategy, and I would expect that to continue.

Got it. And you don't adjust and tweak that strategy given all of the tariff stuff that's going on between us and China, correct?

Well same equation in China applies here. We build about 95% of what we sell in China in China and the supply chain is localized. So yes, it's the same equation as we have here region-in-region.

You achieved nearly 9% organic revenue growth in the first half of 2018. You mentioned a 15% bookings boost, possibly with some pull forward as you discussed, but it doesn’t impact the third quarter. So, for the implied organic growth in the second half, around 6% to 7%, is that just a cautious estimate at the midpoint? Or are there any concerns that might slow the second half down, or is it expected to remain steady?

Well, some of the bigger growers in the quarter would have been applied and it would have been compression technologies equipment. So in essence, we're building to 2019 as we speak. And I would say a lot of that is our view toward building a profile for '19.

Just wanted to circle back on the Industrial segment, if you could give any color within compressors, any specific markets or regions that you thought gave the orders a particular lift? And also on the Industrial segment in general, following up on an earlier question, I mean, the margin guide implies sort of flat margins, I think, sequentially in the second half, which is quite unusual in Industrial, particularly given the sales trends. So I don't know if there is any extra color you could give on why that's the case?

Yes, regarding the market, we mentioned Asia specifically, and that's accurate. The growth was evident across all oil-free technologies, including centrifugal and oil-free rotary, as well as in our quick ship and quick book and turn business. The demand for short-cycle compressors was strong too. Service growth has been robust overall. The team has done an excellent job implementing their sales excellence operating system to drive daily improvements. The market coverage and the activity we are experiencing in that coverage are significantly stronger than what we have seen previously. This approach is influenced by strategies we've adopted from our HVAC business in China, focusing on a more comprehensive and innovative market coverage. North America also performed well, particularly with Contact Cooled technology, which has shown solid results. The centrifugal technology's penetration into the general industry has also been promising.

Understood. And then just on the margins sort of half-on-half in Industrial. Is there anything particularly weighing on that, that back half in terms of higher investments? Or at this point, you think you've raised the margin guide enough for now, and we'll just see how Q3 plays out?

No. We wouldn't do that, if we thought it was better we'd roll that through, but that's the roll-off we've got at this point in time, and that's going to be a combination of mix and timing of projects. So I think it's a good forecast where we think the year is going to end at this point.

To clarify Jeff's earlier question, when you mentioned margin parity and price/cost parity for the second half of the year, you were referring to margins rather than dollar amounts, correct?

Somewhat margins, right.

Yes.

Okay. Got it, got it. Yes, I think that probably clarifies it. Maybe talking about the growth that you're seeing specifically on Climate and into 2019, Mike, can you provide maybe some color on some of the orders that you're booking that could potentially be longer cycle that could start benefiting '19 as well?

Yes. I mean, we're seeing, again, there's very little variability between unitary, applied, controls and service. It's just a strong healthy global environment for us, really all regions of the world. There were no large performance contracts in there and something that would skew the results. That's really important to know. So because you're seeing such strength in applied, you're generally finding longer lead projects. And so if anything there, again, you're building quarter 1, quarter 2 of '19 backlog, which we're already well into that based on customer timing.

Cool. That's good to hear. And then I guess my follow-up there is really just price/cost is better than we expected this quarter. I was just wondering, did you benefit at all from like the pullback that we started to see in copper? And then what are kind of like your assumptions for the key commodities into the second half of the year?

Well, really, it's the best price effectiveness I've seen in 33 years of going through this, both in the urgency to get it done and in the ability to maximize what it was that we were asking for. So the combination of that got us a bit ahead of the curve, which is great, further along than we thought we'd be in Q2. And then the ability to absorb the first $50 billion into the pricing that we put out in the marketplace would be the success there. As it relates to copper specifically, we ladder and hedge, and so yes, it's great that things are moving down. But as you kind of enter quarter 3 and the back half of the year, a smaller percentage of the spend is really in the spot market, we begin to lock that in. So if it continues, we'll see some benefit, but that would be reflected in the locks that we would be doing going into 2019 at this point.

Yes. I think that's right, Joe. When we think about that, the goal that I would have is to get ourselves to the point where, in 2019, that, that blended rate gets through our locks and that sort of dollar cost averaging that we're doing on a copper buy comes down overall. So we never lock, as we've told you, to the full amount of the commodity, 75% at the beginning of a quarter. So we do get some benefits on any purchase that we're going to make from those prices coming down. But I would look at that as more of an opportunity for 2019 as we go forward. So it's always good because we are always buying all 3 of the commodities. So we'll certainly take advantage of any price drops that we get.

Obviously, you've covered a lot of ground here, and you've provided good details, so I haven't got a huge amount here, but I'm actually pretty paranoid about the sustainability of the strength and obviously 15% growth is not going to sustain. But as you look beyond July and look at the front logs, RFP activity, customer conversations, what do you think you see in the next 6 months or so? Are we still looking at a double-digit type order cadence here? I mean, any cause of concern? Any color there would be very helpful.

Globally, as we monitor proposal activity and assess market trends, things are strong for us everywhere. This largely relies on the nature of the business, with about 80% to 85% of our activity in North America, Europe, and the Middle East being driven by replacement needs, and even in China, newer economies are split between replacement and new construction. The key is creating solutions that deliver economic value and payback linked to energy productivity and efficiency. When we can connect that with a narrative that supports customers in achieving their greenhouse gas emissions or sustainability goals, it opens up significant demand that isn't always reflected in typical market data worldwide. This represents a lasting trend related to energy efficiency and sustainability. As I mentioned earlier, increased urbanization, heightened energy and environmental pressures make it clear that our involvement in HVAC, which is a significant factor in building efficiency and greenhouse gas emissions, along with transport, refrigeration, and industrial processes, positions us well to make an impact. Our product offerings, investments in controls and digital solutions, and enhancements in our distribution channels are all designed to bolster this effective model.

That's great insight. Regarding service trends, we usually don't observe service growth in the high single digits. I understand that this is largely attributed to your internal initiatives related to connectivity and the significant investments made in that area. However, is there any indication that we've noticed an increase in utilization, particularly on the Industrial side? Is there a sense that we have older equipment in the field that may require more attention, potentially leading to increased activity on the OE side?

Services actually grew in the mid-teens, which is unusual to see alongside mid-teen growth in equipment. This success can be attributed to our ongoing sales excellence initiatives that are starting to yield results over time. We also expect to see similar growth in regions like China in the next three to five years, aligning more closely with what we observe in Western Europe and the U.S. This is certainly affecting our service growth positively. Additionally, rental services play a crucial role in our strategy by supporting customers' uptime needs and providing seasonal equipment, leading to more service opportunities in that area. If you have further questions about industrial productivity, please feel free to ask.

Could you provide more information on the industrial compressors, particularly whether we're seeing increased usage of those machines driving service or if this is more related to internal IR?

Well, you're definitely seeing utilization rates across most of the economies in the world increasing up to critical points where you are finding expansion opportunities. So to me, what's really happening in the Compression Technologies business is the market coverage we're taking on and the investments we're making in covering the service opportunities in the markets has taken on a whole different sense of urgency. That connectivity strategy that Todd talked about for really a couple of years at this point in time is something that's showing up in the results in a meaningful way.

And then it's a quick one, Mike, on mix in residential. 1 or 2 of your competitors talked about a slight negative mix in U.S. resi, did you see that at all in your business?

No. Not at all. Simple answer, no.

Mike, on the performance contracting project. So nothing this quarter. Earlier in the year, you said some things could hit, but at this point, is it fair to say that's all going to come in '19?

No. I think we could see improvements in the third and fourth quarters. It seems like we're settling down in a couple of areas, so my guess would be that those improvements will occur in the third and fourth quarters.

And would those have some sort of mix down impact on Climate on the margin side?

No, no, it wouldn't. The contribution there is going to be just fine. In gross margins, you'll see a little bit, but the contributions will be accretive.

And institutional orders consistent with overall Climate orders growth organic-wise?

Yes. I mean, really you're seeing applied, which I would link to Institutional growing at the same rate as unitary, growing at the same rate as service.

In the first half of the year, M&A activity impacted cash flow by $286 million, which includes the committed transactions with ICS Cool Energy and Mitsubishi from year-end. I want to broaden your perspective on capital allocation. We prioritize investing in the business first, followed by maintaining a strong dividend, and then the remaining cash goes towards M&A and share buybacks, especially when the stock is undervalued. For the first half of 2018, we saw increased capital expenditures of $163 million linked to footprint optimization and new product development. We also distributed $222 million in dividends and executed a $500 million share buyback, totaling over $1 billion in excess cash deployment. M&A is part of our strategy, and we will continue to evaluate opportunities. The capital allocation has been robust in the first half.

Rich, specifically on the deals done, they're integrating well, and we're achieving what we thought we would achieve, which had a high threshold. So I don't think any changes with the guidance we gave you around '18 and '19 around the contribution.

Maybe a couple quick philosophical things, if I could. First, on Thermo King. Based on the data we see, it doesn't really look like the fleets of trucks and trailers are actually growing that much, which would suggest that what we're seeing here is kind of a technology upgrade, and I know there's much better energy efficiency with the more recent units. But how long do you think that can last? I mean, where are we in the process of upgrading the fleet, do you think?

From a U.S. perspective, there is tight shipping capacity and regulatory changes, along with the effects of the Tax Cuts and Jobs Act and immediate expensing, all of which will create opportunities. Technology plays a significant role; for example, the need to manage diesel engines, reduce fuel consumption, and minimize greenhouse gas emissions from refrigerated trailers presents a substantial opportunity that is likely to persist for a long time. Similar to consumer vehicles, we can expect increased electrification over time, supported by our current hybrid applications and telematics investments across the portfolio.

Okay. That's helpful. And then even maybe a more broad picture. At some point, I suppose all these price increases, we should start to worry about some demand destruction in certain end markets. And some of the pricing we're hearing, especially in the HVAC, is pretty impressive. And I guess I'm just curious how you think about when that starts to crimp growth or maybe it doesn't, I don't know, maybe these markets are consolidated enough now. But I'm curious how you think about that and how you might even sort of measure and monitor it.

Well history would say that it doesn't happen, that there isn't a destruction over time. And so I rely a lot on history, and I would also rely on a lot of the discipline that happens within the industries themselves. And so the structure of the industry is something we do look at, but we're not seeing any changes to historical patterns here.

I just had 1 or 2 little ones. Can you break out the bookings in Industrial by the different product lines just because there's been a couple of questions around the edges of that? I think that would just clear a lot of things up.

Joel, Club Car was the weakest, just marginally negative and the strongest would have been CTS and material handling, albeit material handling being a smaller business. But CTS would have been additive, Club Car would have been dilutive and power and fluid management right in the hunt there. So that's the rundown there.

So you won't provide us with numbers. That's fine. Can you discuss a bit about...

I probably gave you enough of the algebra there that a smart guy like you, Joel, can handle that.

Once I run out of fingers, I'm done. And can you just give us a little sense on the second half share repurchases that are baked into the guidance? And also, are there any larger acquisitions that, over the next 18 months, like you can fuzz it up a little bit, but just a little color on anything bigger that might be percolating?

Well, let me do the second part first, Sue can tell you about share buyback. But on the first part, nothing has changed with regard to our methodology, the discipline about how we're thinking about M&A. I think about 80% of what we look at in M&A are assets that we know and think fit the portfolio. 20% are always a good idea that come in from additional sources that get evaluated to see if we're missing something or there's a fit. So nothing has changed there with regard to how we look at the pipeline, how we manage it, how we think about it strategically or how we compare that to other alternatives, including share buyback. And Sue, you may want to comment on share buyback?

Yes, on the share buyback, the way that we modeled this, Joel, for purposes of the guidance is absolutely consistent with where we started out the year. So we put a placeholder in for $500 million, which, as you know, we've completed. But that isn't the capital allocation strategy. The capital allocation strategy says we're looking to deploy the excess cash and that we're going to look at the M&A pipeline as well as more share buyback to absolutely finish out the capital deployment for the year. So the model today with the guidance is consistent with where we started out the year with the $500 million.

This is Andrew Krill standing in for Deane. Referring to the trucking and freight shortage issues, I noticed that one of your competitors mentioned a significant impact in June for residential HVAC. I wanted to check if you experienced anything similar and could you provide an update on how freight and shipping costs are trending year-over-year? I believe you previously mentioned an increase of around 15%.

No, I mentioned that refrigerated freight mileage has increased by approximately 30%, which is beneficial for our TK business. During that time, we observed dry freight rising in the market by about 15%. I didn't specify our rate increases, but I earlier indicated that there is a 20 basis point effect from productivity and other inflation factors that we're considering. So, when looking at that data, which appears flat, there is a 20 basis point challenge related to freight in those figures. That's the impact we're experiencing. Additionally, several of the productivity initiatives planned for the third and fourth quarters are focused on improving our strategies around freight and warehousing, which is an exciting area we have been exploring for about a year now. We are fortunate to have this work set up for Q3 and Q4 this year, which should significantly aid this situation.

Got it. And then on the resi, did you have any impact on just shortage of being able to ship resi units in this quarter or maybe in 3Q so far?

No. We'll ship all you want. Again, send us your orders. We're happy to do that, and we've got no problem building them and shipping them.

Got it. And then just as a quick follow-up on the China HVAC strategy, with all the tariffs and issues between the U.S. and China, have you seen any backlash against U.S. brands in general? Or does the value proposition still remain strong enough that it doesn't seem to matter at this point?

Well, we employ a lot of people in China. We've got factories and technology and product built for the market. And so in China, we think of ourselves as a Chinese company. In the U.S., we think about ourselves as a U.S. company. Fundamentally we're a global company, and we've got to act that way in the markets that we serve. So to your question specifically, no. We haven't seen any reaction to that one way or the other.

On the organic sales guidance increase, the 3.25% to 7.5%, how much of that was higher price than you previously assumed?

I need to consider that. There was indeed a second price increase that would have occurred around the middle of the year, varying by business. Therefore, we wouldn't have had a significant impact in that regard. Certainly, we have been monitoring material inflation and changes in freight costs, including 232 and 301 tariffs, and we're working to manage those as they arise. So David, we may have to revisit that topic later. However, it’s not something that stands out as a significant change from our initial position.

No. Because David, the way I think about that is with the pricing and generally your pricing realization in the neighborhood of 1% to 2% is going to flow through. So it might slightly affect growth, but it won't be the main factor in changing it. The growth is primarily driven by the volume coming from the end markets rather than pricing, foreign exchange, or acquisitions, which are having a similar impact to the original guidance.

David, I'd probably say maybe 1 point to 120 basis points for the full year would be price. Everything else is going to be pretty well volume.

So that's not all new pricing from the previous guidance, right? That's full year, what you had said?

That's all. That's right.

I mean, the reason I ask is when you look at the segments, and I don't know if it's conservatism or, as you said, a lot of the inflation is in Climate, but you just raised your revenue guidance for Climate $475 million, but you only raised the EBIT $46 million, right? So basically a 9.7% incremental profit on the incremental sales you're now looking for. And that sort of begs the question, are we really saying price versus cost maintains the margin? Or price of $100 offsets cost of $100? So just to be clear, we're saying price/cost does not erode the margin the rest of the year, especially in Climate? Or is it, no, it's $100 of cost get offset by $100 of price and yes, that does dampen the margin, but at least we're offsetting it in dollar terms? Just the incremental margin on Climate just seems low on what you just raised the sales by.

But I'm thinking out loud, David, as we go through this. But I think what you have to do with all of this is you can't just parse out a couple of pieces. And it really is important to understand that the majority of the big inflationary items are occurring in the Climate segment of the business and that as we're looking at the Climate segment itself over the second quarter, you're actually seeing an improvement in the overall margins for the quarter. So we're offsetting the headwinds and continuing to improve margins in the business.

David, our calculations are a bit different. To achieve a 10 to 20 basis point expansion in Climate for the full year, we will need an improvement of around 50 to 60 basis points in the latter half of the year. This implies an organic leverage of approximately 23% to 25%.

Thank you all for joining today's call. I want to let you know that we will be available for questions today, tomorrow, and throughout the upcoming weeks. We also look forward to connecting with you in the coming weeks. Thank you.