Ingersoll Rand Inc. (IR) Q2 2019 Earnings Report, Transcript and Summary

Good morning. Welcome to the Ingersoll Rand's 2019 Q2 Earnings Conference Call. My name is Chris, and I will be your operator for the call. The call will begin in a few moments with the speaker remarks and then a Q&A session. All callers are on mute. [Operator Instructions] Thank you. Zac Nagle, Vice President of Investor Relations, you may begin your conference.

Thanks, operator. Good morning and thank you for joining us for Ingersoll Rand's second quarter 2019 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 our actual results to differ materially from our anticipated results. This presentation also includes non-GAAP measures, which are explained in the financial tables attached to our news release. Joining me 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 the call over to Mike. Mike?

Thanks, Zac, and thanks, everyone, for joining us on today’s call. I'm proud of our team's performance in the second quarter. Once again, we delivered strong revenue growth, margin expansion and EPS growth. We welcomed our new Precision Flow Systems team into Ingersoll-Rand and we’re well underway towards a separation into two standalone businesses and our proposed strategic combination with our Industrial segment and Gardner Denver. With that backdrop, let's get started. Please go to Slide 3. I'd like to start with a brief overview of the global business strategy that we're executing to deliver consistently strong financial results for our shareholders. Fundamentally, our strategy is at the nexus of environmental sustainability and impact, which are strong secular tailwinds for our business. The world is continuing to urbanize while becoming warmer and more resource constrained as time passes. We excel at reducing the energy intensity of buildings, reducing greenhouse gas emissions, reducing waste of foods and other perishable goods, and we excel in our ability to generate productivity for our customers, all enabled by technology. Unless you think the world is getting cooler, less populated, less resource constrained as time passes, these strong secular tailwinds will continue to provide opportunity for shareholders and purpose for our vision. As we continue separation, integration planning and business transformation activities related to our strategy and combination of our industrial segment with Gardner Denver and move towards creating the premier pure play climate business in 2020, our aggressive pursuit of excellence in delivering solutions to mitigate the impact of these secular trends only intensifies. Our climate business squarely focuses 100% of our portfolio at the nexus of sustainability and global environmental impact where our products and services can reduce the impact of these mega trends and create a platform for the company to grow above average global economic conditions. Moving to Slide 4, I'll spend a few minutes discussing how 2019 has progressed through the first half of the fiscal year and what we're expecting to see through the balance of 2019. The key takeaway is that we remain bullish on our strategy, our end markets broadly and our ability to execute using our business operating system to deliver against our organic revenue growth and adjusted EPS guidance ranges for fiscal 2019. In fact, today we're raising EPS guidance by $0.05 to approximately $6.40. We expect to deliver top-tier financial performance again in 2019. Commercial HVAC globally and particularly in North America and Europe has continued to be very strong for us and our backlog, incoming order rates and sales pipeline give us confidence this business will continue to deliver strong results in the second half of 2019. Our residential HVAC business had strong mid single-digit growth in the second quarter and we expect this business to continue to deliver strong performance for the full year supported by a solid residential replacement market. In our Industrial segment, we saw healthy order growth and long cycle projects in our Compression Technologies business in the second quarter and we have a favorable outlook for continued long cycle growth in the second half of the year. Conversely, the short cycle market softened in the second quarter primarily impacting revenue growth in our core Compression Technologies and Tools businesses, which are both down low single-digits. We expect short cycle markets to continue to be challenging throughout 2019. The positive impact of healthy long cycle markets presents a positive setup as we move into 2020 when these orders convert into revenue and operating income given the long lead times associated with these projects. Price realization has been outstanding across our businesses and we're effectively managing all inflation and tariff-related costs with an 80 basis points spread in the second quarter. As we've highlighted before, we have been effective in managing inflation and we expect to continue to maintain a positive spread and our target range of 20 basis points to 30 basis points in the second half of the year when we begin to lap the strong price realization in the third and fourth quarters of 2018 and when we began to see the full impact of the increase in List 3 tariffs on Chinese imports moving from 10% to 25%. Lastly, we continue to expect strong free cash flows in 2019 of equal to or greater than 100% of net income, which will further strengthen our balance sheet and enable us to maintain good optionality. We've deployed significant capital on dividends, acquisitions and share repurchases over the years and again in the first half of the year. We'll continue to follow our dynamic and balanced capital allocation priorities and we expect to deploy 100% of excess cash over time. Please go to Slide 5. We've delivered solid bookings and revenue growth in virtually all businesses and regions in the second quarter. On the booking side, our largest HVAC businesses continue to lead the way and delivers strong growth with North America and Europe HVAC up high single digits in the second quarter. China was also healthy with low single-digit growth against the very tough comp of low 20s growth in the second quarter of 2018. We also drove strong bookings growth of 8% in our Industrial Segment versus a tough comp of 8% in the prior year led by Compression Technologies and Small Electric Vehicles. Compression Technologies growth was driven by strong growth in long cycle partially offset by softness in the short cycle markets. Small Electric Vehicles growth was driven by successful execution of our consumer vehicle strategy. Transport refrigeration had a significant decline in bookings against very tough comps in 2018 for reasons we've discussed in detail on prior calls. However, as we've said before, these declines don't impact or negate a strong growth in our other transport businesses or impact their ability to grow revenues in 2019 and 2020. The transport refrigeration business had extremely strong bookings in 2018 and is returning to historically normal levels of bookings in 2019, but with backlog that is more than two times the historical levels with a strong backlog and solid bookings we're seeing in 2019. We expect this business to deliver solid revenue growth in 2019 and the prospects heading into 2020 continue to look promising. On the revenue side, our largest HVAC businesses continued to deliver very strong growth with North America, Europe and residential all up mid to high single digits in quarter two. Transport refrigeration also delivered strong revenue growth. Bringing all the pieces together, we're pleased with our organic bookings and revenue growth performance through the first half. We expect organic revenue growth rates to increase heading into the second half based on healthy backlog, deliveries and incoming order rates and remain confident at our 5% to 6% organic enterprise revenue growth target for the full year. Please turn to Slide 6. We've outlined a number of takeaways for each major business on the next two slides. Commercial HVAC continues to be very strong, particularly in North America and Europe. Our backlog, incoming order rates and pipeline of projects are driving confidence that we'll continue to see solid growth in the second half of the year. Residential HVAC had solid mid single-digit growth in quarter two and we head at end of the second half of the year expecting 2019 will shape up to be another good year led by a healthy replacement market. I've talked at length about transport refrigeration, which continues to be led by North America trailer, truck, APUs and aftermarket. Based on our record backlog and healthy incoming order rates, we remain confident that our transport business will deliver another solid year in 2019. Please turn to Slide 7. In our Compression Technologies business, we're seeing a healthy growth in long cycle markets and softness in short cycle markets. The long cycle business strength positions us well for good growth in late 2019 and in 2020 as these orders convert into revenue. Small Electric Vehicles is having a great year driven by successful execution of our consumer vehicle strategy. And now, I'd like to turn it over to Sue to provide more details on the quarter. Sue?

Thank you, Mike. Please go to Slide #8. I'll begin with a summary of a few main points to take away from today's call. As Mike discussed, we drove strong financial results in the second quarter with adjusted earnings per share of $2.09, an increase of 13% versus the year ago period. Our Q2 performance gives us confidence in our ability to execute against the full year growth in margin targets we provided in our guidance in the beginning of the year. As a result, we are raising our full year adjusted continuing EPS guidance to approximately $6.40 up from approximately $6.35 that we communicated last quarter. Second quarter organic revenue growth was strong, particularly in our climate segment. We also saw strong organic bookings across most of our major businesses. When excluding our Transport business that saw outsized order growth in 2018, organic bookings were up approximately mid single digits for both the enterprise and our climate segment. In our Industrial Segment, organic revenues were up 2% compounding on a tough comp of 9% organic growth in the prior year. Strong revenue growth in CTS services and small electric vehicles offset the weakness in the industrial short cycle market Mike mentioned previously. Industrial organic bookings were strong, up 8% and compounding on an 8% growth rate in Q2 2018 fueled by long cycle compression technologies growth and small electric vehicle demand. Despite ongoing trade and tariff negotiations, CTS China bookings growth continued to strengthen in Q2 providing cautious optimism going forward. During Q2, we expanded adjusted operating margins 80 basis points and delivered 37% operating leverage, which is ahead of our full year expectations. We continue to leverage our business operating system across the enterprise to manage direct material, tariff related and other inflationary headwinds. As we look to the back half of the year, we anticipate we will continue to realize price to effectively manage material inflation and tariffs including the recent increase in List 3 tariffs on Chinese imports from 10% to 25%, but this spread should narrow as we lap the 2018 mid-year price increases. As Mike mentioned, we continue to expect strong free cash flows in 2019 of equal to or greater than 100% of net income. We exit the second quarter with working capital sufficient to support our ongoing cooling season demands and we expect working capital requirements to approach the long-term target of approximately 4% of revenues by the end of the year. Importantly, we continue to deliver on our dynamic capital allocation strategy. So far this year, we have completed the strategic acquisition of Precision Flow Systems for approximately $1.45 billion, deployed approximately $259 million in dividends and approximately $250 million on share buybacks. Looking forward, we expect to consistently deploy 100% of excess cash over time. Please go to Slide 9. We delivered organic revenue growth of 4%, adjusted operating margin improvement of 80 basis points and adjusted earnings per share growth of 13%. Organic revenue growth was led by strong broad based growth across our Climate segment. Continued disciplined focus on pricing and productivity actions enabled us to effectively manage inflation and tariff related headwinds and drive margin expansion across the enterprise. Please go to Slide 10. Our Climate segment delivered another strong quarter of operating income growth, enabling us to drive solid year-over-year EPS growth in the quarter. Our Industrial segment delivered solid results. Our full year industrial margin outlook remains intact. In addition to good segment performance, second quarter corporate costs were lower than prior year impacting results by approximately $0.05. The cadence of corporate expenses is lumpy in 2019 driven primarily by the timing of stock-based compensation that is not linear as well as the timing of a number of other functional spending items. The full year corporate cost guidance of approximately $250 million remains unchanged. Please go to Slide 11. In Q2, strong execution drove 80 basis points of adjusted operating margin improvement, price versus material inflation was positive for the fifth consecutive quarter. Pricing net of material inflation expanded margins by 80 basis points reflecting strong carry over price from 2018 and incremental pricing actions in 2019. We delivered solid margin expansion from volume growth in the quarter. Margin expansion was tempered by softness in short cycle industrial revenues, which tend to have higher margins. Consistent with our full-year expectations we continued to deliver productivity in excess of other inflation. We continue to heavily invest in our business. Incremental Q2 investments of approximately 40 basis points were fairly evenly weighted between growth and operating expense reduction projects. Please go to Slide 12. Our Climate segment delivered another strong quarter with 5% organic revenue growth and adjusted operating margin expansion of 50 basis points. Consistent with our expectations we delivered strong volume growth, price realization and productivity. Please go to Slide 13. Our Industrial business delivered solid organic revenue growth of 2% against a tough comparison of 9% growth in Q2 of 2018. Industrial leverage was impacted primarily by the inclusion of the PFS acquisition midway through the quarter. PFS acquisition revenues lever at operating income margin rates instead of gross margin rates for the first year under our ownership. Additionally, as I mentioned previously, margin expansion was tempered by softness in short cycle industrial revenues, which tend to have higher margins. Excluding these factors leveraging the industrial was north of 30% in the quarter. Looking at EBITDA margins, the PFS acquisition was an immediate contributor to our EBITDA margin expansion of 60 basis points in the quarter. Please go to Slide 14. We remain committed to a dynamic capital allocation strategy that consistently deploys excess cash to the opportunities with the highest returns for shareholders. We maintain a healthy level of business investments in high-ROI technology, innovation and operational excellence projects, which are vital to our continued growth, product leadership and margin expansion. We have a long-standing commitment to have a reliable, strong and growing dividend that increases at or above the rate of earnings growth over time. We continue to make strategic investments in acquisitions that further improve long-term shareholder returns like the PFS acquisition completed during the quarter. Earlier this year, we secured an additional $1.5 billion in senior notes taking advantage of the current favorable interest rate environment. We remain committed to maintaining a strong balance sheet that provides us with continuing optionality as our markets evolve. We continue to see value in share repurchases when shares trade below their intrinsic value and we expect to consistently deploy 100% of excess cash over time. Please go to Slide number 16. The integration of Precision Flow Systems with our existing ARO business is underway and is progressing according to plan. We expect PFS to contribute approximately $400 million in revenue on an annualized run rate. That equates to approximately $250 million of incremental revenue in 2019 with approximately $50 million already delivered in Q2. EBITDA margin expectations for PFS remain unchanged with percentages in the high-20s and adjusted operating margins are expected to be in the mid-teens for 2019. PFS is expected to be cash flow creative consistent with the EBITDA attribution in 2019. For your reference, we have also included estimated non-GAAP adjustments related to PFS for the year. Additionally, we completed a senior notes offering in March, which we anticipate will add approximately $60 million in interest on an annual run rate basis, $47 million incremental to 2019. For 2019, we expect the adjusted operating income of PFS to essentially offset incremental interest from the senior notes offering. Please go to Slide number 17. I want to take a moment to further clarify the impact of PFS on our full-year 2019 revenue guidance. As you can see on the chart, adding approximately $250 million of PFS revenues to our prior revenue guidance range increases our industrial reported revenue growth rates by approximately 7.5 points and our enterprise revenue growth rates by approximately 1.5 points. There is no other change to our revenue guidance ranges for 2019. Please go to Slide number 18. When we're on the road, we often get questions about the status of the strategic announcement we made at the end of April to combine our industrial segment with Gardner Denver. We continue to be excited about the prospects of creating a premier industrial company as well as a leading pure-play Climate solutions company focused on HVAC and transport refrigeration. I’ll give you a brief update today. One of the transaction closing conditions was recently satisfied. The HSR Act waiting period expired. We will continue working through the remaining regulatory and other closing conditions. We anticipate approximately $150 million to $200 million in separation and transaction related costs, including the estimated cost of separating legal entities. We also expect to mitigate the approximately $100 million in stranded costs by the end of 2021, this is unchanged from what we communicated last quarter. In preparation for closing, we have begun three separate work streams. The first work stream is focused solely on the separation of our Industrial segment. After years of leveraging across our Industrial and Climate segments we have tasked the separation team with separating Industrial segment business processes, systems and functions. This includes technical and financial operating processes, including taxed and systems, manufacturing operations and supply chain services, real estate, along with all business regulatory filings. There is a lot of work to be done and the team has a methodical roadmap to work this out. The second work stream center is on integration planning with Gardner Denver, given that we continue to operate as two separate companies and compete in the marketplace until the close of the transaction. The integration planning work must be managed under clear rules and anti-trust protocols. While integration preparation is underway and will continue over the coming months in compliance with these rules much of the work to integrate the two companies will take place after the expected close. The final work stream is focused on the transformation efforts of our Climate segment. As we plan and execute within the transformation work stream, we have the advantage of building on an incredibly strong foundation with great businesses, engaged and talented people and a distinctive winning culture and core values. Our strategy focus on reducing the world's energy intensity and greenhouse gas emissions remains unchanged. We are focused on developing a new climate structure that allows us to better serve our customers and unlock value for shareholders. At this point, this work is early on and we will give more updates at a later date. All in we're well underway on this strategic transaction and we believe we are on track for closing in early 2020. And with that I'll turn the call back over to Mike.

Thanks, Sue. Please go to Slide 19. In summary, we're pleased with our first half performance and we expect to deliver strong revenue and EPS growth and free cash flow in 2019. Looking forward, we continue to believe that company is extremely well positioned to deliver strong shareholder returns over the next several years. Fundamentally, our strategy remains at the nexus of environmental sustainability and impact. Today 15% of the world's carbon emissions come from heating and cooling buildings and transport refrigeration creates another 80 million metric tons of CO2 emissions annually, which can be eliminated through electrification over time. We are bending the global warming curve by changing the way the world heats and cools buildings and moves refrigerated cargo. New technology we've developed can reduce up to 99% of the emissions that come from heating and cooling of commercial building. And this doesn't include the substantial environmental benefit of increasing system energy efficiency to reduce both power generations at the source and storage requirements. We're continually working to innovate in this way to electrify heating, electrify diesel engines used to cool trucks and trailers that transport perishable goods and reduce the energy intensity in greenhouse gas emissions and residential and commercial buildings. We recently announced our 2030 ESG commitments to meet the challenge of climate change, while increasing access to air conditioning, perishable foods and medicines, and improving the quality of life for people and communities where we operate and serve. We are committing to reduce our customer carbon footprint by 1 gigaton of CO2 through our HVAC and transport refrigerant products and services. We believe this is the largest customer climate commitment made by any B2B company, and our math shows that this reduction could equate to 2% of the world's emissions. The size and scale that’s equivalent to the annual emissions of Italy, France, and the UK combined. We continue to transform our supply chain and operations to have restorative impact on the environment including achieving carbon neutral operations and giving back more water than we use in water stressed areas. We are committed to increasing opportunity for all strengthening economic mobility and bolstering the quality of life of our people. This includes gender parity and leadership roles, workforce reflective of our community populations, maintaining a livable market competitive wages and broadening community access to cooling, comfort and healthful foods. We've been investing heavily for years to build franchise brands and to advance our leadership market position to enable consistent profitable growth. We have an experienced management team and a high-performing culture that instills operational excellence into everything we do. We remain committed to dynamic and balanced deployment of capital and we have a strong track record of deploying excess cash to deliver top tier shareholder returns over the years. Lastly, we're extremely excited about the proposed transaction and the strategic combination of our industrial segment with Gardner Denver. Combining two of the premier complimentary industrial companies offers the opportunity to drive significant innovation and growth with meaningful revenue and cost synergies supported by secular growth trends and diverse end-market exposure. We're also very excited about creating the premier pure-play HVAC and transport refrigeration company with our existing Climate segment businesses. We have a tremendous opportunity to leverage a simplified business model and structure and sharpen our sustainability focus with our investments. Our climate businesses have clearly differentiated performance and we see significant opportunity as a pure-play to build on this performance for our employees, customers, and shareholders. And with that Sue and I will be happy to take your questions. Operator?

Thank you. [Operator Instructions] Your first question comes from Steve Tusa of JPMorgan. Your line is open.

Hello.

Good morning, Steve.

So just wanted to ask on HVAC? What are you seeing in resi so far in July? And also on the commercial unitary front, how are trends in that part of the business this quarter and what do you expect for the rest of the year there?

Resi was strong in the quarter, bookings and revenue. While we think it continues for the balance of the year. We think the market might be low-single-digit, mid-single-digit. Steve, we think we'll be mid-single-digit for the year there, so that’s progressing. Again, as you know it’s 80% replacement. We're heavily indexed there and anything we do incrementally with new construction is actually an add. That’s growth for us. So we feel like we're in a great position. With regard to commercial North America, we’re seeing strengths in unitary, we seeing strength and applied and services. We are seeing particular verticals like K12 Labs and data centers that are growing nicely. So they'll let up there and then just to anticipate some questions, I think that people may ask, if you think about our backlog today across the globe from an HVAC perspective, we're up 21% year-over-year and even up sequentially from quarter one to quarter two. So that is, I think indicative of just continued strong markets and a solid pipeline going forward.

Okay, great. And then so you think you guys are taking share, it sounds like some of the other guys that put up numbers that are obviously not as good as that?

Well in the markets that we get really good data, third party which is the easiest to look at absolutely, that’s a fact, yes.

And then lastly, just third quarter. Can you just talk about seasonality? You expect normal seasonality here in the third quarter, I know things are moving around in the global economy and also orders. Do you think orders are going to take out another step down or how do that compares look so that maybe were more stable here in the low-single-digit type of number for climate? I know you don't like to guide that, but there's obviously a lot moving around in the economy. I was just curious as to how you guys see that playing out?

Well, I don’t see any changes in sort of HVAC globally. I think we've got a pretty good read on the global landscape. Most markets are strong and there's pockets for this weakness, but surprises where markets are strong. Example of that would be Mexico has gone through a couple quarters of negative GDP. It's a pretty big market for us. So that's a newer information but we’re relatively strong in an equivalent market in the southern cone of Latin America. So it's that sort of thing on the edges that we're looking at, but the market's remained strong. There's a lot of focus on Thermo King and I think we've done a decent job explaining the constraints that exist in 2018 at Class 8 tractors and how customers lined-up in advance really to pull on that supply capability. It translated down to trailers and of course that all translated it those customers ordering either APUs or refrigerated trailers. The actual tab time of how the heartbeat of a plant runs and we match trailers and units to actual tractors or trailers, it’s very smooth and that backlog generates just mid-single-digit revenue growth that's been pretty consistent. So the noises around the TK bookings, but again I think you just have to separate that from the 28 constraints with our customers, and think more about the HVAC market being strong and transport just generating solid revenue growth and good backlog and generally healthy markets. And we're still seeing good order intake rate at Transport. So it's not as if things are drying up even on the order input side there, just tough comps.

Okay, great. Thanks a lot.

Thanks, Steve.

Your next question comes from Julian Mitchell of Barclays. Your line is open.

Thanks, good morning. So maybe just sticking to the two question rule. My first question would just be around the industrial division. It looks like on Slide 17, you're still assuming maybe 5% organic growth this year. That seems to imply a step-up from the first half. So maybe just help explain why you think industrial organic growth should reaccelerate in the second half please?

Yes, I think we've got our eyes wide open on the short cycle and we've accommodated that in our forecast. We had strengthen longer cycle, some of which we expect to shift in the fourth quarter a lot – we’ll shift in 2020. We've had excellent growth and our consumer strategy related to a small electric vehicles. So – and Julian we just finished the five plus seven forecasts not even a month ago. We've had the opportunity to update that last month with risks and opportunities. I think that we feel pretty good about that forecast. When I look back at the beginning of the year relative to guidance, I would say that climate markets are trending toward maybe the upper end of that. And industrial markets may be – would be trending to the lower side of that, but not that we feel like great, where we need to be in terms of the guidance that we gave.

Thanks very much. Then my quick follow-up would be around the climate division. You had about 7% profit growth in the second quarter, a bit of a step down from Q1 and then you're sort of guiding for a pick-up in the second half? Similar question I guess. What drives you think that slightly better EBIT growth in the second half? Maybe it’s actually with the resi versus commercial versus transport or something on the margins around price material. Any color at all on that aspect?

Yes. Juliana, I mean when you look at leverage, first of all in the quarter we actually had really good leverage. We had leverage above gross margins there north of 30% and we were able to be right about 30% for the first half of the year. So the question probably relates to what you're thinking to be a step down in the revenue. But again here, when you look at 21% year-over-year backlog and sequentially improving backlog from quarter one and quarter two, no deliveries and service business being about half the business. The amount of book in turn we need to do is actually is small as I can remember it. So again, feel pretty good about the revenue number and I think that segment in general leverages pretty close on the full-year at the 25% rate we guided to originally. So I'm not seeing a lot of weakness there.

Perfect. Thank you.

Your next question comes from Scott Davis of Melius Research. Your line is open.

Hi. Good morning, Mike, Susan.

Good morning.

Sometimes when you are executing kind of a deal like this of the size, there tends to be a little bit of a letdown ahead of the closing and some companies we say they have to adjust compensation plans and such to prevent that. But have you guys – did you feel the need to do anything. Have you done anything? Is there a risk that there's a little bit of a distraction amongst the operating heads, walking into the back half of the year here?

We've got over the years a wonderful operating system that in terms of the metrics and any of the early warning indicators that we would get, Scott feel good about seeing that. Of course we're seeing none of it today. The more important thing we're doing though is organizing ourselves in a way that we can compartmentalize, what needs to happen and then think about the interdependencies between things. So as an example, our Number 1 priority is to run the business and run it well every day and execute on the commitments we've made. The second priority is the separation itself. Of course, there is no integration without the separation. So there's a separate team focused on separation that does not involve the integration team, which is the third priority. Third priority around integration is to the extent we can under the rules of engagement is to support GDI’s lead in that effort and so that continues. And the fourth thing that we're doing is using the opportunity, the value stream map, much of the company and core process to customers and use the opportunity to think about those core processes in a way that we can make sure that the maximum value added to customers is being delivered and how we might structure from that output and what that might mean of course with the cost structure and maybe speed the market in some cases, it's pretty exciting. But we've tried to make sure that the teams, our different people, to the extent we can. Of course a group like tax is going to be related to all four of those activities but we're doing a pretty good job of compartmentalizing that and running it and using the metrics that we've always used to run the business.

Okay, that's helpful. And then just as a quick follow-up and at this, I know this is always hard to answer a question around market share on the HVAC side. But sometimes, I mean it’s clear that you're gaining share, but sometimes that's due to geographic mix or the types of projects that are growing. I mean, is there a – is there kind of a no-BS answer to that question of why you think you're winning not the usual or better than the rest kind of stuff. But is there any other explanation that you can give to be helpful in that regard?

We've really designed – really our technology and go to market strategy around sustainability and around eliminating both emissions and reducing efficiencies. So this passion around having the most energy efficient commercial systems out there in the world today using the most responsible refrigerants that we can put into these systems of leveraging the analytics, the data, the controls around that to put more sophisticated service offerings together. The belief that on that commercial side, we need to be doing that ourselves. Not through independent distribution because of the complexity of what it takes to model cell, service, deliver against those plans, that's been our strategy and we've been consistent about that and just executing hard against that. I think from a goal deployment perspective, again another core part to the operating system, there's no mystery in the company as to what our goals are, what's expected, what we're measuring, so that – it just coming together in a way that has worked, Scott over a long period of time.

Yes, clearly. Well, good luck to you guys. Thank you.

Thank you.

Your next question comes from John Walsh of Credit Suisse. Your line is open.

Hi. Good morning.

Good morning, John.

Good morning.

So, I guess just going back to the price cost spread you talked about the 20 basis points to 30 basis points here in the back half. I guess I understand the tariffs, but just kind of looking also at recent price increases and I realize they're not all created equal. It does look like you've pushed through some kind of another round of healthy price here across the commercial parts of your portfolio. I mean, is that – should we view that as kind of a conservative placeholder for the back half or is – there's something else that would kind of make that decelerate further?

Well, wait John would – a right John what I would say is when you think about how we called price cost for the year, we're basically in line with how we called it. So we knew then we were going to have some great price comparisons on a year-over-year basis in the front half of the year. And we knew that in the back half of the year we were going to lap some comparisons to last year. So price is going to actually be – it's not a deceleration at all but the comparisons to pricing the back half of last year are going to result in a little bit less of a spread than in the first half of the year. But in terms of expectations, that's exactly what we would have expected. The prices are going through, they are sticking, they are actually being realized in the business and material inflation is actually doing approximately what we thought it would do for the year, which is we've gone the tariffs covered, we've got all of the elements of costs covered and we're seeing a little bit of material stabilization but again, stabilization to our expectations in the back half of the year and a little bit of deflation, but given the way that we buy materials, probably more of a 2020 impact. So when I think about the whole price cost sort of put it in a basket, I think the price comparisons are more difficult in the back half of the year than the front half of the year. Material inflation is doing about what we expected and that gives us roughly the 20 basis points to 30 basis points of spread for the entire year on price cost. I mean, maybe its [indiscernible] conservative, but it looks about like we thought it would look, which is the really good part of that.

Okay. Thank you. And then I guess just as a follow-up. If we could maybe look at the Americas or maybe actually drill down into the U.S. versus China, just what you saw in terms of service versus equipment growth in the quarter?

Yes, both are progressing well there, John. I'm always surprised at the degree of service penetration in China, how quickly that's maturing. So there is really no surprises there and from a service perspective we continue to do well there, so not much more to say. Obviously the U.S. and Europe are the gold standard around penetration and linkage and then China is quickly over the years coming to that point and over the next five years, I think it'll be at the same level as our North American European penetration.

All right, thank you.

Thank you.

Your next question comes from Nigel Coe or Wolfe Research. Your line is open.

Thank you. Good morning everyone.

Good morning, Nigel.

I want to turn it back to Industrial and the – that the long cycle bookings growth that you call outs and, I mean I think rules sort of thinking CapEx kicked down the road, perhaps some of these projects push out. But where are you seeing the bookings strengths that would you call it any end markets in particular? And then switching to the shorter cycle pressure you're seeing? Would you say that's mainly inventory reductions or genuine end market weakness?

Yes, Nigel, I would call it Asia on your first question, probably to be what we're seeing the long cycle bookings and here you are seeing a chemicals manufacturing energy? Their separation would be another for sure, so that will be the – what I point out there. With North America, with the U.S. in particular, there was a slow down. It seemed after there was a flurry in the U.S. MCA discussions between Mexico and the U.S. and the possibility of the U.S. imposing additional tariffs, if Mexico wouldn't secure the border from the Mexican side. Roughly after that we saw a slow down. I think it was certainly an end user demand and that obviously effected sell through of distribution short cycle products there. And it bounced around a little bit but off kind of that lower level. So hopefully all that I get cleaned up permanently and I think that'll have a restorative impact on short cycle and it does. I think it will be a nice bounce up when there's certainty around that.

Okay. That's great. Thanks Mike. And then digging back to the North American commercial as a quick follow-on, I think some of the peers saw weakness within the commercial unitary markets and [indiscernible] on the replacement side and what impacts we call out there? Did you see there as well? Would you call out the light commercial as weaker in North America?

No, I know exactly it was exceptionally strong for us. So, no, I would say it would be a highlight of the quarter as opposed to a weakness.

Okay. That's great.

I can't tell you why it would be different, but I can tell you it was a standout in the quarter.

Thanks Mike.

Thank you.

Your next question comes from Jeff Sprague of Vertical Research. Your line is open.

Hey, thank you. Good morning everyone.

Hi Jeff.

Hey, Mike you never like to mention whether Nigel threw it out. I mean, anything in the resi business that you thought was discernible and you run your inventories pretty lean, but is there anything kind of in the early set up in the third quarter that overhang from that – that would be of note?

No, it was a little bit last year of some pre-buy; I think they got pulled in the second quarter. That's really the only kind of – it wasn't a big number, but it was a little bit of a compare – difference there. I think the number of companies had that happen, so no, not really Jeff that answer your question, I think it's just fundamentals remain strong. I think that consumer genuinely still feels pretty good – pretty healthy and we're not seeing any changes to that?

Then bigger picture, Mike. I was wondering if you can elaborate a little bit more on what you mean by transformation, right. I think the idea may still be kind of coming into view, but it seems like you've got a relatively crystallized view of where you want to take things. It'd just be interesting to get a little bit more perspective now kind of three months hence making the announcement, kind of what you're thinking about kind of pure-play transformation?

Yes, the starting point, just to be clear, is something that we're all very proud of over 10 plus years. And so transformation does not mean, if there’s something bad, it's something good that it means there’s an opportunity here to really go think every – I mean obviously from a name and a brand all the way through to simplification of legal entities. The way that we might look at the way support services are performed across the company. We will apply the same value stream mapping that we would do in a manufacturing process to the way record to report or procure to pay or any kind of order the cash process would work. We'll look through our field organization and understand how that would pan out in terms of incentives and some of the metrics that are out in the field. And just to make sure that those are we want them to be. There is likely different structures that will evolve when you answer those questions. And I think with a goal toward customer focus, a goal towards simplification, being tighter on some of the investment focus on our core sustainability themes. All those things I think are exciting to people inside the company because we're building off a piece of a strong foundation.

Great, thanks.

Thank you.

Your next question comes from Gautam Khanna of Cowen and Company. Your line is open.

Thanks. Good morning guys.

Hi, Gautam.

Hey just a follow-up maybe on Jeff Sprague's question. You mentioned the year-over-year on orders with the pull forward last year, but just speaking about Q2 2019, did you see any difference on the resi HVAC side between your indirect and direct channels? And maybe if you can speak to – Lennox, on their call, talked about being over-indexed to some of the swing regions in the U.S. where it can be hot or cold, and so weather was particularly uncooperative given their exposure. I mean how does your footprint kind of contrast with that, if at all?

Yes, I can’t really contrast it to anybody else, but I can tell you, we're about 50:50 direct and indirect. We really didn't see any difference in order rates there at all. I guess in 45 or so earnings calls – I can't remember, I don't think I've ever used weather as a strategy or as an excuse. I can tell you weather normalizes very quickly often within a year, with a bias toward a warming planet. There's more degree days in the future, not fewer. So it's a great place to be, and we like the footprint that we've got. Our focus is on market share and margin expansion as it is for every product growth theme we have inside the company. So those are two clear goals that we have, and that doesn't change.

That’s helpful. And then just as a second question, maybe can you give us some color on your expectations for Thermo King growth next year, given what we're seeing in the truck market and what you have as offsets with the APU penetration, and like you said, the backlog running into next year? Any preliminary view on that?

Yes, it’s too early on that. I mean we'd like to see the update that's coming out around Class A. We'd like to see the updates coming out around refrigerated trailers to know that. My sense is there's no way to burn off all of the backlog we've got in 2019. I know we're into 2020, as it stands. Order rate is still healthy. So just a really early view, which was the same view we gave last time, is when you normalize the 2018 bookings over a 2019 and 2020 revenue cycle, I think you get kind of the steady tact coming out of the business of mid-single-digit growth rates. So I would have no reason to deviate from that at this point.

Thank you, guys. Good luck.

In fact, Gautam, I hope, depending on how sort of Brexit really unfolds and unwinds, that next year, we're sort of getting through this low point in Europe. And potentially, we're seeing strength in Europe, which has been markedly slower than North America as a result of just what's happening with the broader European economy.

I appreciate it. Thank you.

Thank you.

Our next question comes from Andrew Obin of Bank of America. Your line is open.

Hey, guys. Good morning.

Good morning, Andrew.

Just a question. There's been a lot of articles. I think the Wall Street Journal had an article how the Europeans are still reluctant to embrace HVAC even despite sort of climate change and the heat wave that you're seeing in Europe. What kind of conversations are you having with customers in Europe regarding HVAC? And are you seeing any structural changes in adoption rates?

Yeah, I think you’re largely talking about what consumers might think. But if you think about any institutional building, any data center, any industrial building in Europe, they've got the same requirements that you've got all over the world. And I would say the booking rates there, for us, for multiple years have been extraordinary. We've said, I think in 2016, that we would double the business by 2020, and we're going to definitely do that. So I look at economy there, that even though it's modeling around kind of flattish, we've had bookings growth and revenue growth that's been in that high teens, low-20s range now for multiple years. But we're not focused on the consumer there per se. Although there is an extraordinary opportunity, I think going forward around the electrification of heat in Europe, as you'll see more of that application as opposed to the problems of boilers in Europe over time. When that happens, I do think we've got a business and a product portfolio that will benefit from that regulatory conversion in Europe to electrification of heat.

No, I think I was referring more, if you visit office buildings in Europe in August, they certainly have a different idea of what HVAC is versus North America So I was wondering if requirements are changing. But we can take it off-line. Another question is on supply chain. Are you guys rethinking where and how you're spending CapEx, given all the uncertainty that's taking place?

Are you meaning uncertainty in the economy? Uncertainty where?

No, I am thinking about – I am thinking trade uncertainty. And are you thinking – are you changing where are you spending CapEx globally? And are you sort of having conversations with your supply chain about moving some sources?

Yes, when we think about our CapEx, there's been a little difference to how we think about it because we want to make things where we sell things, and that's generally what we've always done. And I would say there's even a stronger concentration of that than it was five years ago. That's been our strategy. As it relates to the supply chain, it depends. Where there is an easy answer, yes, we'll look for an opportunity there if we can, and we've made some movement there. So the answer to your question is, from our own footprint perspective, we're continuing to do what we do from a supply chain perspective. Around the edges, there's things that we do to move supply where we can.

Great. Always nice to have an HVAC company that doesn't blame weather. Thanks a lot.

Yes, Andrew, just a bit on your question. I'm just going to follow up, I know you're off the line here. But it's interesting a, lot of the Chinese customers that we have that we're looking to move production away from China to maybe avoid some of the U.S.-China tariffs. We're thinking about Mexico as well. I think that some of what they've done and decided has changed over time, and I think we're seeing more in areas like Vietnam, as an example, as opposed to Mexico. So there are changes with our customers in terms of how they're working their footprint for sure. I will take the next question, Chris.

Your next question comes from Nathan Martin from Seaport Global. Nathan Martin from Seaport Global your line is open.

There is no Nathan on the call queue. I think you’ve got the wrong person.

Our next question comes from Joe Ritchie of Goldman Sachs. Your line is open.

Thank you. Good morning, guys.

Good morning, Joe.

Good morning.

All right, so maybe my first question, Mike, just focusing on Climate operating leverage for the quarter. And so, obviously, like price cost came through well. It seems like the leverage is maybe a little bit lighter than we expected. Was there anything that like just impacted Q2 just from a mix perspective on the Climate side? Anything out of the ordinary?

So, Joe, I've got 32%. Were you expecting more than that in the quarter?

Yes, and then my assumptions on price/cost must be slightly different.

Okay, I am just taking $40 million of operating income on a $124 million revenue rise, and that's what I'm looking at.

Okay, all right. Well, I can take it offline. I was trying to sort out the price/cost component and trying to really determine what the volume leverage was, and it seemed like it was a little bit lower than anticipated. But that's okay. And then I guess maybe just kind of sticking on the commodity, the price/cost question and see your comments earlier on it being [indiscernible] conservative in the second half of the year. I guess as you're thinking about commodity inflation in 2H, if you look at copper, copper still are going to be pretty depressed. You guys typically will buy ahead of it. And so I guess where were you locked in for copper for the second half of the year? And I guess, what are the kind of – what are the offsets, potentially, to a copper tailwind in the second half of the year?

Well, Joe, if you remember, we actually – when we gave our original guidance for the year, we had actually planned on both copper and steel perhaps having less inflation in Q3 and Q4, and that's basically coming true. So if you think about copper specifically that you asked about, we're about 75% locked for the back half of the year, which is typical for us. Where you'll see the benefit of those spot rates on copper that really have come down is really in 2020, as I said. So we're doing buys every month for whether it's for 2019 or for 2020, so you'll see the advantage of that appearing in the 2020 numbers. And pretty much the same thing on steel. We know what we're paying for steel about six months in advance. And with either one of those commodities, the highest spot prices were in Q1. They started to come down in Q2, and they'll – the spot rates that we see right now are down in Q3 and Q4. But again, that's more to our expectations. I don't expect that to be a huge tailwind in the back half of the year. On the other hand, the good news is, is it's not actually a headwind like we've seen for the last couple of years. So like I say we’re taking advantage of it with our buying processes and with our supply chain each and every time we buy the commodities, but it actually is performing about like we expected and called for during the year.

Got you. Thank you both.

Thanks, Joe.

Your next question comes from Andy Kaplowitz from Citi.

Hey, good morning guys.

Good morning, Andy.

Mike, just following up on China HVAC. Last quarter, you basically were flattish in terms of order growth, and this quarter, up modestly against the tough comps you mentioned. As in last quarter, you were seeing China related demand improved throughout Q1. So did you see that improved demand level of at all in Q2 as other industrial companies are seeing, or do they generally stay steady or even improve in the quarter?

I would say, in both Climate and Industrial, from March, forward, bookings have steadily improved in China, specifically. And – but the markets have shifted. As an example, electronics would be down, say, 15% as a market, but you're going to find other markets that have been compensating for that and some of the heavier industries that would have compensated, and steel would be an example there, something that's – or power generation, where there's a market both for Industrial and for process cooling in those markets. So that's been good. Yes, we're stacking quarter one and quarter two of 2019 against plus 20s kinds of comps in quarter one, two of 2018, so the stack in that is sort of still mid – kind of low to mid-teens growth over the two-year period. So we're happy with kind of what's going on in terms of the strategy there that we had around the direct sales force that we've put in place. And then we're happy with the linkage, the service there. China is slower than it was historically, but still a pretty good market. And there's a focus not quite as strong as Europe around sustainability, but certainly, as I've talked in the past, much more of focus in China around clean air and clean water. That's having a positive impact on what we do.

That’s helpful, Mike. And then Mike, you gave us a good clarity on PFS. But could you give us more color on how it's doing as it entered the Ingersoll portfolio? Obviously, a fair amount of industrial and, obviously, more oil and gas exposure there. So have you seen any slowdown in that business versus your initial expectations? It will be helpful if you could just talk about how it's going in so far.

Yes, let me start by saying, first of all, from a cultural fit and a performance mentality, from our goal deployment process, from – I feel like these guys have been here for years, which is fantastic. It's a great fit inside the company. And in terms of achievement of their management plan, they're on track with that. So the mix has changed a little bit, and you see that in some of the shorter cycle, but like the rest of Ingersoll-Rand, they've got kind of measures for how they're dealing with changes. So frankly, it's been positive. Sue, do you have any color on that?

Yes, it is actually a refreshing type of business because they do have several different brands that they operate under and several different end markets that they go to, and the management team is excellent at finding a real balance between the opportunities in the portfolio and the risks in the portfolio. And they are operating to the management plan that we use when we bought the business, which is great news, both revenue, operating income as well as cash flow.

Yes, Andy, maybe some – just I give you one point of specificity here to the bookings growth in the quarter against if you think about sort of all the food management peers that are out there, that I think are booking negative. We are proud of that.

Thanks, guys. I appreciate it.

Thank you.

And I will now turn the call over to Zac Nagle for closing comments.

I would like to see everyone – thank you everyone for joining on today's call. And we – Shane and I will be available for questions over the next day or two and then in the coming weeks. So if you are interested in having a call, please give us a call and we will schedule sometime. And we look forward to seeing you soon on the road. Thanks.

This concludes today's conference call. You may now disconnect.