Good morning. Welcome to the Trane Technologies Q2 2022 Earnings Conference Call. My name is Chantel, and I will be your operator for the call. The call will begin in a few moments with the speaker remarks and the Q&A session. [Operator Instructions]. I will now turn the call over to Zac Nagle, Vice President, Investor Relations.

Thanks, operator. Good morning, and thank you for joining us for Trane Technologies Second Quarter 2022 Earnings Conference Call. This call is being webcast on our website at tranetechnologies.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 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 Dave Regnery, Chair and CEO; and Chris Kuehn, Executive Vice President and CFO. With that, I'll turn the call over to Dave. Dave?

Thanks, Zac, and everyone, for joining us on today's call. Let's turn to Slide #3. Before we dive into the quarterly results, I want to frame up the bigger picture, the strategy that enables Trane Technologies to deliver differentiated financial performance and shareholder returns. First and foremost, we are driven by purpose. We love what we do because we are forging new ground for a better, healthier world. Our people take pride in knowing their work makes a real difference for our customers, for our communities and for the world. Our purpose-driven strategy is aligned to mega-trends that are only getting stronger. We see the impact of climate change every day, including more frequent and intense weather events, like the heat waves we're experiencing in many parts of the world. These climate events have serious and far-reaching impacts on the economy, the environment and human health. We must act now to mitigate those impacts and ensure the health of our planet for the next generation. Trane Technologies is proud to be leading our industry with bold sustainability commitments and action to back it up. Our innovation is accelerating decarbonization of commercial buildings, homes and transport. Our customers recognize our innovation and our expertise, and we are their partner of choice in achieving sustainability goals while improving performance and efficiency. Demand has never been higher. Our purpose-driven strategy, relentless innovation and strong customer focus enables us to deliver superior growth profile through cycles. This, in turn, helps us drive strong margin and powerful free cash flow to deploy through our balanced capital allocation strategy. The end result is strong value creation across the board for our team, our customers, our shareholders and for the planet. Moving to Slide #4. Q2 was another strong quarter for us. Our global teams faced adversity…

Thanks, Dave. Please turn to Slide #6. Organic revenue growth of 11% in the quarter was strong despite the volume impacts from China's COVID lockdowns and a temporary plant shutdown related to extreme weather in Transport Americas that Dave mentioned earlier. FX was about a 2% headwind. Pricing was strong, up more than 10%, comprising the majority of the revenue growth this quarter. Price versus inflation was positive on a dollar basis and improved from the first quarter, but was still a margin headwind in the quarter. Productivity, mix and lower corporate expenses were favorable and we continue to make incremental business reinvestments to support innovation in the quarter. Organic leverage was solid at approximately 16%. All in, adjusted EBITDA and operating margins declined 40 and 20 basis points, respectively. Adjusted EPS grew 13%, driven primarily from strong operating performance and higher adjusted operating income. Please turn to Slide #7. We discussed the key revenue dynamics for each of the businesses earlier in the presentation, so I'll focus my comments on margins. Each of the businesses was heavily impacted by continued supply chain challenges and associated inefficiencies across our operations. In the near term, we are incurring higher costs to serve customers across the value chain, including significant investments in spot buys and expedited freight. Each segment also continued to make significant investments in our strong innovation pipeline. Our Americas segment delivered strong price, which offset inflation on a dollar basis, and modest volume growth with strong incrementals and solid productivity, leading to a modest decline in margins. In EMEA, price was offset by inflation on a dollar basis, negatively impacting margins. Acute supply chain challenges are having an outsized impact on productivity in the region and are expected to improve as we move through the second half, as is price versus inflation. In Asia Pacific, lower margins were primarily the result of lower revenues, which delevered at roughly the region's gross margin rate, consistent with our expectations. Now I'd like to turn the call back over to Dave. Dave?

Thanks, Chris. Please turn to Slide #8. As we've discussed throughout the call, underlying demand for our innovative products and services has never been higher, with unprecedented levels of bookings and backlog across our businesses. Relentless innovation and franchise brands with leading market positions, customer focus and operational excellence are hallmarks of our market outgrowth over a long period of time. In North America, our commercial HVAC business is driving record demand and share gains demonstrated by our order growth of approximately 45% on a 2-year stack. And we're exiting the second quarter with another quarter of record backlog, up more than 70% year-over-year and more than double historical norms. End markets remain strong, with a variety of economic indicators pointing to growth in 2022. Unemployment is low, and indicators like the Architectural Billing Index, which has been over 50 since February of 2021, remain favorable. Demand remains strong in data centers, education and health care. Every day, we see customers establishing their own sustainability targets. And we're partnering with them to create decarbonization road maps to achieve their targets through our customized system-based approach. We're helping our K-12 customers deploy federal stimulus funds to improve the indoor air quality of schools. We see both decarbonization and indoor air quality as multiyear tailwinds for our business given our deep customer relationships and expertise. Demand for our residential products remained strong, with a book-to-bill of 101% despite strong revenue growth. Turning to Americas Transport refrigeration. ACT projects continued market growth through 2023. We'll talk more about transport refrigeration outlook in our topics of interest section. Turning to EMEA, while we have muted expectations for market growth with a volatile geopolitical backdrop continuing, demand for our sustainability-focused systems and services remain strong. And we continue to see good opportunities for market outgrowth and share gains. Turning to Asia, we are monitoring the COVID lockdowns in China and their broader impact on the region. The business is healthy with strong bookings growth in the second quarter. Potential geopolitical and COVID-related risks have proven hard to predict for the region. For the year, we continue to see underlying strength in China's data center, electronics, pharmaceutical and health care markets. Outside of China, the picture is mixed, with COVID-related lockdowns still impacting market expansion in some countries. Our direct sales model is differentiated in the region and provides good opportunities for market outgrowth in both equipment and services. Now I'd like to turn the call back over to Chris to outline our updated full year guidance. Chris?

Thanks, Dave. Please turn to Slide #9. As Dave discussed at the outset of the call, we are pleased with our first half performance. In our second half outlook, strong backlog and pricing execution gives us confidence to raise our full year revenue and EPS guidance. We are raising our full year organic revenue growth guidance to approximately 12%, up from our prior guidance of 10%. We're raising our adjusted EPS guidance range to $7.05 to $7.15, which is higher by $0.05 at the midpoint. As Dave mentioned previously, this is $0.10 higher when you factor in the negative impact of FX, partially offset by M&A. We continue to expect a stronger second half on revenue growth and leverage versus the first half, with an improving supply chain and product redesigns coming online that will help us serve our customers better and provide added resiliency to our supply chain. Organic leverage for the third quarter is expected to be similar to Q2 or around mid-teens. We expect free cash flow to remain strong and equal to or greater than 100% of adjusted net income. Our outlook includes capital expenditures of approximately 2% of revenues across high-ROI projects in support of our profitable growth objectives and our sustainability commitments. These high-ROI projects include manufacturing automation, supply chain resiliency as well as investments to further decarbonize our operations. Our free cash flow outlook also includes modest investment in working capital, with a particular focus on strategic inventory to support continued growth. Please go to Slide #10. We remain on track to deliver $300 million of run rate savings from business transformation by 2023. Importantly, we continue to invest these cost savings and high-ROI projects to further fuel innovation and other investments across the portfolio. Please go to Slide #11. We remain committed…

Thanks, Chris. Please go to Slide #14. Overall, global transport refrigeration markets are expected to remain healthy in 2022. In North America, ACT has raised their 2022 forecast modestly, primarily reflecting actual builds coming in a bit stronger than expected in the first half. On balance, 2022 weighted average growth is expected to be up 10% versus up 8% prior. Growth is expected for 2023 as well. Overall, the forecast for EMEA markets is relatively unchanged. The total market size has dropped year-over-year to reflect the removal of the Russian market. Russia comprises about 14% of EMEA market for trailers and trucks. Effectively removing Russia from the total available market for 3 quarters of 2022 lowers the market size for trailers and trucks by approximately 11% and the weighted average market size by approximately 6% for the year. While the reduction in the total available market will impact our EMEA business growth in 2022, we continue to expect to drive growth through share gains and strong price realization across the region. After clear share gains in truck, trailer and APU in both the Americas and EMEA in 2021, we're expecting global outgrowth and continued share gains in 2022 as well. Please turn to Slide #15. We've updated the North America ACT trailer market growth outlook slide and added the 2024 forecast for reference. You can see that ACT continues to call for a 10-year average for North America trailers in the mid-40,000 unit range, with growth through 2023 and a modest step-down in 2024. IHS has not updated its outlook for EMEA beyond 2022 at this stage. Please go to Slide #16. Energy efficiency, decarbonization and sustainability mega-trends continue to intensify and create record levels of demand for our innovative products and services. We are uniquely positioned to deliver leading innovation that addresses these trends and accelerates the world's progress, supported by our business transformation and our engaging, uplifting culture. With the strength of our business operating system, we continue to successfully navigate macro challenges with a customer-first mindset. Our first half performance, record backlog and our outlook for the back half of the year give us confidence in raising our full year revenue and EPS guide. We believe we have the right strategy, the best team and a solid foundation in place to deliver strong performance in 2022 and differentiated long-term shareholder returns. And now, we'd be happy to take your questions. Operator?

[Operator Instructions]. Your first question comes from Andy Kaplowitz with Citi.

To your point of considering backlog at that $6.5 billion, up over 40% versus just orders, maybe you can give us your perspective in terms of the visibility that backlog gives you into '23 amidst the macro headwinds that everyone knows about. And then just in terms of that visibility, have you seen any slowing in core Americas commercial HVAC orders across any end markets given those concerns?

Yes. I'll start with the orders and orders were very robust in the second quarter really, especially in the commercial HVAC business in Americas. It's really across all verticals, Andy. So we didn't see any soft spots there. As far as the backlog, I mean our backlog right now is at record level, $6.5 billion. Our book-to-bill in the second quarter was 111%. We see a backlog entering 2023, it will be north of $6 billion. And that will give us great visibility into 2023, especially in our longer-cycle businesses, which are 80% of our backlog or 90% of our backlog, 80% of our business.

Dave, that's helpful. And then maybe just digging a little bit, can you give us a little more color into the EMEA supply chain and the price/cost issues you've seen in that particular region? It's obviously a much smaller region for Trane than the Americas, but you've been hit hard there with supply chain issues, negative price versus cost. So what's the difference there versus in the Americas? And could you talk about your confidence in expected improvement, especially if Europe does fall into a bigger slowdown?

Sure. Now I'll start with the positive. In our commercial HVAC, we continue to have a strong backlog in EMEA. Order rates were up low teens and we continue to see strong demand. Revenues was up high single digits, with growth in both equipment and services. Thermo King business also continues to perform well, with organic revenues up low teens, outpacing the markets. We did see acute supply chain challenges in Europe and a higher cost to serve our customers with spot buys and expedited freight. However, we see these as investments, really good investments, especially with the demand for a thermal management system and the opportunities to minimize the need of fossil fuels for our customers. Overall, I'm very confident long term with Europe. This region continues to grow share through leading innovation. Supply chain will improve in the back half, it's going to be a gradual improvement. And as it improves, the efficiencies in our factories will improve and we'll get our margins back on track.

Your next question comes from John Walsh with Credit Suisse.

Maybe I'll make a suggestion first. It'd be great on topics of interest, maybe we take a look at services. We've done a lot of deep dive into the truck trailer market. But maybe we can start there. I mean services, up double digits. I remember when we used to think this was a mid-single-digit plus grower. Kind of what's happening there? And where do you think services can continue to grow?

Yes. I mean we're very happy with our services business, and I'll take your suggestion in topics of interest. But our Service business over the last 5 years, and I'll speak globally, it's got a compound annual growth rate of high single digits, and that's over a 5-year period. In 2020, a pandemic year, we had -- our Service business was flat to 2019 despite the fact that we were constrained with getting access to facilities. So very happy with our Service business. It's roughly 1/3 of our total business globally. And in the second quarter, it was -- again, it was up double-digit rates. So very happy with the performance there and a very resilient business.

Great. And then maybe just starting on the price/cost conversation. Maybe just remind us if you think we can get some of the commodity deflation benefits here in the back half or if this is more of a 2023 story and kind of how you guys would think about the phasing of the lower commodity costs rolling through.

Yes, John, it's Chris. I think it's going to be more of a 2023 story. Our practice has been, for a long time, to hedge and lock in on our main commodities for steel and copper and aluminum. 1 to 2 quarters out, we're 70-plus percent locked. And then 3 to 4 quarters out, we're 50% to 60% locked. And certainly, we're seeing the volatility in those markets, even in the second quarter, which looked like a bit of a pullback on steel and then a little bit of an uptick in terms of steel prices later in the quarter. But we see that more of a 2023 tailwind, if we continue to see these commodities start to come down in terms of cost inputs. But at today's point, we're being selective on the backlog and making sure we're booking orders with as much visibility as we can get, so we price appropriately. And we're really happy with the price performance here in the second quarter and it being positive on a dollar basis in Q2 over cost.

Great. Good quarter. And I'll pass it on.

Your next question comes from Julian Mitchell with Barclays.

Maybe just a first question around the operating leverage. So I think as you highlighted, you did sort of 16% in Q2. It sounds like Q3 is guided about the same. And so that implies a big step-up to sort of 35% plus in Q4. So maybe just confirm if that's correct. And I guess why in Q3 are you not seeing operating leverage improve if Asia is going from steep volume declines to a catch-up? And globally, you're probably over the hump in terms of price/cost headwinds and those should narrow.

Julian, if I step back on the first half. Organic leverage was up about 12%, about 16% in Q2. So we saw a nice improvement from the first quarter to the second quarter. Back half of the year, we're expecting leverage to really be in the high teens, low 20s range. Our full year guide on leverage is consistent with what we said in May that it would be organically up mid-teens on a full year basis. But we baked into the guide, as I think about the third quarter and the fourth quarter, Dave mentioned an improving but gradually improving supply chain. We baked into the guide that we're going to continue to see additional costs to serve our customers with spot buys and expedited freight. It's going to continue to cause factory disruptions certainly on a year-over-year basis, Q3, Q4. And while it does get a little bit better sequentially, it's going to be a little bit of a challenge to the leverage in the second half. So it will be a gradual improvement, but that's where we thought Q3 would be, around that mid-teens level like we saw in Q2. And then Q4 would get a little bit stronger than that.

That's helpful. And then just sort of one follow-up around that. So when we're thinking about kind of third quarter earnings, probably sort of 10% or so growth year-on-year, mid-high teens leverage. So are we thinking sort of $2, that kind of earnings range? And then any sort of thoughts on resi HVAC? What's gone into that back half after a very strong Q2?

Yes. I think for the third quarter, Julian, for the -- think about the second half revenue growth kind of in that low teens range. We see that growth roughly the same in Q3 and in Q4 on a year-over-year basis, roughly the same growth. Now the third quarter comes with higher dollars of revenues. It's traditionally our strongest quarter of the year in terms of top line revenues. And then Q4 would come down off of Q3. So revenue growth, roughly the same for the second half and the 2 quarters. Leverage in Q3, more around that mid-teens organic range and then it'll step up into the fourth quarter. And that's how we kind of see that second half playing out.

Yes. And I'll chime in here on the second part of that question on resi. First of all, I'll start with the second quarter, and we had just -- the team did just a fantastic job in the second quarter. I mean we had 30% growth in the top line and our book-to-bill was 101%. So our backlog was flat with a 30% growth on the top line. We have tough compares all year in resi, with bookings level that we haven't seen before in 2021. So we'll have some tough compares going into the back half of the year. And for sure, we could see some negative bookings like we saw here in the second quarter. But you got to really look at the backlog, the book-to-bill and I couldn't be happier with our performance in our residential business to date.

Your next question comes from Scott Davis with Melius Research.

I want to switch gears and go back to M&A. It's always kind of a question of, is there another round of consolidation? Or what more can be done globally? And I know there's lots more opportunity perhaps outside of the U.S. But is your main pipeline in the distribution channel? Is that how we should think about it? Or is there more you think you can do down the road?

Yes. I mean it's a great question. I mean, obviously, our M&A pipeline is full, as you would expect. We get to see all the opportunities being a large global player in HVACR. It's active. We don't just look at channel. We look really at any fits in the pipeline that's available. But I'd tell you that we don't need to do anything, as I've said before. We have great equipment portfolio, a great service portfolio, great access to channel. But we'll look and we're going to be patient and we're going to make sure that we make the right investments.

Okay. Fair enough. And just separately, really going back to the supply chain questions. Is it a broad list of components -- are hard to get? Or is it more specific stuff? I mean we have other companies who are just -- semiconductors and stuff. But you guys, is it a wide list of stuff that's kind of short? Or is it narrowing or a shorter list?

Yes, good question. I mean our supply chain performed as expected during the second quarter and we anticipate, as I said earlier, a gradual improvement through the back half of the year. Our team continues to do an excellent job managing through this environment, working closely with our suppliers. Yes, electronics still is a theme, okay? Chips have gotten somewhat better. We see progress working with our suppliers that, that's going to continue to get better in the back half. It's other components like wire harnesses, too. But again, we're working through it. We have a great team. They're able to solve problems. And it's open communication with our suppliers and good things happen.

Your next question comes from Joe Ritchie with Goldman Sachs.

Can we just maybe on price/cost, I think you guys told us last quarter it was like roughly a 100 basis point impact to margins. I'm curious if you have that same color for Q2. And then whether that's supposed to get better in the second half of the year. And then I guess just maybe, just thinking through that resi growth number that you gave, the 30%. I'm just curious if you can give us how much of that was price as well.

Joe, it's Chris. So as I think about the second quarter kind of price/cost, certainly, a margin headwind, you're right, we described Q1 as about 100 basis points. I would describe Q2 as less than 100 basis points from margin headwind. I don't want to dial it in any further than that. We were happy with the performance on a net basis with turning dollar positive, really moderately positive in the quarter. And it's giving us even more confidence as we think about the balance of the year to be positive on a full year basis. So I think that's one of the most improved parts of our business operating system. And for the last 18 months, in a very highly inflationary environment, we've been able to stay on the right side of the price/cost equation and happy to see us deliver that here in the second quarter. The second part of your question was resi growth -- resi price. So yes, 30% growth in the quarter overall for resi. What we're going to report today, price for the enterprise was up 10.4%. We report in the Q that the Americas price was up about 11.8%. And I'll just say that resi was better than those averages here in the quarter in terms of price realization.

Okay. Great. That's helpful. And a quick follow-up. I know last quarter, I think you talked about K-12 order rates really picking up. I think they were up 50% in the first quarter. I'm just curious like what -- did we see another step in the right direction on K-12 orders in Q2?

Well, I'd start. The education vertical, Joe, has always been very strong for us and we continue to see stimulus funds flow there. Incoming order rates in the second quarter were very strong for the education vertical. They were north of 40%. So we continue to have -- show great progress there and we have a great process in place to help our customers track funds and to make sure that they're able to make the proper upgrades to their facilities.

Your next question comes from Joshua Pokrzywinski with Morgan Stanley.

I want to go to Europe first, if you don't mind. Pretty solid commercial HVAC bookings growth there and obviously a bit more macro uncertainty to say the least. Just wondering how much of this you guys feel is sort of driven by what's going on, i.e., like the energy paybacks, with prices just skyrocketing there. Or if this is just sort of stuff that had started through the process, maybe kind of pre Russia-Ukraine, and has just continued to go through? Like where are we in terms of 2Q kind of representing what's really going on in the market?

Yes. I'd say that Europe has shown market outgrowth for a long period of time now with our innovations that we have, specifically around thermal management systems. Obviously, what's happening right now with the war in the Ukraine and the supply of energy into the rest of Europe from Russia, that's getting tighter. So it is a bit of a tailwind for sure, as our thermal management systems eliminate the need for fossil fuel. And so our original value proposition, which was extremely strong to our customers, just got stronger. And we think that will be a continued tailwind into the future.

Got it. That's helpful. And then just on the price/cost, everyone's trying to skin this cat a little differently. But I think in the applied business, there's kind of a less of a list price maybe go-to-market there and more of like a job bidding strategy. Like what's been the historical kind of ability to hold price or maintain that spread as commodities come in, understanding that it's less like a list phenomenon?

Yes, Josh, what I would say is on those longer lead-type projects, first is the team is thinking about what does that future curve look like for commodities and costs when they're ultimately bidding the job. Some of those longer-term projects also allow for cost escalation, depending on an external index for which we can adjust price if something were to change after we bid it out. But as I think about the whole company in a normal year, we go into the view of getting price/cost say 20 to 30 basis points positive. And with the commercial businesses being the largest part of the company, they're very much in that same ballpark of, in a normal year, getting positive price/cost. But then also having a lot of visibility as best we can into the forward curves of inflation and cost to price accordingly.

Yes, Josh, if I could just add, we don't see pricing going down next year. I mean, price increases that we've seen over the last 18 months likely won't continue at the same rate into the future, but we don't see prices coming down.

Your next question comes from Steve Tusa with JPMorgan.

Good execution in a choppy environment for sure. The -- just digging back into the resi, up 30%. What do you think your channel movement was? I know you guys are kind of 50-50 independent and captive. 30% is just like a pretty big number, obviously, relative to other guys that are reporting. So just curious as to if there were any differences between the channel and your more captive distribution.

Yes. Good question. I mean we're really proud of the results we got in residential. I mean up 30%, you're right. And the good news there is -- the shocking there is that our book-to-bill was $101 million. So our backlog stayed flat as we enter Q3. Just to put some context around it, the sell-through in our IWDs was up in the 20s, right around 20% there. It was a little bit stronger in our own channel. So as far as inventory levels, they're about where we would expect them to be, Steve. We track that pretty carefully, especially our independent [Technical Difficulty]

[Technical Difficulty] captive distributors. What percentage is like parts and pieces or non-equipment?

I mean we're about a 50-50 shop, if that was your question. I'm not sure if you're going through like the parts side of our business, Steve? Or...

Yes. Yes, just your captive distributors, if they do parts and services and things like that, the guys you own.

The guys we own, absolutely. I mean we have -- they have part of that. I don't have the exact percentage in front of me, but we could dig that up for you.

Okay. One follow-up, quick follow-up on commercial. What was light commercial up in the quarter for you, guys?

Yes. It was -- our incoming order rates for light commercial was very strong. In the Americas, it was up over 30%.

Your next question comes from Nigel Coe with Wolfe.

So we've covered a lot of ground, but I just want to come back to residential. You're obviously -- extremely strong results. You did use the word dynamic. So I'm just wondering what sort of you're referring to there? Is that sort of the damage we're seeing elsewhere across the residential sector? Not HVAC, but across other end markets? So just wondering what dynamic would mean there. But really, this kind of punitive bill from the inflation protection bill had some provisions around subsidies for high-efficiency equipment. Just wondering kind of like how you do that and what that could do to the demand over the next 12 months or so.

Yes. I mean, dynamic -- I mean it is a dynamic environment. Obviously, we've seen a lot of price there. We're seeing volume there as well. A lot of different things happening at the same time. And obviously, we have a backdrop of very, very strong compares from prior year. So that's kind of what we mean around the being a dynamic space. As far as the IRA that's currently working its way through Washington, yes, there is a -- at least the way it's written right now, at least the pre-draft that I've seen, there is a provision in there for electrification of heating, right, which is in the heat pump space for the homeowner. So that could be a tailwind for sure if that goes through. But we'll see -- we'll wait and see how that gets written and let the final proposal goes to Congress and to the Senate.

Fair enough. No, that's good. And then my follow-up is on the buyback cadence. You've done $750 million of -- well, $750 million or thereabouts of buyback and M&A, so it's a bit more of a back-end load, that $1.9 billion. Just given the share price sort of through the second quarter, I thought I might see a bit more buyback activity during the quarter. So just wondering if there's any restrictions on buybacks during the quarter. Was there some M&A activity potential during the quarter? But just wondering on the cadence there.

Nigel, I would say we're kind of looking at this quarter by quarter as we go through the year. You're right, about $750 million of deployment between M&A and share repurchases so far this year and about $1.1 billion left to go when you already account for dividends that will be paid out in the second half. So I think to Dave's point, the pipeline remains active in M&A. Certainly, by the end of the year, I'd like to see 1 or 2 transactions closed or committed to by the end of the year. So we're just trying to make sure we leave some powder for that. At the same time, our balance sheet is, as you know, very strong. We got a lot of capacity here to do a lot of different things with the cash we have. But I'd say at this point, the share price continues to look very favorable and trading well below our calculated intrinsic value, so we would continue to deploy cash to shares if M&A isn't available as we think about Q3 to Q4. Let me, if I could -- Nigel, I want to go back to a comment that Julian made earlier around leverage. And I think for the third quarter, we commented that it would be around mid-teens, similar to Q2. It could be a little better than that as we work through the quarter. So the EPS estimate, Julian, we put out of around $2, I think that could be a little higher than that, maybe it's closer to $2.10 range than it is the $2 range. And that would come with a little bit of stronger leverage, probably not above 20%, but maybe it could be higher teens, in the mid-teens, would be the range I'd be thinking about for Q3. Thanks for letting me add that.

Your next question comes from Jeff Sprague with Vertical Research.

Dave, can you just address lead times? And not lead times in your own supply chain but just kind of the customer order behavior. We've seen across really the spectrum here that customers are ordering further in advance. So I wonder if you could kind of just address that. Are orders being booked further in advance than typical? And what is it that you're doing on kind of price and other things to make sure you're protecting yourself on the kind of longer tail on some of these orders?

Yes. I mean I think the answer is yes, they are getting booked sooner, and that's -- there's 2 reasons for that. One is our customers want to make sure we have enough visibility. And the second is that our lead times out of our factories are longer with all of our backlog. So yes, that is a fact. As far as how we're protecting ourselves from the pricing, some of the longer lead items, we would actually put in escalations on. That's a portion of the business, it's not the entire business.

And -- but you don't do that for transport? What is the difference for all the transport orders?

Yes. That's not -- we don't do that in our transport business. There, we basically -- we'll go out like a quarter or 6 months at a time to fill the backlog. We'll control that. It's not that we're not working with our customers on slots. We just won't be able to price it until we, in fact, get to a point in time. So like we have not yet opened up 2023 yet for orders. Now we're talking with our customers, so we understand what their demands might be so we'll slot it, so we make sure we don't disappoint them. We're just unable to price it at this time. We just want to make sure we -- in that business, it's very difficult to go back and say, we'll have to reprice something. And it's been very volatile. So we just want to be conservative in that -- from that standpoint and make sure we have the right price on the product.

And maybe just finally for me, just more kind of big picture cycle. You're -- sort of your call on resi from here, right? You're well aware of the debate and the replacement cycle, but it's hotter and we're running them longer and SEER changes. There's kind of a whole mix of things going on. When you look forward into '23 and '24, I mean do you see a legitimate argument for resi to stay at least on a relatively high plateau? Or do you think there's some kind of impact that we need to get here cyclically?

Yes. It's pretty dynamic, Jeff. I'll start with that. As I said earlier, I think the other variable that you may want to put into your model there is the SEER change that will be coming in 2023. Remember, that's going to be -- depending on the model, that would be 10% to 15% on the top line. I wouldn't expect it to be -- expect margins to be neutral on that because, obviously, the product costs more for the higher-SEER product. So that's another tailwind on the top line that we'd be seeing. It's -- we haven't come up with our guide yet for 2023. We're working through our planning process now. We have -- as I said before, we have very detailed models in this space. And when we come up with a guide for 2023, we can explain to you in a lot of detail as to what's happening. But remember, I sound like a little bit of a broken record here. But residential is only 20% of our total business. So even if it did fall by 10%, it'd be a 2% drop for the enterprise. And the opportunities that we see in our commercial businesses on both Thermo King and our Trane commercial business far exceed the 2%.

Our next question comes from Andrew Obin with Bank of America.

You have Sabrina Abrams on for Andrew Obin. So first, I wanted to ask another question on Europe and sort of how the conversation on HVAC is changing in Europe given the recent weather. And in the longer term, what it means for your organization in Europe and what you need to do to be better positioned in Europe in order to get positioned for new climate trends.

Yes. Well, first of all, I think we're very well positioned with some of the latest innovation that we've introduced into the marketplace with our thermal management systems. So -- and I think that as you could eliminate the need for fossil fuels and buildings, that's -- the value proposition was already great, it just got even better. These products are significantly more efficient than conventional ways of thinking, which would have been a separate chiller plant and boiler plant. We now have technology that combine these. Your efficiency is up between 2 and 4x, depending on what your heat sink is. So we're very happy with our position there and we're seeing a lot of traction.

Cool. And just quickly on the 2023 SEER change, can you talk about where you are in terms of transitioning production to the new high-SEER equipment?

Yes. We're certainly ready. We're well equipped for this. We already sold all the higher-SEER product prior to the change. So we're in good shape there.

Our next question comes from Gautam Khanna with Cowen.

I had a couple of questions. One, nothing you said on the call would point people to worry in the commercial markets at least about a slowdown. But I'm curious, can you comment on the front log? Some of the project pipeline, is there any timing slips related to any funding issues that you're seeing emerge even anecdotally more so than was the case maybe a year ago or 3 months? I mean is there any sign...

I'm assuming your question is more slanted towards the Americas, but it's been strong. I mean if you look at the Architectural Billing Index, which is a good macro indicator to look at, I mean, it's been over 50 now for 17 months. So we continue to see strength in the Americas. We have nice strength in EMEA, as we already talked. And it was a good trend we had in Asia in the second quarter with our order rates there up in the 16% range. So overall, lots of strength. And if you look at the longer-term macro trends, I would say it's going to be with us for a while.

And then secondly, we talked a little bit about raw material, copper, steel, aluminum. What about components broadly in terms of cost next year? Do you guys -- are you seeing inflation in those continuing and maybe offsetting whatever benefit we get from raws? Or do you think it's a net positive as we stand today on the cost side?

Gautam, we track -- for these calls and others, we generally spend a lot of time on Tier 1, but we track everything on the Tier 2 which would be the components you described from electrical components to motors to metal fabrication. And we're tracking that on the input costs from the commodities to that but also impacts on labor costs and others. But as it stands right now, with things looking a bit more deflationary at this point versus, say, 3 months ago, 6 months ago, for us, it's really kind of looking as more of a benefit and a tailwind in 2023. Locking in steel, we locked that in for really 6 months, so a cost in June is really going to be realized in December. So any type of pullbacks we see in deflation here in the third quarter, that really carries over into the first quarter of next year for steel. And then we've got the locking mechanisms in place with respect to copper and aluminum that also really push any change in price out roughly at least 3 to 6 months. So I think it represents a tailwind if we continue to see a deflationary environment. I think that's also a dynamic where it's hard to tell which way the market is going. But we're really just making sure we follow a process where we hedge each and every quarter out to a similar level. So we smooth any type of increases on the way up, and that means also a bit of a smoothing on the way down if we see deflation.

Our next question comes from Deane Dray with RBC.

A question on data centers. Just what kind of growth rate are you baking in? And a bit of a technical question. Do you see any threat to the growth in liquid cooling in data centers? Is this going to take share? Or can they both coexist and not affect each other's growth path?

Yes. I'll start with the latter there. The liquid cooling is certainly emerging technology that we're certainly doing a lot of work with. And we'll see how that moves forward. So we are aware of the technology and some of our scientists are looking at that very closely. As far as the -- we saw a nice growth in data centers. I don't have the exact number in front of me, we can dig that up for you. But we continue to see nice growth in data centers. I think your understanding -- it's part of the office vertical, so it gets a little bit complicated. But we continue to have a nice growth there. We have dedicated teams that work on data centers because there's a specific expertise there that we have that we work with our customers on.

Got it. And then as a follow-up on indoor air quality, we talked about the education market. But do you still feel good about that broad estimate of a 10-year path, 200 basis points annual top line? And then just another more technical question. There was, a year ago, lots of focus on air disinfection technologies. That seems to have waned a bit. But just give us a sense of what's the take rate in businesses, offices that are using disinfection technologies?

Yes. I mean, first of all, we see indoor air quality as a long-term secular mega-trend for the industry. And we continue to see growth there in lots of different verticals, okay? It's not just in health care we have -- we're doing indoor air quality. We're continuing to do indoor air qualities in several different verticals, including education, office as well as health care. As far as the cleaning of the air, products like dry hydrogen peroxide product, we continue to sell, we continue to see demand for. So we don't see it waning. We think that indoor air quality is going to be top of mind for our customers for the foreseeable future. It's generally embedded in our applied systems as well as our controls and our services, so it's harder to track as a stand-alone item. But we continue to see it as a growth tailwind for the -- for our business and really for the whole industry.

We have reached the end of the question-and-answer session. I'll turn the call back over to Zac Nagle for closing remarks.

I would like to thank everyone for joining today's call, and we'll be around for questions in the coming days and weeks as always. And we look forward to seeing you on the road, hopefully in person, in the near future. Thanks.

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