Earnings Call Transcript - CARR Q2 2025

Operator, Operator

Good morning, and welcome to Carrier's Second Quarter 2025 Earnings Conference Call. I would like to introduce your host for today's conference, Michael Rednor, Vice President of Investor Relations. Please go ahead.

Michael Rednor, Vice President of Investor Relations

Good morning, and welcome to Carrier's Second Quarter 2025 Earnings Conference Call. On the call with me today are David Gitlin, Chairman and Chief Executive Officer; and Patrick Goris, Chief Financial Officer. Except where otherwise noted, the company will speak to results from continuing operations, excluding restructuring costs, amortization of acquired intangibles and certain significant nonrecurring items such as acquisition and divestiture-related costs. A reconciliation of these and other non-GAAP financial measures can be found in the appendix of the webcast. We also remind listeners that the presentation contains forward-looking statements, which are subject to risks and uncertainties. Carrier's SEC filings, including our Form 10-K and quarterly reports on Form 10-Q, provide details on important factors that could cause actual results to differ materially. In addition, we plan to file certain recast financial statements in connection with our resegmentation, which occurred during the first quarter of 2025. With that, I'd like to turn the call over to Dave.

David L. Gitlin, Chairman and CEO

Thanks, Mike, and good morning, everyone. Another strong quarter. My thanks to our 50,000 team members globally for their continued great work. As expected, our organic growth picked up in Q2. We delivered 6% organic growth with exceptional 45% growth in commercial HVAC in the Americas, total company aftermarket growth of 13% and very strong growth in India, Japan, and the Middle East. We converted the strong organic growth to attractive earnings, expanded adjusted operating margins by 130 basis points, and increased adjusted EPS by 26%. Free cash flow was also strong with first half free cash flow of about $1 billion. We remain on track for $3 billion of buybacks this year. Turning to Slide 4. At our Investor Day on May 19, we laid out our game plan for driving sustained 6% to 8% organic growth by exceeding customer expectations through differentiated products, double-digit aftermarket growth, and unique system solutions. On products, we continue to win. With respect to data centers, we are on track to double our revenues to $1 billion this year and are continuing to build our backlog for next year and beyond. Our non-data center commercial HVAC business is expected to grow about 10% this year. In the Americas, we have increased both chiller capacity and revenues by more than 2x over the past few years and continue to build our backlog globally. For example, we recently booked a data center order for $45 million for a customer in the Middle East. Our global commercial HVAC sales, which exclude light commercial sales, will be about $6.5 billion in 2025, up close to 20% year-over-year. Product introductions have been instrumental to our win rate. For example, our new large capacity air-cooled chiller with a proprietary magnetic bearing centrifugal compressor is both significantly more efficient than our competition and can operate at elevated ambient temperatures, both key performance requirements from our customers. We also continue to leverage Viessmann and Toshiba technologies to introduce differentiated offerings in our RLC businesses. In the Americas, we are about to launch a fully integrated air-to-water heat pump that provides heating, cooling, and domestic hot water. This all-in-one solution provides homeowners with improved energy efficiency, frees up valuable indoor square footage, and provides us with market expansion and mix up. Our aftermarket sales are up 10% through the first half of the year, and we remain on track for our fifth year in a row of double-digit growth. Our number of connected chillers was up 40% in the quarter compared to last year. And over the last 3 years, we have increased the number of connected chillers by more than 3x from roughly 20,000 to 63,000. With respect to Abound, we introduced enhancements to our Abound app that leverage AI to boost operational insights and user efficiency. For our Climate Solutions transportation business, Lynx subscriptions were up significantly in Q2 and are now close to 200,000. Turning to systems. In North America, our Carrier Energy team is making great progress. We are working with several utility companies to initiate field testing at homes in the United States for our fully integrated battery heat pump solution this quarter. We remain on track for market introduction next year. We also continue to make significant progress with HEMS in Europe. In Q2, sales from our Viessmann Systems Profi partners showed strong growth, significantly outperforming those of non-Profi partners. On the commercial HVAC side, we continue to build out our capabilities for data centers, including QuantumLeap and its integrated CDU offering and are in active discussions with key customers. Outside of data centers, we recently had an important win with the Shanghai Oriental Hub infrastructure project, which includes a combination of our innovative centrifugal chillers, heat pumps, and our differentiated building management system. By integrating these offerings, we expect to improve our customers' energy efficiency by about 20%. This is another great example of how fully integrated systems add outsized value to our customers and help us drive differentiation and an increased share of wallet. Productivity driven by carrier excellence is now deeply ingrained in our DNA as reflected in continued strong adjusted operating margin of 130 basis points to 19.1%. Turning to Slide 5 for a brief update on our RLC business in Europe. Though the overall European market since our combination has been more challenging than we expected, other benefits of the combination have exceeded our expectations. Our differentiated strategy around HEMS and Hydronics in the Americas are made possible by Viessmann. HEMS leverages Viessmann's battery, integration, and digital expertise. Our global common design around controls and embedded software are both based on Viessmann design standards. We are deploying the underlying technology of Viessmann's One Base digital ecosystem, which connects the company, installers, and homeowners on a single platform to the Americas. Leveraging our respective supply chains is helping us drive more than $200 million of expected cost synergies by the end of next year, and our purposeful multi-brand multichannel strategy is yielding great results. Take, for example, the opportunity around air conditioning in Europe, where only 20% of households have air conditioning versus 90% in the United States. Earlier this year, we introduced new offerings through the Viessmann channel, and our air conditioning sales in Europe were up over 25% in Q2. In terms of Q2 for RLC Europe, our sales were flattish as we expected. Though Germany was down, our heat pump unit sales in Germany were up over 50%, and the ratio of heat pumps to boiler has improved from 30-70 last year to about 50-50. We like this mix up and combined with our expected reductions in electricity prices and easy compares with total German heating units that are close to historic lows, the business is well-positioned for a return to growth. Our RLC sales in Europe outside of Germany have returned to growth, up 3% in the quarter, and we expect that to further increase in the second half of this year. The integration of RLC and commercial HVAC in Europe also presents great sales and cost opportunities. Carrier and Viessmann are both top players in commercial and residential, respectively. The countries where Carrier and Viessmann are both leaders are, in many cases, different, which provides the opportunity to leverage each other's respective strengths. Slide 6 is a reminder of where we have come over the past few years. Our portfolio is much more focused and simplified with a higher growth profile. Adjusted operating margins have expanded on average over 100 basis points per year, and our adjusted EPS has grown at a high-teens CAGR. Despite a few unforeseen headwinds, the team continues to control the controllables and overdeliver, and we remain on track to deliver close to 20% adjusted EPS growth this year. Our team continues to deliver strong results, and I am confident that we will do so again in the second half of 2025 and beyond. With that, I will turn it over to Patrick.

Patrick P. Goris, CFO

Thank you, Dave, and good morning, everyone. Please turn to Slide 7. We had a strong second quarter. Sales, adjusted operating profit, margins, and adjusted EPS were all ahead of the guide we provided in May. Reported sales were $6.1 billion with 6% organic sales growth and 1 point of tailwind from foreign currency translation, partially offset by a 4% net headwind from acquisitions and divestitures, driven by the sale of commercial refrigeration. Q2 adjusted operating profit of $1.2 billion increased 10% compared to last year, driven by organic sales growth and strong productivity. Tariffs were net neutral in the quarter. Adjusted operating margin expanded by 130 basis points compared to last year, about half of which is due to the absence of commercial refrigeration, the balance due to productivity, mix up, and price offset by mix. During the last earnings call, we indicated that we expected about 20% adjusted EPS growth. We delivered adjusted EPS of $0.92, an increase of 26% year-over-year, better than expected due to slightly higher sales and stronger productivity. Year-over-year adjusted EPS growth was driven by organic revenue growth, strong productivity, lower net interest expense, and a lower share count. We have included a year-over-year adjusted EPS bridge in the appendix on Slide 18. Free cash flow of $568 million in the quarter was also stronger than expected. Moving on to the segments and starting on Slide 8. The CSA segment had another very strong quarter with organic sales growth of 14%. Commercial, excluding NORESCO, led with sales up 45%. Residential sales were up 11%, below our expectations due to lower volume, which was down mid-single digits, reflecting a late start to the cooling season. Regulatory mix up and pricing were all as expected. Combined, they were a benefit of mid-teens organic revenue growth. Over 90% of our volume was 454B. Light Commercial came in as expected, down about 20%. Adjusted operating margin was 27%, up 210 basis points, driven by strong organic growth and productivity. Overall, the Americas had another outstanding quarter. Moving to the CSE segment on Slide 9. Organic sales growth in CSE overall and residential and light commercial were both about flat. We delivered strong heat pump growth in Germany, the sales benefit of which was offset by a still weak overall German heating market with total units down about 25% so far this year. Commercial was up low single digits. Adjusted operating margin was about flat with cost synergies offset by unfavorable regional and product mix. Moving to the CS Asia Pacific segment on Slide 10. Organic sales were down 4%. Mid-teens or higher sales growth in Japan, India, and the Middle East was more than offset by continued weakness in residential China and parts of Southeast Asia. Within China, our residential and light commercial business was down around 20%, and commercial was up low single digits. Adjusted operating margin of 15.3% was in line with expectations. The decline year-over-year was driven by lower volume and the absence of a prior year favorable currency-related item, partially offset by productivity. Moving to CST on Slide 11. Organic sales were down 1%. North America Truck and Trailer returned to growth and container strength continued with sales up mid-single digits. This was more than offset by weakness in Europe and Asia Truck and Trailer. Adjusted operating margin of 17.6% expanded 340 basis points compared to last year, largely due to the commercial refrigeration exit. Turning to Slide 12. Total company organic orders were down high teens in the quarter as we faced a tough compare versus the prior year where orders were up 30%. North America residential was down about 60% compared to orders up over 100% a year ago. This was only partially offset by strength in commercial Americas, up high teens, light commercial Americas up over 20%, and transportation up high single digits. Excluding CSA residential, total company orders were up mid-single digits. Overall, we ended Q2 with a robust and growing longer-cycle backlog in commercial, which sets us up well for a strong second half. Moving on to Slide 13 and shifting to full-year guidance. For the total company, we are reaffirming the guide we provided in May. We continue to expect mid-single-digit organic sales growth, about 100 basis points of margin expansion, and close to 20% adjusted EPS growth at the midpoint. Moving on to Slide 14. Each segment's organic growth is unchanged, but there are some moving parts within some of the segments, as you can see on the slide. Moving to profit and cash guidance on Slide 15. Total company adjusted operating margin expansion remains unchanged, up about 100 basis points versus the prior year. With respect to tariffs, the net tariff impact in our July guide is 0, just as it was in our May guide. The incremental price to neutralize tariffs is now about $200 million versus $300 million in our prior guide. The margin impact of tariffs is about a 20 basis point headwind versus the prior year. As you can see on the slide, we made some minor adjustments to margin expectations in the segments. We are maintaining our estimate for free cash flow between $2.4 billion and $2.6 billion, reflecting roughly 100% conversion and still expect to repurchase about $3 billion worth of shares in 2025. We are maintaining our adjusted EPS guidance range of $3 to $3.10. Compared to the prior guide, lower sales in CSA residential and light commercial are offset by CSA commercial sales, and we are targeting incremental productivity and cost actions to offset unfavorable mix in CSA and CSE. Additional full-year guide items are in the appendix on Slide 20. Some color on Q3. We expect Q3 sales of about $6 billion with mid-single-digit organic growth versus the prior year and anticipate adjusted operating profit to be flat year-over-year. In essence, we get a $200 million year-over-year sales benefit from currency translation and tariffs, tariff-related pricing with no drop-through, while the benefit of productivity, mix up, and price is offset by unfavorable mix due to lower CSA residential sales. Q3 EPS is expected to be about $0.80. We expect Q4 EPS to be up about 20%, similar to first half EPS growth, including the benefit of productivity and cost actions. In summary, we remain on track to have another strong year with mid-single-digit organic growth, close to 20% adjusted EPS growth, and strong free cash flow. With that, I would like to ask the operator to open up the line for Q&A.

Operator, Operator

Your first question comes from Jeffrey Sprague of Vertical Research Partners.

Jeffrey Todd Sprague, Analyst

Perhaps we could just dive a little bit further into Europe. It looks and feels like maybe things are getting better there, but the margin guide has actually come down. So Dave, can you just unpack that a little bit more? Patrick mentioned mix, but just where are you at on the synergy capture in Viessmann? What's going on with the mix? And what do you think about the margins off this level looking into next year?

David L. Gitlin, Chairman and CEO

Yes. Jeff, let me start with synergies and maybe a bit more on the business, and Patrick can give the breakdown on kind of the margins and second half margins. Overall, look, we were flattish in the quarter as we thought we were going to be. We were a little bit stronger outside of Germany than within Germany, and we actually typically have slightly higher margins in Germany. And the other issue is boilers in Germany were coming down a little bit more, and we make pretty good margins, of course, on boilers. And there's a particular type of boiler, a floor-standing boiler where it was down a bit more, and our margins there are even a bit higher. So there were within the RLC Europe business, a few mix issues. I will say we feel really good about the cost synergies. We talked about $200 million by the end of next year. We will certainly meet or exceed that. The team is being quite aggressive, not only on supply chain and some of the other indirect. But the teams had to take a lot of very aggressive other discretionary overhead cost actions. They did a lot last year. I can assure you that Thomas and the team are doing a lot more this year. So they are going to take costs out of the business. And I will tell you that it really positions us for margin drop-through as the volume starts to recover as we get into the second half of this year and next year. And then, Patrick, any more on the margins?

Patrick P. Goris, CFO

I think you covered it. The margins in Germany are a bit stronger, while sales in Germany were somewhat weaker, but sales outside of Germany were a bit stronger.

Jeffrey Todd Sprague, Analyst

And then maybe we could just delve into price a little bit more. Patrick, you gave us the tariff-related price impact. Can you just share with us kind of what the total price capture was beyond just what you did on tariffs, if there is more, both in the quarter and what you're expecting for the year in aggregate?

Patrick P. Goris, CFO

If I look at price including the regular price increase and then the price related to tariffs in the second quarter, it was about 2 points for the overall company. For the full year, it will also be about 2 points. So it's about 2 points each quarter so far this year, and that excludes the mix-up benefit, Jeff.

Julian C.H. Mitchell, Analyst

Maybe just wondered if you could flesh out a little bit more those assumptions on U.S. resi light commercial for sort of the back half and how you see kind of the end market sell-out trends varying there versus the sell-in and the comps? How is the actual end market movement in terms of dynamics on price or repair and remodel? Anything changing in those assumptions?

David L. Gitlin, Chairman and CEO

Yes, Julian, the good news is that both price and mix are in line with our expectations. We’ve been achieving a mix increase of about 10%. Looking at the second half of the year, we expect sales to be nearly 100%, amounting to 454 billion. In Q2, prices increased in the mid-single-digit range, which was positive. However, we encountered an unexpected decline in volume in Q2, which dropped more than anticipated, seeing a mid-single-digit decrease instead of the expected low single-digit growth. For the second half of the year, we now project a volume decline of about 20% to 25%, along with a mix and price increase of 10% to 15%. This adjustment means our overall sales for the second half are likely to decrease by around 10%. As reflected in Patrick's slide, we've adjusted the full-year forecast for residential sales to reflect a low single-digit growth; approximately 15% for the first half and a 10% decline for the second half, leading to mid-single-digit growth for the year. We have not observed any major shift from repair to replace, as we've repeatedly confirmed with our channel partners. Consumer movement was slower in Q2 than we anticipated, and while it was somewhat sluggish in July, it began to pick up towards the end of the month due to the heat across the country. We believe we’ve accurately assessed the year, particularly for the second half with our updated volume estimates. However, given that inventory levels are somewhat elevated and movement has been slower than expected, we felt it was wise to lower our volume projections for the second half.

Julian C.H. Mitchell, Analyst

That's helpful. And we'll see if 1 million times is enough to satisfy some of the skeptics. On the second question would just be a more silly one, perhaps for Patrick, just around that fourth quarter implied. I suppose it's organic sales up mid-single year-on-year in Q4. So sort of down, I guess, high single digits sequentially. And then the EPS sequentially in Q4, it's a much smaller decline than sort of normal in inverted commerce. Anything to call out there on specific segments or something going on with mix that's a tailwind this Q4 versus historical ones?

Patrick P. Goris, CFO

So yes, Julian, the way you can think about it is, first of all, our Q4 year-over-year adjusted EPS growth has to be similar to what we've seen in the first half of this year. So about 20%, about 100% margin expansion we expect in Q4, and Q4 is expected to be our highest organic growth quarter of the year. So we expect actually close to high single-digit organic growth with both easier comps in Europe, in Asia Pacific, and transportation is expected to return to more attractive growth in Q4 as well, and in Q4, of course, the benefit of that volume mix up and productivity somewhat offset by the unfavorable mix in resi in the U.S., and then from a margin perspective, tariffs are slightly negative, and then, of course, in Q4, we will see more of the benefit of the cost actions that we've been implemented versus what we will see in Q3.

Nigel Edward Coe, Analyst

Patrick, maybe just unpack a little bit more the 3Q framework. So you said flat margins, and it seems like the residential decline is really weighing on the Americas margin. So maybe just unpack the segmental margins, and I think you said $0.80 based on $6 billion of sales and basically 17.5% of operating margin flattish year-over-year. I don't get to $0.80 mechanically, Patrick. So I just want to make sure there's nothing below the line to think about as well.

Patrick P. Goris, CFO

I'll start with the overall company in Q3. We have around $200 million in sales benefits from currency and tariffs with virtually no drop-through. Additionally, while we benefit from price productivity and mix, this is countered by lower residential sales, which have declined by approximately $200 million to $300 million year-over-year and sequentially in the third quarter. As a result, the organic growth is effectively negated by the unfavorable mix. Assuming a 24% effective tax rate for the quarter, we arrive at about $0.80 to $0.81. This equates to $6 billion in sales, flat operating profit year-over-year, and a 24% effective tax rate.

Nigel Edward Coe, Analyst

Okay. That's helpful. And any way to think about the segment margins?

Patrick P. Goris, CFO

The way you can think about segment margins in the third quarter, we expect that CSA will be down about 200 basis points year-over-year, and the explanation is basically the same. It's the resi mix that's really weighing on the margins over there. For the rest, Europe, we expect it to be flattish year-over-year, and then Asia will be slightly down and transportation will be up probably 200, 300 basis points, reflecting the CCR exit.

Scott Reed Davis, Analyst

Happy to be on my first Carrier call. I get to ask really stupid questions, get away with it for a while, maybe always. As we take a step backwards and just look at big picture, I hear you talk about productivity, and will we eventually see productivity on the gross margin line? Or is it more explicitly kind of SG&A productivity that you guys are talking about?

Patrick P. Goris, CFO

It will be both, Scott, and actually, over the last several years, I think we've driven both productivity and gross margin line. Now I call it adjusted because we yank out any amortization of intangibles, but productivity has had an impact both on gross margin and on the operating margin, and we will continue to see it because the biggest driver of productivity for our company is on the cost of goods sold with materials, that alone is a $10-plus billion bucket, warehousing logistics, there is still an enormous amount of opportunity there to drive cost out. So I would actually say, Scott, that the biggest opportunity is on the gross margin line rather than on the, call it, the SG&A line.

David L. Gitlin, Chairman and CEO

Yes. Scott, I know you've been familiar with us for many years, and many used to view us as a company with a 10% return on sales. This past quarter, we achieved 19.1%. In fact, it was our highest operating profit quarter ever. As Patrick mentioned, it's reflected not only in the gross profit, but it also shows in our general and administrative expenses, which used to be over 9% of sales and is now around 7%. So, this improvement stems from both product costs and various indirect costs.

Joe Ritchie, Analyst

Sorry if I missed it, but can you describe how the canister issue played out in Q2, where we stand today, and whether that's still a problem on the residential side?

David L. Gitlin, Chairman and CEO

It's no longer an issue for us, Joe. The team really jumped on it. We started precharging a number of units. We were going to tremendous lengths in Q2 to ensure our customers had plenty of canisters. We do not hear that canisters in the field are a problem. We made significant changes in May and June, and I commend the business and the operations team for their work with our channel. It's no longer an issue.

Joe Ritchie, Analyst

Awesome. Dave, I heard you mention that your non-data center business was up about 10%, maybe slightly better than that in CSA. Can you provide more details on what you're seeing in that non-data center segment?

David L. Gitlin, Chairman and CEO

Yes. In the CSA segment, non-data center activity increased by 20% in the quarter. Overall, we anticipate that for both the quarter and the year, non-data center activity will be approximately 10%. Specifically, our applied business in CSA saw an increase of over 100%, while our service business was up around 20%, and controls experienced growth in the high teens. In the Americas, data centers rose by over 300%, with non-data centers also growing by about 20%. Gaurang, Steve, and the team performed exceptionally well this quarter. This success is a result of expanding our capacity; we have a new factory in North America and have also expanded operations in Charlotte, which is performing very well. We have launched new products, including a magnetic bearing for air-cooled systems, which is appealing to many of our hyperscaler clients. Additionally, we have implemented innovative strategies to support our customers in the aftermarket. Overall, both the data center and non-data center segments, including significant projects and the return of manufacturing to the United States, have resulted in notable global successes.

Steve Tusa, Analyst

Sorry, I didn't catch the 1 million times. What was that in reference to?

Patrick P. Goris, CFO

That was the question about whether we've seen a trend repair versus replace. And that was...

Charles Stephen Tusa, Analyst

Okay. Got it. I just heard the number. I didn't quite catch it. There's a lot of earnings this morning. Can you just bridge us to the 20% increase as far as what you're assuming for any headwinds in resi in that particular quarter? It's a really nice bounce back, obviously, and the data center stuff is on fire. So you guys are clearly taking market share there. But what are you assuming for the 4Q in resi?

David L. Gitlin, Chairman and CEO

I'm sorry, Steve, the question is for resi, what are we looking at?

Charles Stephen Tusa, Analyst

Yes, just 4Q, yes, in 4Q because there's a lot of volatility, obviously, with the year-over-year comps. And I totally get the data center stuff that's really strong, but the resi side and maybe light commercial as well.

Patrick P. Goris, CFO

Yes. For resi Q4 sales, down about 15%, of which volume is about 23%, give or take. And then the rest rounded would be price and regulatory mix.

David L. Gitlin, Chairman and CEO

And Steve, on the light commercial side, in Q4, it will be flattish to last year. We do have the benefit of that being our easiest comp quarter. Last year, light commercial was down a little over 10%. So we think about flattish for light commercial in Q4. And look, the first half was kind of rugged, of course, on light commercial. But over the last 6 weeks or so, we have seen some level of encouraging trends in terms of field inventory levels down, orders up. Some of the paralysis that we saw on our small business customers has been lifted a bit as we've gotten more tariff certainty. We've seen more demand come back on the small and medium business side. And we've had some very, very nice wins on the retail side, some of the fast food, especially the higher-end fast food, we've done a really nice job with share. So we do see the second half down probably mid-single digits, probably down about 10% in Q3, flattish in Q4.

Charles Stephen Tusa, Analyst

Yes, super easy comp. So you're basically saying that the resi stuff is pretty consistent year-over-year 3Q and 4Q. And the RLC, the light commercial makes a lot of sense because of the comps, obviously.

David L. Gitlin, Chairman and CEO

Yes. And remember, resi has a very tough comp to last year because we were up about 35% and volume was up about 30% in the fourth quarter of last year.

Andrew Alec Kaplowitz, Analyst

Dave, can you share more about the situation in Climate Solutions Asia Pacific? You revised your outlook for China slightly downward for the year, but the rest of the segment shows growth and you didn't alter the overall growth projection. Is this indicative of a new normal for the segment as we look ahead? Please provide an update.

David L. Gitlin, Chairman and CEO

I think what's encouraging in Asia is that Michael and the team have done a fantastic job identifying growth in places where Japan previously had no growth. We saw high teens growth in that quarter, while India increased by just under 30% and the Middle East had mid-teens growth. Given that China's performance has been softer than we anticipated and for a longer duration, the team has excelled in handling this situation. There were also some countries in the first half, like Thailand, that performed unexpectedly weaker, but I believe that will recover due to a mix of performance and market factors. We are optimistic about the commercial sector in China, with good growth prospects and a growing backlog from some impressive wins. The team has been effective in building up the backlog for the commercial HVAC business in China. However, the residential side has faced challenges for a while due to high inventory levels in retail. We are putting significant effort into project work and I believe we will eventually see improvement in retail, although not immediately, as I expect Q3 to still show a decline. Therefore, we need to focus on project work and the commercial HVAC business in China. Additionally, I see tremendous opportunities to succeed in regions like India and the Middle East.

Andrew Alec Kaplowitz, Analyst

Very helpful. And then, Dave or Patrick, just following up on U.S. resi for a second. Are you seeing any share movements across the major OEMs? And then Dave, I think there's been some talk about having to rebate in terms of pricing. How are you thinking about the stickiness of pricing in the second half of '25?

David L. Gitlin, Chairman and CEO

We have been performing well on pricing. In the first half, it increased by mid-single digits, and we expect that to continue into Q3, around 5%. We anticipate it may be slightly softer in Q4, closer to low single digits. Overall, we are not heavily engaging in rebating, and the 10% mix with 454B has remained stable. Regarding our market share, I cannot comment on other OEMs, but we believe our share is holding steady. We are confident that we have not lost any market share. When our volume was lower than expected in Q2, we became quite concerned. We scrutinized every distributor and communicated with many dealer partners to investigate any issues. I attribute the lower volume to the delayed start of the cooling season and some caution from consumers. I expect we may face some challenges with volume in the latter half of this year. Nonetheless, our teams have done an outstanding job navigating transitions and managing canister activities, and overall, we are performing well in terms of market share.

Deane Michael Dray, Analyst

It's a sign of the times now that you divide your commercial HVAC business between data center and non-data center.

David L. Gitlin, Chairman and CEO

I know that's new.

Deane Michael Dray, Analyst

Could you focus on the non-data center aspect of your business? You've mentioned some significant project wins. Can you walk us through the verticals, such as K-12, and share any notable positive or negative highlights among them?

David L. Gitlin, Chairman and CEO

Yes. On the negative side, the K-12 sector has been weaker than anticipated throughout the year, which I believe is due to a mix of factors, including some of the DOGE activity and local funding uncertainties. Despite the availability of state bond funding, estimated at around $76 billion, that segment remains softer. Higher education has been a strong contributor for us for some time, but it showed a slight decline in Q2 compared to our expectations. Typically, we mention that commercial real estate is soft, but strangely, we observed a small increase in Q2, though I wouldn’t categorize it as a trend—it's still something to watch. On the positive side, we are pleased with the significant growth in data centers. Many mega projects have performed well both in the U.S. and internationally, with notable successes such as the Shanghai Oriental Hub. When we refer to systems, it's not only about QuantumLeap for data centers; we have been enhancing our global systems sales approach. We've seen some strong systems wins in Europe and Asia. The healthcare sector has also been performing well. Despite the overall weakness in warehousing and retail, we have seen significant success, particularly in the light commercial segment of retail and on the commercial side of warehousing. Yes. In the quarter, it was up 13%. We're up 10% year-to-date. We fully expect to see double-digit growth again this year. This will be our fifth consecutive year of achieving that. The underlying metrics are looking good. Ed and the team on the refrigeration side have performed well with subscriptions on Lynx. Abound is gaining momentum. The number of connected devices in the HVAC chiller segment has reached 63,000. Service coverage is robust. One of our top priorities is ensuring that with our data center victories, we establish the right long-term agreements with our hyperscaler and colo customers to support them for many years ahead. This is a key focus area for us. Overall, the team performed very well in Q2 in aftermarket, and we're confident that this trend will continue throughout the year.

Andrew Burris Obin, Analyst

Just maybe a question on transportation. You're saying that North America returned to growth. Can you just talk what you're seeing in North American refi market because the truck volumes continue to remain weak, but maybe that market has found the bottom. Just more granularity there.

David L. Gitlin, Chairman and CEO

It's challenging to determine the lowest point in NATT. It was encouraging to see some growth in Q2. As we move into the second half of the year, we have easier comparisons since the last three quarters were down about 15% and close to 30% in the fourth quarter. Therefore, we benefit from these easier comparisons in the latter half. We are beginning to feel optimistic as we monitor orders in NATT. There has been a slight recovery in ETT within our European Truck Trailer business, and we expect the container segment to perform well this year. NATT is particularly short cycle, so we will have to wait and see. We have promising growth projections for the second half, and if those do not come to fruition, we have sufficient performance in sectors like Sensitech and Container to compensate. We believe our team is performing strongly and we are positioned for growth in NATT during the latter half. What we require is some stability regarding tariffs for our customers, and the increasing clarity on this issue seems to be beneficial to them.

Andrew Burris Obin, Analyst

That's great to hear. And just a question on resi. You were still constructive, I think, in May and the May weather, if you look at the temperature was weaker and June was actually quite warm. And what we hear from the channel is you guys are as close to your distributors as anyone from a very positive standpoint. So can you just tell us when did you figure that North American resi was going to be weaker? And is it the inventory that was the red flag? Just maybe just walk us through what happened.

David L. Gitlin, Chairman and CEO

Yes. The bottom line, Andrew, is that May movement was just a lot softer than we thought. We had a rule we would do our best never to talk about the weather. Obviously, it's a bit of a reality when you're dealing with the kind of business that we're in. But cooling degree days were softer in the last six weeks of the quarter than usual. But having said that, the weather is the weather, but what really happened was movement was softer in June in particular. And what that did is that's built up a bit more inventory in the channel than we'd like. So what we did as we thought about the second half is we tried to take a look at some of the movement trends that we saw in June and then assume that continues for July and August. So we'll have to see what ends up happening. And we also have been very purposeful in our projections to take inventory levels down to where they were last year when we end Q3 and where we end Q4. So in our sales guidance, we assume that we get inventory levels back into balance.

Joseph John O'Dea, Analyst

Could you talk about back half of the year margin expectations in Europe? I'm not sure if we should be thinking kind of around 11%, but any kind of variation from Q3 to Q4? And then just how that bridges from kind of a seasonality and volume perspective versus mix or other factors?

Patrick P. Goris, CFO

Thank you for your question. In Europe, residential accounts for about 80% of our total business. Typically, the second half of the year is stronger than the first half due to the heating season, with a typical sales increase of 10% to 20%. Regarding margin expectations, in the second half, we anticipate margins to be around 11% to 11.5%, with the most significant margin improvement occurring in Q4. Last year, our Q4 margins in Europe were quite low. For Q3, we expect margins to be approximately 10% to 10.5%, remaining steady compared to last year, but increasing to about 12% in Q4 due to stronger sales and the productivity measures we have been implementing all year. It does take longer to see these changes in Europe, so we expect the effects of our productivity initiatives to become more apparent as we progress through the year.

David L. Gitlin, Chairman and CEO

I think part of it is the shift in refrigerants. As people consider the long-term, they understand that we will be transitioning to the 454B, making it increasingly difficult to predict the pricing on the 410A as we support this change. Therefore, it seems natural that this is essentially a replacement business; when an air conditioning unit fails, many will likely prefer to replace it entirely rather than attempt a costly repair, especially knowing that they will need to support it with potentially pricier refrigerants. Overall, we feel that our pricing is appropriate for both the 454B and the necessary base price increases to address inflationary or tariff pressures we've encountered. We also have not observed a significant shift from repair to replacement nor any major downturn in our entry-level products compared to the next tier up. We've been monitoring this closely. We believe the market is experiencing a slower start to the cooling season, consumer behavior is being affected by persistently high interest rates, which has dampened residential new construction and home purchases. This slowdown has impacted our business as we typically benefit when people move between homes. Consequently, we anticipate this trend will continue into the second half of the year, and we'll have to see how it unfolds.

Chris Snyder, Analyst

I wanted to follow up on the commentary on the softer resi volumes in Q2. I guess from your perspective, do you think that was just softer end demand? Was it maybe some more downstream inventory than expected? Or did that come out faster? I guess any view on that? And how do you kind of separate between those two drivers when you look at the data?

David L. Gitlin, Chairman and CEO

They overlap a bit. We started the quarter with elevated inventory levels, and movement needed to increase to support ongoing sales growth. However, movement was considerably softer in June than we had anticipated due to various factors including interest rates, consumer sentiment, and perhaps weather. It is what it is. Looking at residential over the past few years, the team has done an outstanding job of gaining market share. We are close to capturing one-third of the market and have not only gained but also maintained this share while achieving good margins. We expect some comparison challenges in the second half regarding movement, and we need to reduce inventory levels a bit. We'll have to wait and see what unfolds in the second half. There were a couple of issues we noted in Q2, but overall, the team is performing well, and the mix and pricing have aligned with our expectations.

Patrick P. Goris, CFO

No. Certainly appreciate that and kind of can see that strength that has come through the past couple of years. And then just, I guess, following up on that, obviously, the volume declines for resi into the back half, the comps are incredibly difficult. So is this just a function of kind of sluggish demand and very difficult comps? Or do you think the channel will kind of continue to pull down inventory in the back half of the year? Or do you think it ended Q2 at a pretty balanced place?

David L. Gitlin, Chairman and CEO

Yes, we plan to intentionally reduce inventory in the second half of the year since it's currently higher than we would prefer. We are very diligent each month and quarter in striving to align inventory levels with what we believe they should be. We make every effort to ensure that there isn’t more inventory in the market than necessary. We collaborate closely with our distribution partners, not only regarding the total inventory levels but also the mix they require. We aim to avoid shipping more than needed to keep inventory levels balanced. Our goal is to have the inventory at the end of Q3 align with where it was last year.

Stephen Edward Volkmann, Analyst

I'm curious sort of longer term, where are you relative to capacity and capacity additions for the data center business or for the large applied type business?

David L. Gitlin, Chairman and CEO

Yes, we are in good shape. One of the positive aspects when we speak with our hyperscaler customers is their demand for capacity availability on a global scale, and we have it. We repurposed a brand-new facility that now focuses entirely on both air-cooled and water-cooled chillers to support North America. Our Charlotte facility has been expanded by about 40%. Overall, in North America, we've more than doubled our capacity in just the last few years, which is evident in the applied growth we've experienced. In the past, we were restricting growth even for activities outside of data centers due to limitations, but that's no longer a concern. We're encouraging our teams to actively pursue data centers and other opportunities because we have the capacity. This applies globally as well; we have locations in China, India, and France, and we are exploring creative and exciting opportunities in places like Saudi Arabia. Currently, we have ample capacity worldwide, and it’s reassuring because our teams are introducing new products and achieving success, generating a lot of excitement among our customers. Well, if you look at the algorithm that we laid out at our Investor Day, we did say that there was always a point or two from the market, and then we have this 3-pronged strategy, which is products, aftermarket, and systems. Driving double-digit forever is going to give you a lift there. Systems, we said are going to be a point or two, and we're seeing really nice progress on things like HEMS in Europe, and we'll start getting our first revenues next year from HEMS in the United States. When we talk systems on the commercial side, it's not only QuantumLeap, where there's a fair amount of activity picking up for this combined liquid cooling, traditional cooling, but also we're seeing it in non-data center activity, working more as one carrier combining our BMS and traditional chillers as well. So we see systems picking up and then products. So you're always going to see a little bit of variation by segment as they face different either tailwinds or headwinds. But what we've said is no segment left behind. The expectation is every segment grows 6% to 8%, and they're building their pipeline as we gear up for a really strong 2026.

Amit Singh Mehrotra, Analyst

I'll just be very quick here. First, just be helpful if you can talk about how you think volume is impacted, if at all, from some of the incentives going away at the end of September, I guess, related to the Beautiful Tax Bill or whatever it's called. Can you just talk about it, is there any assumption in your guidance around any impact from that? Or if you can just give us a little bit more color there?

David L. Gitlin, Chairman and CEO

We don't see a significant impact from 25C 179D. While some of the provisions were beneficial and made sense, they were not substantial or particularly meaningful for us. Therefore, their removal does not have a significant effect.

Amit Singh Mehrotra, Analyst

Okay. That's helpful. And then just one quick follow-up to an earlier point around rebates or rollbacks on pricing. It didn't seem that there was any assumption for that in the revised outlook. Certainly, the margin for CSA didn't appear to seem that way for the full year. Is there any assumption for pricing rollbacks this year or later this year? Or is that not a factor you think as the year plays out?

David L. Gitlin, Chairman and CEO

We don't believe there are any significant price changes. Patrick discussed pricing trends by quarter, and they seem fairly stable. For residential in Q4, we've been modeling a 5% to 6% increase per quarter, but we now expect it to be closer to a few percent. That's about the only adjustment. Overall, Patrick outlined that pricing has remained consistent throughout the quarters.

Patrick P. Goris, CFO

Yes. And the only change versus the prior guide really is tariff-related pricing is now $200 million instead of $300 million in the May guide, but the net tariff impact on operating profit remains 0.

David L. Gitlin, Chairman and CEO

It's difficult to determine the lowest point for NATT. It was encouraging to see a slight growth in Q2. As we enter the second half, we have favorable comparisons since last year saw a decline of about 15% in the third quarter and nearly 30% in the fourth quarter. This should provide us some advantage for the latter half of the year. We noticed some positive trends in orders for NATT and a recent small recovery in ETT within our European Truck Trailer sector. The Container segment is set for strong performance this year. NATT operates on a short cycle, so we’ll have to monitor the situation closely. We expect significant growth numbers in the second half, and even if they don’t materialize, we have enough stability in other areas like Sensitech and Container to manage. The team is performing well, and we're optimistic about growth prospects for NATT in the latter half. What we really need is some stability regarding tariffs for our customers, and the increasing clarity on this matter is beneficial for them. Thank you, everyone, for joining. There are many variables in the current market, but I am very proud of our team for their strong performance in the second quarter. I am confident that we will continue this momentum in the second half of the year, which we believe will reflect our strengths. I appreciate our team and our customers for their support, and thank you all for being here.

Operator, Operator

This concludes the meeting. You may now disconnect.