Trane Technologies plc (TT) Q2 2021 Earnings Call Transcript

Good morning. Welcome to the Trane Technologies' Q2 2021 Earnings Conference Call. My name is Hilary, 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. At this time, all participants are in a listen-only mode. After the speakers' remarks, there will be a question-and-answer session. Operator provided instructions to participants. Thank you. I will now turn the call over to Zac Nagle, Vice President of Investor Relations.

Thanks, operator. Good morning and thank you for joining us for Trane Technologies' second quarter 2021 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 two. 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 David Regnery, CEO; Chris Kuehn, Executive Vice President and CFO; and Mike Lamach, Executive Chair and former CEO. With that, I’ll turn the call over to Dave.

Thanks, Zac. Before we jump in, I want to take a moment to recognize Mike Lamach. Mike has reinvented this company a couple of times over. He built our high-performance culture and an incredibly strong team. I'm proud to have worked with Mike in his capacity as CEO and I'm looking forward to continuing to work with him in his role as Executive Chair until his retirement in the first half of 2022. And now I'd like to turn it over to Mike for a few words.

Thank you so much, Dave. After we announced Dave as my successor, I appreciate that we're able to connect with a large number of analysts and investors. First, I want to personally thank everyone for the kind words, e-mails and letters. I'm thankful for the opportunity I've had to work with such a great group of people. In fact, today is a bit of a milestone, it marks my 50th and final earnings call. Second, I want to share how excited I am to have Dave leading Trane Technologies. As a retiring CEO, in my view, you only hope for two things. The first is that you're leaving things a little better than when you started; and the second is that you have complete confidence and trust in your successor. I have absolute confidence in Dave, having worked closely with him for 18 years and spending the last several years co-architecting our strategy together. I'm extremely proud of what we've accomplished, and I believe we have tremendous opportunity ahead as a climate-focused sustainability leader. Now, back over to you, Dave.

Thanks Mike and thanks to everyone for joining us on today's call. I've played an active role on these calls in the past several quarters, but this is my first official call as CEO. I'd also like to thank the long list of shareholders and analysts who have had the pleasure of speaking with us right after the announcement. As Mike and I highlighted on those calls, this transition in leadership is an evolution, not a revolution. We co-created the Trane Technologies strategy and have worked closely together for many years. Please turn to slide three. While the world has contended with unprecedented change over the past 18 months and continues to face significant challenges, our purpose-driven sustainability strategy remains steadfast. The long-term sustainability megatrends that underpin our strategy have only intensified and our innovation leadership is transforming the climate industry, as the world decarbonizes. This is more critical every day, as the clock is ticking on climate change. Our aggressive goals and bold actions can dramatically reduce carbon emissions and accelerate the world's progress. In addition, we are proactively addressing emerging trends, as we see heightened focus on indoor air quality, energy efficiency, cold chain and the need to upgrade aging infrastructure in our schools. We are committed to making a difference consistently, relentlessly and over the long term. This unyielding approach drives market outgrowth over the long term, which in turn helps us drive strong margin and powerful free cash flow to deploy through our balanced capital allocation strategy. The end result is more value across the board for our customers, for our team, for our shareholders and for the planet. Moving to slide number four. After posting a very strong first quarter, we have significantly raised our 2021 guidance range to reflect top quartile EPS growth for full-year 2021. The raise reflected both a positive demand outlook and expected acceleration in global vaccination rates. Through the first half of the year, demand is shaping up consistent with our high expectations. While the delta and other coronavirus variants continue to pose considerable risk, large portions of the global economy are rebounding and continue to gradually improve. Our global teams delivered a strong second quarter, with robust organic bookings growth of 30%, driving backlog to a record high. Backlog is up 15% from record Q1 levels and up more than 50% from the end of 2020. It's also up more than 50% versus any quarter in 2019. Net, our backlog is extremely strong, not only in the context of a modestly down 2020, but also in the context of strong financial performance in 2019. Demand for our innovative products and services is high and our record bookings and backlog provide good visibility into 2021 and 2022. Performance was strong throughout the P&L, with organic revenue up 18%. Adjusted EBITDA margins were up 180 basis points on 30% organic leverage and adjusted EPS growth was up more than 50%. In many ways, 2021 is shaping up largely as we anticipated on our Q1 earnings call. So I thought it would be constructive to take a few minutes and talk about what has changed and how that's affecting our approach to the second half of 2021. There are two areas that are making the operating environment substantially more challenging. The first is the speed and slope of material and other inflation that has risen dramatically. You'll recall that we saw unprecedented inflation and tariff impact in the 2017 to 2018 time frame. However, if 2021 plays out as we currently expect, we'll far exceed the peak inflation and tariff numbers we faced during that time frame. In 2021, not only are we seeing higher material cost inflation, but Trane Technologies, and from what we're seeing in the market, the entire industry are implementing price changes faster and with far less lag time than in 2017 to 2018. The net result for us is we are implementing about $150 million of incremental pricing in the second half of 2021 to offset about $150 million in incremental inflation. To be clear, this is $150 million above and beyond what was already baked into our guidance at the end of Q1 in both cost and price. Successfully executing the price action offsets otherwise negative EBITDA impacts, but also drives organic leverage on our incremental revenues lower in the second half of the year. However, our industry typically holds on to price. So long term, we expect these actions to be a solid tailwind for our business. The second thing that has changed is the strong economic environment, combined with other factors such as strained logistics systems and tight labor markets have further stressed already tight supply chains. This is resulting in higher cost and greater inefficiency throughout the value chain. We are fully leveraging our high-performance business operating system and transformation initiatives to manage and mitigate these impacts and meet the needs of our customers. But there is no silver bullet. We believe we can limit the impact of these inefficiencies to a few points of leverage in the back half of the year as we work to meet our customers' expectations and strong demand. Our multiyear track record of delivering high-quality earnings and free cash flow fuels our balanced capital allocation strategy. Year-to-date, we've deployed about half the cash we expect to deploy in 2021. We have a solid pipeline of M&A prospects and continue to see value in our shares. Longer term, our purpose-driven sustainability strategy continues to be focused on secular megatrends that are powerful tailwinds for our business and support continued top-tier performance and differentiated returns for shareholders. Please turn to slide number 5. We delivered robust organic bookings and revenue growth in the quarter, up 30% and 18%, respectively, with growth across all segments and business units. Our Americas Commercial HVAC business delivered robust growth in the quarter. Unlike many other peers and industrials who entered the quarter with easy growth comps after being down significantly in 2020, Americas Commercial HVAC organic bookings were up mid-20s and revenues were up low-teens in Q2 of 2021, building on mid single-digit declines in the prior year. The Residential HVAC markets continue to be extremely strong, and our Residential HVAC team delivered high 30s bookings growth, with independent distributor sell-through up high 20s. We entered the second half of the year with record backlog, up significantly from record backlog at the end of the first quarter. Our Americas Transport Refrigeration business continues to outperform the North American transport markets, delivering more than 30% revenue growth this quarter. Transport bookings were up low single digits, which may look like a miss, but actually it's a positive story and simply reflects a natural pause in orders from substantial bookings growth in Q1 as industry trailer production has largely maxed out capacity for 2021, and the focus has turned to booking slots for 2022. We only recently opened up the order book for our first quarter of 2022, prudently keeping an eye on inflation, looking several months out. It's also worth noting that this quarter's bookings build upon very strong prior year truck and trailers, where bookings were up nearly 50%. Turning to EMEA, our teams delivered 53% bookings growth in the quarter, with strong growth in both Commercial HVAC and Transport Refrigeration. Revenues were also strong, up 28%. We continue to see strong demand for our innovative products and services that help reduce the energy intensity and greenhouse gas emissions for our customers. Our Asia Pacific team delivered bookings growth of 12% and revenue growth of 2% in the quarter, with growth in both Commercial HVAC and Transport. The impacts of the COVID-19 pandemic continue to challenge the region, with low vaccination rates and partial lockdowns in some countries. Now I'd like to turn the call over to Chris.

Thanks, Dave. Please turn to slide number 6. We drove strong adjusted EBITDA and operating margin expansion, supported by strong organic leverage of 30%, despite increasing headwinds as we moved through Q2. Combined with strong revenue growth, we delivered outstanding adjusted EPS growth of 51%. In addition, we increased business reinvestment in innovation, technology and productivity initiatives in the quarter. As Dave outlined at the beginning of the call, we're relentless when it comes to innovation to advance our proven sustainability strategy and fuel our growth. Please turn to slide number 7. In the Americas and EMEA, volume growth, transformation savings, productivity and price realization drove strong EBITDA margin expansion of 170 basis points and 460 basis points, respectively. Asia Pacific's margins declined modestly, but remained at strong levels, and we continue to be very pleased with the progress the region has made since implementing its direct sales force strategy in 2017. Since 2018, Asia's margin improvement is impressive, up approximately 500 basis points. Further, on a two-year stack, EBITDA margins were up 270 basis points in the quarter or 135 basis points per year on average. As you look across our portfolio, a couple of common themes will continue to drive strong performance. First is our relentless focus on investments in superior innovation to help our customers solve their most challenging and complex problems and fuel market outgrowth over the long term. The second is using transformation savings to fund business reinvestments and drive margin expansion. We're on track to deliver $300 million in transformation savings by 2023, which we'll touch on a bit later in the presentation. Now I'd like to turn the call back over to Dave.

Thanks, Chris. Please turn to slide number 8. Commercial HVAC Americas has significantly outperformed the broader markets over a number of years through strong focus, agility and execution, combined with relentless innovation for our customers. These defining characteristics power the business forward today. End markets are improving with continued strong data center and warehouse demand. Demand in the education and office end markets is also growing. We're benefiting from increased demand across our K-12 customers, with federal stimulus funds supporting both current and more importantly, future growth. We see this as a multiyear tailwind for our business, given our strong position in the education market and our direct sales force with deep relationships in this vertical. Vaccination rates are improving and end market indicators are generally strong, with ABI over 50 since February, as one example. Demand remains high for comprehensive indoor air quality solutions, with particularly strong interest from education, government and office end markets. We continue to see indoor air quality as a long-term tailwind for our business. Though we remain prudent and cautiously optimistic, given the emergence of new COVID variants and the unpredictable impacts they may have, we enter the second half of the year with very strong backlog and are encouraged by the healthy demand picture that is forming. Turning to Residential, we delivered record second quarter bookings and revenue and are entering the second half of the year with record backlog. Overall, we delivered a strong first half and expect a challenging second half against tough comps, given record bookings and revenue in the second half of 2020. Turning to Americas transport, we're expecting continued strong growth for the balance of 2021, with weighted average transport market growth of approximately 24% for the year. Given strong demand for trucks, trailers and APU through the first half of the year, and supply constraints at OEMs limiting the market size for 2021, we have pretty good visibility at this point, but our transport business will continue to have a strong year and 2022 has the potential to be even stronger. I'll talk more about transport outlook in our topics of interest section. Turning to EMEA, economic conditions are improving across the region. We expect continued improvement in the back half of the year with increased vaccination rates supporting the reopening of venues. Transport markets have been and remain strong. We are expecting 9% weighted average market growth. Our transport business is outperforming the broader markets and 2021 should be a very good year for us. Turning to Asia, we expect growth in China in 2021, supported by increased vaccination rates and strength in data centers, electronics, pharmaceutical and healthcare. Outside of China, the picture is mixed. Vaccination rates generally remain low, with partial lockdowns in some countries. Now I'd like to turn the call back over to Chris.

Thanks, Dave. Please turn to slide number 9. After an outstanding first quarter, we raised our full year guidance significantly with a clear goal of delivering top quartile EPS growth in 2021. Halfway through the year, we're seeing the market strength play out largely as expected. Importantly, we continue to see our 2021 EPS growth guidance as top quartile among peers and other industrials, as we move through the Q2 earnings season. Given increasing inflation and supply chain headwinds, we believe our guidance remains prudent at this time. We are raising our revenue guidance, largely to reflect the additional $150 million in pricing we are executing to offset an additional $150 million of inflation in the second half of the year, as Dave outlined. Net, we've raised our organic growth estimate to approximately 11%, up from our previous guidance of 9%. We also expect to deliver strong organic leverage of approximately 30% for the full year. Other elements of our guidance remain largely unchanged, as you can see on the slide. All in, total revenue growth is expected to be approximately 13.5% and adjusted EPS is expected to be approximately $6.05, which translates to approximately 36% earnings growth versus 2020. We continue to expect free cash flow to remain strong and equal to or greater than 100% of adjusted net income. Please go to slide number 10. We've covered the main points of our guidance, so I won't spend a lot of additional time on this slide. The key takeaways are that we continue to expect strong organic growth, leverage and adjusted EPS in 2021. Additionally, M&A and FX each add additional revenues with modest EPS impact. The primary driver, which moves our leverage target from 35% to 30% for 2021, is the additional $150 million in price we're executing in the second half of 2021 to offset incremental inflation. Please go to slide number 11. We typically only provide annual guidance, however, given the comparisons from unusual 2020 throughout this year, we believe it may be constructive to provide some additional details on the second half outlook. Based on orders, backlog, and market visibility, we currently expect organic revenues to be up approximately 7% in the second half of the year. Acquisitions are expected to add about 1.5 points of growth. Assuming FX holds at current rates, FX would add about another 50 basis points of growth. All-in, total revenues are expected to be up about 9%. In the back half of the year, we continue to expect additional volume to generate strong underlying leverage in the high 20% range. Embedded in that expectation is a netting of transformation savings and other productivity programs, inflation, and continued reinvestment in the business. All of these elements were part of the full year guidance we provided in May. As we've highlighted, the main change since providing guidance in May is $150 million of additional price we discussed. Mathematically, this drives leverage around nine points lower in the back half of the year. We're also taking stock of where we are from a stressed supply chain and logistics standpoint, which is not unique to us, but carries with it real costs and inefficiencies. Our business operating system and our transformation savings are mitigating a large portion of these inefficiencies and we expect to see just a few points of leverage headwind in the back half of the year. All-in, we expect organic leverage in the high teens during the second half of 2021, with successful execution of price to cover material inflation. The other piece of guidance we would provide at this time is that we expect the fourth quarter to have stronger revenue growth than the third quarter, with similar leverage in both Q3 and Q4. Please go to slide number 12. As we outlined during our investor event in December, by transforming Trane Technologies, we initially identified $100 million of fixed cost reductions by 2021. We exceeded our initial cost reduction expectations, delivering $100 million of savings in 2020, a full year early. In 2021, we're on track to deliver $90 million of incremental savings, for a total of $190 million in savings. This performance gives us confidence to deliver $300 million of run rate savings by 2023. We will continue to invest these cost savings to further strengthen our high-performance flywheel, which has a reinforcing and compounding effect over time. Please go to slide number 13. We remain committed to our balanced capital allocation strategy that is focused on consistently deploying excess cash to opportunities with the highest returns for shareholders. We continue to strengthen our core business through relentless business reinvestment. We remain committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve. We have a long-standing commitment to a reliable, strong, and growing dividend that increases at or above the rate of earnings growth over time. We continue to pursue strategic M&A that further improves long-term shareholder returns, and we have a strong pipeline of M&A opportunities. We also continue to see value in share repurchases as the stock trades below our calculated intrinsic value. All-in, we expect to consistently deploy 100% of excess cash over time. Please turn to slide 14, and I'll provide an update on how we're deploying excess cash in 2021. We are on track to deploy approximately $2.5 billion in 2021. Year-to-date, we have deployed $1.3 billion in cash, with nearly $700 million to M&A and share repurchases, including approximately $250 million of share repurchases in July. We have paid $282 million in dividends and $300 million to pay down debt. As I shared, we have a strong pipeline of M&A opportunities and continue to see value in our shares. Now, I'd like to turn the call back over to Dave.

Thanks, Chris. Please go to slide number 16. As we've done in the past couple of quarters, we want to provide an update on the transport markets. Our outlook for 2021 is largely unchanged, with modest adjustments to North America and EMEA numbers. As we discussed earlier, trailer production capacity is constrained in 2021, which is shifting volume to 2022. EMEA added one point of overall growth on truck and trailer strength. Halfway through the year, we're seeing considerable strength in both of these markets across bookings, revenue and backlog, which supports the forecast from ACT and IHS, with an even higher degree of confidence than when we reported our first quarter results. The other point I'd like to highlight is that ACT's forecast for 2022 stands at 51,100 units, up 17% from 2021. This is another strong tailwind for us as we look towards 2022. Please go to slide number 17. 2021 is shaping up to be a strong year for us overall. Our current guidance firmly places our EPS growth in the top quartile of industrial companies, supported by high-quality free cash flow. Energy efficiency and sustainability megatrends are only growing stronger, and we are uniquely positioned to deliver leading innovation that addresses these trends and accelerates the world's progress. And we're not only focused on investments in innovation and growth, but also on investments in our business transformation. We are on track to deliver $300 million in savings that will continue to improve the cost structure of the company. This will enable additional reinvestment to expand margins and further strengthen our ability to outgrow end markets. When combined with the megatrends underpinning our strategy, strong demand in our end markets, our exceptional ability to generate free cash flow and our balanced capital deployment, we are well-positioned to continue to drive differentiated shareholder returns. And now we'd be happy to take your questions. Operator?

Thank you. Operator provided instructions to participants. Your first question comes from the line of Julian Mitchell with Barclays.

Hi, good morning. Maybe just homing in on the color on slide 11, which is very helpful. On the operating leverage, is there any sense when you look at that second half all-in sort of mid-teens leverage figure, which geographic segments may be hardest hit by that, if any? And any context around commercial HVAC versus Transport versus Residential? Any big changes in the operating leverage or divergences across those categories?

Hey Julian, it's Chris. I'll start and then Dave may jump in. As you know, we don't guide specifically to margins or revenue growth by segment. We are anticipating in the second half, high teens organic leverage, really mid-teens all in, when you factor in M&A and FX for where we see it today. Underlying leverage across the businesses is strong. What we're factoring into the second half is additional price to cover material inflation, which is driving down those decrementals by approximately nine points versus our previous guide of 30% organic leverage for the second half of the year. That, plus the supply chain constraints that Dave talked about earlier, are really factoring in why we think it's high teens organic leverage across the second half of the year. And really, when you think about supply chain and price, it's impacting all of our segments. When I think about the Americas, EMEA and Asia, we're all being impacted by similar concerns around raw material inflation and supply chain constraints, they're happening in all the regions.

Yes, Julian, thanks for the question. We're really seeing this across the globe. Supply chain constraints are real and not unique to Trane Technologies. The material inflation has accelerated from the end of the first quarter to the second quarter, and that's why we've taken our third price increase of the year.

And you gave some helpful context around the third and fourth quarters having similar operating leverage across both of them. Let me try and look a little bit further out beyond the next few months and what you've announced on extra price increases. When you take into account the rolling of hedging rates and cost management, do we think that you get back into balance with more normal operating leverage early next year, or is it too early to call that given the many moving parts right now?

Julian, there's a lot of moving parts at this point for us to call 2022. As we talked about in our December Investor Day, we're really looking towards 25% organic operating leverage on an annual basis. We still think we have the demand and the internal structure and cost takeout transformation actions to support that, but as we get closer to 2022, we'll have a much better view of the inflation environment and supply chain environment.

Your next question comes from the line of Jeff Sprague with Vertical Research.

Hey, thanks. Good morning everyone. Just two for me. First on capital deployment. How active is the M&A pipeline? I understand if it doesn't materialize you'll toggle to share repurchases. But is there a decent shot that there's a sizable chunk or two going into M&A here as we close out the year?

Yes, Jeff. I won't give too many specifics, but our pipeline is very robust. We've had a great track record with the M&A we've deployed in the last several years, whether on the channel side or the technology side. So our M&A pipeline is robust and we're hopeful we can execute on some of that.

Okay. And just as a follow-up, on the supply chain in general, with labor and other issues, are you actually at a point of capacity constraint where you're not fully meeting end demand as it materializes? How do you see that playing out in the back half?

The good news is order demand across the globe has been extremely strong in both quarters. We have stressed our supply chain, and this is not unique to Trane Technologies; all industrials are facing this. We have some challenges in the supply chain. Our team is doing a great job managing it and helping our suppliers ramp up. We anticipate this challenge will continue through the third quarter and see improvement in the fourth quarter as key suppliers ramp up. Many competitors use the same suppliers, so the issue is industry-wide. It is constraining us somewhat and causing inefficiencies. Our team is working to get components to the factory, but they are not always showing up when needed, so we constantly reschedule lines and rebalance output to meet customer demand. It will be challenging through Q3 and better in Q4.

Great. Thanks for the color. Appreciate it.

Thanks.

Your next question comes from the line of Josh Pokrzywinski with Morgan Stanley.

Good morning. On Residential: between supply chain and instances of sell-in versus sell-through, the numbers moved around a lot this quarter. Could you say where you ended up in the quarter and how you feel about backlog and ability to deliver in the second half vis-à-vis supply chains and the independent channel?

We're seeing very strong demand in Residential. Bookings in the quarter were up 37% and year-to-date bookings are up over 40%. Sell-through through our independent wholesaler distributors was up in the high 20s, very close to 30%, which is how they're serving dealers. Sell-in to the channel was up in the mid- to high teens. Revenue in Q2 was at record levels and backlog was at record levels. We typically measure backlog in this business in weeks and we're now close to two months. Industry-wide, everything you make right now sells. Demand has outpaced supply chain capabilities. We're helping suppliers ramp up and see challenges continuing through Q3, with the supply chain stronger in Q4. We expect incremental growth rates in Q3 will be less than Q4. Production peaks may extend for an extended period and we'll run factories at peak rates for a continued period. Regarding share, over the last six years we've gained share in Residential. There will be short-term disconnects between order share and shipping share, but over time as backlogs normalize, we expect share gains to show through.

Got it. And on the commercial side in the Americas, how would you carve off the strength between light commercial bounce, new construction, and energy retrofit activity? Which verticals are most responsible?

Across the verticals in our Commercial HVAC Americas business, strength is widespread. Every vertical has growth. ABI has been strong since February, which is a macro tailwind. We're seeing strength across data centers, warehouses, education, and offices. Indoor air quality is a tailwind as well. Stimulus funds are being used to upgrade school infrastructure, creating a multiyear tailwind given our strong position in education and our direct sales relationships. In short, it's broad-based with strength in energy-efficient and innovative solutions.

Great color. Thanks guys.

Your next question comes from the line of Nigel Coe with Wolfe Research.

Hi, good morning. On Residential, this isn't Trane capacity constraints alone, it's suppliers and competitors. Where are the major pinch points on the supply chain? And what measures are you taking to help suppliers cope?

Supply inconsistencies are global across our business. It started with the freak storm that hit the Southeast and impacted resin supply, which had knock-on effects through the supply chain including wire harnesses and electronics. Our products have more electronics across motors, fans and compressors, so it's broad-based. Our team is working 24/7 to mitigate this. It's a whack-a-mole where one supplier is fixed and another has issues. We're working with strategic suppliers as partners, with teams helping them ramp up. We have visibility that Q3 will be challenged and Q4 should be better as suppliers execute ramp-up plans.

On the M&A pipeline, some deals in the market are richly priced. Is the barrier pricing or fit? Are you focused mainly on hardware acquisitions or more on software and technology?

Our M&A pipeline is very robust. We use the same disciplined model we've always used and will ensure opportunities clear our hurdles. We're not buying for the sake of buying. There is value out there; we've seen it in channel acquisitions and technology acquisitions. Stay tuned.

Okay. Thanks Dave.

Your next question comes from the line of Andrew Obin with Bank of America.

Good morning. If we could talk about Residential, given seasonality where September and October are lower volume months, is it fair to assume you could have been up year-over-year in Resi given demand and backlog if it weren't for supply chain constraints? Also, could you comment on the applied business visibility in key institutional verticals, particularly education and healthcare?

Backlog in Residential is very large—close to two months versus our typical 1 to 2 weeks—so as we burn backlog we'll return to normal rates. Supply chain is a constraint now. In February, a freak storm affected our Tyler, Texas plant and caused a partial roof collapse of a small portion of the building. No one was hurt and the plant was producing within five days; the ramp-up is proceeding as scheduled. We're producing at high rates and saw record revenue in Q2. Supply chain is the constraint and we have line of sight to a stronger Q4 versus Q3. From a production standpoint, peaks may extend, and we'll be running factories at peak rates for an extended period. On applied business institutional verticals such as education and healthcare, we're seeing strength; our pipeline remains robust. We have a strong value proposition in these verticals and expect continued activity.

Thank you. I leave it at that.

Your next question comes from the line of Andy Kaplowitz with Citigroup.

Hey, good morning. Regarding indoor air quality demand trending toward the high end of your 1% to 2% range for this year, are you seeing more customers asking you to do the day-two type work? And could you talk about the longevity of this cycle for verticals such as education and offices? Do you see a multi-year 1% to 2% tailwind?

We see it as a 1% to 2% tailwind into the future and expect to be closer to 2% this year. We are seeing day-two activity in education as we provide roadmaps for infrastructure upgrades and stimulus funding is being used. We're also seeing increased demand in offices for indoor air quality audits as employers think about bringing employees back. Indoor air quality solutions are increasingly embedded in applied systems, making it harder to separate IAQ from applied systems, similar to controls, so the impact will persist.

And if I shift gears to transport refrigeration, given the pause in orders in the quarter due to OEM capacity constraints, would you say transport refrigeration still grows double digits in 2022? Do you have good visibility into 2023 now?

We are not concerned about lower order intake in Q2 because Q1 bookings were very strong and the Q2 order pause reflects customers placing orders for the full year and trailer OEM capacity constraints, which shift volume to 2022. You can't sell a trailer reefer unit without a box. For 2022, ACT's forecast for the trailer market is 51.1k units, up 17% from 2021, which is a strong tailwind. For 2023, the forecast is mid-40,000 range in North America, which is where the industry has been for many years excluding 2020. So 2022 should be a strong year for Thermo King and 2023 also looks promising.

Appreciate it.

Your next question comes from the line of Steve Tusa with JPMorgan.

Good morning. Just on price-cost dynamics: can you talk about what you initially planned for the year, what the total numbers are, and what you booked in the quarter?

In Q2, price-cost was positive, and it was positive in Q1 as well. In Q2 we saw direct material inflation roughly four times the size of Q1, so it's ramping up into the second half. With the guide for the second half, we added $150 million of price to offset $150 million of inflation, which is about two points of price in the second half. That $150 million is a bit more than we had in the original guidance for the second half. Historically, in the 2017-2018 cycle it took many quarters to catch up on price, but this time we're positive in Q1 and Q2 and expect to be roughly flattish in the second half as we keep up with inflation. The $150 million is an increase from our May guidance, and volatility remains.

Our operating system today allows us to be much more responsive in pricing versus 2016-2017. Many applied jobs don't have standard price lists, which is why real-time pricing capability is valuable.

So what is the total absolute dollar cost headwind for the year?

I wouldn't peg an exact dollar cost number given the volatility. For the full year, we expect to be flattish on price-cost; it could be a little favorable depending on how things fall out. From a commodity perspective for the second half, roughly 60% of copper and aluminum exposure is locked with hedges, which is an increase from earlier, but we still have some exposure in the second half. It's significant and volatile, so it's difficult to give a single dollar figure.

And on light commercial unitary, how did that perform in the quarter?

Our unitary business was very strong, with incoming order rates up well over 30%. Revenues were also strong and close to that level, though a bit lower than the incoming order rate.

Okay. Great. Thanks for the color. Appreciate it.

Your next question comes from the line of John Walsh with Crédit Suisse.

Good morning. Could you talk about whether customers are delaying applied projects because they see broad-based inflation? I'm thinking more about new construction. Also, could you give color on Europe and heat pump demand and what Commercial HVAC orders did in Europe this quarter?

We're not seeing broad delays in orders; incoming order rates remain strong. We are seeing some delays in job sites being ready to receive equipment, which started to pick up in Q2. The construction industry is having difficulty getting skilled labor, and some job sites have been pushed out, which contributes to strong backlog in commercial. In Europe, orders were up 53% and revenues were up about 28% this quarter, with substantial strength in both Commercial HVAC and Thermo King. We're seeing strong demand for variable water flow systems, which supports electrification of heating, and industrial process cooling demand as we've expanded operating maps for our products. In Thermo King, the Advancer product has exceeded customers' expectations on energy efficiency and we continue to see success in Europe.

Great. Thanks for taking the questions.

Your next question comes from the line of Joel Tiss with BMO.

Hi. Could you provide color on Asia? Any implications from government actions or attractiveness in Residential? Are you still gaining market share in Asia?

Our Asia business is executing well. Incoming order rates in the quarter were in the low teens. We're continuing to see margin expansion; since we invested in our direct sales force, margins have improved meaningfully, up about 500 basis points since 2018. We're pleased with the balance of revenue growth and margin expansion; margins in backlog remain strong. In China, government moves such as the launch of the carbon trading market in July are a tailwind for our business. Their goals to be carbon neutral by 2060 create a large built environment opportunity where our portfolio can help decarbonize their economy.

I'd add the Asia team has struck a great balance between revenue growth and margin expansion, showing strong discipline on both sides.

That's great. Thank you very much.

Thank you. I'll now turn the call back over to Zac Nagle for closing remarks.

Thank you everybody for joining today's call. As always, we'll be available at any time to take your questions. We look forward to seeing you all soon and have a great day. Be safe.

Thank you. This does conclude today's conference call. You may now disconnect.