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Trane Technologies PLC
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Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the Trane Technologies Q2 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Mr. Zac Nagle, Vice President of Investor Relations. Please go ahead, sir.
Thanks, operator. Good morning. And thank you for joining us for Trane Technologies' second quarter 2020 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 Mike Lamach, Chairman and CEO; Chris Kuehn, Senior Vice President and CFO; and Dave Regnery, President and COO.
With that, please go to Slide 3, and I'll turn the call over to Mike. Mike?
Thanks, Zac. And thanks, everyone, for joining us on today’s call. I’d like to start today's call with some perspective on the unprecedented level of change was seen around the world, both in business and in our personal lives over a time period of just a matter of months and why and how this is particularly relevant for Trane Technologies.
The COVID-19 pandemic has disrupted long-lived paradigms on what was considered normal and is exposed obvious truths about the many ways the old normal wasn't good enough. Normal has meant rapidly rising emissions and temperatures, creating a global climate crisis and pollution and poor health in many of our world's biggest cities where COVID-19 has had a disproportionately damaging impact in communities, where the demographics are most socioeconomically challenged. Normal has meant hunger, even though one-third of the global food supply is lost or wasted each year. And normal has meant inherent, systemic racism, injustice, and inequality.
At Trane Technologies, we want to be part of creating a better new normal. We will challenge the status quo to create a new normal where communities thrive, where quality is foundational and where the environment is protected for future generations. We're putting a stake in the ground that Trane Technologies will lead by example, by setting historic and ambitious commitments and taking action to change our company, our industry, and the world.
Our Gigaton Challenge commits to reducing our customers’ carbon emissions by one gigaton or a billion metric tons by the year 2030. To give you an idea of the size and scale that's equivalent to about 2% of the world's annual emissions, and that's just our company alone. As other companies join in, we can bend the curve on global warming.
We're also committed to creating opportunity for all, with a goal to achieve gender parity and leadership by 2030 and racial and ethnic diversity that is reflective of our communities. As Chair of the National Association of Manufacturers, I introduced a pledge for action, which the executive committee unanimously adopted on behalf of its 12,000 members focused on advancing opportunity for black people and other people of color through advocacy, education, training, and workforce development initiatives.
We're having important dialogue within our own organization and in our communities and how we can accelerate our efforts to combat racism and better support communities in need. This includes programs to eliminate hunger, sport education and economic mobility, and to increase affordable housing.
Our transformation plan for Trane Technologies is another example of how we're creating a new, better normal for our team, customers and shareholders executing against the new blueprint that culminated in May, after 10 months of analysis and planning. Setting these and other bold plans in motion, our talented team around the world has exhibited all the commitment and passion for change that has marked our last decade.
Our goal is simple, to create a new normal where opportunity is accessible for all, where healthy food, water and medicines are moved to people who need them, where emissions trend down and blue skies trend up. Our business sits right at the intersection of making those things happen. With our unique positioning as a focused climate innovator, transformed and fit-for-purpose, we can tackle these pressing and complex challenges and drive differentiated returns for shareholders.
Moving to Slide 4, the global COVID-19 pandemic continues to present ongoing challenges to virtually every aspect of daily life. As much progress as we've made, this crisis is still very much with us and the questions we were all contemplating months ago regarding the depth and duration of the downturn and the speed and shape of the recovery, that's still very much a question.
As we navigate through the pandemic of paramount importance is staying true to our culture, purpose and values for maintaining world-class employee safety as part of our DNA. The decisive and aggressive investments we made in the first quarter were important and necessary steps in order to bring all of our facilities online, operating efficiently and safely.
As a result, today, we're up and running under new readiness protocols and well positioned to meet customer demand. Despite very challenging global markets, our teams remained focused and agile with strong execution and solid financial performance. We outperformed our end markets broadly and effectively managed deleverage within our gross margin target levels in all regions and in all business units.
We continue to play aggressive offense in order to emerge stronger and to thrive as business conditions improve and new opportunities emerge. We maintained high levels of business reinvestment and innovation and growth programs through the second quarter. And we expect to aggressively invest in the second half. We're also accelerating our stranded costs and other fixed cost reduction initiatives to deliver more bottom line savings in both 2020 and beyond.
We remain in an exceptional financial position with strong liquidity and balance sheet optionality, which are competitive differentiators for us. We have ample capacity to run the business, effectively deploy capital and remain nimble as market conditions evolve. We'll discuss this in more detail later in the presentation, but our best line of sight at this stage will put revenue somewhere between down 10% and down 15% for 2020. Better than illustrative scenarios we laid out in quarter one.
Our strategy remains unchanged, secular mega trends of energy efficiency and sustainability are becoming more pressing every day. We excel at addressing these mega trends and challenging what is possible for a sustainable world, redefining a higher standard for what the world considers normal. This passion powers us forward to deliver top tier financial performance and differentiated returns for our shareholders.
Please go to Slide 5, bookings and revenues were heavily impacted by the pandemic in all regions in the second quarter. In the Americas, the impacts of the pandemic continue to be far reaching and severe. Broadly speaking, the economy is slowly progressing forward, but the situation remains tenuous and provides limited visibility.
In North America, our Commercial HVAC business has been relatively resilient through the second quarter, with bookings and revenues each down mid single-digits. Backlog continues to be strong and services are outperforming equipment.
Our transport refrigeration business outperformed the overall market as it continues to move through a deep down cycle, which has been exacerbated by the pandemic. Bookings are showing signs of stabilization, although it's too early to say the market has stabilized.
Revenues were down more than 40%, outperforming the market, which was down more than 50%. Our Residential HVAC business had low single-digit bookings decline, with distributor sell-through down mid single-digits. June saw record bookings and backlog and July is off to a very strong start.
Turning into EMEA, Commercial HVAC bookings were down mid-teens, while revenues were down high single-digits. Services outperformed equipment with building access continuing to improve. EMEA transport was down approximately 20%, outperforming the broader transport markets, which were down approximately 40%.
Asia-Pacific continues to be mixed. China is showing signs of improvement, having made the most progress against the pandemic. Growth in China was more than offset by declines in the rest of Asia, with developed countries generally recovering slowly, while many developing countries are lagging.
Now I'd like to turn the call over to Chris to discuss the results for the quarter in more detail. Chris?
Thanks Mike. Please turn to Slide number 6. The pandemic has continued to significantly impact both top and bottom line results. Mike provided a good overview of our top line results on the prior slide. So I'd like to focus my comments on the bottom line. Adjusted EBITDA margins were down 80 basis points, primarily impacted by significant volume declines in the quarter.
We continue to execute our recession playbook in the second quarter, evolving with market conditions. We delivered strong productivity and managed deleverage within gross margin target levels, despite lower volumes, fixed cost under absorption and other pandemic and volume related inefficiencies.
We also maintained high levels of business reinvestment and continue to ramp up our facilities and further invest in employee safety measures. Price/cost remained positive in the quarter, while mix was a significant headwind, with steep declines in transport revenues in both the Americas and EMEA. There were a few other relatively modest puts and takes on margins and EPS that are outlined on the slide for your reference.
Please turn to Slide 7. Turning to the regional segments, I'll once again focus my comments on margins, given Mike covered revenues earlier. In each region, strong productivity, partially offset volume declines, fixed cost under absorption, investments in employee safety and other business reinvestments and innovation in growth programs to deliver better than gross margin deleverage. Price/cost was largely favorable, while transport makes us a headwind on lower transport revenues.
Now I'd like to turn the call over to Dave to provide details and color on what we saw in our end markets in the second quarter. Dave?
Thanks, Chris. Please turn to Slide number 8. As we've discussed throughout the presentation, the COVID-19 pandemic continues to have far reaching impacts across the global economy, as it continues to evolve, which limits our forward visibility into our key end markets. With that caveat, this slide endeavors to provide our best view of our end markets at this point in time.
As we've highlighted, North America Commercial HVAC has been relatively resilient through the second quarter. Order rates continue to be soft, and we expect a continuation of this trend heading into the back half of 2020, given the high level of economic uncertainty that persists. Services typically hold up better than equipment on a downturn, as owners look to extend the life of existing equipment. And we're seeing signs of that during this pandemic.
On the other hand, the number of pandemic related businesses and school closings or partial reopenings and generally low level of building occupancies are having a negative impact on services. We're also seeing high levels of interest in comprehensive indoor air quality assessments and momentum in this space continues to build. The universe of opportunity is huge based on billions of installed square footage that could ultimately be evaluated but the opportunity is still early stages.
Our tremendous installed customer base and best-in-class sales and service capabilities put us in a strong competitive advantage as this market evolves. Longer-term fundamental energy efficiency and sustainability mega trends, underpinned sustained secular growth for these markets.
We expect to outperform the markets in 2020, given competitive advantages throughout the value chain from channel to sales, to controls and digital services to the largest, most capable service organization in North America. Residential HVAC had mid-single-digit sell-through declines and Q2. Record bookings and backlog in June and July is off to a very strong start, which are positive indicators for this business near-term. Consumer economic indicators are mixed and volatile and unemployment remains at historic levels, which limits longer-term visibility.
Transport markets continue to move through a cyclical downturn in 2020, amplified by the COVID-19 pandemic. ACT most recent forecast for transport still has the second half of 2020, down more than 40%. We continue to expect to outperform the markets, but looking at a down 40% second half forecast suggest tough sledding ahead. Looking out into 2021 ACT continues to project a snapback in the North America trailer market of over 20%. In EMEA, given the depth and impact of the pandemic on many European countries, most major cities are taking a cautious day-by-day approach.
For commercial HVAC, we see opportunities for overall market outperformance through our clear focus on our sustainability advantages, but overall visibility remains limited. In transport, we’ve recently introduced new products such as the Advancer product, I'll discuss on the next slide. These products have clear competitive advantages that will be tailwinds as market conditions improved. Most recent forecast for the transport markets in EMEA have deteriorated dramatically from April's forecast, down almost 50% for trailers and down over 100% for trucks for 2020, further pressuring our second half transport outlook.
We have a slide in the appendix on the transport markets, you may find useful. We've talked at length about Asia Pacific, while China continues to recover at a steady pace with strength in data centers, electronics, pharma and healthcare, the rest of Asia remains mixed and difficult to call when they will improve.
Please turn to Slide number 9. We've been clear at Trane Technologies, we are playing aggressive offense during this downturn, in part through heavy investment in a robust pipeline of product innovation in growth programs. Today I'll highlight just four tangible examples that are emblematic of innovation, market-leading products and services, we're bringing to market. Indoor air quality is generating tremendous interest in the market. Our customers are turning to us for our expertise to improve the safety of their buildings and to build the confidence of their building occupants.
In commercial HVAC, we're providing indoor air quality assessments, which are fact based data driven analysis on four key contributors to indoor air quality, contaminant source management, humidity control, filtration and fresh air intake. These assessments are not checked the box exercises. We check everything thoroughly. Some large campuses and manufacturing locations can take 100s of hours to complete. Once the assessment is completed, we work with our customers to implement a layered approach that balances the key contributors to indoor air quality, while finding opportunities to reduce energy intensity.
The layered approach is fully customizable and might include modifications to control sequences, improve filtration or additional sensor that closely measure and adjust for changes in humidity and CO2. Our unmatched application expertise, direct service channel and remote services, uniquely positioned us to balance energy intensity and indoor air quality in a customized solution for each customer.
Last week, our European commercial HVAC team announced our synthesis balanced for pipe chiller. The synthesis balance utilizes low global warming potential refrigerants to simultaneously heat and cool a building with zero direct greenhouse gas emissions. The synthesis balance can deliver hot water with temperatures over 150 degrees Fahrenheit to replace the need for a separate boiler, and is more than 350% more efficient than the boiler it replaces.
Our European transport team recently introduced our next generation trailer technology, the Advancer, the Advancer has the lowest total cost of ownership and is the most sustainable trailer refrigeration unit on the market. The Advancer delivers 30% better fuel consumption than any other trailer unit and reaches its target temperature 40% faster and take 60% less energy to produce. We also recently launched our large truck hybrid series. Our hybrid truck refrigeration unit can operate in three different modes to meet our customer's needs. The system automatically selects the best operating mode depending on the circumstance to deliver up to 50% fuel savings, when operating in a hybrid mode.
With unmatched operating flexibility, these hybrid units provide our customers full access to cities restricting or banning vehicles due to noise or diesel emissions. These are just a handful of the innovations we're bringing to market during the downturn. Making these types of investments through down cycles enables us to continuously expand our competitive position year-after-year.
Now, I'd like to turn the call back over to Chris, to discuss our efforts to reduce our fixed cost base. Chris?
Thanks, Dave. Please go to Slide number 10. At the time we announced the industrial RMT transaction, we recognized that there would be approximately a $100 million of stranded costs from the transaction. We quickly mobilized the transformation office last year to remove $100 million of structural costs from the business by 2021.
Our goal in January of this year was to eliminate $40 million of the $100 million in stranded costs in 2020. With the onset of COVID-19, we've significantly accelerated this timetable and total savings target. We now expect to eliminate the full $100 million of stranded cost target in 2020, a year ahead of schedule. In addition, the programs we're executing to achieve the $100 million in stranded cost reductions in 2020 are expected to yield run rate, fixed cost savings of $140 million in 2021. As we previously disclosed, we expect onetime expenses of approximately $100 million to $150 million to eliminate the $100 million in stranded costs. And the table on the bottom right of the slide shows our status to date. We have spent approximately $75 million year-to-date with $44 million in the second quarter.
Please go to Slide number 11. We are operating from a position of financial strength as we move through 2020. We have a strong balance sheet, excellent liquidity and have maintained solid investment grade ratings over many years. Additionally, our consistent track record of delivering free cash flow of equal to, or better than 100% of adjusted net income over time with a five year average of 107% further bolsters our strong financial position.
In addition to cash on hand, we have access to $2 billion in revolving credit facilities. During the second quarter, we refinanced $1 billion credit facility extending its maturity to 2022. The second $1 billion facility matures in April of 2023. Even if we were to fully utilize both facilities, we would remain well below our primary debt covenant of 65% debt to capital. Both facilities were undrawn at June 30th and remain undrawn today.
Please go to Slide number 12. We remain committed to balance capital deployment, as we have consistently done for many years. We see this as a time to aggressively reinvest in our business and to solidify and extend our market leading positions through value accretive investments that will make us an even stronger company coming out of this crisis than when we went in. We expect to continue to pay a competitive and growing dividend, and I've already paid approximately $253 million in dividends year-to-date.
To preserve liquidity, we paused share repurchases during the first half of 2020, entering the back half of the year, we will retain optionality for share repurchases as visibility improves. Regarding debt obligations, we paid $300 million in April to retire debt at maturity and expect to pay another $300 million to retire debt at maturity in February of 2021. We continue to evaluate strategic value-accretive M&A, we expect to maintain a strong investment-grade credit rating, offering us continued optionality as markets evolve. Lastly, we remain committed to deploying 100% of excess cash to shareholders over time.
And now, there are formal guidance remains suspended until market visibility improves. I'll turn it back to Mike to provide an update on the scenarios we presented last quarter. Mike?
Thanks, Chris. Please go to Slide number 13. On our Q1 earnings call, we shared two revenue scenarios, one down 15%, one nearly down 25%, to demonstrate that under both scenarios, we remained in a strong financial position, continue to make investments in the business, fund the dividend and play aggressive offense during the downturn. Looking out towards the back half of the year at the current pace and progression of the reopening of global economies, we expect to outperform both of these scenarios unless the pandemic or some other unknown negative catalyst catapults the markets lower.
Given current course and speed, our best view at this stage is to expect revenues to be down somewhere between 10% and 15%. We will continue to confidently and strategically execute our downturn scenario playbook operating from a position of financial strength, as we've done through the first half of the year.
Please go to Slide 14. Energy efficiency and sustainability mega trends are only growing stronger as time passes. Fundamentally, we excel where these global mega trends and sustainability intersect with our innovation and capabilities, which drives high demand for our products and services. We've been investing heavily for years to build franchise brands and to advance our leadership market positions to enable consistent profitable growth. As Dave outlined with a few tangible examples, we intend to press our advantage during this downturn to leverage our strong financial and competitive positioning and to invest heavily in the future of Trane Technologies.
Not only focused on relentless investments in innovation and growth, but investments in blueprinting and transforming into a leaner, fit for purpose, pure-play, climate innovator. The elimination by stranded costs and the execution of transformation initiatives that will fundamentally improve the margin profile of the company over the long-term. Lastly, we remain committed to dynamic and balance deployment of capital, and we have a long track record of both delivering strong free cash flow and deploying excess cash to deliver top tier shareholder returns over many years.
And with that, Chris, Dave and I will be happy to take your questions. Operator?
[Operator Instructions] Your first question today comes from the line of John Walsh from Credit Suisse. Please proceed with your question.
Hi, good morning everyone.
Good morning, John.
Good morning.
Hi. I guess can we first start talking a little bit more about service, I guess maybe what would be contemplated in that scenario framework of down 10% to 15% for the back half as it relates to your service business and did you see kind of improving trends throughout the quarter as you were able to get access to buildings?
Yes. Thanks for the question, John. This is Dave, I'll take a first shot and then Mike could add comments and Chris. During Q2, we saw equipment and services down really in every region and services was much more resilient than equipment. As the quarter progressed, if you remember at the end of the first quarter, we were talking about our service business being impacted by not being able to have access to buildings. As the quarter progressed, we had those safety protocols worked out with our customers, so that became much less of a problem. We still have a few areas in the world, maybe some countries in Asia where that's still a problem, but for the most part, we've overcome that.
As far as your question on the outlook, we expect service 300 basis points to 400 basis points better than equipment in the back half. We are seeing a lot of interest in our service business in our indoor air quality assessments. And we're also seeing a lot of opportunities in service in our digital connections.
Great. And then maybe just a question around the conversations you're having with customers and there is probably a wave one of decisions as it relates to a building, maybe it's air changeovers, cleaning. Wave two, I would think would be some more of the higher retrofits you talked about. Where do you think customers are on that decision process as it relates to maybe doing, larger, heavier renovation or retrofits of their systems for indoor air quality?
Yes. I would tell you, we're going at this at a very holistic level, okay. So when we do an assessment, when we've been asked to do 1,000 of these assessments, it's really at a system level. So the first thing that we would do is we would come in and make sure that the system was in fact operating as it was designed, once that has been achieved, we start layering in different options for our customers to evaluate not only the indoor air quality, but also the energy intensity. And that could be things such as fresh air exchanges, if you're exchanging three times an hour, perhaps you want to move to five times an hour, filtration, if you're going to change your filters, what would that sequence look like?
And what would the ramifications be to the rest of the system? We see a lot of people out there just changing filters that could solve a problem or it could actually cause an additional problem, meaning you could have too much friction in your air ducts, you won't be able to move air through it, thus causing less clean air into the indoor air quality assessment. So we take a very holistic view, we then go and we look at the energy intensity, because everything I just mentioned, filtration and fresh air exchanges tends to use more energy and we're working with our customers to find other ways to offset that energy.
John, in some cases where the capacity of the systems, as Dave said, when you – you might increase filtration to a very high MERV filter, but the pressure drop across the filter may not support the ability for the fan, the fan may be under size or the casing. So the duct work could be under size, you can actually implode systems or blow up fan motors. And so it's the level of modeling and sophistication and retrofitting required for each unique situation. And that's, I think a tremendous advantage of us – our capability to be able to provide that.
So as Dave said, there is really been 1,000 of assessments done. I assume we're going to be doing 1,000s more assessments for a long time. And it's such a big opportunity, it's hard to put a number on it, because you're talking about billions of square feet around the world and everybody's dealing with the same kinds of issues and problems.
Great. Thank you. I'll pass it along.
Your next question comes from the line of Joe Ritchie with Goldman Sachs. Please proceed with your question.
Thanks. Good morning, guys.
Hey, Joe.
Hey, Joe.
Mike, maybe you can kind of touch on just the commercial market for a second, there is a lot of consternation out there regarding what non-resident structure is going to look like, through the end of this year and then into next year. And I'm wondering, one, if you could just kind of give some commentary on how you think things are going to play out and how your business is positioned? And then two, just as it relates to 2020, is there a possibility for some type of like budget flush from facilities? Because maybe they haven't spent as much money in the first half of the year and there is maybe some opportunity for additional spending in 2H.
Hey, Joe. I’ll start and I’m going to give Dave a chance to put more color on that. But yes, look, I think that in terms of buildings reopening, there could be a need for buildings reopening to do service that's been deferred or delayed. But frankly, I think what'll take precedence over that is these indoor air quality assessments to make sure buildings actually can open and open safely. So, if you think about a strategy for returning to school, K312 in the U.S. would be a great example of that.
It's not a function of just going in and doing deferred maintenance, it’s a function of going in as Dave said and looking at if whether or not the systems are working to design or code or to standards or what might be done to provide more reassurances. And so, my sense would be that in some cases you could see what would have been preventative maintenance being spent on more retrofits into the system itself and how that looks into 2021, it's hard to tell. I mean, if you think about our business today in North America, it's 50% services, 50% equipment, of the 50% equipment, really only 20% or 30% of that is equipment, as we reported as Dodge put in place, the balance of that is retrofit.
So my sense is the 70% of our business is going to be a tremendous amount of interest, I would say in indoor air quality first. And then I think as everybody knows, it's just not a matter of putting in a new system or retrofitting a system to have better indoor air quality characteristics, you don’t have to maintain that system again that new better higher standards. So I think in the long run it really helps our model, it helps our business and clearly it creates a safer environment for occupants.
Yes. I mean, the only color I would add to that, Mike is, there is a lot of science behind indoor air quality and we've been at this for a long time. So we know how to do this, we've been selling this for years, it's just now we're getting a lot of attention, obviously, because of COVID. The other area that we're seeing, and I mentioned it earlier is in our digital connections. We're seeing a lot of customers now asking to be remotely connected, they understand the advantage of that now. So that's another area that they're making investments and we think that will continue into the second half.
That's helpful guys. My one quick follow-up here. You guys mentioned that on the resi side of your business in America, the distributor sells through was only down mid-single-digit. I'm just curious, like where do you think inventory levels are? Is there a possibility for restock to also kind of help that business?
Well, we're actually joining in a great position to answer that because half of our business would be independent wholesalers and half of our business is, they're company owned wholesale distribution points. So we sell both, we see both the sell in and the sell through. But it's such an archaic time, one like, I've never remembered before where you saw in April and May the normal sort of selling that you would do to independent distribution really didn't happen as independent distributors made a decisions about what they’ve thought the economy was going to hold for them and probably some preservation of working capital, some hesitation there.
What they found out was the consumer was relatively resilient during that period of time. And probably, on average, found out they were holding say 25% less inventory as they entered June, than they needed to, of course, the sell through didn't changed, and we saw that on the company owned side of the equation. So that led to a record June in bookings for us, and it's led to a record July. I'll just give you one intra-quarter data point there, which is July, because it is such a quick book and turn business that it is relevant.
So the numbers there were quite extraordinary, June bookings up say 40%, July booking say up 50%, all that pushed out from what would have been the normal seasonality of April and May. So the important thing I think for investors to look at right here is how healthy is the consumer, what's the sell through the actual take rate from the consumer and are they mixing up or mixing down?
Interestingly, we're seeing a mix up and that's different. We're fortunate to that because part of what we're seeing in terms of our growth and our performance has been – we're now in the value segment of the market in this downturn. But ironically, we're seeing growth in both. We're seeing growth in for us at the entry level, at the value price points and we're seeing the premium systems also continue to have some solid strength.
Thanks. Great color, guys.
Your next question comes from the line of Scott Davis with Melius Research. Please proceed with your question.
Hi. Good morning, guys.
Good morning, Scott.
Good morning.
On the M&A side Mike, what's your appetite to potentially going outside of the cold chain? I mean, you could define your exposure to buildings pretty broadly and building controls and all kinds of things, maybe unrelated to the cold chain. Is that in your – is that a possibility or are you more likely to stay within your core?
Well, it's interesting, Scott, because as you really look at the value chain inside the cold chain in the adjacencies that we would have still inside the cold chain, easily get to a $250 billion or $260 billion market. And even the example that Dave gave, which is the electrification of heat in Europe, right, we've never been in the boiler business, we've never been in the heating business per se in Europe. But now you create a solution where between cold air and hot water, you may be three or four times better than independent solutions, and we find ourselves now really in an adjacency, which is growing the business in Europe with ductless four pipe systems that allow us to participate in $1 billion market in Europe that we didn't participate in before.
So one of the beautiful things about the work we've done in the transformation has all the strategy work to understand these adjacencies and see where the leverage is. So right now, everything we're looking at is fundamentally is how we see the adjacencies in the HVAC and refrigeration space. It doesn't mean that over the long run, we wouldn't look, but I think we've seen great opportunity right in our sweet spot, in our core competencies utilizing our channels, our engineering talent, our R&D, all the things that we're really good at.
Okay. That’s helpful. And just as a follow-up, the indoor air quality stuff is dynamic, for sure. Is there any sense that perhaps government level standards could be established and maybe that's helpful for you guys like CDC or governments around the world that, I mean, may perhaps catalyze some of these changes? Because we all know without sometimes a little bit of a push sometimes building owners can be a little slow to move.
Yes. Scott, there is some talk about that, obviously, we'd be a big part of any kind of standards that were derived, we've worked with ASHRAE, which is really the organization that kind of monitors this and has a lot of the testing associated with it. We've been asked by our customers, if you see in the presentation kind of that emblem there, they want their employees to know that in fact an expert has come in, has taken a look and have made changes to make the environment a safer place. So there is a chance that could become like the next lead. But right now, there is no quote standards around that as we speak.
Yes. The only thing I'd add, Scott, building codes generally adopt, like in the case of the U.S. example ASHRAE standards. In fact, the ASHRAE standards were adopted throughout the world often in terms of codes and standards. So although the federal government is not mandating a particular standard, it's all built into the building codes that you would see in various States and municipalities around the list of country here.
Okay. All right, guys. Good luck. Congrats on keeping the wheels on and doing well.
Thanks, Scott.
Thanks, Scott.
Your next question comes from the line of Steve Tusa with JP Morgan. Please proceed with your question.
Hey guys. Good morning.
Good morning, Steve.
Hey, Steve.
Good morning.
Can you just talk about what you think the market did for resi HVAC? I mean, I think you guys said you were down mid-singles for the quarter. Did you – do you think you gained market share?
There is no doubt about the second part of your question. I think Dave, the market might've been down 11%, 12%, because of the weak April, May.
Yes. And it really has to do with the week April, May, as Mike said.
Right.
June was extremely strong.
And you define the market is just the AHRI kind of factory shipments.
Yes. You can do that in hardy, I mean, you triangulate between the two for sure. Yes.
Okay. When it comes to kind of the pipeline for commercial and these orders, I mean, you would think that this is a late cycle market and things will fade here over time. Are you expecting orders to kind of decelerate here or has that kind of bottomed as well?
Well, for new put in place Dodge data, the 20%, 30% of the North American commercial business, you've really got to pull that apart – pick it apart by vertical market. And some vertical markets are obviously going to be growing and be more resilient, warehousing and data centers have been more resilient as an example versus retail office buildings or retail restaurants, that sort of thing. So you have to really pick that apart. But for the balance of the business, I think there's going to be a very active multiple year opportunity around going into the 70%, 80% of the business, right, both the service business and the retrofit business, the demand that we drive.
Really looking at what the outcome needs to be around, some of these IAQ assessments and whether or not a customer can do everything at one time, thinking about a large school district or campus, or they want to prioritize certain things over time, you could really run out multi-year asset plans for customers around the facilities and what would work. So it's hard to know sort of, if you think about the percentage of the 20%, what would decline and compare that against what the opportunity is for my key basis, resulting retrofits and service opportunity within that, it's too early to tell Steve. But there's reason to hope for us that there's going to be a busy time for us relative to being able to drive demand through what we know how to do from an IAQ assessment.
And then as Dave said and I followed onto Dave, all this is a tremendous tax on the energy efficiency of a building. So whether a building is occupied at 50% or 100%, in terms of running the systems, you're still running those systems at very high usage rate, and the intensity of course is very high with HVAC and lighting systems. So if you're going to take these IAQ ideas, which all our tax on energy used in the facility, we're going to have a second round or really a parallel round of when customers take an action to improve indoor air quality, looking for offsetting energy conservation measures to neutralize that, that I think is an opportunity as well. But it's too soon for us to tell kind of what really plays out.
Okay. Great. Thanks for all the detail.
Thank you.
Your next question comes from the line of Andy Kaplowitz with Citigroup. Please proceed with your question.
Hey, good morning, guys. Nice quarter.
Thanks, Andy.
Hi, Andy.
Mike, can you give us a little more color regarding the contributors to the better than gross margin, detrimental margin that you deliver in the quarter? Because it looks like you had several productivity projects that were effective, price versus cost was obviously very strong in the quarter. And then we know that you would – you said you would continue to deliver a detrimental in line with gross margin, maybe better than that in Q4. But given some improvement in your markets, why couldn't you deliver detrimental closer to Q2’s performance?
Yes, let me kick it off just with a general comment. I may have Chris for more specifics. But we wanted to establish sort of a set of guardrails, the guardrail being – we were going to run the leverage no worse than the gross margins of the company. And we're making a commitment for shareholders to know what to understand, would be one side of the guardrail. What we also said is we're going to play aggressive offense around running the business for the long run and trying to emerge a much stronger company through this.
Now to the extent we can do both and invest in everything that we want to do, including the products and services that Dave mentioned, launched in the quarter, there is a possibility of doing better than the worst guardrail. So that's what happened in quarter two.
But you have to realize these differences between a 20% leverage rate and a 30% leverage rate in the quarter like this past or last quarter, might have been $20 million or $30 million, right. Which in the grand scheme of things, if we choose to make an investment, which runs it to 30%, as an example, or we take another action, it's not as meaningful to us inside the quarter. But the one thing that investors should look at is the commitment that says, there's a guardrail that says, we're going to run the business with decrementals for the full year, add them inside our gross margins. Chris?
Yes. Mike, I would just add, all-in, it is a mix it's not clear today, how much is temporary versus permanent but we are really proud with the productivity, the tight spend control we had in the second quarter. With that, what is permanent are the structural cost takeouts that have happened that we've announced here and getting a full year ahead of taking out $100 million of stranded costs from the transaction.
And maybe last, just to add there, as we think around the fourth quarter of this year, we may actually see deleverage be a little bit better than gross margins. You may recall we had a couple of one-timers in the fourth quarter of last year that we should comp better against here in the fourth quarter, Andy. But otherwise, Mike's laid out for you kind of the guardrails and happy where we landed in the second quarter.
Thanks for that. And then, Mike, I just want to follow-up on some of the residential comments you made in the sense that, you did mention the 50% growth in residential bookings, if I'm not mistaken July, which is obviously [indiscernible] demand just for a month, obviously.
But we know it got hotter, home sales have improved a bit. But did you see this boost as more of a fundamental change in the market, given the evolution of work from home? So maybe this change is more sustainable. I mean, we know we're not going to have that kind of growth every month, but just as there is something different about the market from what you can tell?
Yes. That's why it was important this time to just give you the best information we can and to make it as simple as we could for any investor to understand was look at the sell-through, because it's just these aberrations we're seeing where distributors might've had 25% less than they would have normally needed coming into June. Let me see this 40% and 50% kind of growth in the order rates. It's a little bit of a catch up but I think that that sell-through is we want to look at here and look, I mean, best guess. And it's hard to know because we've only seen seven months of the year. You could see sell-through kind of down five downtime, Dave, I think that's probably five of the best case, time may not be the worst case we don’t know we haven't seen the rest of the year yet. But the sell through is the important thing.
The aberration was really in, you think about any independent wholesaler thinking about their own working capital, playing out their own recession playbook, worried about really less about a pandemic maybe and certainly about a pandemic, but more also about the long-term effect of a recession. There was a retrenchment and depending on how you place bets, as a distributor, you either did or didn't have enough stock to serve customers.
So then, frankly, you get more into a panic situation in June and July. And it's a whipsaw, so I wouldn't pay attention to the 40 to the 50, I pay attention to the sell-through. And I think that that sell-through is probably going to be in that five, 10, Dave.
Yes, I think it's around, probably closer to five. The other thing that's a little bit different too, is that and Mike mentioned it earlier is we're actually mixing up on SEER. So in past downturns, we tended to sell more lower SEER products. We're actually selling – we're actually mixing up and the high SEER products are very attractive to homeowners. And some of that obviously could be because a lot of people are working from home and they understand the advantage of those products.
Thanks guys.
Thank you.
Thank you.
Your next question comes from the line of Gautam Khanna with Cowen. Please proceed with your question.
Yes. Thanks. Good morning guys.
Hi, Gautam, good morning.
Good morning, Gautam.
Good morning. To follow-up on Steve's question about Commercial HVAC bookings. As we move into the second half and into the first half of next year, I'm just wondering, it sounds like there's a lot of potential to work the installed base, as they kind of re-scope what they want. But does that also lead to a potential air pocket as these projects are re-scoped and you do the assessments. Is there just a natural lead time that's pretty extended to actually convert some of these folks into us to take on these new solutions that you're pinching?
Yes. I'd tell you, Gautam, we've really seen the whole spectrum there, right. In some cases we have customers that need to do major work like they want to increase the amount of outside air they're bringing in, which actually means they need more cooling capacity. So that could be the longer lead side. And I would tell you that on the shorter lead side, we're seeing customers that really just need to fix some of their handling equipment and make sure the dampers are working properly and maybe increase a fan speed so that we can increase the filtration rate.
So it's really all over the board and it's pretty early days here, right. I mean, so we can't, we're obviously tracking this very closely and we'll continue to do that. But we're probably a quarter or two away from being able to, actually give you more color around the size and what the whole opportunity will be.
And I know this is a stretch, but would you be willing to pontificate on whether you think Commercial HVAC sales could actually in aggregate, be up next year versus this year, based on that opportunity set?
It’s too early for us to be able to say that, Gautam. What I would tell you is our sales force, commercially, we think about it really as a – it's a 100% commission sales force, which is very unique out in the marketplace. They're not going anywhere. And if there's less things for them to do around new buildings and new construction, they're going to get after the billions of square feet that are out there where people need help.
So I can tell you that we're going to have all the urgency to outperform the market going forward, that you'd expect. And for us, the most important thing is whatever the market is, we want to outperform the market. We want to grow EBITDA margins. And that's always been the case, the product growth teams has been the case around our product development cycles, it's been the case around why it's important for us to own and operate and service our commercial channel.
Thanks guys.
Thank you.
Your next question comes from the line of Josh Pokrzywinski with Morgan Stanley. Please proceed with your question.
Hi, good morning guys.
Hi Josh.
Good morning.
Just to ask kind of the second half outlook question, maybe a little differently. Mike, how should we think about backlog consumption or backlog levels within the down 10 to 15? Is that kind of a backlog neutral type establishment or do you think that that's really just predicated on, hey, we have a lot to convert here, particularly in resi. And beyond that, we just don't know.
Well, first of all, resi, don't even think about backlog, right. I mean, a typical quarter, we might pull two or three days worth of backlog across the quarter. What was different here is we pulled 10 times that across the quarter or more than that across the quarter. I'm sorry, a month a month. So that's an anomaly. On the commercial side, Chris, do you have a point of view on that?
Yes, I think it could be trending flat to slightly down on backlog by the end of the year, depending on the order rates that come in, what we're seeing. But I think it's a little bit too early to tell where we're going to land. I think the service offerings, Dave and Mike have talked about with indoor air quality, otherwise could also be a catalyst here for backlog. And for projects that I'd say at this point, it’s too early to tell.
We have a business – here, we call it turnkey. Turnkey for us, generally speaking, projects under $100,000, we're going in and doing retrofits and energy conservation projects and going forward, you're probably going to find a lot of indoor air quality projects going in that.
So part of it is trying to understand how much increase in turnkey that we demand generate versus, what are we seeing in terms of traditional projects going through design, plan, spec, sourcing, construction and then ultimate delivery of product and services, hard to know. So this is – earlier point that I think Steve asked, just need more time here to see how this really plays out in terms of the kinds of opportunities and retrofits we see with IAQ.
Got it. Then just follow up on where we stand with. I guess, some of the initiatives proposed by Biden. I think talking about retrofitting 4 million buildings. I think you have a long enough memory as July on the American Reinvestment and Recovery Act, which didn't seem like a needle mover at the time. But any perspective you would have on either lobbying to make sure HVAC is a big piece of that, or sales teams that are particularly geared to focus on it. Any, either lessons learned from history or perspective on what's been out there so far?
We're a huge supporter of that because the payback on that it's not a handout, it's a payback. And so to the extent, federal and state buildings could be retrofitted. This always has been this enormous opportunity that I think that that sort of thing could really unlock for us. And certainly we're talking to the administration frequently around the opportunity there would be a strong supporter of that type of activity.
And we're uniquely suited to be able to go address those challenges because, frankly, it's really doing two things. It's not just infrastructure, renewal, indoor air quality and energy savings. We're doing this stuff typically with reducing greenhouse gas emissions dramatically, if not completely, if they use our EcoWise portfolio. So it just checks so many boxes that are good for the country and for the world. And the paybacks on these things are very short.
Great. Thanks Mike.
Thanks Josh.
Your next question comes from the line of Julian Mitchell with Barclays. Please proceed with your question.
Hi, good morning. I think there's been a lot of discussion on the buildings facing markets. So maybe turn the spotlight to transport refrigeration for a second. Your comments on the second half outlook, I guess were fairly downbeat, understandably. But just wondered if you could frame, sort of likely timing as you see it today for a recovery? And any kind of historical context this market tends to see quite rapid rebounds when they do occur? Is there any reason why you would think this time might be different?
Yes, Julian, I'll start and Mike can add some color. But in North America, ACT right now is saying that 2021 will have a rebound of the – in the 20% range. IHS in Europe has got a little bit more conservative bounce back. So their models are saying that, we obviously have our own internal models that we track. There's been a lot of deferred buying, I would say, especially in the long haul space in North America.
So we're hoping that ACT is correct. But I tell you, there's still a lot of uncertainty out there right now. And I would tell you that a lot of these trucking companies, they're very good business people and they're not going to make investments that they don't need, or they can't really see the return on. So we're cautiously optimistic on 2021.
Thanks. And I'm just – my second question around capital deployment. Your sales outlook is a bit better than what it was for the year back in April, maybe there's a little bit more visibility in general today than three months ago. So just wanted to check in on that appetite to put the balance sheet to work in the next, call it six to 12 months and how you're thinking about the priority of acquisitions relative to buybacks at this point?
Yes, Julian, this is Chris. I'll start out with an answer. I mean, I think our strategy here around deployment has not changed. Right now, we're making sure we're funding the business with the investments that it needs, as Dave highlighted with the four product introductions we've had in the quarter. That's really important for us to make sure that's priority number one.
I think we're keeping our optionality open for the second half, as it relates to share repurchases. As it relates to dividends, we're locked into dividends here through the third quarter. We'll have $375 million paid out approximately in dividends by the end of September. And after that, it's really looking to visibility into the future. The better visibility we have would give us a lot more confidence in deploying more at that point. So but right now the focus is on investment. Mike, anything?
Yes, Julian. I think that our litmus test around share buyback versus M&A is just sort of the intrinsic value. But we think the share price, share value is and what we think the long range return is for the acquisition, the M&A. And so we've always been sort of agnostic and fair about looking at that. I mean, clearly all things being equal, we'd rather build and grow the company and have the opportunities that that presents itself.
And so we are seeing a pipeline, it is active. We will do some things in the back half of the year. Frankly, COVID and travel is actually hurt things like due diligence, the amount of time we spend and the speed in which we could perhaps react and go see things. And so that's been a little bit more challenging for us, but I think we'll still be active this year with some M&A.
Great. Thank you.
Your next question today comes from the line of Andrew Obin with Bank of America. Please proceed with your question.
I appreciate you fitting me in. Just a question, AIA, I think recently just published the summary 2021 forecast for non-risk construction. And I think most of the forecasts that they have sort of indicate that I think buildings are going to be down next year. And I guess that's another way of asking question about market outlook for next year.
But I think last year, I think Mike was highlighting the fact that, you guys have multi-year visibility on the cycle and just wondering what you sort of think about visibility on the cycle in light of this? And because it's late on the call, my second part is a lot more specific. What kind of visibility do you have on institutional market into the second half, specifically hospitals and education? Thank you.
Yes, Andrew, remember that the AIA data is going to really look at 20% or 30% of our North American Commercial HVAC business and correlate to that. It's not going to correlate to the other 60%, 70%, which is going to be service and retrofit of the equipment base or even 70%, 80%, which is relative to the service plus the retrofit base.
So we would intend to do better, I think, as a result of the service business to driving retrofits and these IAQ opportunities on that front. As it relates to sort of institutional activity and construction, it's a very late cycle activity. These projects take a long time to get started this typically funding, bond issuance, tax, taxes that funded these projects, they're often multi-year projects or multi-phase projects. And so they tend to last a long time and there's plenty of infrastructure required now.
Dave, any more comments you might have on individual verticals or anything that might be helpful?
I would just say that, this isn't normal time. Maybe last year we had a lot more visibility, but obviously things are changed right now. Like I told you earlier, it's pretty fuzzy right now as to what the verticals are. The good news is, is that we're very diverse in the verticals. So we're not over-weighted in any one vertical.
And I think I said earlier, we are seeing strength in warehousing and strength is the right word, but they're stronger than other verticals and things like retail and office have slowed down considerably.
Yes, I think market-wise, I'd worry more about the parts of the market that are much more consumer-sensitive like light commercial retail, big box, those sorts of things. We see more bankruptcies, more mall closures things like that, sort of the light unitary, the rooftop market, those respond much quicker to economic shock.
I think what I was sort of referring to is I think lack of elective procedures really disrupted sort of finances at the hospitals. And I think sort of some of the dealers we talked to highlighted this uncertainty. So I was just wondering if any sign of hospital behavior returning to normal by year-end.
Yes, look, it’s put pressure on hospitals finances clearly without being able to do elective surgeries and whatnot. So that's something to keep an eye on. But one thing for certain is the healthcare infrastructure in the United States is not going to fail, right. If you think about any stimulus or any risk of that happening, I think that would be a place where you would see support coming in to help hospitals in that situation.
So I'm not worried about the long-term or even the mid-term effective healthcare. And I think we've gotten through, hopefully we're getting through the worst of this non-elective surgery component, which drives revenues through the healthcare system.
Really appreciate it. Thank you.
Okay, thanks.
And at this time, I will turn the call back to the presenters for any closing remarks.
Hi, this is Zac Nagle. I just wanted to thank everybody for joining the call today. We really appreciate it. And as always Shane and I'll be available over the next coming days and today to take any questions or calls that you may have. So please reach out. Thanks. And we'll speak to you soon.
This concludes today's conference call. Thank you for your participation. You may now disconnect.