Carrier Global Q2 2023 Earnings Call Transcript

AlphaStreet
Provided by AlphaStreet
July 27, 2023
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Operator

Good morning, and welcome to Carrier's Second Quarter 2023 Earnings Conference Call. I would like to introduce your host for today's conference -- Sam Pearlstein, Vice-President of Investor Relations. Please go-ahead, sir.

Sam Pearlstein
Vice President of Investor Relations at Carrier Global

Thank you, and good morning, and welcome to Carrier second quarter 2023 earnings conference call. With me here today are David Gitlin, Chairman and Chief Executive Officer and Patrick Goris, Chief Financial Officer.

We will be discussing certain non-GAAP measures on this call which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to GAAP figures in our earnings presentation which is available to download from Carrier's website at ir.carrier.com.

The company reminds listeners that the sales, earnings and cash-flow expectations and any other forward-looking statements provided during the call are subject to risks and uncertainties. Carrier's SEC filings including Forms 10-K, 10-Q and 8-K provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. Once the call is open for questions, we ask that you limit yourself to one question and one follow-up to give everyone the opportunity to participate.

With that, I'd like to turn the call over to our Chairman and CEO, Dave Gitlin.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Thank you, Sam, and good morning, everyone. Our theme at Carrier remains performing while transforming, and I am proud of our team as we are progressing well with both. You see that strong performance in our Q2 results on slide 2. Organic sales grew 6% with both HVAC and Fire and Security up 9%. We drove strong double-digit growth in light commercial and commercial HVAC global truck and trailer controls and aftermarket. Within Fire and Security, growth was broad-based across security, residential, commercial and industrial fire.

Total company backlog remains well above historical levels, up 30% on a two-year stack. Adjusted operating profit and adjusted EPS were up 12% and 13% respectively, and free-cash flow was strong at over $300 million. Price cost was increasingly positive in Q2. Toshiba carrier performance came in stronger than expected, and we are on track to deliver $300 million of gross productivity this year. As a result of our strong first-half performance, we are raising our full-year guidance for organic growth, adjusted operating margins and adjusted EPS.

A key driver of our sustained organic growth and robust backlog is a result of our team leaning into secular trends around sustainability and healthy buildings, as you see on slide 3. With our clear and unwavering focus on being the global leader in intelligent climate and energy solutions, we continue to see traction from our sustainability driven growth initiatives. Resi heat pump sales in North-America have been up double-digits year-to-date. We saw another quarter of over 20% growth in commercial heat pump sales in Europe. And electric transport units doubled in Europe. Our healthy building pipeline is up over two times to $1.6 billion, driven in-part by K through 12 in the U.S., where orders were up over 20% in the quarter.

We are clearly positioned at the core of a transition to a more sustainable planet. We published our 2030 ESG report yesterday, in which we now disclose sustainability progress through the CDP. After completing our portfolio moves, about half of our sales will relate directly to clean tech, and we expect that proportion to continue to increase. We remain on track to reduce our customers' carbon emissions by more than one giga ton by 2030, while achieving carbon neutrality in our own operations.

Our laser-focus on digitally-enabled aftermarket solutions continues to gain traction as you see on slide 4. Q2 saw yet another quarter of double-digit aftermarket growth, with the first half of mid-teens compared to last year, and we remain on track to deliver double-digit growth this year and beyond. The playbook is working, expanding the capabilities and deployment of Abound and Lynx, our key digital platforms, increasing parts sales supported by agile pricing and improved fulfillment rates, increased attachment rates and overall coverage across the portfolio and deploying connected devices to increase recurring and subscription-based revenues.

We're also embedding AI in generative AI capability into Abound the drive solutions for our customers. By analyzing sensor data patterns and performance metrics, generative AI can help prevent equipment failures, drive improved air quality by controlling ventilation and increase energy efficiency by controlling temperature set points, air flow rates and scheduling strategies. So, our execution is progressing well.

A brief update on our portfolio transformation on slide 5. On Viessmann Climate Solutions, the short version is the more we get to know them, the more excited we are to close. Our integration planning team in Frankfurt is actively working to ensure that we hit the ground running on day one. Viessmann Climate Solutions is performing very well, ahead of their projections. First half sales were up an impressive 20% year-over-year, with heat pump sales up over 40%. Viessmann Climate Solutions' profitability is also up significantly compared to last year, and they remain on track to deliver EUR4 billion in sales and EUR700 million in EBITDA this year. We remain confident in the EUR200 million of cost synergies, driven primarily by supply-chain, in-sourcing and value engineering.

The growth opportunity for the combined business is even more compelling. The prime focus areas include expanding Viessmann' sustainable heating and home energy management offerings globally, driving incremental sales through Viessmann's European channel using a multi-brand strategy and building on Viessmann's digital platform to provide even more differentiated end-to-end solutions globally.

Moving to the Fire and Security and Commercial Refrigeration exits. The good news is that strategics and sponsors have expressed considerable interest in these superb assets. We are tracking to the sequencing we've established for these exits. We expect to have commercial refrigeration now including Profoid Mechanical Systems and the security business in the market in September, with residential fire initiating its sale process a month or so later.

Commercial and residential fire exits will follow. The result is the new Carrier that you see on Slide 6. The combination of the acquisitions of Toshiba Carrier and Viessmann Climate Solutions, together with the tremendous positioning that Carrier has established over the past century, position the combined entity to become a true global climate champion in very attractive and growing market segments. Focus matters and our focus on sustainability and differentiation, position us as a pure-play, high-growth company. Our combined channels, brands, technologies and world-class talent will create solutions for our customers, our people and the planet for generations to come.

And with that, let me turn it over to Patrick, Patrick?

Patrick Goris
Chief Financial Officer at Carrier Global

Thank you, Dave, and good morning, everyone. Please turn to slide 7. We had record reported sales of about $6 billion, up 15% versus the prior year with 6% organic growth. 9% growth from acquisitions and divestitures was substantially driven by Toshiba Carrier whose results will become organic starting in August. The deconsolidation of KFI was not material to Q2 total company sales, but had a three-point negative year-over-year impact due to Fire and Security segment reported sales.

Q2 adjusted operating profit of $964 million was up 12% compared to the prior year. Adjusted operating margin in the quarter was 16.1% and includes a 100 basis-point headwind from the consolidation of Toshiba Carrier. This means adjusted operating margins would have expanded about 60 basis points, excluding the impact from the TCC consolidation, driven by volume, productivity and price-cost as well as strong margins in TCC.

Core earnings conversion was about 30% in the quarter. Adjusted EPS of $0.79 was ahead of our expectations, mostly because of stronger-than-expected sales, price cost and TCC performance. Free-cash flow generation of $310 million was up significantly compared to last year, helped by inventory reduction. This positions us well to deliver approximately $1.9 billion of free-cash flow for the full-year.

You will notice that our U.S. GAAP results include the impact of the deconsolidation of KFI and the mark-to-market adjustments related to foreign currency hedges associated with the Viessmann acquisition. You may recall that we fully hedged the cash portion of the euro dominated purchase price. As of yesterday's rates, most of the Q2 non-cash loss on the hedges would be neutralized. We exclude these items from our adjusted results.

Now please turn to slide 8 to cover our segment's performance in more detail. HVAC had an excellent performance in Q2. Organic sales were up 9% driven by high-teens growth in commercial HVAC, double-digit growth in aftermarket and controls, and over 60% growth in light commercial. North-America residential HVAC sales were down mid-single digits in the quarter, a bit weaker than we expected.

Overall, residential volumes were down mid-teens, as we adjusted to slower-than-expected movements in the quarter. North America residential revenues continued to benefit from price realization and mix-up from the 2023 SEER transition. Adjusted operating profit for the HVAC segment was up 29% compared to last year, driven by volume, productivity, TCC performance and favorable price cost.

Adjusted operating margin was up 70 basis-points compared to last year despite a 200 basis-point headwind from the consolidation of TCC. All three businesses within HVAC had strong margin expansion, residential light commercial, commercial and global comfort solutions. Based on the first-half performance, we now expect 2023 full-year HVAC segment margins to be closer to 16% versus our prior guide of over 15%.

Let me move to Slide 9 and provide a brief update on our Toshiba Carrier acquisition, as we closed that transaction about one year ago. As a reminder, we acquired Toshiba Carrier for $900 million, about 10 times EBIT. We committed to a $100 million in cost synergies in five years and projected to achieve mid-teens EBITDA margins in that same timeframe. Our Tokyo based team is doing an outstanding job, and performance is running ahead of all of our projections. Japan returned to profitability earlier this year. We are already achieving double-digit operating margins, and are now projecting $200 million of cost synergies, which would drive EBITDA margins in the high-teens, rather than mid-teens. In short, excellent performance by that management team, and we are of course, using their experience and playbook as we plan for the Viessmann integration.

Moving to refrigeration on slide 10. Reported sales were down 7% in the quarter, with organic sales down 6%. The difference is a small divestiture we discussed in the first quarter. Within transport refrigeration, North-America truck and trailer sales were up double digits, and European truck/trailer was up mid-teens. This continued strong performance was more than offset by container, which was down roughly 35% in the quarter year-over-year. Importantly, we delivered more container units sequentially, and we expect the sequential improvement to continue in Q3 and Q4. As a result, we expect the container business and the entire refrigeration segments to return to organic sales growth in the second-half of this year.

Commercial refrigeration was down high-teens year-over-year, as a European food retail customers continue to see pressures. The commercial refrigeration team is doing a great job managing working capital and adjusting our cost base to position this business for strong financial performance as the top-line improves.

Adjusted operating margin was down 240 basis-points compared to last year, mainly due to the volume declines in container and commercial refrigeration, and the absence of the $7 million gain in last year's second quarter. Price cost was favorable. Excluding the onetime gain on sale in the first-quarter, Q2 adjusted operating margins for refrigeration grew 250 basis-points sequentially from Q1, and we are pleased with the progress this segment made in the quarter.

Moving onto Fire and Security, on Slide 11. Fire and Security sales were up 5% on a reported basis. Organic sales were up 9%, this was partially offset by 1% currency and a 3% decline from the deconsolidation of KFI. We saw a strong organic growth across the F&S portfolio, including double-digit growth in industrial Fire and Security, and high-single-digit growth in both residential and commercial fire.

Adjusted operating profit was up 1% versus the prior year, which includes the year-over-year headwinds from the deconsolidation of KFI, which was about $10 million or about a penny of adjusted EPS for Carrier. Adjusted operating margins were down 50 bps in the quarter as favorable price-cost volume and productivity were offset by mix, and the year-over-year impact of the KFI deconsolidation. Sequentially, adjusted operating margins were up 230 basis-points, and we expect adjusted operating margins to improve as the year progresses.

Turning to slide 12, total company organic orders were down mid single-digits in the quarter, as lead times continue to normalize throughout our businesses. As you can see on the left, backlogs remain at very healthy levels, about two times 2019 levels, and for our longer-cycle businesses extend into next year. We believe that strong backlogs and normalizing supply chains are reflected in our order rates.

Overall, HVAC orders were down 5% to 10% in the quarter, with both business units seeing some declines. Commercial HVAC orders were down mid single-digits, but the backlog remains robust and grew sequentially, excluding NORESCO. Over the past month, commercial HVAC orders have returned to growth.

Refrigeration orders were up 10% in the quarter, with growth in transport refrigeration and a decline in commercial refrigeration. Global truck and trailer demand remained strong, with orders up about 40%, and those were partially offset by declines in container. Container orders were about flat sequentially as demand begins to recover. Orders in Industrial Fire remained strong and were up double-digits with lead times improving in security and Commercial Fire, orders moderated and were down in the quarter.

Now moving on to guidance on slide 13. Performance in the first half of 2023 was better than we expected. We now expect 2023 revenues to be a couple of $100 million more than $22 billion, with mid-single-digit organic growth. The increase is primarily driven by commercial and light commercial HVAC, and somewhat higher net price. We now expect adjusted operating margins to be between 14% and 14.5%, a little higher than what we previously guided, driven by slightly higher organic sales, improved price-cost and better performance at Toshiba Carrier. We now expect full-year price-cost to be about $300 million positive for the year.

As a result, despite a $0.03 adjusted EPS headwind from the deconsolidation of KFI, we are increasing our adjusted EPS guidance range by $0.05, and we expect full-year adjusted EPS to be at the midpoint of the new range.

For your benefit, we included an adjusted EPS guide to guide bridge on slide 17. As the free-cash flow, we continue to expect to generate approximately $1.9 billion this year. So overall, another good quarter, and an improved outlook for 2023.

With that, I'll turn it back over to you, Dave.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Okay, thanks, Patrick. Let me first correct something that I misstated on the business exits. We expect to have commercial refrigeration and security in the market in September, Industrial Fire a month or so later, and then Resi and Commercial Fire will follow.

So just in summary, before we get into the Q&A, Carrier continues performing while we are transforming. Despite Resi HVAC declines, we realized mid-single-digit organic growth in the first-half of 2023, secular trends and our aftermarket focus continue to drive demand, price-cost improvements and productivity are helping operating margins and funding growth investments, Toshiba performance is well ahead of schedule, giving us further confidence in the upcoming Viessmann integration, our exciting portfolio moves are tracking to schedule, and we are raising full-year guidance for organic growth, adjusted operating margins and adjusted EPS.

And with that, we will get into the questions.

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Operator

Thank you. [Operator Instructions] Our first question comes from Jeffrey Sprague with Vertical Research Partners. Your line is open.

Jeffrey Sprague
Analyst at Vertical Research Partners

Thank you. Good morning, Dave and Patrick.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Good morning, Jeff.

Jeffrey Sprague
Analyst at Vertical Research Partners

Dave, would love your view on kind of the political wrangling in Germany on the heat pump related incentives and how that plays into or does not play into your view on kind of decent growth, as you look forward the next couple of years.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Well, we're confident in the Viessmann growth regardless of specifically how the German legislation plays out. I mean, keep in mind the proposed legislation that's being debated now was proposed in April, well after we had already approved our business case. And what we're going to see in Germany is a clear transition to heat pumps. We're going to see continued -- you may see more district heating than we thought previously which will be good for us. So, what we know is that regardless of whatever legislation gets approved in September, our business case stands fully intact, and perhaps what Viessmann continues to do is under-promise and over-deliver, and that's what we saw in the first-half of the year. I mentioned 20% overall growth, 40% growth in heat pumps without this proposed legislation. And by the way, Germany is less than 50% of their total sales, I think it's just over 40%. And more broadly in Europe, there are 17 countries that have announced or implemented bans on fossil fuels, 19 countries in total have heat pump incentives, 12 European countries have bans on fossil fuel boilers for newbuilds. So, look, we'll continue to monitor the specific German legislation, but our competence in the transition away from fossil fuels towards electric heat pumps, towards solar PV, towards batteries remains very, very confident.

Jeffrey Sprague
Analyst at Vertical Research Partners

And then also, maybe you could elaborate a little bit more on the length you are indicating between TCC and Viessmann, and I guess the sport and spirit of my question right is, Viessmann is not about headcount reductions, and culturally those are difficult, and I don't think a big part of what you've done at TCC, but you are seeing better synergy capture. So maybe just elaborate a little bit on what you mean by that playbook and lessons learned that we're going to apply to Viessmann.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Yeah, look, the first aspect of the playbook in TCC has been cultural integration with a multi-country representation, pulling together as one team to drive results for our customers. You look at what Saif Siddiqui and the team have done there, it has really been being very culturally sensitive to what's working extremely well and not breaking what works well, and just focusing clearly on value-creation. We had similar constraints in terms of head count in Japan that we do with Germany. Most of the synergies which, as Patrick said, will be far higher than $100 million. We're looking at least $200 million now for TCC, that's coming from the same kind of areas. It's coming from sourcing, it has come from value engineering, there are some elements of in-sourcing, so that same playbook on the cost synergy side applies there. But we're also seeing tremendous synergies on the revenue side. Toshiba has tremendous technology that we've cascaded globally, Viessmann Climate Solutions has tremendous technology that we plan to cascade globally. We want to be very culturally sensitive. And look, Viessmann Climate Solutions is a phenomenally well-run company. Thomas Heim will be running our European business, which will include Riello [Phonetic]. Our goal is to make sure that we allow them to go do what they need -- what they know how to do better than anyone in the world, while we look for areas of combined value creation, that's worked with Toshiba and that same playbook will work here.

Jeffrey Sprague
Analyst at Vertical Research Partners

Great, thank you.

Operator

Thank you. Our next question comes from Steve Tusa with J.P. Morgan. Your line is open.

Steve Tusa
Analyst at J.P. Morgan

Hey guys, good morning.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Good morning, Steve.

Steve Tusa
Analyst at J.P. Morgan

Just turning towards Resi and light commercial. On the Resi side, where do you see channel inventories now relative to where you were in the first quarter?

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Yeah, when we look at inventory levels, Steve, we basically closed 2Q in balance. And underneath that, furnaces were down about mid single-digits, splits were higher than we would have liked. We do expect some destocking there in the second-half, and what I'll say more broadly, Steve, is that obviously, you know, we get a lot of questions on Resi, and we've been saying that it's 20% of our portfolio, and that we can grow of course with Resi down, and that's exactly what we saw in the last quarter. We saw HVAC grow 9% with Resi being down mid single-digits.

So, look, as we calibrate where we are for Resi for the rest of the year, remember, for the full-year, we said that sales will be flat with volume down high-single-digit, that still feels about right to us, even though 2Q was a little bit lower than we had thought, because we will see some level of destocking on splits in the second-half, but when you look at it more recently, obviously the heat wave will translate into movement which will help our replacement business. We had thought that the new construction piece we came into the year saying, residential new construction will be down 20% to 25%, that looks like it's going to be better than we thought, probably down closer to 10% or so. So, as we look at the full year, we still feel calibrated in what we said, I mean could it instead of it being flat, it could be down a point or two perhaps, but we're still in the zone. And remember, in the second-half of the year, we have easier comparison. We're pleased with some of the recent trends. The only other thing I'll say on inventory levels is splits was down sequentially in terms of inventory levels in the channel.

Steve Tusa
Analyst at J.P. Morgan

And then, light commercial, these are pretty big numbers, you are catching up on backlog, obviously, but even backlogs up a lot. I mean, like what's the driver of that? And is that is that like a tough comp for next year at all? These are like some pretty big numbers on light commercial.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Well, look, anytime you produce sales over 60%, you create inherently a tough comp, but look, I think we could not be more pleased with how Justin and Christian and the light commercial team are doing, an it's frankly it's a good example of where we've invested in technology differentiation. We are seeing result in growth and share gains. We've talked a lot about this in axial fan, which is far more energy-efficient than the previous generation, and that has proven to help us take share of the right way, because we've been getting a lot of price. We talked about 50% sales, but about half of that was volume, and the other half was about price and mix and whole bunch of other things, because remember, there's mix involved in light commercial just like there is in the residential piece. So, overall, light commercial, it was an easy compare in terms of versus 2Q of last year, but that team is performing very well. We'll continue to track inventory levels in the channel there. But the good news is backlog is very robust. Backlogs are up over 60% year-over-year, and it gives us strong coverage through the rest of '23 that extends into '24.

Steve Tusa
Analyst at J.P. Morgan

Got it, great, thanks a lot.

Operator

Thank you. Our next question comes from Julian Mitchell with Barclays. Your line is open.

Julian Mitchell
Analyst at Barclays

Hi, good morning. Maybe just a first question perhaps for Patrick around the cadence of sort of earnings and the topline within the second half. So should we be thinking about sort of EPS is flattish sequentially in Q3, and then a normal step-down, and then on the organic sales front, I think you grew low-to mid-single-digit organically first half and then the years up sort of mid single. So do we think about an acceleration year-on-year kind of in Q4 being up mid high-single-digit, is that the way to think about sales?

Patrick Goris
Chief Financial Officer at Carrier Global

Julian, on the on the first question, you can think of operating profit being very similar in Q3 than in Q2. A key difference will be the effective tax-rate we think will be closer to 25%. And basically, that gets you to an EPS that very similar, maybe a penny or two below. And so, then you have after depth normal drop-down in Q4 that you were referring to. So, that is kind of the sequence. In terms of organic growth for the full year, we're now at mid single-digits, which is better than the low-to-mid single digits we had before. Similar organic growth in Q3 that we expect, as we've seen in Q2 and then the balance, of course, would be in that Q4, which means that Q4 will be a little weak. That's our current assumption.

Julian Mitchell
Analyst at Barclays

Thanks very much. And then just my second question. Looking at slide 12, where you have the backlog trend chart on the left-hand side, and clearly different markets and geographies are sort of rebalancing, lower at different times as lead times shorten, but when you're thinking about the backlog trend from here next, call it, six to 12 months, just wondered how you're thinking about kind of the aggregate for Carrier? Do we see the backlog naturally moderate because of normalizing supply chains. Just any thoughts around that, please.

Patrick Goris
Chief Financial Officer at Carrier Global

Julian, that is what we were looking at it, and I think it depends for what businesses we're looking at. If you look at some of our shorter-cycle businesses, and we've seen that the best example is probably residential HVAC. Typically, we would have four, maybe six-weeks in backlog. A few quarters ago, we were talking of backlog of more than one quarter. And so, as supply chains have normalized, we've seen the backlog normalize, for example, residential HVAC were back in that four to six-week range, and you don't get to that without an adjustment of the order intake, and that's why we see some of the big declines in orders year-over-year as at those backlogs normalize. So, I would expect that some of our short-cycle businesses, we will see a more back to normal backlog level. At the same time, there are some longer cycle businesses like commercial HVAC, those are businesses that have backlogs of six months and in some cases longer, and there we see continued growth and we see continued strong demand.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

What I would add, Julian, is that if you look at sort of the anomalies of the environment that we've seen over the last couple of years, COVID leading into supply-chain issues. Looking purely at year-over-year order trends is really not the best indicator of future growth projections. So, what we've been looking a lot at is the backlog levels, which we feel still very good about with commercial light, commercial HVAC, and some of the longer pieces of Fire and Security, where the backlog levels are. So, we're looking at do we have the backlog in incoming growth order rates to support our growth projections, and we do feel good about those.

Julian Mitchell
Analyst at Barclays

Great, thank you.

Operator

Thank you. Our next question comes from Deane Dray with RBC Capital Markets. Your line is open.

Deane Dray
Analyst at RBC Capital Markets

Thank you. Good morning, everyone.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Good morning, Deane.

Deane Dray
Analyst at RBC Capital Markets

Yeah, I was hoping to go through some of the price-cost dynamics in the quarter, and you mentioned the higher mix contribution from the new SEER. Could you take us through that? And then the pace of improving price-cost, that $300 million, what was the -- if you could decompose that, how much was let's say, the raw-material better pricing there as well. Thanks.

Patrick Goris
Chief Financial Officer at Carrier Global

Okay, Deane, Patrick here. In terms of the quarter, you can think of the 6% organic growth we had, think of it as pricing being about four points, and think of volume and mix. So, we put the mix up as part of the volume mix as being the remainder, the two points. So that's kind of the overview for the for the quarter for the full year. We think that the price utilization [Phonetic] it won't be 4%, we think it will be a little less than 4% for the full year, probably closer to 3%, which is of course to be expected as we lap some of the price increases from last year. And then the second part of your question was.

Deane Dray
Analyst at RBC Capital Markets

Oh, just the, you said the pace of improving price cost.

Patrick Goris
Chief Financial Officer at Carrier Global

Yeah, you may recall that in Q1, we mentioned that price cost was modestly positive, and it had a few 10s of basis-point positive impact on our segment operating margin, and we said that Q1 would be the weakest price cost of the year. You can think now of price-cost being closer to $300 million positive versus 200 million the prior guide, and it's about 100 bps benefit for the full year, year-over-year, so better than Q1, which is basically what we expected. In terms of the equation, both price is a little bit better. On the cost side, we're seeing some pluses and minuses, the area where we probably see the best, the most favorable impact is on logistics. We're seeing some on materials. There are some plus and minus there, but logistics and freight is probably the area where we see the biggest benefit on the cost equation.

Deane Dray
Analyst at RBC Capital Markets

That's real helpful. And then just as a follow-up, Dave, you gave a lot of specifics on the sale process going on and the timing and so forth, which is really helpful. Just from a management side to this, how do you keep each one of the units focused when there is this change in ownership pending as just how do you keep the eye on the ball here?

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Well, we are so fortunate to have a phenomenal team in both Fire and Security and Commercial Refrigeration. Jurgen and his team in Fire and Security, Tim working with markets on commercial refrigeration, they are true professionals, and they know what we know, which is that the opportunity for the business is in the hands of someone who is either strategic or sponsor, who is the core of what they do, will create value for their people for generations to come. So, we are very lucky. It's one of the reasons why the decision was tough, because we're partnering with team members that come to work every day, put their heads down and do a phenomenal job for their customers and create value. They are performing very well. So, we're lucky to have great people. We work closely with them to paint the vision for the future for them in their businesses, phenomenal franchises, phenomenal brands. I've been very, very pleased with the level of interest, and we've shared that with both respective teams. So, we know -- it's just like when Carrier spun, there was a fair amount of uncertainty as we spun from UTC. But we knew that, and Greg knew that us as an independent company would create value for us and our customers, and the same will be true for them.

Deane Dray
Analyst at RBC Capital Markets

Thank you.

Operator

Thank you. Our next question comes from Nigel Coe with Wolfe Research. Your line is open.

Nigel Coe
Analyst at Wolfe Research

Thanks, good morning, everyone, thanks for the question. Hey, just want to go back to price and maybe mix, Patrick. Obviously, non-commercial has 60% growth, how much of that would it be price and mix, and maybe the $300 million of price cost, if you can just maybe be a bit more granular in terms of how that phases through the year.

Patrick Goris
Chief Financial Officer at Carrier Global

Yes, for light commercial, more than half would be volume and the remainder would be equally split between the mix up and price realization. And then on price-cost, we can think about it, Nigel -- this is, so I mentioned at $300 million for the full year. I mentioned of 100 bps benefit for the full-year, weakest by far was Q1. The next two quarters will be similar, and I think Q4 will be a little bit stronger than Q1. So, I cannot serve you the exact numbers by quarter, but clearly we've seen a significant pick-up in the second quarter. We expect that to continue for the year and from a year-over-year margin perspective. The margin impact on Q2, Q3, Q4 will be similar, to get to the 100 bps for the year. So basically, a little over 100 bps every quarter Q2, Q3, Q4. That is the granularity I have.

Nigel Coe
Analyst at Wolfe Research

That's great. Thanks, Patrick. And then my follow-on is coming back to the portfolios. I mean, based on the indications of interest you've clearly seen from both PE and strategic, you are at a point now where you can rule out a spin process, do you think there is a buyer out there potentially for the whole package of assets? Maybe excluding commercial refrigeration, but the whole fund security assets, and I know there's a there's many parts of the question, but is the KFI Chapter 11 still a gating factor for the fire sales. Thanks.

Patrick Goris
Chief Financial Officer at Carrier Global

Yeah, the way I would describe it, Nigel, is that for commercial refrigeration and then the security business and industrial fire, those will be divestitures. We mentioned that we have the first two of those three. We're targeting having those in the market a bit after Labor Day. So, we're targeting having those out in the market before the end of September, and then Industrial Fire will follow a month or so later, and that will also -- we also plan that to be a divestiture, and we're still waiting through all of our options with respect to the commercial and residential fire pieces of that portfolio, and those can take a whole bunch of different forms. They can be divestitures, spins, split like that, the different forms those can take and go in a lot of directions, and we're going to be weighing all of those. But right now, we're focused primarily on those first three to make progress and try to get signed executed deals here in the coming months on those.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

And in terms of the KFI process, that's being of course handled by the independent Board of KFI. It's our sense that they've been progressing well and appropriately through the Chapter 11 process. All of the AFFF litigation against KFI was automatically stayed upon the filing. And since then, all of the AFFF claims against Carrier and F&S have also been stayed, and that came with the consent of the creditors committee. So that whole process is proceeding as planned. We anticipate the sale process that the Board will do for KFI will begin as they start to sell themselves in the next couple of months. And then within the next year, we do anticipate Chapter 11 discharge for KFI which would resolve the AFFF lawsuits against KFI, Carrier and the other entities. So, I think that's progressing as I think their Board would have expected to progress.

Nigel Coe
Analyst at Wolfe Research

Okay, thanks Dave.

Operator

Thank you. Our next question comes from Joe Ritchie with Goldman Sachs. Your line is open.

Joe Ritchie
Analyst at The Goldman Sachs Group

Hey, thanks, good morning, everyone.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Good morning, Joe.

Joe Ritchie
Analyst at The Goldman Sachs Group

Maybe just starting off on the lead times normalizing comment. I'm just curious how far above normal are we still with lead times, and when do you expect that will fully normalize?

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Joe, it varies a little bit by business. Light commercial has come down, but it's still above normal. It looks like Resi is getting closer to normal. It's closer kind of, Patrick said in that four to six range -- with four to six-week range would be normal and starting to -- starting to kind of approach those levels that we've seen in the past. For Resi and commercial HVAC, still has a very strong backlog. That would be above normal, and it almost varies by region. In places like Europe and China, it's a little bit closer, but higher than traditional backlog levels. But in the United States, we've had some operational challenges in our Charlotte facility, which the team is working very hard to address and has been making a lot of progress on some of the underlying issues. But until we get those fully in the box, we will continue to see elevated backlog levels that go well beyond this year into next year. So, it's nice to have the backlog, but we still do need to make in that particular side, more progress on the supply-chain issue. So, in general, it's getting closer to traditional levels, but it kind of varies by region, by business, and it varies a little bit based on our supply-chain overall performance.

What I will add, Joe, is that one thing that we're doing is doubling down on the basics. We brought in a new team to help with our [Indecipherable] processes, our sales inventory operations planning, because we're in an environment where there is some fluidity on the demand side, and we still have some longer lead times for things like chip. So, we need to have very agile demand and materials planning, so we can give our customers what they want and what they need when they need it, and not get stuck in the middle with inventory levels, and that's been a whole focus area for us internally.

Joe Ritchie
Analyst at The Goldman Sachs Group

Got it, that makes sense, and I guess maybe just connecting the dots with the backlog, it was it was good to hear that backlog grew sequentially. It sounded like the commercial business had started to reaccelerate, but I don't want to put words in your mouth. So just maybe just talk to us a little bit about the order trajectory there, and what you're seeing on the ground real-time.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Yeah, I think that with respect to commercial, Patrick mentioned that, I think, Joe, the question is about commercial HVAC.

Joe Ritchie
Analyst at The Goldman Sachs Group

Yeah, I would just say commercial and applied more broadly.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Yeah, yeah, I think that -- look, it was nice to see over the past four weeks or so, we've seen that demand IS positive. You look at the commercial HVAC business, we still have in some cases, as I mentioned, in North America, for example, backlogs that go well above, well beyond historical levels, and that does have an effect on incoming orders. So, as those backlog levels will start to moderate especially in North-America, we do expect that the demand will continue to be there. You look at ABI, it was over 50, the Architectural Billing Index was over 50 in both May and June. It's been over 53 in the last four months. And I think when I look at the job that Gaurang and the team are doing, they've been very agile. We talked a lot about when you fish, you go where the fish are. When you go -- when you're in a business like ours, you go where the customers are, so K through 12 has been strong with healthy buildings. Industrial activity has been strong, data centers continue to be positive, healthcare is positive, and then we transition away from some of the areas which show some areas of weakness, so commercial and residential real-estate in parts of China were weak. We pivoted hard to industrial infrastructure, and that's been driving a lot of demand. So, we feel good about the backlog, and it's nice to see the order rates over the last month or so.

Joe Ritchie
Analyst at The Goldman Sachs Group

Great, thanks Dave.

Operator

Thank you. Our next question comes from Josh Pokrzywinski with Morgan Stanley. Your line is open.

Josh Pokrzywinski
Analyst at Morgan Stanley

Hi, good morning, guys.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Hey, Josh.

Josh Pokrzywinski
Analyst at Morgan Stanley

Dave, I want to just pick your brain a little bit on follow-up to that last question, what's your sense on non-residential construction? I think some of the data is getting worked around by the mega projects, which I think maybe the HVAC content is a little harder to tease out. Obviously, things like warehouse that are declining, but maybe not as important. So, what's your sense on that market? Now the data seems like it's good. You've talked more about backlog normalization and real demand shifts, but are you seeing anything on the ground level there?

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Well, yeah, I think that clearly, we've seen the areas that have been a bit weaker in some areas of retail, but interestingly some of the lower-end retail has been positive. So not all retail but some areas of retail in our applied business and areas of commercial real-estate have been weaker, and that's, and you know this, Josh, but remember that commercial real-estate is less than 10% of our North American applied business. So, we watch it, we watched some of the reaction that we were going to see with the regional banks, but there's been nothing terribly acute, and I think on the flip side, some of the areas that continue to be very positive as K through 12. I mean, we still have significant amount of that ESSER funding to be spent higher, and has been extremely strong. And then you look at industrial Chips Act, bringing some new construction back to the United States, and that space has been positive. Data center is good, healthcare is good, so we look at it globally. I think in general the theme is around real-estate is a watch item. I will tell you on the flip side, it's encouraging. You know that ABI is about a six-month leading indicator for new order activity. So, to see ABI showing some growth, it could indicate that folks see an eventual moderating of rates, which should drive some new construction activity on the real estate side six months out. So, we'll have to watch and see if that happens, but in the meantime, some of the other verticals have been strong. And as you mentioned, warehouse has been a bit on the weaker side, I would say.

Josh Pokrzywinski
Analyst at Morgan Stanley

Got it that's helpful. Very comprehensive. And then just a follow-up, and if someone asked already, I missed that. I apologize. Heat pumps and IRA, something that was obviously very topical kind of six to nine months ago, and maybe gotten a little less attention lately, it seems like the heat pump market in general has been strong, but what's your sense on the IRA uptake and maybe any kind of tighter quantification of what you think that might be worth over the next 12, 18 months.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

It's hard to exactly dimensionalize it, but I will say what happened is the legislation got passed and then we went into a bit of a lull period, while that was actually getting effectuated. And in some cases, you're dealing with not only the IRS, but a state-by-state implementation. So, I think that I would call, like 2023 the year of things getting codified, 2024 is going to be the year where we start to really see the benefit of it, and I think it's going to kick in really in the first quarter of '24, and we are very pleased with how it's gotten codified overall, which has been that the $2,000 incentive for heat pumps in the United States getting applied to that mid-tier level, which was very important to see the kind of take rate that you would want to see to have the impact you would want on consumers, but also on the planet.

There still is one area where how they define some of the levels for heat pumps in the North and the South, there is a variance there. We'd like the definition that we're seeing in the South applied equally to the north, because in the background we are working on the technology for cold-weather heat pumps. So, there is still some, I think, improvements to be made in the legislation for the Northern part of the country, but I expect we'll start to see, I think a tangible benefit as we get into '24.

Josh Pokrzywinski
Analyst at Morgan Stanley

Got it, helpful update. Thanks a lot.

Operator

Thank you. Our next question comes from Noah Kaye with Oppenheimer. Your line is open.

Noah Kaye
Analyst at Oppenheimer

Good morning, guys. Thanks. I just wanted to get maybe a deeper update on the regulatory approval process for these spins. You mentioned on track to close by year end, but maybe just take us through where the regulatory approval key steps are at? Any potential for slippage around the timeline.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Well, it's been progressing very well, hats off to the team, because we got the FDI approval in Germany, we've gotten various country approvals as we've been going along, such as China that was positive to see, and I think the key one that will be down to is in the European Union, and that's frankly progressing very well, and it's progressing well because there's really no material overlap between us and them. So, we said that we would close around year end and we remain on-track for that.

Noah Kaye
Analyst at Oppenheimer

Okay, great. Switching to different topic, Aftermarket and Services. Aftermarket had another double-digit quarter, services sales up 16% and you, Dave, you mentioned in the prepared remarks around embedding generative AI and Abound and the digital platform. If you could maybe help tie together for us some of those investments and the sales traction you're seeing. How does AI and generative AI actually help increase penetration of digital and aftermarket.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Well, we've working with Bobby George and the digital team, we are establishing an AI, generative AI Center of Excellence as the skill-set. Look, we've been using it for a while. There are some areas where it's a bit more basic like in our call centers, where we can drive much more efficiency and responsiveness for our end-customers in our call centers using generative AI, and that's very encouraging, and I think in the area of things like our digital platforms, Abound and Lynx, what you're really looking at is capturing data and using that data to make using algorithms to anticipate issues before they occur, that can then affect the controls and ultimately drives automation, and that as we build out all of the applications and capabilities around Abound and Lynx, the fundamental capabilities around generative AI are going to be very significant. We've been at this for many years. We're now taking it to a new level because of some of the advances we're seeing in the AI capabilities where you start to anticipate a failure of equipment before it occurs because you're looking at certain physics-based algorithms associated with the temperature, pressure and other aspects of the equipment. You start to look use links to use geofencing and other capabilities that go beyond temperature controls and prognostic and diagnostics the cold-chain side. So, it's very exciting. It's yet another distinguishing feature we can add to our digital platforms.

Noah Kaye
Analyst at Oppenheimer

That's really interesting. Thanks for the color.

Operator

Thank you. Our next question comes from Stephen Volkmann with Jefferies. Your line is open.

Stephen Volkmann
Analyst at Jefferies Financial Group

Great. Good morning, guys, thanks for fitting me in here. Just a couple of questions, maybe a little bit longer-term, but I'm trying to think about or how you think about pricing in '24 '25, do we kind of go back to the historical norm, do you think? Or is there a reason that might stay a little bit higher, and is there any reason that mix wouldn't continue to improve as we go a little bit longer-term?

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Well, look, I think that I do see pricing continuing, but being more at historical levels. I mean, you have to keep in mind that you look at pricing over the last couple of years, we are dealing with, I think close to a couple of billion dollars of price over the last two years, and we're going to continue to see, I think Patrick said around $600 million of price this year. So, I think that we will be in the normal what we assume to more typical levels on price, we don't certainly see price reductions, but we see continued price increasing, but not at the kind of pace that of course we've seen over the last couple of years. Mix continues to be positive. We'll continue to see the '23 benefits that we saw in the SEER change extended to next year on the residential light commercial side. We also see mixed benefits on the refrigeration side, the same transition that we're seeing on the HVAC side, we are seeing in places like the United States and Europe as they transition to lower emission, diesel-powered truck and trailer units, but also a transition to electric, that mix up is very beneficial to the truck trailer side as well. And then as we get into parts of '24 that extended to '25, in North America will have the refrigerant changes as well, which would be a further mix up. So, mix will continue to be positive on all aspects of the business, and then will resume normal pricing levels. But in the background, it's our job to drive productivity. So, we talked about 2% to 3% net productivity forever. The team is driving a few hundred million this year, and one of the things that our new Head of Operations, Adrian Button and the team are doing very well is not only looking at productivity for '23, but we have one source of the truth, one digital platform that everyone looks at every week, and we're using digital tool to set ourselves up for '24 productivity as well. So, we get really good line-of-sight going well beyond 12 months.

Stephen Volkmann
Analyst at Jefferies Financial Group

Perfect. Okay, thanks, and then just a quick follow-up maybe for Patrick. How should we think about the cadence of TCC as we get into '24? Is it still margin-dilutive?

Patrick Goris
Chief Financial Officer at Carrier Global

The key -- well, the key reason why this year it's margin dilutive is instead of recording equity income as we did prior to the acquisition, now we're consolidating the entire P&L. So, this year, I mentioned that your operating margin would be it's already at the double-digit level. So, a little bit lower than the company average. I would expect that to continue to improve, and next year it might not yet be of the overall company average, but I would expect to get significantly closer to it. But the main reason why it is dilutive this year is because we basically consolidate $2 billion of revenue with $100 million-plus-ish of incremental operating profit, that's the dilutive impact.

Stephen Volkmann
Analyst at Jefferies Financial Group

Perfect, thank you guys.

Operator

Thank you. And our last question comes from Vlad Bystricky with Citigroup. Your line is open.

Vlad Bystricky
Analyst at Smith Barney Citigroup

Good morning, guys, thanks for taking my call. So, I just wanted to ask about the uptick in China orders in the quarter. I know year-ago comps got easier, but China is one market I think we're just trying to understand a little bit or what's the trends are there. So, can you just talk about what you're seeing in terms of underlying demand trends in China, and how you're thinking about the potential to maintain positive orders momentum there going forward over the next couple of quarters?

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Yeah, Vlad, I got back recently from China, and just to level set, it's about 9% of our total sales, and our overall outlook in China is promising. We see it up double-digits for us this year, the comps are a bit easier, but we still do see underlying growth. The first-half was up just over 20%. Now, Q2 had some easy compares, because remember, there were the COVID lockdowns in Q2 of last year, and Q2 was up 30% or so for us in China, but when we look overall, we see growth in Applied in China, especially on the industrial side, though industrial verticals were up over 20% in the first-half and those verticals like the renewable energy, medical, pharma was strong, and that helped -- that's been helping us offset some of the weakness that we saw in the commercial real-estate side. By the way, I think I might have said that the first half was just under 20%, not over 20%, but it was kind of in that range. And the other thing I'll say about our teams in China, and this applies to commercial HVAC, it applies to the residential light commercial side, that's part of our GCS business, our Fire and Security and rep side is we've seen the key to success as being very agile. That's true globally, but I think it's true especially in China. If you look at where we are at commercial HVAC, just five years ago our mix was 70% property, 30% industrial, it's now 40-60, the reverse. So, we've been very, very purposeful about shifting our sales folks, our sales incentives to go after where we see the growth, which has been extremely strong with some of our partners over there in that I&I space, so -- and I do believe that the government will continue to incentivize further growth there. So, we overall it's not going to be a straight line, but overall, we remain bullish on China.

Vlad Bystricky
Analyst at Smith Barney Citigroup

Okay, great, that's really helpful, Dave. And then, just as my follow-up, maybe shifting to North America. I know you mentioned, and you've seen obviously good strength in the K to 12 Vertical. One question or concern that we hear from some investors is around potentially peak-ish spending in the K to 12 market, just given the strength we've seen there. Can you talk about how you're thinking about growth runway in the K to 12 vertical broadly going-forward, and whether you are seeing any signs of sort of increased budget constraints in from those customers.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Yeah, I actually, I view at the opposite of that. I think there is tremendous runway on K through 12 Remember that, this is the first time in decades where the K through 12 area has had dedicated and sufficient funding, and they've allocated -- the federal government has added allocated $190 billion of ESSER funding, or $290 billion -- there's $190 billion in the ESSER fund over the next 15 months and $90 billion of that has still yet to be allocated. So, 90 of the 190 still has to be allocated over the coming 15 months. Now whether or not that physically possible remains to be seen and whether or not there will be an extension of that remains to be seen. I would suspect there needs to be, but in the meantime, there is actually more runway ahead, and there has been growth in the past. I mean, we continue to see, orders have been up double-digits for a long time. We saw K through 12 orders up 20% as I mentioned in the quarter, our pipeline in Q2 is now up 60% over where it had been. So, we think it's a very attractive vertical, and the way that funding gets spent some of the initial funding is the lower lead-time, less expensive type projects. As you get into ESSER 3 funding, and there still 120 of 190 is in ESSER 3, that's when you get into things that have to do more with like HVAC. So, we think there's a lot of runway ahead in K through 12 in the U.S.

Vlad Bystricky
Analyst at Smith Barney Citigroup

I appreciate the color there. Thanks.

Operator

Thank you. I'd like to turn the call back over to Dave for closing remarks.

David Gitlin
Chairman & Chief Executive Officer at Carrier Global

Well, look, my thanks to the 55,000 team members at Carrier. We have a lot of moving parts in the system. The team continues to work tirelessly on behalf of our customers and achieve great results. So, my thanks to everyone at Carrier our thanks to our investors, and of course, Sam will be available for questions as we go through the day. So, thank you all.

Operator

Thank you for your participation. [Operator Closing Remarks]

Corporate Executives
  • Sam Pearlstein
    Vice President of Investor Relations
  • David Gitlin
    Chairman & Chief Executive Officer
  • Patrick Goris
    Chief Financial Officer
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