Trane Technologies plc (TT) — Q1 2015 Earnings Call Transcript

Thank you, Danielle. Good morning. Welcome to Ingersoll Rand's First Quarter 2015 Conference Call. We released earnings at 7:00 a.m. this morning and the release is posted on our website. We'll be broadcasting, in addition to this phone call, through our website at ingersollrand.com, where you will find a slide presentation that we'll be using this morning for the call. And this call will also be recorded and archived on our website. If you would, please go to Slide 2, which is our safe harbor statement. 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 laws. Please see our SEC filings for descriptions of some of the factors that may cause our actual results to vary materially from our anticipated results. This release also includes non-GAAP measures, which are explained in our financial tables to our news release. With me this morning on the call are Mike Lamach, Chairman and CEO; and Sue Carter, Senior Vice President and CFO. So if you will please turn to Slide #3, I'll turn the call over to Mike. Mike?

Great. Thank you, Joe. Good morning, and thanks for joining us. In the first quarter, our adjusted earnings per share was $0.38, an increase of 31% versus last year's quarter. We closed 2 acquisitions in the quarter. The acquisition of the Cameron centrifugal compressor division closed on January 1, so results were included for the entire quarter. We also closed the acquisition of FRIGOBLOCK in early March, so that had a very minimal impact in the quarter given that less than 1 month of results were reported. Both integrations are going very well. Cameron compressor achieved our forecast for bookings, revenue, and operating income. We are seeing some early traction on cross-selling and synergies, and we expect continued progress for the balance of 2015. Currency had a significant impact throughout the results. So in our comments today, we will mainly focus on organic growth, which excludes currency and acquisitions, so that you can get a better view of end market trends. In the first quarter, we saw solid organic revenue growth of 8%, led by strength in the U.S. and Europe, particularly in the Climate segment. Order rates remain healthy in the first quarter at 5%, excluding currency and acquisitions. Adjusted operating margins increased 40 basis points, and increased to 100 basis points excluding the impact of currency, and bringing Cameron results into our financial statements for the first time. Adjusted EPS for the quarter was $0.07 above our adjusted EPS guidance midpoint of $0.31. The improvement primarily came from higher-than-expected volume, mainly in North America, and good cost control and execution to our plan. Foreign exchange translation negatively impacted the quarter by about $0.01 compared with guidance, however, this was more than offset by FX gains recorded in other income. Now Sue will walk you through the first quarter in more detail, and then I'll come back to take you through our outlook.

Thank you, Mike. We're very pleased with our performance and execution in the first quarter. As Mike mentioned, there are several factors at play with currency and purchase accounting, and we're providing detailed information to help you understand the quarter through both the slides and our comments. Orders for the first quarter of 2015 increased by 3% on a reported basis and by 7% when excluding currency. When excluding both foreign exchange and acquisitions, orders were up 5%. Climate orders rose by 2% and by 6% when excluding currency. Global commercial HVAC bookings increased in the mid-single digits on a reported basis and by high single digits when excluding currency. Transport orders went up in low single digits and high single digits when excluding currency. Organically, Thermo King saw strong order growth in North America and high-teens growth in Europe. Orders in the Industrial segment rose by 3% on a reported basis and by 9% when excluding currency. Industrial orders increased by 2% when excluding currency and acquisitions. We observed organic order growth of low single digits in air and industrial products, and high single digits improvement in Club Car. Here's a look at the revenue trends by segment and region. The top half of the chart shows revenue change for each segment. For the total company, first quarter revenues were up 6% versus last year on a reported basis and up 8% on an organic basis, which excludes both foreign exchange and acquisitions. Climate revenues increased 6% on a reported basis and 9% x currency. Commercial HVAC was up high single digits and transport revenues were up mid-teens, both x currency. Residential HVAC revenues were up high single digits. Industrial revenues were up 7% on a reported basis, up 13% excluding currency, and up 4% excluding currency and acquisitions. And I'll give you more color on each segment in the next few slides. The bottom chart shows revenue change on a geographic basis with and without currency. Excluding currency, revenues were up 10% in the Americas; 22% in Europe, Middle East, and Africa, led by strong HVAC performance; and Asia was down 3%. If you back out acquisitions as well as foreign exchange, the primary change is in the Americas, which would be up 8%. This chart shows the change in operating margin from first quarter 2014 of 5.7% to first quarter 2015, which was 5.9%. Consistent with prior quarters, this is shown on a reported basis, and we've spiked out the restructuring to get you to adjusted margins as well. Volume, mix, and foreign exchange, collectively, were 40 basis points positive versus prior year. Price was positive but was slightly less than direct material inflation. Pricing was most competitive outside of North America. Productivity versus other inflation was positive 80 basis points, driven by strong productivity in the quarter. Productivity favorability was in direct materials, G&A and solid execution, including the third phase of our ERP implementation in the first week of April. Year-over-year investments and other items were 80 basis points. This was the first quarter which included results from Cameron and, as expected, impacted margins by 50 basis points due to inventory step-up and intangible amortization. In the box, you can see 60 basis points of headwind from investments and 30 basis points positive from lower restructuring costs. In the gray box at the top of the page, overall leverage on an adjusted basis was 12%. Backing out currency and acquisition results, leverage was approximately 20%. The Climate segment includes Trane commercial and residential HVAC and Thermo King transport refrigeration. Total revenues for the first quarter were $2.2 billion. That is up 6% versus last year on a reported basis and up 9% x currency. Global commercial HVAC orders were up mid-single digits on a reported basis and up high single digits x currency. Organic orders were up in all geographic regions, with notable strength in North America and Europe. Trane's commercial HVAC first quarter reported revenues were up mid-single digits and up by high single digits x currency. Commercial HVAC equipment revenues and HVAC parts, services, and solutions revenue were both up high single digits versus prior year x currency. We saw year-over-year gains in both applied and unitary ducted and ductless equipment. Thermo King reported orders were up low single digits and high single digits versus 2014's first quarter x currency. Organic orders increased in all regions except Latin America. Thermo King reported revenues were up high single digits and up by mid-teens x currency, with strong gains in North America truck and trailer and auxiliary power unit. In Europe, organic revenues were up high single digits. Residential HVAC revenues were up high single digits, with volume gains in all major residential product categories as well as in light commercial products, which were up low double digits for the quarter. The adjusted operating margin for Climate was 7% in the quarter, 40 basis points higher than first quarter 2014 due to volume and productivity, partially offset by inflation, currency, and higher investment spending. First quarter revenues for the Industrial segment were $729 million, up 7% on a reported basis and up 4% organically, which excludes the Cameron acquisition and currency. Air systems and services, power tools, fluid management, and material management organic revenues and orders were both up low single digits versus last year. Organic revenues in North America were up low single digits, while revenues in overseas markets were flat. Club Car organic revenues in the quarter were up high teens from improved sales of golf cars and utility vehicles. Organic orders were up high single digits versus prior year. Industrial's adjusted operating margin of 11.9% was slightly down compared with last year as we're in the early days of the Cameron acquisition, including heavy purchase accounting impact and negative currency. For this segment, price offset direct material inflation, and productivity offset other inflation in the quarter. We achieved our Q1 plan for the Cameron acquisition and the business will continue to add benefit as we continue the integration process. Industrial's organic operating margin at constant currency was 13.9% for Q1, an increase of 180 basis points over prior year. For the first quarter, working capital as a percentage of revenue was 6.3%. The increase versus prior year is primarily inventory. This includes some incremental inventory related to the regional standards change in residential HVAC, and additionally, we have intentionally increased stock inventory levels of key component assemblies in order to ensure availability of supply as we enter the prime selling season for commercial and residential HVAC product. We had good collections in the quarter, with our days sales outstanding and days payable outstanding both improving over the prior year. Our balance sheet remained very strong. We have no debt maturities this year given the financing we did last October and the early retirement of the 2015 note. Our cash balance is at normal levels. We expect free cash flow in 2015 to be in the range of $950 million to $1 billion. Before I conclude, you saw that we devalued our assets in Venezuela in the first quarter due to the ongoing decline of the Venezuelan currency. This charge was recorded in other income and expense, and we've adjusted it out of earnings per share given its unusual nature. And with that, I will turn it back to Mike to take you through our guidance.

Okay. Great, Sue, thank you. Please go to Slide 10. Overall, our forecast has not changed materially since the last call in January. North American institutional markets were up in the first quarter, and we expect to have a positive year, albeit at a more moderate pace than the current Dodge forecast. We also continued to see growth in commercial and industrial buildings and retrofit. Based on this, we expect mid-single-digit growth for 2015 in North American commercial HVAC markets. We expect Latin American, Asian, European and Middle East HVAC markets in the aggregate to be up low to mid-single digits at constant currency but flat to down after considering currency. We expect North American transport markets to be up mid-single digits in 2015 and European markets to be down, including FX. We expect residential HVAC industry motor-bearing unit shipments for the year to be up low to mid-single digits, and revenues should be up mid- to high single digits due to favorable mix. We expect industrial markets to be up low to mid-single digits. Golf markets are expected to be up low single digits. Aggregating those market backdrops, we expect our reported revenues for full year 2015 to be up 4% to 5% versus 2014. Overall, foreign exchange will be a headwind of about 3 percentage points, and we expect the Cameron centrifugal business to add 3 points for the year. So for organic growth, excluding foreign exchange, we end up back at the 4% to 5% range. Translating that to our full year outlook by segment, we expect Climate revenues to be up 2% to 3% on a reported basis and 4% to 5% excluding currency. For the Industrial segment, revenues are forecast to be in the range of up 13% to 14% on a reported basis and 4% to 5% excluding Cameron and foreign exchange. Industrial has a higher proportion of revenues outside of the U.S. than Climate, so Industrial experiences more impact from FX as compared to Climate. For operating margins, we expect Climate margins to be in the range of 12.5% to 13.5%. We expect industrial margins, including Cameron operations and amortization but excluding the impact of the inventory step-up, to be 14.5% to 15.5%. The inventory step-up will be reported in the first and second quarters; it's about $12 million per quarter. Since it's noncash and isolated to those 2 quarters, we felt it was more representative of ongoing earnings to spike out the step-up. If you remove the Cameron impact, the legacy Industrial segment has operating leverage over 50%. Please go to Slide 11. Transitioning to earnings. Our reported earnings per share guidance range is $3.42 to $3.60. Excluding the Cameron inventory step-up, restructuring and the Venezuelan currency devaluation, the range is $3.66 to $3.81, an increase of 10% to 14% versus 2014. When you exclude the impact of bringing Cameron revenue and earnings in for the year and currency, the legacy company leverage is at approximately 30%, and including acquisitions and currency, we should be in the 25% range. The $0.07 per share outperformance for the first quarter largely offset the additional currency headwind from the strengthening of the dollar against overseas currencies in the quarter. For example, we built our original guidance at a euro rate of USD 1.16 and our current forecast is at USD 1.08. Just as a reminder, the information we gave you last quarter to give you some simple math to gauge our sensitivity to currency movements, a 1% movement in the euro means about a $0.01 in earnings. If all currencies move 1% versus the dollar, that would be about $0.02 of earnings. To focus on second quarter guidance, see the right-hand column on the chart. Second quarter 2015 revenues are forecast to be up 4% to 5% on a reported basis. You can see the currency and acquisition impact on the slide. Reported second quarter earnings per share are forecast to be $1.14 to $1.18. The inventory step-up all hits in the first and second quarters and impacts second quarter by $0.03. We also expect about $0.01 of restructuring costs. Adding this back to get to an adjusted basis, the EPS range is then $1.18 to $1.22. We have provided EPS bridges for the second quarter in the appendix to give you the walk from year-to-year. For the full year 2015, we expect to generate free cash flow of $950 million to $1 billion, which is at our long-term target of 100% of net income. We increased the dividend by 16% to be consistent with the payout ratio in the peer range. We also utilized EUR 100 million of cash to pay for FRIGOBLOCK. We anticipate a minimum of $250 million of spending for share repurchase, which will offset dilution from equity issuances. So that leaves about $350 million of cash that will be put to either value-accretive acquisitions or share repurchase. We have a pipeline of acquisition opportunities related to our core businesses, and we weigh those risk-adjusted opportunities against buyback in terms of returns and shareholder value. Our strategies for growth and operational excellence have delivered a multi-year trend of excellent operating leverage, margin, and earnings improvement. Our focus is to continue to grow earnings cash flow through further implementation of those strategies. We have proactively worked to deliver productivity and make prudent investments for the future. We continue to execute a consistent value-maximizing capital allocation program. In closing, we've given you a lot of data and analysis on our operations this morning. There are a lot of moving parts for this year's numbers and it's likely to continue as we go through the year. Filtering out all the noise, I hope it's obvious that our overall business fundamentals are strong. Our investments are fueling our revenue growth and our productivity improvements are on plan. Our 2 new acquisitions are on forecast, and we believe we have purchased 2 very sound businesses. There's still a lot of work to do, but I'm very pleased with our steady operations improvements and the growing maturity in our operations. Proud of the progress we've made, the results we've delivered, and believe we are well-positioned for 2015 as well as for the future. And with that, Sue and I will be happy to take your questions. Danielle, I'll turn it over to you.

So just wanted to just kick off first of all with the margin bridge from the slides, and a little bit surprised to see 20 bps impact from price rolls this quarter, especially given the deflation we've seen in raw materials. So I'm just wondering, can you maybe make some commentary on price and why that was negative?

Yes, Nigel. We had positive price in the quarter. We had a little bit of carryover material inflation just due to some of the assemblies that we're working on. But essentially, the price would come into the Asian market, particularly China, a bit into Latin America, which really in the last quarter or 2, those markets have struggled, and we've got some local competitors, I think, with some capacity to utilize. So that's been a bit more pressure there. We also had a bit of a rebate timing from Q4 to Q1, and if you sort of add that back to Q1 and normalize it, we were pretty close to being flat, which is 20 basis points less than what we had hoped for, but it was fairly flat.

Is there a little bit of conservatism in guidance on the organic growth expectations? I suppose some of that's because 1Q is really seasonally weak. Don't want to read too much into the year, but your trends seemed pretty good and certainly outpacing the 4% to 5% organic growth expectations.

Yes, I mean, the optimism in the quarter was the strong growth, but as you pointed out, it's seasonally such an insignificant quarter to the full year for us that we typically go back and fine-tune in July, and we'll do that again this year. But your question and Nigel's earlier question, where we might see potentially some upside to volume, mix was not particularly favorable in the quarter for us. Currency is still quite a bit of headwind if you look at the euro at $1.08 and currencies where they are today, it's about $0.11 of headwind. We offset about $0.07 in the first quarter, but we've got more room to work for the balance of the year. And then, again, the pricing question, we've got a more aggressive view around pricing for the balance of the year. So you net it all out, I think it nets out to a balanced view on guidance. But specifically, on your question, if we were to see stronger markets by July, we would probably make a little higher call there at that point in time.

Okay. And then you mentioned Industrial hits better than 50% incremental margin in the legacy business. Can you describe what's really driving such strong incremental leverage?

I believe it relates back to what I discussed regarding the segment, particularly how they are more affected by currency fluctuations. If we exclude that impact, along with the early-stage effects of the Cameron acquisition and associated purchase accounting, the segment actually experienced positive price growth compared to direct material inflation. They achieved productivity gains that mitigated inflation, resulting in a strong quarter of operational performance. Additionally, their investments were proportionate to revenue in the first quarter of 2015. When we filter out some of those distractions, it’s clear they leveraged their position very effectively for the quarter.

Club Car did a great job, too, doing what we expected against a very easy comp from last year, but Club Car did a nice job in the quarter.

A couple of questions. I was hoping you could give some clarity on that whole inventory situation with residential HVAC and the new SEER requirements and has that inventory been sorted out. And then secondly, some commentary on the strength you saw in EMEA that upped 22% x FX.

Deane, regarding our current status with 13 SEER, we won't be discussing it in detail for competitive reasons. We're not ready to share our position at this time. The key point to mention is that we've experienced significant order volatility across the business since last summer, which I previously noted in the third and fourth quarters. This volatility exceeded our typical min-max requirements for stocking essential components. To address this uncertainty, we've adjusted those min-maxes for critical materials and assemblies, especially in high-margin sectors with short cycle times where there were discretionary opportunities with customers interested in purchasing available stock. This adjustment is important as we aim for strong fulfillment rates and balance inventory levels, leading to significant growth in the quarter and improved customer delivery rates. I cannot predict exactly where our working capital will settle, but if we can sustain strong growth and fulfillment, it will be a cost-effective investment in terms of EPS growth for the company. Although Europe has shut down the HVAC business, I must emphasize that all our segments performed well overall, with HVAC standing out as it has for more than a year. This success is due to having the right management team in place, a range of new products launched at the right time, and the synergy of these factors resulting in excellent outcomes. Growth in that business was likely over 20% before accounting for currency fluctuations.

Mike, could you give us a little more color on what's going on in the institutional markets, institutional applied in particular? And it does sound like commercial unitary was robust also. Is there any particular verticals there that are standing out?

Dodge is predicting an 11% increase in institutional markets, although this is still about 25% lower than its peak. We believe the recovery in institutional markets will likely be a moderate mid-single-digit growth over the next 2 to 3 years. Education is expected to perform slightly better than 5%, while health care is anticipated to be just under 5%. These two markets are crucial for us. I mentioned that we needed to see education orders progressing, and we are beginning to see that, which is encouraging. We anticipate health care, which often involves more complex work, to see activity pick up late this year or early next year. The commercial and manufacturing construction sectors remain robust. Specifically, in the HVAC vertical, we see ongoing strength in the construction of industrial and commercial buildings. Additionally, our light commercial product team has achieved notable success, demonstrating double-digit year-over-year growth, which we are very pleased about across that segment.

I have a quick question for Sue to follow up. We had foreign exchange gains in other categories. Could you describe your current hedging position for the year, your strategy, and how much you've hedged?

When considering the other income and expense and the favorable results seen in Q1, this line includes several components. One significant aspect is foreign exchange, which I will discuss shortly. Additionally, it encompasses earnings from our equity affiliates, some interest income, and various other items on the P&L that do not align with a specific line item. Typically, this line item will show a favorable range between $2 million and $6 million. Looking back to the fourth quarter, it was indeed $6 million favorable. Therefore, having $10 million in the first quarter is not unusual. The main contributors for this quarter were improved earnings from our equity affiliates and foreign exchange gains and losses, excluding the Venezuelan currency devaluation. The foreign exchange gains and losses involve cash flow hedging solely on our balance sheet position and known factors. When we establish these hedges and the dollar strengthens, closing out those positions results in a gain, which was observed in the first quarter. However, this is not guaranteed to repeat since rolling those hedges resets the rates. Notably, Q1 showed the most significant quarter-over-quarter change in foreign exchange rates, particularly with the euro, averaging $1.33 last year compared to $1.09 this year. There were indeed positive gains from a transactional perspective. While there isn't a specific percentage of hedging that I can indicate, we are addressing intercompany loans and other known factors that generally have minimal volatility and risk; this process is routine for us as we implement cash flow hedges for such transactions.

I just want to talk about the trajectory for the U.S. nonresidential construction in terms of how you're seeing it, in terms of the exit rate, in terms of orders coming into March and April. How are you feeling about the year? And then maybe if we could talk about operating margins throughout the back half.

I think that a mid-single digit view is a good view. Again, I think that you'll see education maybe a bit of north of 5%, health care a bit less than 5%. We'll still have a good unitary business for office and manufacturing. So really sticking to that kind of mid-single digit. And to your earlier point, if things continue to shape up, maybe it's to the high end of that range, and we'll come back and adjust in July.

And just given the cadence for the year and all the noise you're seeing and obviously some of the incremental headwinds with FX, how should we think about the cadence for incremental margins of Climate throughout the back half of the year?

Well, for the company overall, I would say the all-in reported gross margin is around 25%, and if you exclude acquisitions, it's likely closer to 30%. The Climate segment would show similar figures. Interestingly, our company experiences variations in translation effects; for example, the Industrial business, which has a higher exposure to foreign currency, typically operates at a higher margin compared to our Climate segment. This also applies to the TK, another global business we operate. Therefore, the impact of currency fluctuations is more pronounced there. Consequently, we need to push harder on productivity to navigate this situation. That’s the strategy we’re developing. Many companies have reduced their guidance due to currency impacts, but I believe it’s premature for us to do so at this stage. We have achieved good productivity levels and solid sales volume this past quarter, which leads us to feel that we can maintain our current range.

And the other part of that, Robert, is the direct material inflation. We mentioned that we experienced some inflation in the first quarter and a bit in the second quarter, with some Tier 2 carryover expected in the second half of the year. We anticipate that this will level out, and we won't face material inflation, which will support leverage in the latter part of the year for both segments.

Just a question on the Industrial margins. You've got the target for the year of 14.5% to 15.5%. I just wonder if you think you'll be able to get into that in Q2 or it's really about a big sort of second-half move.

I think that as we look at it, Julian, our projections would say that we're going to continue to grow and that the second quarter will be stronger than the first. So I don't want to not allow for any breakage, but I think we'll start to see things get close to that range in the second quarter for Industrial. And when we think about what's happening there, they're still going to have the big FX impact, they're still going to have the Cameron step-up, but there is productivity and the additional volume that is going to help them. So the short answer to your question is, yes, we should get close to that in the second quarter.

So then my second question. Asia revenues organically were down sort of 4 consecutive quarters now. Just maybe give a bit of an update on that. I understand there's been a price war in Chinese HVAC for sort of 6 months or more. And do you think that your Asia business can get back to organic growth in the next 6 months?

The overall market is declining, so it's not really a share issue. It's somewhat unstable. We've seen similar fluctuations in China, experiencing cycles of two quarters down followed by two quarters up, ultimately resulting in growth. You can expect the same trend here. The pipeline indicates that the latter half of the year should perform better than the first half. For the second quarter, the company is likely to remain flat overall, with a decrease in bookings. However, for Climate, I anticipate an increase in Q2, potentially in the high single digits or even better, provided the timing of bookings aligns with our expectations. For the entire year, we should see considerable growth in HVAC.

My question's on Thermo King. The strength, positive in North America for a while, but seeing some improvement in Europe. Can you flesh that out for us? What are the order growth rates you're seeing in Europe? Just trying to maybe find a little offset to Thermo King is down in '15 domestically, do we have some international offsets?

Yes, I don't think we've seen the order growth rates really coming back in Europe, although I think there is more optimism, in general, in Europe. And if you take currency out, obviously just look at the market for itself, there's more sort of optimism around Europe. But we didn't really see that in the first quarter. The growth we had in TK there, it was largely North American truck and trailer. But across the world, we would have seen great container growth again. We saw APUs with really strong growth, something near 50% in that regard. Also, air, rail and bus combined were up as well, David. So those businesses are becoming more significant as a total part of the mix at TK. North America's performing about where we thought it would be. Europe hasn't quite recovered, but we think we will a bit toward the end of the year on a constant currency basis. And we expect the ancillary products around rail, bus, and APUs and containers to continue to have good growth. Overall, kind of a mid-single-digit view.

And for this year, at least, Thermo King domestically has a pretty healthy backlog. How far does it extend into? Does it cover now pretty much the majority of the rest of '15?

We've got a pretty good view at '15. We're slightly less than ACT. Looking at 43,000 units, I think, in the last forecast, and we would be something a bit less than that at this point in time. So where ACT is calling for, say, 10%, we're calling for kind of more of a muted mid-single-digit growth rate there. Again, if there was some optimism, if we chose to view that, hopefully ACT is right. Again, this is where we've got inventory in place in case it is right. That typically could be some longer lead items on diesel engines, and that's one of the positions we took would be a stronger backlog of components in inventory there.

My first question is about Cam. You've had Cam in the fold for a quarter. Could you provide us with an update on your outlook for that business? Specifically, have you experienced any pricing pressure, especially in the oil and gas sector of that business?

Let me try to walk you through the business and the different markets that they're participating in. As we told you, they met our revenue and operating income expectations for the first quarter, and we're on track with generating the synergies and doing the things that we are planning to integrate the business. So everything is going along as we would expect with the business at this point in time. If I divide and go into the individual markets for them, processed gas, again, a piece that does have some exposure on the oil and gas side, we're actually seeing some strength in the business with natural gas and with LNG. There are some project delays that are happening in, perhaps, the Middle East. But petrochem is holding up as well as power generation in some of the pieces. So all in all, processed gas is holding up well. Plant air, we're seeing good activity there with the business, and the book-and-turn activity was good in the first quarter. Engineered air, which is the piece that is exposed to air separation and some of those markets, is showing a little bit of a pull back, and that's really more of an across-the-industry type of pull back, particularly in Asia where there was a lot of building and a lot of overcapacity in air separation. And on the aftermarket side, the aftermarket is stable for us. But we, of course, have plans to grow that, as we talked about when we did the acquisition. So all in all, we're seeing what we expected to see out of the businesses. The markets haven't really let us down in any big way. And again, our exposure, being more on the gas side than the oil side of this, are keeping us on track with what the plan was for the business.

That's really helpful. One follow-up on the incremental margins being slightly lower this quarter for various reasons with many moving parts. Given your expectation for improved price/cost leverage as the year progresses, is it reasonable to think that in the second half of the year, incremental margins could reflect levels closer to what you experienced last year?

Well, if you go back to the first quarter guidance, we probably did just maybe a point or 2 better in terms of operating leverage than we had guided. So we're pretty close on that. Got there a little bit differently than what we expected: a little bit weaker price, material inflation; a little stronger productivity; a little better volume; a little worse mix. But the bottom line is it was a solid execution to get to the leverage that we had planned. When you look at getting the 25% reported op leverage, a 30% x acquisition op leverage, it would imply a better back half than front half. And I think we're, at this point, all of the productivity pipeline, all the plans we have for price realization are in place, so it's a matter of executing on that. But again, our forecast to be 25% reported, 30% x acquisitions on leverage for the full year.

Just a question on the acceleration in the Americas HVAC bookings, up to the high single digits. I think it's been a while since we've been there. Does that feel like sort of achieving lift-off to you guys or is there something sort of keeping you in check, whether it's because it's 1Q or something else you're seeing out there that doesn't want to extrapolate that?

I believe we're seeing great progress from the product growth teams we've established. I am very pleased with the efforts of the entire team, which includes a wide range of product management, engineering, operations, and sales personnel doing an excellent job. I am more satisfied with the execution of the product growth team than I would be with any further labeling beyond what I've already stated, which is a solid institutional market that we are thrilled to see after years of negativity; it’s finally turning positive. I also think that the commercial and industrial building and retrofit markets still have potential. Overall, even Dodge would note that we're 25% off the peak, indicating we have a long way to go.

Right. And then just on the M&A versus buyback, with the discretionary cash, maybe just a little more color on what you're seeing out there in terms of the M&A environment, what kind of things you're looking at, sort of which segments or size we might view as possible.

We have adopted a philosophy to seek the best opportunities across all of our businesses. The filtering and balancing we perform will be done at the corporate level. Currently, all our businesses are focused on identifying suitable tuck-in opportunities in markets we are familiar with, whether that involves finding channels to introduce new products and services or vice versa. We have products that require a channel for distribution. Typical acquisitions we are pursuing align with our goal of achieving a 15% overall operating margin for the company, pushing us to target businesses where synergies are evident, which is certainly a challenging standard for us. The acquisition landscape remains competitive, and many opportunities take considerable time to develop, often relying on historical relationships or new connections we are creating with potential partners or suppliers in various domains. This approach is comprehensive, and I wouldn’t want to emphasize any single business opportunity over others.

A couple of questions I'd like you to put a finer point on. The first one is on your material inflation assumptions for the rest of the year. Copper, steel, particularly, seems to me like there's a lot more opportunity than what I'm hearing in your commentary. Can you just help me understand how you're thinking about your raws?

Yes, copper and steel are moving in the right direction, Steve. We buy a lot more components than assemblies. That is twofold. One is, in some cases, you're paying more for overall general wage inflation or freight inflation in some of those commodities. It's not always just a material commodity decrease as a part of the assembly. But we're working with suppliers to make sure we're getting our fair share of that back, and where that's not happening, we'll clearly resource that to the supplier with a better price point. And that will take some time as well. So I think we're on top of it. We do see sort of a flattish to down overall inflationary environment. And certainly, steel and copper and zinc are factors that are positive in that as well as freight for that matter.

Okay. I think you'd be in a pretty good negotiating position right now on those. On the other question, the finer point on volume mix. So 8% core growth; and volume mix, 100 basis points of expansion. Mix must have been really bad, or just help me understand the trade-off between those a little bit, given the very, very strong core growth you had.

Climate experienced significant growth in HVAC, which was the primary contributor to the company's overall results, mainly driven by equipment. This sector has a long service cycle, which takes time to reflect in results. The mix of higher Climate performance versus Industrial and stronger HVAC compared to TK presents some challenges. But that essentially summarizes the situation.

I think the majority of your inventories are about 50% LIFO, is that right?

Something like that, yes.

We can let you know, Steve.

Yes.

Is there a dynamic in how the benefits from raw materials will play out, considering the more pronounced seasonality in your business? That’s the first question. What impact might that have? Additionally, regarding the buyback, could you please update us on your authorization for the buyback? If you plan to do more in the second half, will you need a new authorization?

So let me take the share buyback because that's probably easier than LIFO, but I'll come back to LIFO. We had the $1.5 billion authorization in 2014 and as of the end of the year, we had utilized about half of that. So given the minimum of $250 million that we had said for 2015, that still will carry us through the year. So no problems on the share buyback authorization. On the LIFO side, with prices going down and volumes, there was no impact as I looked at the financials, really, in the first quarter from LIFO, and I wouldn't expect that to change as we go through the latter part of the year, Steve.

Okay, great. And then one last question about the non-residential sector. JCI is noting that the outlook is quite positive. On the institutional side, it seems that the Dodge forecasts have improved significantly. Could you provide some insight into the sales guidance? It appears that the situation is improving overall. What level of visibility do you currently have for the latter half of the year regarding commercial HVAC?

Look, I mean, we had great performance in the quarter, revenue; great performance in terms of orders applied. The books are filling up through the fall. Education, a little less applied. Health care, a little bit more applied. So you'd see more of a move up there. Unitary continues strong, Steve. That, I don't think is going to slow down much for the year. So yes, we are optimistic in kind of a mid-single-digit growth rate. Dodge has been optimistic for a long time. And so we've generally used our own pipeline and a triangulation of all the data that we have and have had a fairly accurate estimate over the last, say, 4, 5 years around that. I don't see any reason to change from that. With that being said, look, if there is some sort of a boom we're missing here, once again, it's this sort of component inventory, particularly on the applied side, that we're going to make sure that we're not cutting ourselves too thin in terms of inventory. And we have plenty of capacity. That's not an issue for us at all in the capacity for applied.

I wanted to start by just clarifying what the message was on the commodities. I don't want to mince words too much, but I think on the 4Q call, you had talked about commodities still being a modest net headwind for this year and I know, Mike, you just mentioned that being flat to down. So I just wanted to clarify what the bottom line message is there.

It's so close to flat that I couldn't call it either way, frankly. But it's certainly not going to be, to my mind, much of a headwind, if any headwind, at this point in time. If things continue as they're continuing, it would be a slight tailwind for us.

Okay. So that sounds a little better than what the message was last quarter, which...

It's also part of why pricing probably isn't as strong, too. Again, it's all about this gap between price and some of the commodities, which drives some of the pricing in the marketplace.

Yes, fair enough. And then I also just wanted to follow up on the answer to a prior question about TK in Europe and clarify the outlook, I think you guided to low single-digit decline in Europe. In the first quarter, you're seeing high single-digit growth; I don't know if one of them is with currency and one is without, but maybe you can clarify that. And if you're seeing high single now and expect low single for the year, does that imply a meaningful deceleration through the year? Any color there would be helpful.

Yes, European revenues were actually up high single digits organically. If you take FX against that, obviously you get a story, which isn't as rosy.

Yes, yes, the low single digits was with currency.

Mike, you mentioned kind of being more confident in your product groups and the way you're going to market in commercial versus, say, optimism about demand side. Can you just give us a little more color on what they're doing right? What you're excited about from new product or how they're going to market differently that's driving that?

Well, the market analytics and the segmentation we're doing around some of the customer segments has been really critical, both in understanding about what will grow and why, what competitors are doing, are likely to do, scenario planning around that, economic value estimation of the products we're launching and making sure we're valuing sort of the product versus looking at it on a cost-plus basis. All that really consummating and having an operations team, an engineering team, and a product management team having the same goals and objectives. Just as an example, if a plant manager is looking to maximize inventory turns and a product manager is looking to maximize product availability, they're obviously in conflict. When these people all agree on what it's being the #1 or #2 thing to grow market share and margins, great things happen. We've got those teams totally aligned on how to grow margin and how to grow market share. And if you talk to anybody on that team, no matter sort of what stripe they wear, from ops, engineering, sales, or product management, they're going to give you the same exact answer. And that's where the investments are going and they're not going anywhere else. And again, this is why we've got 3, 4x growth in the overall portfolio last year. This is why I'm excited about doubling that this year and ultimately, this is why I'm excited about the next, say, 5 years because we'll build this thing out all the way. People are having great time doing this, they feel like they're winning, and we're going to keep going as fast as we can.

Okay. Thank you, all, very much for this morning. I hope to see you at our Investor Day in May. I'll be around for the rest of the day, so please call me if you have any additional questions.