Trane Technologies plc (TT) — Q1 2016 Earnings Call Transcript

Thank you, Lauren, and good morning, everyone. Welcome to Ingersoll Rand's first quarter 2016 conference call. We released earnings at 6:30 this morning, and the release is posted on our website. We'll be broadcasting, in addition to this call, through our website at ingersollrand.com. And that's also where you'll find the slide presentation that we'll be referring to this morning. The call will be recorded and archived on our website. If you would please go to Slide 2. Statements made in today's call that are not historical facts are considered forward-looking statements that remain pursuant to the safe harbor provisions of federal securities law. Please see our SEC filings for a description of some of the factors that may cause actual results to vary from anticipated. And our release also includes non-GAAP measures, which are explained in the financial tables attached to our news release. And to introduce the participants on this morning's call, Mike Lamach, Chairman and CEO; Sue Carter, Executive Vice President and CFO; and Joe Fimbianti, Director of Investor Relations. Please go to Slide 3. And I'll turn it over to Mike.

Thanks, Janet. For those of you who don't know, this is Janet's last time reading the safe harbor statement. She's retiring at the end of this month after a brilliant career here at Ingersoll Rand. We're going to miss Janet greatly, and we want to wish you and Ron all the best in your retirement. So with that, we delivered a very strong quarter that exceeded EPS guidance and reflected excellent execution across the whole company. The quarter really demonstrated the consistency we're seeing in our strategy, which is to deliver sustainable, profitable growth, and I'd highlight a few areas here. First, we're leading in our markets in the innovation and development of energy-efficient, reliable, and sustainable products and services. Second, we're deepening the penetration and maturity of our operating system, and we're delivering operational excellence across our businesses. Third, we're maintaining a disciplined and dynamic approach to capital allocation. And finally, as I've said before, critical to any sustained culture transformation, our employees are engaged. Their scores are continuing to increase across the company. Employees continue to see Ingersoll Rand as a great place to work, which in turn leads to a better customer experience and ultimately delivers shareholder value. Our performance in the first quarter gives us confidence to raise our full-year guidance, essentially flowing through the first-quarter operational beat. Now this morning, I'm going to give you an overview of what we're seeing in our end markets across the globe and use the opportunity to talk a bit about how we're performing against this market backdrop to give you some color on how we're progressing for the year. I thought it'd be useful to highlight where our performance maps specifically to our overall strategy. And then I'm going to turn it over to Sue, and she'll take you through the quarter and our revised guidance for the remainder of the year. So over the past 16 weeks, I've spent the majority of my time on the road with leaders across the company, and during that time, I've met with customers from many of our business units across vertical markets and regions of the world. I've spent considerable time with our customer-facing employees, from service technicians to sales teams. And as always, I've spent time inside our operations talking with the people who are building and engineering our products to gain their perspective on the maturity and momentum in our operating system. And I've witnessed good momentum in the deployment of our operating system and remain confident that there is still a long runway of opportunity in front of us. With that, let's go to Slide 4. And I'm going to note that all of my comments are on an organic basis. So they're going to exclude currency and acquisitions. Now I'll turn first to the North American Climate segment, where our business remains strong overall, and we expect this momentum to continue for the balance of the year. In commercial HVAC, recent put-in-place data continues to support mid-single-digit growth, and we believe this should continue through at least 2017. We continue to see strong growth in the retail and office markets. Within the institutional markets, education and government markets are also strong. We saw a low-teens revenue growth in the quarter, coupled with high single-digit bookings growth. I want to point out, too, that we expect to see a record for quarter 2 with commercial HVAC North American bookings, which should be up approximately 25% over quarter 2, as a result of some large institutional project awards. We expect to continue to outperform the overall market for the balance of the year. Additionally, we're executing well on the volume and saw excellent operating leverage in the quarter. Growth here is a direct reflection of the constant investment we've made over the past years. And we're seeing growth specifically in the areas where we have invested, whether in product growth teams, products, or channels. As in 2015, we are beginning quarter 1 of '16 with double-digit growth in our Controls and Service business. With over 4,300 companies' direct service mechanics and technicians, we believe we are now the largest provider of mechanical HVAC service to commercial customers in the world. Additionally, when we break out our critical growth programs from the base business, we are seeing mid-teens growth in these programs. Overall execution has been excellent. With clear discipline, the management team is running the business through our operating system. Like commercial, our residential HVAC North American business is likely to continue to outperform the market as well. We're proud of this performance and what's ahead for this business. I'm occasionally asked, 'What do investors misunderstand about Ingersoll Rand?' In reading some of the sell-side reports, I think there is some misunderstanding about the success we've had in the residential HVAC business, and so I want to lay out some of the facts for you. According to AHRI data, we have increased share each quarter over the past 6 quarters, including the first quarter of 2016. For all of 2015 and continuing into quarter 1 of '16, we have a residential HVAC business with mid-teen EBITDA margins, which makes it accretive to the segment and IR as a whole. Quarter 1 brought mid-teen bookings growth for the second consecutive quarter and mid-single-digit revenue growth and very strong operating leverage. Our market outlook remains positive. We forecast 4% to 5% unit growth for the industry, and we anticipate our revenue growth to be in the high single-digit range for the year. The residential team has done an outstanding job implementing our operating system across its full footprint. The team is running the entire business in a full product growth value stream, and it's showing in the execution. And strategically, we've executed well on our complete product refresh, repositioning of our channel strategies, and in our connected home strategy, where we have a profitable business platform, robust diagnostic capabilities, and nearly 200,000 Nexia enrollments to date. Additionally, connected home is a key driver of our residential controls business, which has more than doubled since 2011 and continues to grow at around 25% annually. Shifting to North American transport refrigeration markets. The management team did a great job in the quarter and managed to improve their margins with high operating leverage. North America continues to hold up well, especially in the truck and trailer market. Our current view of truck and trailer has improved from our original view of the market from earlier this year. ACT raised its trailer units forecast to 47,000 units, which is up about 1% versus last year. Their prior forecast was for the market to be down 10%. We view this market data as being a bit aggressive, but we have raised our own forecast for approximately 45,000 units. And you may recall that our own prior forecast was 39,000 trailer units. So even though we do expect the market to be down over the record performance last year, our view has improved from when we spoke in February. Our truck refrigeration business is also solid, and the overall market for Class 3 to 7 trucks is showing moderate growth. We continue to pursue growth strategies in rail, bus, and auxiliary power units to continue to balance North American business into additional vertical markets. As we look toward the HVAC and transport refrigeration markets in Europe, the Middle East and Africa, we plan to continue to outperform the market in the year ahead, with additional new product and service launches planned in the year and excellent management teams executing on the ground, delivering good margin expansion and cash conversion growth. We continue to do very well in Europe with organic bookings in the high single digits against a flattish market backdrop. We are seeing excellent uptake on the new product introductions, and like North America, the Service business also grew at a double-digit rate. I visited our FRIGOBLOCK team and operations a few weeks ago. The progress made and the adoption of our operating system was absolutely amazing. With our FRIGOBLOCK acquisition, we've taken a step forward now in integrating hybrid electric technology into our product roadmap. The acquisition has been a great success for us. Middle East markets are certainly softening. We're seeing a contraction in the number of building projects planned and would expect this to continue for some time, as lower oil prices are driving an investment pullback. Moving to Asia Pacific, it's difficult to know if markets have reached an inflection point in China. The data is mixed, and it's not that consistent month-to-month. Our performance, though, has been deviating from the market in a positive way due to investments in products and the focus we've put on increasing our direct channel marketing investment to achieve fuller market coverage. Climate bookings in China were up mid-single digits in quarter 1 and up low teens for Asia Pacific as a whole. Our strategic focus on growing the Service business continues to be successful in Asia, too, achieving a mid-teens growth rate in the quarter. We're also seeing strong mid-teens bookings growth in transport refrigeration equipment as the market continues to grow. And our local engineering and manufacturing teams continue to tune the product to local preferences. Strong growth outside China is being driven by growth in Thailand, India, and our performance in Singapore, along with good transport refrigeration growth in Australia. So concluding the HVAC and transport refrigeration geographic update will take us to Latin America, where markets remain very volatile, with strength in smaller but fast-growing markets in the Dominican Republic and Panama but deteriorating conditions in Brazil, Venezuela, Ecuador, and Argentina. Conditions though in Mexico remained fundamentally sound. Organic revenue for the region was flat, with low-teen increases in HVAC equipment. So we're pleased with our performance in the market. We've expanded margins in a very tough and volatile Latin American marketplace. Let's move to Slide 5. And here, we'll look at the end markets for the Industrial segment of our business, and I'll start with an overall comment that our compression technologies business bookings and revenue were down organically low single digits in the quarter, with equipment essentially tracking the overall market, but with service up mid-single digits. Again, we are focusing on growing our service businesses across the enterprise and have been executing well on that strategy. In North America, U.S. manufacturing capacity utilization remains relatively low, hitting 75% last quarter, which is the lowest point over the last 12 quarters, and large equipment CapEx, typical for what we would see for large centrifugal and large rotary air compressors, historically rebounds the utilization readings above 80%. On one visit, I had the opportunity to meet with a major customer that's been around for decades, building small-scale LNG plants that range from 50,000 to 500,000 gallons per day. I asked this Ph.D. physicist what the most reliable leading indicator he would look for in his end markets, and he responded very simply by saying, 'It's when the telephone rings.' Fortunately, he did say the phone is beginning to ring, as is ours, in that area, but whether it's small-scale LNG systems or larger air compressors, our sense is that even early activity in large machine quoting activity probably will have little impact on large machine deliveries in 2016. To give you a little bit more color on this for the North American market, you look at compressors between 500 and 400-plus horsepower, the market for small compressors, those between 5 and 15 horsepower is up roughly 10%, but compressors larger than 250 horsepower are down more than 30% in the first 2 industry-reported months of the quarter. The small air compressors are quicker to book and turn, with inventory restocking occurring in that category. We also believe we are seeing some restocking to the wholesale channel in our tools and fluid management business. But our Material Handling team has done a great job managing their business, essentially holding the business to breakeven on a 50% reduction in revenue. So again, across the business, with the management team doing a very good job, exhibiting strong cost control and execution discipline on the backdrop of continued declines and projected global market growth. In Europe, we're seeing increased exports and industrial production across Western Europe. Eastern Europe continues to be fairly weak. And for Asia-Pacific, the current environment continues to experience pricing pressure across the region, but we're cautiously optimistic to see if we have reached an inflection point, as manufacturing indices signal pockets of improvement in countries such as China, Thailand, Indonesia, South Korea, and China's power consumption has also shown growth in the first 2 months of the year, and India is seeing strong market growth in verticals like textile, pharma, and food and beverage. So rounding out the geographic update for the Industrial segment, we'll go to Latin America, where volatility in the markets there across the region continues to be driven by political instability, and this has contributed to reduced investment in key verticals such as energy, oil, and gas, mining, and metals. However, other verticals like food and beverage, pharma, and textile remain with positive outlooks. So before turning it over to Sue, let me conclude by saying again we had an excellent quarter. We continue to invest in the products, service offerings, and footprint of the company while using our operating system to deliver well above industry average results. And I'll turn it over to you, Sue, to cover the financial review and guidance.

Thank you, Mike. Let's go to Slide 6. Let's begin with an overview of the first quarter. Q1 was a strong operational quarter across all of our businesses. As you heard in Mike's comments, end markets continue to be strong in Climate and weaker than expected in Industrial. Our business operating system guided us through good execution in our factories and in our cost centers. Our focus was on good operating results in a low-growth environment. Our results show that we did not let costs get ahead of revenues in the quarter. Revenues grew slightly on a reported basis and were up 2% organically. The Climate segment grew 4% organically. Industrial was down 5%, both on a reported and an organic basis. HVAC revenues grew in each of our Climate businesses, led by commercial and residential in North America. Revenue in our Industrial businesses declined in the quarter with tough comparisons to the first quarter of 2015. Large centrifugal compressors and other industrial equipment were weaker than our estimates, but Club Car performed as expected, with low year-over-year growth. Our adjusted operating margins grew 140 basis points year-over-year, with organic operating leverage of 75%. Adjusted segment margins grew 150 basis points, which shows the alignment between our operating performance and our Q1 results. Our strength was in price, direct material deflation, and mix. Earnings per share grew 32% year-over-year, exceeding our prior guidance. In Q1, our capital deployment actions included repurchasing $250 million of shares, and we increased our dividend by 10%. We completed the sale of our remaining interest in Hussmann on April 1, 2016. All impacts will appear in the second quarter. Please go to Slide 7. I've included a slide to reconcile our Q1 EPS actual results with our prior guidance. I've said on a few occasions this morning that our results were the result of good execution and operational performance. Price and direct material deflation were the largest drivers of the margin expansion in Q1. This is an area where everything went right in the quarter; there was no breakage, price was positive in both segments and direct material deflation was also very positive to our guidance. Cost savings and controls were a positive $0.03 for the quarter. Each of our businesses and corporate functions had favorable variances to start the year as we controlled spending while we evaluated our end market volatility. Currency, share count, and other income were about $0.01 each. We opportunistically repurchased shares earlier in the year than we would normally, and currency was a bit favorable to our guidance range. Restructuring was favorable to our guidance by $0.03 for the quarter. This is timing. We have identified projects to execute and continue to work on restructuring projects that have good returns and shorter paybacks, and we'll spend the remaining $0.03 throughout the remainder of 2016. Please go to Slide 8. Orders for the first quarter of 2016 were up 4% organically. Climate orders were up 6% organically. Organic global commercial HVAC bookings were up high single digits, led by high-teens growth in North America unitary and double-digit growth in Asia applied. We continue to see excellent growth in service controls, contracting, and parts, with double-digit growth in the quarter. Originally, for commercial HVAC, we saw high single-digit booking increases with a high single-digit increase in North America and Europe; up low teens in Asia; and with declines in both the Middle East and Latin America. Residential bookings were up 17%. Organic transport orders were down low single digits with low-teens growth in truck and trailer in North America and Europe that were offset by lower container orders. Orders in the Industrial Segment were down 5% organically. We saw a low single-digit order decline in compression equipment, a low-teens decline in other industrial products, and a mid-single-digit decline in Club Car. Performance in compression technologies was mixed in the first quarter. We had an improvement in small compressors, oil-free and in some of our component businesses, like dryers and filters. We also had a small improvement in our aftermarket business. These gains were offset by declines in core industrial compressors and by large centrifugal equipment. Please go to Slide 9. This slide provides a directional view of our segment performance by region. In our Climate segment, which was up 4% in the first quarter, we saw solid performance in North America and flattish growth across Europe, Latin America, and Asia. The Middle East was the only region that declined within the Climate segment. We're seeing a contraction in the number of building projects planned in the Middle East and would expect this to continue for some time, as lower oil prices are driving an investment pullback. Our Industrial Segment performance in the first quarter, which was down 5%, is representative of the volatility that continues across the globe in the industrials market. Strong performance in Mexico contributed to double-digit growth in Latin America. We also saw growth in Europe, while Asia was flat and North America was down high single digits. Overall, our regional performance for the first quarter trends with the end market summary that Mike provided us earlier, with a strong start in North America. Industrial Segment performance is expected to trend with the market. We're planning on expanding margins in a down market in the second half of the year through productivity gains and cost controls. Please go to Slide 10. Operating margin on a reported basis increased 160 basis points from 5.9% to 7.5% from the first quarter 2015 to the first quarter of 2016. Mix was favorable for the quarter 40 basis points, largely offset by unfavorable volume and currency. Net pricing versus direct material inflation was the largest driver of margin improvement in the quarter, favorable by 160 basis points. Price realization was achieved across both the Climate and Industrial segments, which was higher than expected, and commodities remain deflationary. Productivity versus other inflation was positive 10 basis points, driven by ongoing productivity actions, partially offset by other inflation. Year-over-year investments in other items reduced margins by 20 basis points. In the box, you can see that was comprised of 40 basis points from incremental investments, 20 basis points from higher restructuring costs, which were partially offset by a 40-basis-point improvement related to the absence of acquisition-related step-up costs incurred in 2015. Overall, reported operating leverage exceeded 100% in the quarter, as we expanded margins in a low-growth environment. Please go to Slide 11. Our Climate businesses had an excellent quarter in Q1. Adjusted segment income and EBITDA margins improved by 280 and 260 basis points to 9.8% and 12.4%, respectively. Increased volumes, favorable mix, price, direct material deflation, and productivity offset other inflation and investment spending, the leverage for the Climate segment was 118% for the quarter. Revenues for the quarter were up 4% organically. Commercial HVAC organic revenues were up mid-single digits, led by mid-teens unitary equipment shipments in North America and low-teens parts and service revenue in North America. Europe had low single-digit equipment growth and high single-digit services, contracting, and parts. The Middle East had parts and services growth offset by declines in equipment sales. Residential revenues were up mid-single digits in Q1, with very strong leverage and significant margin improvements. Transport organic revenues were down slightly, but this does not tell the whole story for Q1. North America truck and trailer organic revenues were up mid-single digits, and European truck and trailer organic revenues were up in the mid-20% range. Marine container organic revenues declined more than 60% in the first quarter, reflecting a soft start at various box builders for 2016. Please go to Slide 12. First quarter revenues for the Industrial Segment were $681 million, down 5% on an organic basis. Compression technologies and services organic revenues were down low single digits versus last year. Club Car organic revenues were up slightly versus prior year. Organic revenues in the Americas were down high single digits, while revenues in Europe, the Middle East, and Africa were down low single digits and were flat in Asia. Industrial's adjusted operating margin of 9.8% was down 230 basis points compared with last year. Price and direct material deflation were positive. Productivity offset other inflation and volume and mix were unfavorable. Please go to Slide 13. First quarter free cash flow of negative $46.3 million was favorable to prior year by $135 million. Strong operating income improvement and improved working capital performance were the primary drivers of the favorability. For the quarter, working capital as a percentage of revenue was 6.2%. We had strong collections in the quarter, with our days sales outstanding improving 1.3 days over the prior year and days payable outstanding improving 0.7 days. Inventory's on plan for the quarter, and we're well positioned to serve our customers as we enter the heavier volume second quarter. Capital expenditures of $40 million are lower than prior year due to the capitalization of our ERP systems cost in the first quarter of 2015. Please go to Slide 14. Capital allocation is a key area of strategy for us. We continue to invest in our businesses, and I think you'll agree that our results show the value of our product refresh strategies and our operational excellence programs, which are a part of our business operating system. We raised the annual dividend 10% in early 2016, with a goal of maintaining a dividend payout consistent with our peers. We have an M&A pipeline that reflects our desire to add to our products, technologies, and channels, as outlined in our strategy. We are focused on building long-term value. We bought shares to offset benefit program dilution in the first quarter at an average share price of $51.10. Please go to Slide 15. As always, our intention is to give you the best view of what we're seeing in our end markets sitting here today and how that translates to our revenue guidance for 2016. We've broken it down by major end markets and geographies. As you can see by the variation of colors and symbols, our end markets are seeing a wide variation in trends. We also added a column to show you our current versus prior thinking on organic revenue. North American commercial HVAC and residential HVAC, as well as European transport and commercial HVAC markets are generally positive, while global industrial markets have declined. We are forecasting transport markets in North America to be flat. Our forecast for North American trailer volumes has shifted from declines of 15% to down slightly for the year. Asian HVAC markets are expected to be flat to down, and industrial markets in Asia remain under pressure. Golf cart markets are slightly down, offset by increases in the utility vehicle markets. Both the growth forecasts shown here are on an organic basis. We're forecasting mid-single-digit growth in commercial HVAC in total, high single-digit growth in residential HVAC, which is essentially an all-American North American business for us, and a small increase in transport. We expect compression-related products and other equipment to be down high single digits. We expect Club Car to be up low single digits. Please go to Slide 16. Aggregating those market backdrops, we expect our reported revenues for the full year 2016 to be flat to up 2% versus 2015. Overall, foreign exchange will be a headwind of about 2 percentage points. While these revenue outlooks do not show a total change, the segment numbers reflect important updates. We expect Climate revenues to be up 2% to 4% on a reported basis and 4% to 6% organically. For the Industrial segment, revenues are forecasted to be in the range of down 4% to down 6% on a reported basis and down 2% to down 4% organically. For operating margins, we're excluding restructuring costs to get adjusted margins. We expect Climate adjusted operating margins to be in the range of 14% to 14.5%. We expect Industrial adjusted margins to be in the range of 12% to 12.5%. For the enterprise, we expect adjusted operating margins of 11.8% to 12.3%, a 30-basis-point improvement from our prior 2016 guidance and a year-over-year improvement of 70 basis points. Operating leverage would be about 40% on an organic basis for the year. Please go to Slide 17. Transitioning to earnings, the reported earnings per share range is estimated to be $5.39 to $5.54. Excluding restructuring and the Hussmann gain, the range is $3.95 to $4.10, an increase of 6% to 10% versus 2015 and a $0.13 increase from the midpoint of our prior guidance range of $3.80 to $4. As a note for 2016, currency is a headwind of about 2% of revenue. This reflects a full year tax rate forecast of 24% to 25% and an average diluted share count of 261 million shares for the full year. Second quarter 2016 revenues are forecast to be up 2% to 4% on a reported basis and 4% to 6% organically. We are projecting Climate revenues to grow mid-single digits in Q2 and Industrial to decline mid-single digits on a reported basis. Reported second quarter earnings per share are forecast to be $2.75 to $2.80. Back out $0.01 of restructuring and the $1.49 Hussmann gain to get to an adjusted range of $1.27 to $1.32. For the full year 2016, we expect to generate adjusted free cash flow, which excludes restructuring and the Hussmann proceeds, of $950 million to $1 billion. And with that, I'll turn it back to Mike for a few closing comments.

Great. Thank you, Sue. And I'll be brief. As I started out this morning, we had a strong quarter. We improved operating performance in a volatile environment. We realized price in both segments. We achieved outstanding leverage and improved our cash flow. We're growing in the areas where we put a strategic focus. There's clear evidence that the discipline we've created in our operating system is gaining momentum. And I'm confident in our management team, and we feel good about our forecast for the remainder of the year. So with that, Sue and I will take your questions.

Just on the price cost equation here. Clearly, a pretty strong contribution in the first quarter. Can you help us with how that dimensions out, just based on the purchasing agreements and hedges you already have in place, over the balance of the year?

Absolutely. So you're right. The 160-basis-point spread between price and direct material deflation was a strong start to the year. What we expect for the first half of the year is strong performance on a year-over-year basis because last year we were still in an inflationary environment in the first half of 2015. So I think the second quarter will be slightly less favorable than the 160 basis points, but what we've adjusted the full year to now, Josh, is 80 basis points of favorable spread between price and direct material deflation. And so the first half, second half reflects basically the year-over-year compares to last year. And then as we look at the 80 basis points, so Q1 performance was driven by strong price performance, and we expect some of that to continue in Q2 and also strong performance from the materials side. Price is one of those areas where I think you never want to reach out and assume that you can continue to get price at a great execution level throughout the year in a strong deflationary environment. But as opposed to the commodities themselves, here's what we expect. So we have about 70% of our copper locked in for the year through our contracts. We expect that copper and aluminum are going to be fairly stable in terms of what happens throughout the rest of 2016. You'll see some ups and downs. But generally, I think those are going to be pretty stable. We're seeing a slight uptick in steel, but I don't think that's going to impact us in 2016. Because of the way that our contracts are written, we wouldn't start to see that until the very end of the year. So I think our supply base and我们的 commodity teams have done a great job of getting us the deflation that you're seeing in the results. I expect that to continue. All of the Tier 2 pricing really seemed to come in Q1 also. So I think we had a great environment, and I think we'll have a great result. So if you recall, we had given you a look at the full year, I think, 30 to 40 basis points when we last gave guidance, and as I said, we took that up to 80 basis points favorable spread for 2016.

Great, that's helpful. And then, Sue, just as a follow-up, I remember last quarter you talked about some of the toggles for the tax rate and specifically mentioned intercompany debt. Could you just maybe update us where we're at on the total tax strategy in light of some of the treasury rulings?

Right. So I think the first way to start out that question, Josh, is to say that we've looked at all of the proposed treasury regulations, and we don't expect those regulations to have an impact on our effective tax rate in 2016. As we think about the tax strategy that I've talked about getting us into a low 20s type of tax rate on an ongoing basis, I also don't expect those regulations to have an impact on us getting into those areas. The reason I say that is when we're looking at our tax strategy, intercompany debt is one element of some of the things that you can do, trading hubs, procurement hubs, making sure that your transfer pricing is absolutely aligned and other tax-efficient projects can help us get to where we want to go. We've also been looking at a project that helps us look at effective tax rates by each of our SBUs, so that we're all working on tax as we do our plans and we do our forward looks, and I think that will help us with an overall tax strategy that doesn't get impacted by the proposed treasury regulations. We'll obviously continue to look at those and make sure that we understand all of the sort of derivative impacts that might be out there from the regulations. But no impact on the rate and no impact on our strategy going forward.

I guess my first question maybe starting on industrial, where you did see decelerating trends. I noticed that you didn't take up the restructuring at all for the quarter, and if I recall correctly, there were some Cam shipments that were expected to be released in the beginning part of this year. And so I'm just wondering, is there still an opportunity for further action in Industrial? And what's the strategy at this point?

Yes, Joe. So the $0.02 of restructuring that we spent in Q1 was related to Industrial. We are continuing to work on restructuring actions for the remainder of the year. And those are going to primarily be in Industrial. So we called out in the guidance about $0.01 for each of the next 3 quarters. I think what's important about the restructuring and the way that we've looked at it is that the restructuring really does have a payback within 2016. So we fully expect to realize the benefits of that $0.05 of restructuring. And that is also what will help us with my comment earlier in my prepared remarks about industrial margins improving in the back half of the year. So some of that productivity kicks in and some of the restructuring actions that were actually started almost a year ago are going to kick in. Now on the ECC side, we did have some shipments that had pushed out of Q4. We actually had some shipments that pushed out of Q1 also into Q2. But the ECC story is an interesting one. So if I look at first quarter bookings in total, bookings in total for the ECC business are actually up significantly in the first quarter. The majority of that is going to be in the products that are outside of the large centrifugal compressors. Those are really coming down. But so bookings are up, which is good. The revenues that we're seeing are really being impacted by the large centrifugals, but also importantly, as we think about ECC and that business is, we expect to really be on track with the revenue and the cost synergies for 2016 that we had outlined. So lots of moving pieces in the business, but I think you'll see some strength in the normal product and in the aftermarket and some bigger weakness and some shipments moving around in the large centrifugal compressors.

Joe, remember, too, that I think that we've been restructuring now for years, and that's both qualified and nonqualified. So we're always improving the cost base there. When you look at the type of paybacks that we're seeing in that business, we're getting numbers like 7 years, which is indicative of doing a good job around running the plants, the utilization that we've been able to achieve in our plants. You couple that with the lead time to bring on new capacity when the markets return, and that's a 24- to 30-month process, particularly in the machining centers that we would be moving or upgrading to do that. So we don't want to get whipsawed in doing any large restructuring when this thing turns around because the margins come back very strong when the business volumes come back as well. So we're being cautious. Now we're always looking at the ideas that are on the table. If the underlying real estate values change or if tax incentives change from one location to another, it could swing something like that. We are very cautious about looking at an upswing in the lead time to bring capacity on when you need it, and we don't want to ever be in a situation at an upswing in the market to not have sufficient capacity at that point in time.

No, that makes sense, Mike. I guess, maybe my following question, I just want to make sure I heard this correctly. Did you say that Q2 North America commercial HVAC bookings are expected to be up about 25%?

Yes, that's correct.

And is that the reason for the organic revenue guidance raised?

No, it's more of an impact in '17. It's got a little bit of a positive in '16, a little bit of a positive in '18, but the bulk of that would be '17 shipments. So it's really the strength of the business across the board. Unitary continues to be strong. The pipeline looks strong for us. Europe has been a great success story. I think it'll continue as well. So it's, and of course, the residential business continues to put up some very big numbers. And so all of that combined has got more to do with the guidance increase than the large booking number in quarter 2. By the way, quarter 3 should look pretty good for us as well. Although I don't have a prognostication on the percentage rate, it should be a good quarter for us.

Just wanted to say thanks a lot to Janet for all the help, and all the best. In terms of the first question, that would really be back on the Industrial margins. It used to be at sort of 16%, 17%, the odd-quarter here and there, down to 9% to 10% right now. And the guidance embeds that by the end of the year, I guess, they climb back into the sort of low-teens in the next 3 quarters. So maybe just help clarify what's driving that sort of 400-point-plus margin recovery? Is it just about productivity? Or is there something going on with the mix as well of Industrial versus compression?

So Julian, great question. On the Industrial margins, your math is absolutely correct, that in the back half of the year, we do have the operating margins for industrial improving into the low-teens. And as we look at what's going to happen in that back half of the year, so it truly is productivity, still lower inflationary type of rates. So you've got productivity offsetting other inflation. You still have positive price in the back half of the year. And you have just a skosh more volume in the back half of the year than the front. I don't want anyone to think there's a lot of volume recovery that we've built into this. We have not. But there is, by virtue of how the quarters pan out, roughly $50 million of additional revenue in the back half versus the front half. But it's productivity. It is the restructuring actions that are kicking in, and it is the continuation of the actions that the management teams are taking to work through this low revenue and end market decline.

The cost control has been exceptional. Although there is a headline restructuring cost of $0.02, there may be additional nonqualified restructuring costs. This indicates a restructuring process that involves controlling spending rather than outright replacements. There is a cost associated with this in the first half of the year, but it will bring benefits in the second half, aligning with the comments on productivity. A significant aspect of that productivity relates to cost control concerning headcount, which includes both qualified and nonqualified costs in our accounting. Regarding the long-term profitability of the business, Sue conducted some analysis, and it could be helpful to discuss when we might achieve a 17% margin.

That's great. When I reviewed the situation, the first thing we did was revisit the original guidance of a 17% margin for the Industrial business, at which point the revenues were between $3.6 billion and $3.7 billion. Currently, we're approximately in the $3 billion range. While we are taking the necessary steps to align costs, we really need the market to recover, and for revenues to rise back into the higher $3 billion range to achieve the 17% margins. We believe this is achievable, but the timeline largely hinges on the timing of market recovery. As of now, we haven't observed the markets stabilizing; they continue to decline. Therefore, we first need to see stabilization before the markets can rebound. My perspective is that once revenues return to the $3.6 billion to $3.7 billion range, which they were when we provided that guidance, we will be close to reaching those 17% margins for Industrial.

Remember, when you look at the gross margins of that business and look at the fixed cost of that business, say, relative to the Climate segment, you can see very easily why that business snaps back very strongly on volume. So when volume returns to that business, we'll get very aggressive incremental margins out of that. In the short term, we're controlling the heck out of costs the best we can. However, we're not going to sacrifice on it as it relates to capacity.

And then just my follow-up quickly would be on your overall firm-wide margin bridge. Q1, you had about 10 points or 10 bps from productivity and other inflation. I guess, based on what you just said, should we think the number for the year ends up somewhere between that 10 bps and the sort of 90 bps tailwind that you had last year for the year as a whole?

I believe that we will see inflation to be higher in the first half compared to the second half, which is when our salary increases and many benefits will occur. Looking at our plans for the full year, I would estimate it to be around 40 to 50 basis points.

So this North American order spend is really interesting, Mike. And I'm assuming that's really driven by these large pipe projects finally starting to break free, and I'm just wondering what's changed here. I mean, is it just a case of old equipment we're seeing here to the extent that replacement is coming through? Is it budgetary? I mean, any color there would be helpful.

Yes, Nigel, I think all of that is true, but the constant, persistent investment we've made over 5, 6, 7 years in that business, the constant investment in the channel and the service footprint is really paying off. And I just think the focus we've had on all of that development being around energy efficiency, sustainability, new refrigerant development, all that is just such a powerful story when you look at it. This is what we were waiting for. This is what we'd hoped to have seen, which is outsized growth relative to the market and outsized profitability or margin expansion relative to the market. So this is a huge effort by lots of people, all the way through to the technicians providing service on the street for us. This is a real accomplishment.

Okay. And obviously, very, very early to call '17 at this point, but if you just look at the North American commercial HVAC operations, based on the backlog of pipeline, is it reasonable to assume that perhaps you might see some acceleration next year?

Well, the thing you have to think about, though, is what happens to the office and retail business. As an example, our national accounts business has been doing extremely well into retail. Office building is doing really well, as you can see, kind of the high teens booking rates again for unitary. That's been strong again. At some point, you think that that would begin to subside and be replaced by stronger applied growth, which I think will happen. So I think what you end up with is maybe a change in the mix between unitary and applied, but I do think continued strong performance through '17.

On the Climate side, there is a significant margin figure to consider. I'm trying to understand the seasonal trends from the second quarter to the third, and also from the first quarter to the second. In the past few years, there have been increases, such as in 2014 when there was a substantial rise in the profit number for Climate. Can you share your expectations for seasonality in that area or provide a general outlook on the margins for that business as we progress through the year? I suspect that the seasonality may be somewhat muted now due to the emergence of Commercial, which tends to be less seasonal than other segments. Additionally, the high baseline in the first quarter makes it challenging to assess the situation in Climate.

Yes, Steve. I believe that targeting a margin in the 16% range for the entire segment makes a lot of sense for us. As Sue mentioned, pricing might slightly decrease. Material inflation has been relatively steady. Bookings appear strong, and the pipeline looks solid. The decline in the container business on the transport side isn't a major concern for our margins as long as the European and North American trailer segments continue to perform well. So, when you consider all these factors, a margin in the 16% range seems achievable.

Can you, at some point, soon, kind of get to that 17%? Will you kind of hit that at some point this year?

I don't know. I mean, we haven't really looking at Q3 and Q4 at that level of granularity around guidance, Steve. I don't know. I mean, Q2 is seasonally a pretty good quarter for us. Quarter 3 can be. So we've got an outside shot at something like that.

Okay. And then just on the kind of go-forward leverage, so you've had this nice pop off the bottom on margins. Should we continue to expect that if this kind of current mix holds that if commercial HVAC does really continue to roll on here and we have a bit more of an extended cycle than, I think, most people were expecting probably 3 to 4 months ago? Can you still leverage that business really well? Or do you have to add cost or anything like that? I mean, I feel like you got to have plenty of capacity here to let it rip a little bit before you start to throw money at the business from a capacity perspective, right?

The service and controls businesses are experiencing strong growth, and our margins are significantly higher. This may skew how we view fixed costs in relation to factory expenses. I believe we have some capacity within our field service and controls that won't necessitate additional investment. While it involves having personnel available, we are proactive in this area and tend to recruit in advance for the service business. Therefore, I don't foresee any issues with maintaining leverage for the full year in the Climate business.

Okay, and then one last quick question. You increased the price cost year-over-year by about 40 basis points, but your margins only went up by 30 basis points. Is that primarily due to volume and mix at Industrial?

Inflation is impacting wage increases starting in April for the full year, and we are experiencing cost increases that are putting some pressure on margins. However, fundamentally, there isn’t much changing. It’s difficult to believe that prices will remain as high as they typically do, and material inflation is expected to hold steady. We are looking to narrow that gap a bit, likely from the pricing side.

Mike, could you provide more details on the strength of the bookings? Is the 25% figure you mentioned reflective of global numbers, or is it specific to the U.S.?

It'd be the North American commercial business.

North American commercial. It does sound like Europe, though, is fairly strong for you on share gain. How do you see that playing out over the balance of the year?

I visited several of our factories and operations in Europe about a month ago and met with the engineering teams working on products set to launch between August and December. It's one of the best experiences I've had, demonstrating the quickest turnaround from idea to product launch. They are aligning perfectly with customer needs, which has been a fantastic development for us. I don't anticipate this momentum slowing down in 2016. I'm very optimistic and proud of the achievements made in the HVAC sector in Europe. On another note, regarding FRIGOBLOCK, it was a family-owned German company. Typically, you might expect such a company to be slow to adapt or challenging to integrate into our operating system. However, I discovered it was one of the swiftest deployments of an operating system we've executed across the company. This is very encouraging, as is the willingness of our transport refrigeration team to adopt hybrid electric technology for our truck platform. Overall, I left Europe feeling very positive.

And then could you address what's going on in 14 SEER, probably still early in the season to know for sure, but is that price gap versus legacy 13 holding in the 10% to 15% range?

Yes, Jeff, it is holding. And I think the great news about the 14 SEER is, what we saw was the balance of 14 SEER and greater products is still about 80% of the revenues in 2016. So we're seeing price. We're seeing the favorable mix that we expected out of the product, and we're also seeing that the balance between 14 SEER and even the 15 SEER and above has not really changed, which does create a good environment, as you alluded to with the price and cost differential.

So is that 40 basis points of positive mix, Sue, that you elaborated, all in residential? Did you actually have more than that in residential and it came somewhere else?

It was not solely residential; it included both residential and Thermo King. On the Thermo King front, we observed stronger performance than anticipated in truck and trailer segments in both North America and Europe. However, the significant declines in Thermo King were driven by the marine container sector, which experienced a decrease of around 60%. The 40 basis points of mix mostly stemmed from residential and Thermo King, and my recollection is that it was fairly evenly distributed.

So what's driving the 1Q order growth in residential? And what gives you the confidence to kind of move that forecast up ahead of the selling season?

Well, I mean, first and foremost, the product line really at this point has been fully developed. And we've hit stride on all the good success with the furnace product, all the good success with the new launches, the variable speed, growth in Nexia. All these things have just been really kind of coming together. Operationally, we just find the pipeline for projects and productivity and quality to be improving. Deliveries have been exceptional in terms of on-time delivery. Having product available where you need it, when you need it, really investing in the warehousing and investing in the product availability. So just a sense here that things have gone right for a long time here and that we'll do better, particularly as the mix moves up north of 14, which it has. So the mix moves more to 14 SEER, we do better anyway. And as the mix moves more toward replacement and away from new construction, we'll do better.

Okay, great. And then how's the M&A pipeline kind of informing how you're thinking about buyback through the balance of the year?

We want to grow the company and increase long-term value. We are exploring ideas and businesses where we have expertise and have achieved success. FRIGOBLOCK and Cameron are excellent examples of how we can integrate businesses into our operating system, enhance their performance, and meet our accretion goals. We are confident in our ability to do this and are not rushed to engage in mergers and acquisitions. We hold strong market positions and do not have a pressing need to make acquisitions that may not be financially wise. We will assess opportunities that meet our criteria and act accordingly to enhance long-term value for our shareholders. In January, we took advantage of a significant stock price drop, acquiring $250 million at $0.51 per share. We will remain flexible and opportunistic in our efforts to increase shareholder value, including pursuing suitable acquisitions as they arise.

I appreciate the extra details provided in today’s disclosure; they are quite helpful. To start with, Mike, how do you reconcile the strong growth in commercial HVAC with the rather disappointing Dodge data, ABI, and other macro indicators? Are you attributing this entirely to market share, renovations, controls, and service? A bit more clarity on that would be appreciated.

Well, it's sort of all of the above, Steve, which is probably hard to give clarity on that. But if you take Latin America, we're up mid-teens in Latin America. That's clearly our people out in the street creating demand, making it happen. Mid-teens bookings growth in Asia. I mean, Asia is not that strong. Again, our team is hitting the street. Europe, we talked about product development and the pace of product development. There it's best-in-class in the company. And product management, best we have in the company around getting it exactly right on these product growth teams and understanding where we're competing, how we're going to win against very specific competitors in the market. When these products launch and they do exactly what they were supposed to do, that's a positive for us. So there's a lot of self-help here happening. And the backdrop on the markets, with the exception of the Middle East, isn't bad. So you've got decent markets and really strong execution.

Okay. And what is the growth rate on VRF for the current quarter? Any updates on that?

Last year, we were about 30% growth. This year, we're about the same, Steve. We continue to do well in the market. We continue to sell VRF. We're beginning to also see interest in what's referred to as 4 pipe chillers. So this simultaneous heating and cooling around water circulating through buildings versus refrigerant. It's big in Europe, picking up a little bit of interest in the U.S. The idea here is we're going to have whatever products are demanded in the marketplace, and then we're going to work with the customers to figure out what the best solution is for the building. And that's why our business was up 30% last year. It's why our business is up about the same this year as well.

Thank you, and thank you, everybody. Joe and I will be available for follow-up calls later today. And it's been a pleasure to work with all of you. Have a great day. Thanks.