Trane Technologies plc (TT) — Q1 2017 Earnings Call Transcript

Thanks, operator. Good morning, and thank you for joining us for Ingersoll Rand's First Quarter 2017 Earnings Conference Call. This call is also being webcast on our website at ingersollrand.com, where you'll find the accompanying presentation. We are also recording and archiving this call on our website. Please go to Slide 2. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our SEC filings for a description of some of the factors that may cause actual results to differ materially from anticipated results. This presentation also includes non-GAAP measures, which are explained in the financial tables attached to our news release. The participants on today's call are Mike Lamach, Chairman and CEO; and Sue Carter, Senior Vice President and CFO. With that, please go to Slide 3 and I'll turn the call over to Mike.

Thanks, Zac, and thank you, everyone, for joining us today. 2017 is on track with a strong first quarter. Our results marked another quarter of proven top-tier financial and operational performance and are indicative of successful execution of our strategy powered by our business operating system. Our principal approach and the values inherent in our culture have created a unique and lasting commitment to continuous improvement and focus on our customers. That focus and winning culture translates into the sustainable business results we expect for 2017, and I thank our people around the world for their dedication. While still early in the year, our first quarter performance gives us confidence in raising the low end of our earnings per share guidance range by $0.05 from $4.30 to $4.50 to $4.35 to $4.50. Our free cash flow guidance continues to be 100% of net income or approximately $1.1 billion to $1.2 billion for fiscal 2017. As we indicated in our fourth quarter call, in January of this year, we'll be sharing more color on our strategy and longer-term targets out to the year 2020 at our upcoming Investor and Analyst Day in Davidson, North Carolina on May 10. I know many of you will join us at the event or via the webcast, and we look forward to doing a deeper dive on our business at that time. I'll start this morning by discussing our business strategy and how that enables us to deliver top-tier performance for our shareholders, our customers and employees over the long term. I'll also give some color on our outlook for our key markets in 2017, which is largely unchanged from the comments we provided in our Q4 2016 earnings call, so we'll discuss our first quarter performance in more detail and address some topics we know are in the minds of investors before we take your questions. Our strong first quarter performance underscores that our strategy continues to deliver results. We continue to deliver profitable growth through leadership positions in growing markets that are durable because they address a global imperative to dramatically reduce energy demand and resource constraints in buildings, industrial processes and transportation. Sustainability is central to our strategy, and we think of that as a lens on the business to identify opportunities, to help our customers manage their sustainability impact. Our strategic focus served us well in the first quarter. We followed our business operating system to capture growth, improve costs and drive productivity to deliver adjusted continuing EPS of $0.57 and 4% organic revenue growth. We also expanded adjusted operating margins by 20 basis points. Free cash flow was a negative $73 million, but consistent with our expectations given the normal seasonality for the quarter. Additionally, we paid $103 million in dividends and spent $417 million on share repurchases year-to-date. Growth was led by North American Commercial and Residential HVAC. The teams here are doing a terrific job of gaining market share and expanding margins, and we anticipate this momentum to continue through 2017. The Residential business had a record quarter one revenue and margin performance combined with market share gains. Looking elsewhere geographically, we also had strong HVAC performance in China. Year-over-year organic revenue growth improved by more than 20%. Our Industrial businesses continue to maintain focus on delivering improved operating margins through increasing the service mix, new product development, and cost reductions. Our Compression Technologies business, for example, realized the highest mix of services to equipment in its history with quarter one record revenue in bookings for global service agreements. Moving now to Slide 4. I wanted to spend a few minutes providing some color on how we're thinking about our key end markets and businesses on an organic growth basis. So far, 2017 is shaping up largely as we expected. The North American Commercial HVAC and Residential HVAC businesses showed strong growth in the first quarter and are expected to continue in 2017, driven by all areas of the business, including applied, ducted and ductless, unitary and residential equipment, and building controls and services. Our focus on sustainability is a growth driver here, and our robust new product pipeline to provide highly efficient systems and expand our offerings for HVAC systems with next-generation refrigerants, for example, is having an impact on the business globally. It's allowing us to take share in regions like the Middle East, where we have district cooling opportunities, and in Europe, where we can offer customers products and services ahead of regulatory deadlines. For Ingersoll Rand, we continue to forecast mid-single-digit growth in Commercial HVAC overall and mid-single-digit growth in Residential HVAC, which is essentially a North American business for us. Global industrial markets are generally improving, and we saw that in quarter one. We're seeing more positive signs in our general industrial markets in the U.S. and the eurozone as PMIs have improved. We've also generally seen order improvement across our Industrial business. We have had year-on-year growth in orders in our Compression Technologies business for the past four consecutive months, which is encouraging. We continue to plan for a modest rise in Industrial production and a gradual recovery with bumps along the way. The large engineered compressor market is expected to show signs of improvement due to stabilizing activity in energy markets and heavy industry, and we saw some positive signs of this in the first quarter. We still see year-over-year orders rising in 2017. Even with this though, we're still planning for revenue to decline due to depressed 2016 order levels and the average lead time of 12 to 18 months for this type of product. Excluding these longer lead time products, we expect our Industrial segment to be flat to slightly up. We continue to expect the transport markets in the Americas to be down from lower volume for trailers and auxiliary power units, partially offset by truck volumes. Transport in Europe is expected to be up modestly, primarily based on truck and trailer sales. We expect continued growth in Asia Pacific and its relatively smaller base. Given the work we've done building out the Transport business into a more diversified and durable business, we expect to mitigate the impact from North American trailer declines and for revenues to be down low single digits. Golf markets are expected to be flat, and we expect to see some growth in our consumer and utility vehicle markets. The recently launched personal transportation vehicle I mentioned last quarter continues to perform well. Overall, we expect Club Car to be up low single digits. For those attending our upcoming Investor Day, you'll get a chance to experience one first-hand. And now, I'd like to turn the call over to Sue to discuss the first quarter in more detail.

Thank you, Mike. Please go to Slide #5. I'd like to begin with a summary of main points I'd like you to take away from today's call. As Mike discussed, we have started 2017 on a strong note with continued strong bookings growth, organic revenue growth, adjusted operating margin improvement, adjusted earnings per share growth, and free cash flow in line with our expectations. Our results are on track at this stage in the year with continued strong bookings growth and we're, therefore, adjusting our full-year earnings per share guidance up $0.05 at the bottom end of the range as Mike discussed earlier. We have a detailed breakout of our guidance for your review in a few slides. Our bookings and revenue performance were both strong with growth in both segments. Commercial and Residential HVAC led the way, both with high single-digit growth in bookings and revenues. Adjusted operating margins also expanded in both businesses. We were pleased with our Industrial business performance, which is demonstrating steady adjusted operating margin improvement. We continue to take additional actions on operational excellence initiatives, increased commercial focus on aftermarket parts and service offerings, and took additional cost reduction actions to improve operating results going forward. We also drove strong organic bookings growth in the quarter on both equipment and services, which was encouraging. Earlier in the year, we identified our dynamic capital allocation priorities for 2017, including spending $1.5 billion on a combination of share buybacks and acquisitions and approximately another $415 million on dividends. Year-to-date, we can report we've spent $417 million on share buybacks and $103 million in dividends. We also made one modest size acquisition. We are continuing to follow the capital deployment plan we announced in January. Please go to Slide 6. Our focus on execution of our strategy and operational excellence drove solid year-over-year performance. Net revenues were up 4% organically, and adjusted operating margins improved by 20 basis points. Strength in revenue performance was driven by our Climate segment, while operating margin improvement was broad-based across our Climate and Industrial segments. Please go to Slide 7. Organic orders were strong in the first quarter, up 7%, with strong results in both our HVAC and Industrial businesses. Climate bookings strength was broad based with growth across the globe and up 6% overall. Organic Commercial HVAC bookings were up low-teens in equipment with strong results from both unitary and applied products. Residential bookings, again, showed strong growth, up high single digits and continued share gain. We also drove good growth in parts, service, and controls, which is helping us to build a more sustainable business by increasing our income from recurring income streams. Transport organic bookings were down low single digits, primarily driven by the expected decline in North America refrigerated trailers. Our diversification strategy enabled us to partially offset the decline in trailers through growth in truck and international bookings in the quarter. The Industrial businesses' bookings were up 9% organically in the quarter, led by strength in Compression Technologies and small electric vehicles. In Compression Technologies, we saw solid growth in both the long lead engineered to order business, which came off a weak first quarter of 2016, as well as in our small to mid-sized shorter cycle products. In electric vehicles, we are seeing good growth in our new consumer vehicle, Onward. Please go to Slide #8. In our Climate segment, organic revenue was up high single digits in North America and Asia, and up mid-single digits in Latin America. Climate organic revenues were down marginally in Europe and down high single digits in the Middle East off a small base. In our Industrial segment, overall organic performance was up slightly. Modest declines in North America and Europe, Middle East, and Africa were offset by improvements in Latin America and Asia. Overall, North America revenues were up mid-single digits, and international revenues were up low single digits, netting a positive 4% organic revenue growth rate for the enterprise. Please go to Slide #9. Q1 adjusted operating margin improved by 20 basis points, primarily driven by strong volume and productivity, partially offset by material and other inflation. We continue to make significant investments in business innovation and operational excellence to further improve our competitive positioning. Please go to Slide #10. Overall Climate performance was strong in the quarter, with organic revenues up 6% and adjusted operating margins up 70 basis points to 10.6%. Strong revenue growth in both Commercial and Residential HVAC was partially offset by Transport revenues, which were down mid-single digits in the quarter, primarily due to softening North American trailer and auxiliary power unit markets, partially offset by growth in aftermarket and in Asia. Climate adjusted operating margins expanded 70 basis points year-over-year, driven by strong execution across the Climate businesses. The impact of higher volumes, productivity, and price far exceeded headwinds from material inflation, ongoing business investments, and other inflation. Please go to Slide #11. Our commercial focus on aftermarket, operational excellence initiatives, and cost-cutting measures continued to drive operating margin improvement in industrial in the first quarter. Industrial adjusted margins increased by 60 basis points on slightly higher organic revenues. Aftermarket growth was solid, more than offsetting modest declines in compressor equipment. Adjusted operating income and depreciation and amortization was higher by 100 basis points. Please go to Slide #12. Free cash flow was negative in the quarter, consistent with our expectations and normal seasonality. Our guidance for free cash flow remains unchanged from the $1.1 billion to $1.2 billion range we provided in January. Additionally, our balance sheet remains strong and gives us optionality as our markets continue to evolve. Please go to Slide #13. Our expected 2017 cash flow continues to enable us to drive a dynamic capital allocation strategy, employing capital where it earns the best returns. In our 2017 guidance, we highlighted our capital allocation priorities. The first was investing in our business as our number one priority. These include investments in innovation and in strategic growth programs. As I have moved through the earlier slides, I discussed investment in the business multiple times as it's at the heart of our innovation, growth, and margin expansion story. The secondary is maintaining a strong balance sheet. We're BBB-rated today and believe this is the appropriate structure for the company. The third area is our commitment to paying a competitive dividend. We've paid an annual dividend for 106 years and have consistently raised this dividend over time. In fact, the compound annual growth rate of our dividend is 20% over the last 5 years. The fourth priority is strategic acquisitions and share repurchases, but not necessarily in that order. In 2017, we committed to spend $1.5 billion between these two areas, and year-to-date we've spent $417 million on share repurchases and a modest incremental amount on a key strategic acquisition in the Climate space. We intend to spend the balance of the $1.5 billion during the remainder of 2017. We will continue to create long-term value for our shareholders through a dynamic capital allocation strategy as we've consistently done for years. Please go to Slide 15. As discussed earlier, while it's still early in the year, our first quarter performance gives us confidence in raising the low end of our earnings per share guidance by $0.05. We have largely maintained the other elements of our guidance for the year, so the next few charts will be similar compared to the ones we covered in January. The main thing I'd like to point out on Slide #15 is that our operating margin guidance targets have gone up somewhat to reflect the new pension accounting treatment that moves a portion of the cost from the operating line to the other income and expense line below operating income. Net adjusted margins rise by about 10 basis points for each segment and 20 basis points across the enterprise. We provided current and restated numbers in our news release tables that outline the impact of the change in more detail. The difference between our organic and reported revenue contemplates about 1 percentage point of negative foreign exchange from a strengthening U.S. dollar outlook. We continue to expect Climate revenue to be up approximately 4% organically and for Industrial revenue to be down approximately 1% organically, which is consistent with our prior guidance. Please go to Slide #16. We've raised the low end of our continuing adjusted earnings per share for 2017 to be in the range of $4.35 to $4.50, excluding about $0.15 of restructuring. We had a large planned restructuring charge of $0.10 in the first quarter related to the consolidation of three plants to further optimize our footprint. We have a number of actions we forecast taking for the balance of the year, but we think approximately $0.15 for the year is still our best estimate at this time. Please go to Slide #17. There are two FASB accounting changes we adopted on January 1, 2017 and want to make you aware of them. First, we were required to adopt Accounting Standard Update 2016-09 in the first quarter. The primary change is to recognize in the P&L any tax windfall or shortfall from stock option exercises and stock vesting, where previous recognition was deferred to the balance sheet. Our planned adoption of the new accounting standard was built into the 2017 guidance we provided in January and increases the effective tax rate volatility versus the prior accounting. In the first quarter of 2017, we recognized a noncash tax windfall of approximately $15 million, which is reflected at the benefit to our tax expense and effective tax rate. Our full year effective tax rate guidance of 21% to 22% includes the $15 million benefit recognized in the first quarter and anticipates a much smaller benefit to be earned in the rest of the year. Excess tax benefits that were not previously recognized in December 2016 were also $15 million. This amount was reclassified to retained earnings as of January 1, 2017 with no impact to the P&L per the new standard. The second accounting change is related to pension and postretirement benefits. The new standard, ASU 2017-07, impacts where certain components of pension and postretirement benefit expenses are recorded in the income statement. However, there's no change to net earnings or earnings per share. Under the new accounting standard, the traditionally more volatile components of benefit expense are now reported in other income and expense, including interest cost, expected return on assets, and amortization of deferred amounts. Service costs remain in operating income as it represents the services rendered in the current period by participants of these plans. We adopted this accounting standard in the first quarter of 2017 and re-classed approximately $8 million to other income and expense in the first quarter. 2016 amounts have been revised for comparability and were approximately the same amount in Q1 of 2016. Our 2017 estimate of expenses to be re-classed from operating income to other income and expense is $26 million. Please go to Slide #18. Our Q1 spend for planned restructuring was approximately $33 million related to consolidating three manufacturing plants and distributing the products to other facilities in the same region. Facilities were in both our Climate and Industrial segments. The actions further our region of use philosophy to localize manufacturing and the supply chain to help us achieve greater speed to market and implement local product preferences. We expect to spend approximately $0.15 per share for total restructuring expense for the full year 2017. Our corporate costs of $68 million for Q1 were generally consistent with our initial forecast for the quarter and were higher than last year due to planned incubator investments in technologies that benefit all businesses. These investments are heavier in the first half of the year versus the second half. We also had an increase in other employee benefits and stock-based compensation timing. We continue to expect full year corporate spend to total $240 million for the year. Please go to Slide #20. As we've done for the last couple of quarters, I'll comment on a few topics that we know are of interest to you before we open it up for questions. I'll first touch on currency as a headwind for us in 2017. About 35% or $4.8 billion of our revenues are outside the U.S. Our 2017 forecast has built in the continuing strength of the U.S. dollar, which will impact us most notably in the euro and Asian currencies. Overall, we continue to expect a 1% drag on our revenues from currency translation, which will have about a $0.10 negative impact on our earnings per share. We also know that price and material inflation is top-of-mind. Price was positive for us in the first quarter in both segments. Material inflation offset positive price driven by steel and Tier 2 components. We have 10 basis points positive price covering material inflation in our guidance. We've been through various cycles and have a strong history of capturing price to material inflation. For 2017, we expect a negative first half price to material inflation gap and expect to recover in the second half. Please go to Slide #21. Covering our Transport business, we are on track with expectations. For 2017 overall, we continue to expect Thermo King revenues to be down low single digits year-over-year. The North America trailer industry is expected to be down. We're also expecting a continuation of a relatively soft market for auxiliary power units and marine containers. Those declines will be partially offset by gains in Europe, Asia, and aftermarket revenues. Through restructuring and efficiency, we expect only a minor erosion of record operating margins from 2016. And finally, I know we'll receive questions on the status of Industrial. Industrial drove strong first quarter organic bookings, up 9%, and organic revenue growth was a result of significant aftermarket growth in the Compression Technologies business and continued growth at Club Car. Looking at a regional perspective, organic revenue growth in Asia and Latin America was partially offset by declines in North America and Europe, Middle East, and Africa. As we indicated earlier, we expect the Industrial markets to stabilize in 2017, although we cannot declare a definitive turning point yet on large equipment. Excluding large compressors, we expect Industrial to be flat to slightly up and we do expect to realize margin expansion through our operational excellence initiatives, ongoing cost reductions, restructuring actions, and new product launches.

Thank you, Sue. So closing on Slide 22, we are executing on our 2017 plan and building a thriving, more valuable Ingersoll Rand. I began today's call talking about our principled approach, the values inherent in our culture, and how that translates to sustainability of our business. I'm proud of our employees who delivered a strong quarter one performance. I'm proud that we tackled challenging customer problems and we solved them. We take on tough issues and apply some of the best minds in the industry to solve them. Within our company, we have some of the most impressive emissions reductions and efficiency stories in the world. It's what we excel at. Looking ahead, our strategy is unchanged. We will maximize growth through innovation and channel expansion, continue our focus on productivity and costs, deliver strong cash flow with disciplined capital allocation. Our Commercial and Residential HVAC businesses are strong and focused on growth areas with equipment, controls, and service. Our Transport Refrigeration business is diverse and agile and will execute their strategy as they typically do. Our Industrial businesses are focused on market share and margin expansion as markets stabilize. Our culture remains as strong as ever. As a result, I'm confident that we will continue to deliver top-tier financial and operating performance. And with that, Sue and I will now be happy to take your questions.

Just my first question would be, again, on that point that Sue just touched on around the Industrial business. So should we think about the long lead time business being about $200 million of sales probably down high single digits this year? Is that about the right scale of the piece within Industrial that's offsetting everything else?

Yes, Julian. It's Sue. I think that's right. It's a little more than $200 million, but not significantly. What you need to consider is that last year, bookings in that area saw a considerable decline, particularly in the Compression Technologies business. We experienced some positive bookings in the first quarter, which will carry over into 2018, so you're thinking in the right range.

My second question is about the transport market. Considering the bookings for the remainder of the year, they declined in the first quarter and saw a slight increase in the fourth. Should we anticipate bookings to grow in that segment at any point this year? Also, could you remind us of the lead time in Thermo King from bookings to billings?

Let me begin with the bookings and our expectations. In the first quarter, we noted a slight decline in bookings, down about 1% year-over-year, which amounts to approximately $6 million. We anticipated a downturn in the North American trailer markets but expected some strength in the European truck markets. Additionally, we observed some resilience in North America regarding trucks, despite a decline in the marine business. Overall, while there's a mix of performance, we still project a decline in the North American trailer market for the year. Our outlook is somewhat more conservative compared to ACT's projection of 44,000 units, but we expect a downturn nonetheless.

And then, just the lead time of bookings to billings?

The timing is usually dependent on the customer, and what we will receive is an indication of the order quantity for the year. They will make decisions based on their fleets' needs for replenishment, which can vary significantly.

That was sneaky. Rob McCarthy here. I guess, the question I have is with respect to the performance across Commercial HVAC and Residential HVAC. Could you just cite areas of where you're taking outside share? I mean, obviously the narrative has been of structural share restoration or share gain over the past several years, but could you just give us some principal examples because I think you called it out in your results?

Yes, I believe it's widespread. We've observed North American equipment bookings increase by about 20%. Applied North America is seeing growth in the mid-20s. We've achieved success in the Middle East regarding bookings, and China also saw significant growth of around 20% this quarter. Our Controls and Service businesses are performing well. Overall, Robert, we are experiencing success across the board. If there's anything specific you'd like to know more about, please feel free to follow up.

Yes. Could you discuss your expectations for incremental margin improvement this year and in the future, particularly regarding factors like additional compensation expenses or other considerations we should be aware of as we evaluate margin conversion? We're transitioning from a slower quarter into the peak season, especially in the Climate segment.

Yes. I will begin and let Sue provide the concluding remarks. Looking at the operational leverage, approximately 25% of last year's business is related to a price to material deflation mix. We had strong performance in that quarter. We believe that sustained good performance will come from leveraging incremental growth in the business, and we expect to be in the 25 to 35 range, with no change in expectations this year. In the Industrial segment, we will leverage at a much higher rate. Despite a slight decline in sales for the quarter, we experienced an increase in operating income in that segment, and this trend of significant leverage will continue.

The third and final question is about your strong performance and growth in EPS revisions, particularly regarding the mix between Climate and Industrial. Mike, could you explain how these assets can be operated together? Given the current trend of conglomerates and de-conglomeratization, some might argue for selling or investing in this entity, especially considering how pure play Climate companies are valued in the market right now.

Yes, Rob. We will discuss that in more detail later, especially in May, so I don't want to take up too much time on it now. We believe that the operational integration we are currently experiencing, including our technological capabilities, engineering networks across the business, purchasing power, and recent plant consolidations, is leading to significant dis-synergy when separating these areas. There is also a natural cash flow cyclicality between the two businesses, with a historical negative correlation between Industrial and Climate for us. This situation has allowed us to maintain strong cash flow, which we can reinvest into the business. For example, we recently announced the launch of a large rotary refresh of the oil flooded air compressor business. This project was accelerated from five quarters ago because we had great success with the small air compressor utilizing the same technology. Such advancements wouldn't have occurred in this cycle. If we look back to 2010-2013, the success in Industrial at that time contributed positively to the Trane business. We constantly analyze the different components of our portfolio and evaluate the dis-synergies, as separating these parts does not create value.

I have a few questions for Sue. You mentioned there are no significant debt maturities until 2018, but you have a notable one of $750 million at a high interest rate of 6.75%. Given the current lower interest rates, I’m curious about your approach to that maturity. Are you considering refinancing early? What rate do you think you could achieve with a refinance? It seems like 6.75% could drop to around 2%, resulting in substantial savings. Any insights on this would be appreciated.

Well, so the maturity is August of 2018, and we're continually evaluating that. And I'll tell you what I'm balancing on that interest rate of 6.75% versus what we could get today. And I don't know if 2% is the right number, but let's assume that it's much lower than the 6.75%. What's the right timing in terms of the breakage of costs that go along with it? So in other words, if I want to refi now and do that, there's going to be a cost associated with that. And while I could easily disclose that to you, I sort of have a bias towards protecting shareholder value and saying I'm not going to do that unless there's a really good reason to do that. So what drives a really good reason would be is if I thought the rates were going to change dramatically or I get more within the window. So continuously thinking about it, Nigel, but so far, we haven't pulled the trigger on that, and we'll continue to look at it. But you're right, it would be lower interest than the 6.75%.

Nigel, the last time I checked, which was not long ago, we were facing a shortfall of about $10 million, or approximately $0.03 per share. The only consideration in this scenario is whether to act early to protect the deductibility of interest, factoring in some uncertainty around taxes. However, it didn't make sense to make guesses for $10 million without a clear rationale. I want to assure you that we are continuously examining this situation. We wouldn't overlook a potential opportunity like this.

So actually, what is sitting there in 2017 in terms of the Trane amortization is about $105 million, which is about what you said. That actually does not start to roll off, Nigel, until, like, 2023. So it isn't going to start rolling off in 2018. It's going to be roughly the same $100 million.

Actually, there were three different ideas. One involved taking a residential light unitary factory in North America and distributing it across four factories with available capacity. A key benefit of improved productivity over the years has been the ability to open up capacity in other locations, which has positively impacted the HVAC side of the business. The second idea focused on the Industrial business, where we aimed to consolidate two plants within Europe. Lastly, the third idea involved establishing a multisegment plant in Europe. So we addressed all three areas.

Got it. And the payback, expect 2 to 3 paybacks on those?

You've got a gap of under 4 years and cash of under 2.5.

Just a question regarding your previous indication that roughly 45 percent of the year would be in the first half. Is that still the correct estimate?

Steve, I just won lunch, okay? And I'm not going to do any calculus or algebra on this one for you at all. I want to really stick to the guidance we gave, managing within that and let you guys sort of work.

Alright. If you calculate 45% of the high end of the range and combine it with the $0.57 from the first quarter, it brings you to around $1.45, which represents roughly a 4% increase compared to last year's second quarter. I’ll put it this way: I recognize there's a tax benefit this quarter that is advantageous. Are there any other factors you would highlight year-over-year that might significantly hinder that growth rate? I believe that $1.45 could be a solid figure, and it's still above consensus. I'm interested if there's anything you want to address regarding comparable performances, especially since this quarter absorbed some notable impacts from pricing and costs in certain investments, even though the tax rate was favorable. I'd like to know if there's anything else you want to mention to ensure everyone understands the various factors at play without going into detailed calculations.

Yes. To rephrase the question, I would say that our decision to adjust the low end of the range was based on our confidence in the bookings and the desire to reduce the risk on that low end, along with a stronger backlog. When we consider the mid-20s applied bookings in Q1 and the large plant growth in our process industrial bookings, which was mid-teens year-over-year, we see promising signs. The Climate segment is expected to take about 6 to 9 months, depending on the customer's readiness for their project. We can now produce chillers in one day, whereas previously it took 10 weeks, allowing us to deliver within 10 days after an order. However, large plants on our process side may still face lead times of 12 to 18 months. Some bookings may extend into the second half of the year, allowing us to adjust the low end of the range upward. Regarding pricing and material costs, I will let Sue provide more details on that.

Yes. I think that will be another area to monitor in the second quarter. Our material inflation in 2017 is mainly coming from steel and Tier 2 commodities. As the year progresses, we've mentioned that the first half will be a tough comparison to last year, where we experienced a favorable difference between price and material inflation. There has been some volatility in materials, particularly in steel and aluminum, following the election, which will begin to reflect in the second quarter. Aluminum significantly affects our Residential business more than many might realize. In fact, in the first quarter, we used about 15 times as much aluminum as copper in our Residential operations. Therefore, we are more susceptible to changes in aluminum prices. Despite this, we plan to maintain positive pricing throughout the year. We are closely monitoring commodity prices and are very focused on productivity to offset any costs. We are keeping an eye on all aspects, but I would particularly pay attention to materials.

Yes. And maybe, Steve, just more color on that even. You look at the fact that we are getting positive price across the board, that's a good sign. Again, it's the steel, the Tier 2 components, the aluminum, which Sue said, we buy 15 to 1 pounds of aluminum to copper in our residential business, for example. You get to quarter 2, the spreads are 120 basis points. We will still expect positive price and the same sorts of material inflation that we're seeing. And then, you get out to the back end of the year and it literally might take to the back end of the year to kind of flip that into the 10 basis points positive there, but I do believe we've got the strategies to do that. We've also got some excellent value engineering ideas going on right now, testing out and would be finalized this summer, where we would both be able to change some of the alloys and be able to change some of the gauge thickness of materials we're using. If those test out positively, then that's going to allow us to abate some of that material inflation toward the back end of the year. So we're working it and feel pretty good about getting there at the end of the year.

Wait, what's 120 basis points? Sorry, just a quick follow-up on that. You had 50 bps headwind this quarter. What is 120 again?

I think Q2 last year we were at 120 basis points.

So Steve's question is a good one. If you're 120 basis points positive last year and now it's 50 basis points, which is 50 basis points off of that 120, so it's still 70 positive? Is that how I should read it? Or are we actually 50 negative? Or am I just misunderstanding it? It might be that.

No, Scott. I appreciate the question. It's a headwind. I mean, we had to overcome a significant headwind in comps so that's the point we're making.

I understand that there is a headwind in comparisons. I see that you're not explicitly negative in terms of price or cost; it's simply the comparison issue. I noticed that you implemented several price increases on January 1, particularly in the residential sector. Were you able to achieve those increases in January, or were they insufficient or too slow to counteract the rising material costs?

Yes. Remember, Scott, the vast majority of our company doesn't operate on a price list or a pricing. It's really the residential business, some parts of light commercial, tools business to some extent. It starts to fall down pretty quick after that. Everything else is really putting a system together, a project together. And so you're really pricing more or less in real time, when the customer wants an order, and that's how we look at it. So yes, we had price increases where we compete in markets where that's the norm. Where it's not the norm, that's where we've been working this whole top line margin expansion pricing work over time to make sure we understand how to price out into the future when we expect deliveries and try to get on top of that. Of course, as you get to these large long lead items, you're dealing with the fact that you're trying to price out and guess 9 to 18 months out into the future and, in some cases, what's happened hasn't been so much demand related from a commodity perspective, but in the case of aluminum, for example, it's very speculative in nature as to what's going on. Those are more difficult to predict.

Yes. Okay, but...

But ultimately, I believe we will achieve a marginally positive price compared to material costs by the end of the year, with the price itself being quite favorable.

So through April, you spent $417 million on repurchases. Obviously, you've ramped up repurchases especially in April. You do seem committed to your $1.5 billion target. But can you talk about the probability of doing M&A versus repurchases? Are valuations higher to the point where the chance of doing bigger M&A are lower? Do you still see significant opportunities in your pipeline? And then, at what point in the year do you actually step up repurchases if M&A is a little harder to come by and is that happening now?

I would like to start by discussing our strategic plans, which have outlined specific targets we aim to pursue. This list includes some actionable targets, though the reality is that not all of these targets are feasible within our financial guidelines for an ideal acquisition. Considering our criteria, we evaluate our pipeline to determine what is both actionable and financially attractive. Currently, if I were to evaluate the situation, I would estimate that we have between $300 million and $500 million in actionable M&A opportunities that align with our financial constraints. However, this situation can change quickly, and while we're currently focused on that range, it doesn’t mean we won't consider larger deals if they align with our strategic objectives. I will be happy to update you on our position during the next quarter.

Mike, that's very helpful. And then, just shifting gears, can you talk about your Commercial HVAC markets in EMEA and Asia? You mentioned last quarter, your 2017 outlook was relatively flattish, but you did see strong 4Q Asian orders. You said they were lumpy last quarter, but you continue to see good order growth in both markets really and you did raise your forecast a bit for Asian HVAC. EMEA orders didn't look like they accelerated a bit in the quarter, so can you see some upside in EMEA and Asian HVAC as we go through the year?

The Middle East has seen significant growth for us, with mid-teens bookings growth, contrasting with the more stable market in Europe where we expect a flat performance. However, we anticipate that the Middle East will show an increase for the year. We believe we are making progress in the market, particularly with district cooling plants and the new refrigerants we’ve introduced. China also performed well for us, although I want to clarify that this is just for the quarter. While I’m not certain this growth will persist throughout the year, we did experience strong bookings growth in China, driven by new product introductions and effective execution across the board.

You said the Middle East market, it was more you than the market. Did it stabilize though and that allowed you to outperform more in the quarter?

I was there just a month ago, at least where I was, okay, but specifically Dubai would be a point I would raise. I would tell you that it was booming and really no signs of slowing down there. Obviously, as you get outside of Dubai, you're going to reach different dynamics, but we would have seen that our team there is sort of feeling good about what they're able to bring in into the market with new product and services, controls, performance contracting, and capability. The team becoming, I think, stronger there to the point where we can do more work outside of equipment, that's helping us to grow the market. We've got a joint venture we're starting there as well soon. I think that will help us develop in the market further though. So again, I didn't see a terribly depressed situation in the marketplace, but I felt good leaving that trip, understanding what our growth plans were and feeling good about our ability to get growth where it's maybe flattish today or down.

Mike, I'd love to hear your comments about the build ahead of the cooling season. How does the inventory in the channel stand today and maybe your sense about customer bias towards replacing versus fixing their units just given the sentiment today?

Yes, Deane. Regarding inventories, there's nothing unusual in the channel. Some people in the residential and HVAC sectors are considering factors like weather and days of sales, but we aren't seeing anything out of the ordinary. The markets are strong. The replacement market is performing well, as is new construction. We are targeting areas like new construction and non-occupied spaces, which are expanding for us. We are putting considerable effort into these markets. Overall, it looks like it will be another solid year for residential markets, and we are performing well there. Additionally, we are experiencing market share growth and margin expansion. We are not engaging in buying market share; instead, we have a well-functioning business with a strong management team executing effectively on its plan.

That's real helpful. Can you just provide some color on where you think you're gaining share on the residential market? In particular, product lines or just where you think that growth is coming?

In the past three years, we have completely revitalized our offerings. There is nothing we have been selling for an extended period. While we have some ideas about where we are gaining market share, I wouldn't want to make any public statements about those speculations.

I have a couple of follow-up questions. Mike, what are you observing regarding the competition's reaction to your market share gains? It seems a lot relates to the point you just mentioned about excelling in product offerings, but is any competitor adjusting their pricing in response? Have you noticed anyone behaving unusually in the market?

We work in an industry with a handful of large players. It's probably going to consolidate over time and we certainly don't discount any of our competitors' capabilities in these areas. It's a strategy, Jeff, that we've had for a long time about how we wanted to win and where to play. The product growth teams are very additive to what we're doing in trying to isolate opportunities or weaknesses and exploit them. So yes, I said the context of the word culture, I don't know, five times on the opening script and I can tell you that there's something about really embedding that pretty deeply in the organization that we wake up every day thinking about market share and margin expansion and we're supporting that with the field, with great service capability, with a tremendous amount of investment, innovation in products, controls, services across the board. So we just got to run faster and we've got big, strong competitors that are running fast, too. Knock on wood, Jeff, we've had an excellent season. I think every season just gets better and better. The first thing we do at the end of the season is we debrief every learning we had in the season at a very deep level on a plant and product basis, and understand sort of what we would have done if we could hit the replay button. And every year, we get better at that. It's why the profitability of the residential business turned the corner in the first quarter, which historically, I think, forever had been in a loss-making position. It's now in a good position in the first quarter with less inventory, high returns, better cycle times, lead times to customers, more product availability. So we're not seeing anything here that we haven't planned for or thought about at this point, but again, this is not even May, and we've got to go through a few more months here to be confident about that.

I would like to thank everyone for joining today's call. As usual, Joe and I will be available to answer your questions today and the coming days and weeks. We look forward to seeing many of you or connecting with you via the webcast at our Investor and Analyst Day on May 10. Have a great day.