Trane Technologies plc (TT) — Q4 2017 Earnings Call Transcript

Thank you, Zac, and thank you to everyone for being here today. As I've mentioned several times since our Analyst Day in May 2017, I am more optimistic about Ingersoll Rand's ability to execute our strategy for delivering strong shareholder returns over the next few years than I have been at any point during my time as CEO. Let’s start by reviewing the core elements of our business strategy since busy earnings seasons can often shift focus to minor trends and quarterly fluctuations, obscuring the larger fundamental picture that drives long-term value for our shareholders. Our strategic goals remain focused on achieving profitable growth through leadership positions in resilient markets driven by global mega trends such as sustainability and the urgent need to reduce energy demand and resource limitations globally across various sectors. We prioritize innovation, providing reliable, energy-efficient, and environmentally friendly products and services, supported by digital and other advanced technologies. We excel in improving energy efficiency, lowering greenhouse gas emissions, minimizing food waste, conserving natural resources, and enhancing productivity for our customers. We maintain healthy investments in our business to uphold leading brands that rank #1 or #2 in almost every market where we operate. It is essential to note that we continue to invest in maintaining a diverse and extensive portfolio in nearly every major product category. Last year, we continued to advance our product growth initiatives, launching around 70 new major products worldwide. Moreover, we are enhancing our digital capabilities to create value for our customers and gain a competitive edge. For instance, we launched TracKing, Thermo King's new asset management system, which allows customers to use remote connectivity, top-notch mobile applications, and data collection to improve fleet predictability and traceability without taking vehicles off the road, ultimately increasing control and efficiency. This month, we unveiled the Club Car Tempo Connect, the first vehicle with standard digital technologies designed to enhance the experience for golfers and course owners. We also leveraged cutting-edge digital technologies like Trane Go to improve our residential HVAC connections with consumers, aiding them in making better purchasing decisions, which has led to a 30% increase in our consumer lead conversion rate in 2017. Last year, we also doubled the size of our EcoWise product portfolio ahead of regulatory mandates, offering products that minimize environmental impact and comply with next-generation refrigerant standards without sacrificing efficiency or performance. Recently, we added the Trane Agility, a new water-cooled centrifugal chiller line, ideal for retrofitting in existing commercial buildings to our EcoWise portfolio. In the Compression Technologies sector, we continued expanding our products and services. In 2018, we plan to broaden our market coverage for contact-cooled compressors to satisfy the growing customer demand. On the service side, we will be integrating remote connectivity into our rotary and oil-free equipment service offerings throughout North America. Our innovation pipeline aimed at addressing complex customer needs is more exciting than ever, and we intend to keep pushing forward. Additionally, our business model is crafted to efficiently deliver strong top-line incremental margins and free cash flow through our operational systems over the long term. Our business operating system is the foundation of all we do, allowing us to produce high levels of free cash flow consistently, which supports our active capital allocation strategy. In 2017, we generated free cash flow of $1.3 billion, which amounted to 118% of our adjusted net income. While the leverage in our Climate business fell below our historical and long-term targets, we successfully navigated various challenges last year, including persistent inflation and greater success in tapping into underserved HVAC markets in China than we anticipated. We expect our Climate segment to revert to historical leverage levels in 2018 and onward. Capital allocation in 2017 was dynamic and balanced, featuring robust investments in organic innovation as well as new acquisitions and partnerships in key strategic areas. We also significantly increased our dividend and repurchased over $1 billion in shares. Lastly, we have cultivated a skilled management team and fostered a high-performance culture, which gives me confidence in our capacity to deliver strong and consistent results over the long term. I trust this sheds light on why I have never been more enthusiastic about the upcoming years for Ingersoll Rand. We are exceptionally well-prepared to provide impressive returns for our shareholders moving forward.

Thank you, Mike. Please go to Slide #6. I'd like to begin with a summary of main points to take away from today's call. As Mike discussed, we drove solid operating and financial results in the fourth quarter with adjusted earnings per share of $1.02, an increase of 21% versus the year-ago period. We delivered high-quality earnings, which helped drive 2017 free cash flow to $1.3 billion or 118% of adjusted net income. Organic bookings and revenue growth was strong in both our Climate and Industrial segments. In the Industrial segment, we delivered low teens bookings growth in all 3 industrial businesses. We also delivered the strongest organic revenue growth quarter of the past 3 years. Additionally, the business continues to make steady improvements in its overall operating performance. On the Climate side, organic bookings were up high single digits in commercial HVAC with low teens growth in North America and solid growth in all other regions, except for Latin America. Organic revenue growth was also strong, up 6% and was broad based across all of our Climate businesses. Our Industrial business continues to strengthen its operational performance, ahead of our expectations, with 160 basis points of improvement in adjusted operating margins on 5% organic revenue growth. Organic revenues were up low single digits in compressor technology and low teens in Club Car and Industrial Products. Importantly, we also delivered balanced capital allocation results while meeting the commitments we laid out for investors in our guidance in January of 2017. We deployed $430 million on dividends and increased the dividend 12.5% during the year, consistent with our commitment to maintaining a strong and growing dividend over the long term. We deployed $1 billion on share buybacks as the shares continue to trade below our calculated intrinsic value. To date, we've also deployed or entered into commitments for approximately $460 million in strategic value-accretive technology and channel acquisitions, 2 of which we announced in January of 2018.

Thanks, Sue. I'm going to spend the balance of our prepared remarks, discussing the topics of interest we've received from many of you ahead of the call and then do a quick wrap-up summary before we open the floor for questions. The first topic I'll cover is our China strategy. It's one of the topics that has garnered a lot of interest with investors so we want to spend some time providing more detail in the strategy and expected impact going forward. First, it's important to note that our strategy in China for Tier 2 and Tier 3 cities is a proven strategy we've been successfully implementing in Tier 1 markets in the Applied space since we first entered the market. Our strategy is to enter underserved geographic and vertical markets by using a direct sales force, selling the product the way we do in most mature markets on a total cost of ownership basis versus the way you would sell an undifferentiated commodity. This takes a talented network of salespeople and other infrastructure investments to deploy, which we've been doing for the past 18 months. Once the customer has experience with our systems and sees the value in the total cost of ownership equation, we aim to become the basis for design whereby we are advantaged with system reliability, energy conservation and greenhouse gas emission reductions. We fundamentally transform the market landscape to compete on total value terms and are rewarded for our quality, technology and innovation and service support. Margins improve as they would in any market where a product or service is differentiated and has a unique value proposition customers are willing to pay for. With Applied equipment, comes the opportunity to rapidly grow our Service business, which further enhances long-term margins. This strategy has been very successful for us, particularly in 2017 as we accelerated investments. The negative price versus material cost impact is primarily the mix impact of entrants into these new markets, compounded by material inflation, which has been persistent in the region. It's resulted in an impact of more than half of our total negative price versus material cost spread in 2017, so it's important to understand the strategy, the temporary impact from the shift in our mix in China and the long-term endgame. We expect a few things to improve in 2018. First, pricing should improve in these markets as we move through the year. Second, we expect a less-inflationary environment in 2018 as we begin to lap 2017 inflation. Third, we've largely completed the necessary infrastructure investments to complete execution of our strategy in 2018, so these investments should become less of a headwind versus 2017. And lastly, we're focused on growing our services mix in these markets, which should enhance future margins. In summary, for the reasons stated, we expect China to be EPS-accretive in 2018 and believe our investments here will help build shareholder value for years to come. Looking at 2018, we expect to deliver improved operating leverage through the P&L based on a number of factors. First, we expect to drive profitable volume growth based on the continued health of our core markets, as Sue detailed earlier. We also expect to see higher pricing in 2018 versus 2017 and have already put through price increases to cover expected inflation in many parts of our business, which should improve our price versus material cost equation. In 2017, we had a negative price versus material inflation spread of approximately 60 basis points. We expect to narrow this gap considerably, which in and of itself would be a tailwind to margins in 2018. Additionally, we continue to drive material and other productivity through the P&L, which is always an important driver of margin improvement in our business operating system. Looking at the positive price we've seen, combined with the positive material cost productivity we've driven, which is a component of our productivity bridge, we had a positive spread versus material inflation of 70 basis points in 2017 and would expect similar performance in 2018. Additionally, we will see a reduction in headwinds from our China strategy as I detailed earlier.

I'll spend a few minutes walking you through the details for our 2018 guidance. Given the backdrop discussed on the previous slide, we expect total reported revenues to be up 5% to 5.5% in 2018, with both segments positively contributing. The difference between our reported and organic revenue contemplates about 1 percentage point of positive foreign exchange and about 1 percentage point from 2017 acquisitions. For the enterprise, we expect to see solid leverage from higher volumes, improved price and continued high levels of material productivity and other productivity, more than offsetting material inflation. At the midpoint of our guidance, we'd expect to see approximately 50 basis points of margin expansion for the enterprise.

In summary, this has been a key topic of interest in the past so we wanted to include it in our prepared remarks as we close out the year. The bottom line is that our Thermo King business is resilient and our 2017 performance bears this out. During 2017, we achieved a low single-digit increase in total Thermo King revenues in the face of a North American trailer market decline and we maintained relatively flat margins for the business at the same time. Our diversification strategy yielded results, with growth in worldwide truck, auxiliary power units, aftermarket and with particular regional strength in Asia. Looking at 2018, we're expecting similar performance across the business.

Yes, just one last comment. This is Joe Fimbianti's last quarterly call with us. And from all of us at Ingersoll Rand and many of the people that you've known over the years, Joe on the call, thank you for 41 years, 120 earnings calls, beginning in April of 1988, we wish you and your wife a great, long, healthy retirement, Joe. Thank you.