Trane Technologies plc (TT) — Q1 2018 Earnings Call Transcript

Thanks, operator. Good morning, and thank you for joining us for Ingersoll Rand's First Quarter 2018 Earnings Conference Call. This call is being webcast on our website at ingersollrand.com, where you will 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 this morning'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 thanks to everyone for joining us today. Please go to Slide 3. We're off to a strong start for the year, but before I get into the details, I'd like to begin the call with a brief review of the fundamental elements of our business strategy, which drives long-term value creation for shareholders. The first element of our strategy is to continually deliver profitable growth through leadership positions in durable markets. Our end markets are underpinned by global mega trends such as sustainability and the need to dramatically reduce energy demand and resource constraints in buildings, homes, industrial and transport markets around the world. We focus on innovation and delivering the most reliable, energy-efficient and environmentally-friendly products and services available, enabled by digital and other exponential technologies. We excel at delivering energy efficiency and reducing greenhouse gas emissions, reducing food waste, preserving natural resources and generating productivity for our customers. We invest heavily in products and solutions to support our competitive edge here, and this continues to be a winning formula for us with our customers and our end markets. Our continued strong growth rates reflect that advantage. We also take the same advice we give our customers seriously. In 2014, we publicly committed to increase our energy efficiency and reduce the greenhouse gas emissions related to our operations and products. The commitment includes a 35% reduction of greenhouse gas emissions from our own operations by 2020, which we achieved earlier this year, 2 years ahead of schedule. We conducted an energy audit of our own large facilities and upgraded air-conditioning systems, building controls and lighting, and eliminated energy leakage from our compressed air systems while measuring, validating, and reporting the results. We are continuing to deepen our commitment with investments in renewable energy, both on-site at some of our large locations and offsite through a power purchase agreement. We engaged our own Trane energy services business to provide a road map in how to be smarter about our energy purchases and to organize investments that are responsible to the environment and good for our business. As it relates to energy efficiency and reducing greenhouse gas emissions, we're proud to be walking the talk. Second, our business operating system is designed to excel at delivering strong top line, incremental margins and free cash flow over the long term. Our business operating system underpins everything we do and enables us to consistently generate high levels of free cash flow, which drives our dynamic capital allocation strategy. And finally, over the years, we've built an experienced management team and a high-performance culture, which gives me confidence in our ability to deliver strong results consistently over the long term. As we consistently execute our strategy, we continue to build a stronger, more sustainable company for the long term, well positioned to deliver strong shareholder returns. Moving to Slide 4. I'd like to spend some time discussing how things are shaping up at this early stage in the year. It's important to note that given the seasonality of our business being heavily weighted towards Q2 and Q3, we are just a small fraction of the way into 2018. As I said earlier, we are off to a strong start and there are a lot of things that are going well. Our end markets are strong, and we are executing well as evidenced by our high levels of growth in both bookings and revenues globally in both our Climate and Industrial segments. Our Industrial segment continues to make steady improvement ahead of our expectations. All the hard work our Industrial team has done to transform the business commercially and operationally and to restructure the business to take costs out of the system is paying off. The Industrial end markets are also showing steady signs of recovery, which is positive. Our China direct HVAC sales strategy that we've been highlighting since early 2017 is performing as expected with continued exceptional growth in the marketplace and with improving financials. We're also seeing positive signs that the North American trailer market will likely perform better than most had anticipated entering the year based on tight industry capacity, regulatory changes and U.S. tax reform. Lastly, we're achieving positive pricing that is consistent with our expectations in targeted end markets to combat material cost inflation. On the other side of the ledger, the material inflation across the industry and for Ingersoll Rand is both volatile and persistent and continues to be a headwind. We realized adjusted operating margin expansion of 20 basis points, despite these increasing headwinds, through strong volume and price. Commodity headwinds are broad-based across Tier 1 and Tier 2 markets and in freight, where tight industry capacity is ratcheting up freight cost materially. We're managing the entire P&L to drive margin expansion in 2018 and are taking decisive actions across volume, pricing, productivity and our cost structure to help mitigate further impacts from inflationary headwinds. There are also a few wild cards in play, including potential tariffs, potential for trade wars and significant geopolitical uncertainty, that challenge the visibility into full year 2018. On balance, while it's still very early in the year, our Q1 results and our positive outlook for the balance of the year are encouraging and give us confidence that we are well positioned to exceed the top end of our annual guidance ranges on both revenues and earnings per share. We'll provide a detailed guidance update, after we have a couple of quarters under our belt, on our Q2 earnings call, consistent with our guidance cadence. Please go to Slide 5. We've adopted a somewhat different format this quarter. We'll continue to provide transparency around the directional changes in bookings and revenue. Historically, the level of detail we provided, combined with the success of our strategic growth programs, has offered a high level of specificity on our performance for investors but can create competitive challenges. Our intent is to provide additional insight into the key qualitative factors behind the numbers that are driving performance without providing a competitive roadmap. This format should provide investors a greater fundamental understanding of our business, which we believe is in the best interest of the company and our shareholders over time. For the sell-side analysts out there that follow the company, we really aren't trying to drive you crazy, but we are trying to be pragmatic in how we run the business. In the first quarter, we drove positive growth in bookings and revenue across the board, as indicated by the positive signs on the chart. Over the past few quarters, we have seen positive signs of a steady recovery in our Industrial end markets. Combined with continued healthy growth in the majority of our Climate businesses globally, we saw positive growth across the board in the first quarter. Please go to Slide #6. This slide provides insights and color into the key drivers behind the chart in Slide 5 and how we're thinking about the outlook for the year, albeit still at a very early stage. In commercial HVAC, we're seeing positive growth in the markets globally, with good growth in both equipment and services. North America growth was solid with gains in equipment and particular strength in services, contracting and controls. Institutional growth was solid, led by the education and health care markets. Europe, the Middle East and Africa commercial HVAC had solid growth across the board, and we saw additional growth in services from our rental service business, ICS Cool Energy, which we discussed on our fourth quarter 2017 earnings call and closed early in the first quarter. Our direct sales strategy in China is on track with our expectations, where we're seeing continued strong revenue growth and expect improving financials in 2018. Our outlook for total commercial HVAC remains healthy for 2018, and key economic and market indicators largely support our view. Turning to residential HVAC, the revenues were also strong with continued share gain. Our market-leading Trane Go, our online total installed pricing transparency tool that we referenced during our Investor Day last year, is delivering well against our expectations with significant growth in leads and high conversion rates from leads to sales. Key economic indicators in this market also support continued growth through 2018, although we and the industry are lapping tough compares versus high growth rates in 2017. So that's an important factor to keep in mind. Transport continues to be a good news story for us. Our business remains diversified and resilient. We're also seeing improvement in the North American trailer outlook for 2018, fueled by tight shipping capacity, regulatory reforms and the benefit of the U.S. Tax Cuts and Jobs Act that allows for the immediate expensing of certain capital equipment purchases. We saw solid order momentum in quarter 1. APU growth remains strong. The marine market is showing considerable strength through the first quarter, although we have a relatively modest size marine business. Bus and rail were mixed, again, off a relatively modest size base for us. We're seeing continued solid growth in Europe, the Middle East and Africa truck and trailer. We built this into a nice size business for us over time. Overall, the transport market should be stronger than we originally expected in 2018, primarily led by improvements in North America trailer and continued solid performance elsewhere. Compression Technologies & Service is seeing continued signs of industrial recovery, consistent with industrial production and other key indicators. Quarter 1 bookings and revenue growth was led by North America and China, with particular strength in services. For 2018, we expect to see solid growth in the majority of our markets and products. Small electric vehicle growth was healthy, driven largely by successful market penetration of our consumer vehicle, and we expect that to continue through 2018. We also expect to see continued good growth in our Industrial Products business, which is off to a strong start in quarter 1. I hope this provides you with additional insight into our business and what we're seeing at this stage in the year. And now, I'd like to turn it over to Sue to provide more details on the quarter. Sue?

Thank you, Mike. Please go to Slide #7. We delivered strong operating results in the first quarter, headlined by 23% year-over-year adjusted earnings per share growth. Gains were driven by operating income improvement in both our Climate and Industrial segments. Revenue growth was primarily driven by strong volumes and supported by the realization of positive price on key products. Inflation was higher than we planned and a significant headwind to margin expansion. As Mike outlined earlier, netting out our Q1 performance and our visibility into the balance of the year, we are confident that we will exceed the high end of our guidance ranges on both revenue and earnings per share. We took $44 million in restructuring charges in Q1, driven primarily by footprint optimization in our Compression Technologies businesses as we continue to work to optimize that business for peak future performance. It's important to note that this restructuring was planned for Q1 as a part of our annual guidance of approximately $0.20 of restructuring. This is unchanged. Our Industrial business continues to perform well with good growth and 190 basis points of adjusted margin expansion. The investments we've made in fundamentally restructuring the business operations are paying off. Capital allocation was balanced in the quarter. We paid $112 million in dividends and repurchased $250 million in shares. Our acquisition pipeline remains active, and we anticipate regulatory approval of the Trane JV with Mitsubishi in the second quarter. Please go to Slide #8. As we've discussed, strong organic revenue growth coupled with adjusted operating margin expansion led to strong adjusted earnings per share growth in the quarter. Foreign exchange and acquisition-related growth also provided tailwinds on reported revenues. Please go to Slide #9. Operating margin improvement was primarily driven by strong volume and positive price, partially offset by inflationary headwinds and continued investments in high-ROI projects. Productivity in the quarter was low year-over-year but consistent with our expectations based on the timing of projects, and we expect improvement for the balance of the year. The 40 basis points negative price versus material inflation was largely consistent with our expectations for sequential improvement on this metric despite significantly higher inflationary headwinds in the quarter. Please go to Slide #10. Strong operating income expansion in both our Climate and Industrial segments combined for approximately $0.14 of earnings per share and were the primary drivers of our 23% earnings per share growth in the quarter. We saw a negative impact of about $0.01 from higher corporate expenses related to stock-based compensation, primarily tied to time-based vesting, $0.01 from discrete interest expense associated with the company's debt refinancing in the quarter and $0.01 from modestly higher effective tax rate year-over-year. We also saw a $0.02 benefit from the impact of share repurchases in 2017 and 2018 year-to-date. Please go to Slide #11. Climate delivered 8% organic revenue growth in the quarter. Adjusted operating margins were lower by 50 basis points, impacted primarily by strong volume and positive price, more than offset by persistent inflationary headwinds in Tier 1 and Tier 2 materials and freight. Our direct sales strategy in China performed as expected, and we expect margins to sequentially improve as we move throughout the year. Please turn to Slide #12. Our Industrial business continues to make solid steady improvements in its operating performance. In the quarter, we delivered 9% organic revenue growth and 190 basis points of adjusted operating margin expansion. Please turn to Slide #13. We maintain a strong balance sheet, providing continued optionality as our markets evolve. Free cash flow was consistent with our expectations given normal seasonality in Q1, and we remain on track to deliver free cash flow equal to or greater than net income for the year. Please go to Slide #14. We remain committed to a dynamic capital allocation strategy that consistently deploys excess cash to the opportunities with the highest returns for shareholders. We maintain a healthy level of business investments in high-ROI technology and innovation, which are vital to our product leadership and market momentum. We have a long-standing commitment to a reliable, strong and growing dividend that increases at or above the rate of earnings growth over time. We will continue to make strategic investments in value-accretive technology and channel acquisitions that further improve long-term shareholder returns. We are committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve, and we maintain a minimum commitment to repurchase shares sufficient to offset dilution. We also see value in share repurchases when shares trade below their intrinsic value. Please go to Slide #16. Moving on to our topics-of-interest section. We have one topic to cover that we know is on the minds of investors and worth addressing in our prepared remarks: Tariffs. I think the most important takeaway for the market is that we follow an in-region, for-region sourcing and manufacturing strategy. More than 95% of our products sold in the U.S. are sourced from the U.S. Net, the direct impact from U.S. tariffs on foreign imports should be relatively small. Additional tariffs have been proposed by the U.S. and other countries, but the details of those tariffs and the likelihood of their implementation is uncertain and negotiations are ongoing, so it's unclear how that will play out. We continue to watch this space closely. Over the long term, we are in an industry that recovers cost increases through price.

Now I'd like to turn the call back to Mike for closing remarks before we take Q&A. Mike? Thanks, Sue. Please go to Slide 17. We believe the company is extremely well positioned to deliver strong shareholder returns over the next several years. Our strategy is firmly tied to attractive end markets that are healthy and growing profitably, supported by global mega trends such as energy efficiency and sustainability. We've been investing heavily for years to build franchise brands and to advance our leadership market positions to enable consistent profitable growth. We have experienced management and a high-performing team culture that breeds operational excellence into everything we do. And lastly, we are committed to dynamic and balanced deployment of capital, and we have a strong track record of deploying excess cash to shareholders over the years. And with that, Sue and I will be happy to take your questions.

Nice to see this level of growth. I just want to get a sense. Last quarter, you had talked about 1Q earnings contribution kind of being lower than the seasonal norm. I think you talked about the low end of a normal 12% to 14% range for EPS. Should we expect that to still hold? Or when you look at the changes late in this quarter, anything that would lead us to not believe in kind of normal seasonality now that we are hitting Q2, normally, I guess, 30% to 33%?

Yes. The business has diversified significantly over time. We've noted that Transport is becoming more robust and varied. The same applies to our global commercial HVAC division, where service played a crucial role this quarter, surpassing equipment growth. This is largely driven by contracts, so it’s not solely dependent on repairs or weather-related issues. These factors are helping to stabilize our earnings. It’s challenging to rely solely on historical trends to predict future performance because we have been actively working to stabilize the company's cash profile over many years. There is an internal effort to smooth out our results across quarters as much as possible. Even in the Club Car business, which has its own seasonal variations, the consumer vehicle strategy is designed to mitigate some of the typical golf seasonality we usually encounter.

So what does that mean then in terms of what we should think about for the seasonality in Q2?

I think Q2 and Q3 will always be our strongest quarters. I just don't know that you can take 10% to 15% in quarter 1 and quarter 2, or 45% in quarter 1 and 2 and 55% in quarter 3 and 4 anymore. I think at this point in time, we do know we're going to exceed the top end of our guidance. We don't know yet by how much. And we're going to get back to you in quarter 2 once we've seen quarter 2, and I think we'll be more accurate at that point in time.

On productivity compared to other inflation, it seems to be the first negative trend I've noticed in about 12 quarters. Perhaps you have shifted investments elsewhere, so could you provide a bit more clarity on this?

There were a lot of major large projects that we invested in and executed in quarter 1. And you saw that through restructuring, as an example. So we think we've loaded up the year into 2019, with good productivity to follow. So I would expect to be our normal good productivity offsetting inflation for the year. It's just going to be heavier loaded on larger projects, meaning that there are probably fewer smaller projects we saw in the quarter. But it doesn't change the pipeline, where we try to get 125% of what we think we need for the year into the pipeline. And the pipeline remains healthy.

Okay. Regarding pricing, you've already implemented some price increases in various commercial and residential sectors. How do you feel about your current position on these price increases in light of commodity trends?

Pricing is really hitting expectations for us. We, across the board, achieved what we thought we would do in quarter 1. We closed the gap quite significantly from quarter 4 and believe that quarter 1 might look a little bit like quarter 2. But what we priced and will ship in the back half of the year and how we're thinking about price increases going forward throughout the year should lead to good performance in Q3, Q4. So the guidance we gave last time, which was sort of a plus 30 basis point, minus 30 basis point and advising you towards the minus 30 basis point, we're really operating right within that minus 20, minus 30 window.

Mike, this was the best quarterly Climate booking that we've seen in the last couple of years. If we go back to your guidance for the year, you had talked about mid-single-digit expected organic revenue growth for commercial HVAC. But it seems orders are trending a bit higher than that early, so maybe give us a little more color on the acceleration you've seen in orders. You previously mentioned that you could win some bigger Applied projects. Are any of those in the bookings growth that you've had?

The nice news is there was nothing in the quarter 1 bookings that we would have called out or spiked out that would be a difficult comp for next year. It was very broad-based across the globe. And so if you think about going across the globe, North America is shaping up about the way we thought it would shape up, solid growth in equipment. And in institutional end markets, education specifically, would be around K-12, say, versus colleges and universities. K-12 is strong. Particularly, with midyear elections coming, we're seeing more bond issuances that are passing or on the dockets for updating aging school infrastructure. That's good news. Health care is strong. It's not so much in acute care. We're seeing that in a lot of the clinics and specialty hospitals there. That's good, there are more of them. That's been positive. Other verticals are generally stable and positive. So if you look at ABI, auto sales, GDP growth, retail sales, nonres fixed construction, vacancy rates, they all look good. They're all stable or healthy, and they would point to low single to mid-single-digit markets, and we would think that Trane will grow at or above the markets in North America. Europe is strong for us, particularly we're seeing that with a very high activity in our own sales pipelines. We're seeing, obviously, good contribution from the rental services business that we acquired in the quarter. Economic indicators there are positive, around mid-single digits. Brexit is a bit of a wild card, but right now it's not showing up as much of an issue for us. Asia is led by China, very strong for us. That's fundamentally the direct sales strategy we put in place. We are very pleased with what we're seeing there, including service growth that we had in the quarter. Realizing it's about half of Asia, other important markets for us like Singapore and Taiwan will be down just a little bit. India will be strong, probably up mid-single digit. And Thailand is a nice market for us as well. We'll see modest growth. So anywhere across the world, and I probably would throw Brazil in there as well. Brazil is a good market for us in the quarter, and we think that that's on the road to recovery. So just about every place we're running commercial HVAC operations, we're seeing good growth.

Mike, that's great insight. So Mike or Sue, just to switch topics for a moment. You mentioned earlier that there could be a 50 basis points increase in margins overall for Ingersoll in '18. Is that level of margin expansion still achievable in this environment considering your price increases and the focus on productivity projects? Or could you potentially exceed your previous guidance due to stronger organic growth and perhaps some modest margin gains? How should we consider this, particularly in relation to Climate margins?

Yes. Andy, it's early in the year. But I think that when you fundamentally boil it down to operating leverage, we'll see better operating leverage in the back half of the year. Some of this is price/cost relationship. Some of this is the way the productivity and products are loaded into the system. Part of it's based on the assumption that we see continued good volume and mix in the portfolio. So if that goes the way it should go, then I would say that we would see operating leverage for the company along the lines of what we guided to for the full year of 20%, 25%.

Usually my name is pretty easy to pronounce. I want to kind of touch on this, on the price/cost discussion. Mike, 40 basis points of price/cost headwinds this quarter. I know that you guys don't typically love to talk about cadence. But is the right way to think about it that this is kind of the low watermark for price/cost for the year just given the pricing actions that you've taken? Or is 2Q going to look similar to 1Q? I'm just trying to get a sense for what your expectation is.

Yes, I think Q1 and Q2 will look relatively similar, but Q3 and Q4 pick up. I think Q3, Q4 is relatively flat, particularly quarter 4, meaning we're at that point matching cost increase. Now all that's predicated on us having an understanding of what's happening with inflation to the best of our ability. But from a pricing perspective, we're layering in prices where prices are given to the market. So as an example, HVAC will have a May increase as well. But on projects specifically, which have unique pricing, it's factored into those tools as well for pricing into the marketplace. So I think the back half of the year is stronger, and that's how we kind of get to that minus 20, minus 30 for the end of the year.

Got it. I heard you mention increased freight earlier. Could you discuss how that affected the quarter and what you're observing regarding wage inflation, as well as your strategies to mitigate both?

Well, it's a double-edged sword because if you think about our transport refrigeration customers, they're seeing a 30% increase in their rate per mile and great demand. And if you couple that with what they're doing in terms of taking advantage of tax reform, you're seeing growth in the transport refrigeration market. But on the flip side of that, if you think about the industry, and I'm not going to comment specifically on what we've seen, but I'm going to tell you from an industry perspective on dry freight, it's up about 15% over the prior year. So what I would say is that's sort of the number in the marketplace that is out there, and it's a meaningful number to companies like ours.

That's helpful. Maybe one last one. And just thinking about the guidance for the year. Historically, you guys have provided an update in 1Q. Is it really just a wild card to play at this point, the tariffs and the trade wars, on why you decided at this point to just wait until Q2 even though your commentary suggests that things are going to be better as the year progresses?

Yes, there was a year when we provided a first quarter update. Generally, however, we have preferred to reserve updates until later in the year. There are many uncertainties out there, with inflation being one of them. Tariffs and trade wars are also concerns for many. We’re noticing this particularly with larger industrial projects, where customers are showing more hesitance due to concerns about tariffs, input costs, and the location of their plants or expansion plans, whether in the U.S. or elsewhere, rather than focusing on tax reform. In contrast, our trucking customers in the transportation markets have been able to capitalize on tax reform and are not as concerned about tariffs. We're observing a different response from our industrial customers, who seem to be delaying some of their decisions.

Can you discuss the price and cost headwind? I think you mentioned a negative impact of 40 in the first quarter. How does that trend throughout the year? I assume it worsens a bit in the second quarter and then improves in the latter half of the year.

Well, price gets better in the second, so that's true. We think that inflation probably creeps up a little bit again in the second quarter. So you end up Q1, Q2 relatively flat. Kind of think minus 40 basis points is probably a pretty good number there. And as you trend through the back half of the year, there's a more meaningful increase in price. And you're really then offsetting what should be relatively flat inflation at that point because you're lapping pretty high inflation numbers at that point as well. So I think that the back half of the year tends to look flat. The front half of the year tends to look at minus 40. So you're in that minus 20, minus 30 range.

Okay. Can you discuss the performance of your residential business in terms of bookings and revenue for the quarter?

Yes, very solid, very solid. Continued share gain there. It was consistent with our expectations. Replacement and new construction both healthy for us, obviously driven by unemployment and GDP being stable and other indicators that are favoring that. The Trane Go platform, which is the whole total installed pricing transparency tool, is really delivering some significant growth for us. And we're seeing higher leads, higher conversion rates. That's again driving the share gain, I think, there for us as well. And you know this very well, Steve, but tougher market compares Q2 to Q4, but we still think the market will be up low to mid-single digits and we expect share gain to continue there for us.

Were you up double digit in the first quarter?

Not going to comment on it specifically there. But I would say that there was share gain in the quarter. And obviously, you all know that it was a pretty good quarter for the industry.

Yes, so 2 questions. I mean, I guess, one, Mike, as you think about making the turn, this puts a fair amount of pressure on your third quarter just to kind of stand and deliver, right? You become a third quarter team because of the seasonality and association with your business. So I know you don't want to get into quarterly guidance or the quarterly cadence, but what would be the expectations for incremental margins for the Climate business in the third quarter to kind of cause you to raise your guidance for the full year? What do you think is implied, the line in the sand, for the margin conversion we should expect to see in the third quarter?

I'd start with this really good visibility around Q3 as we stand here in April, with half the business being service and the other half being equipment, most of that equipment being in the backlog and really not relying heavily on book and turn to drive the business. So I think that the only wild card we really have is, if you think about it, is inflation. Pricing will be set on deliveries that were going to be made. The backlog is being built. The service business is humming along. So I feel good about the ability to say that we're going to top the guidance that we gave at this point in time. I just don't want to be more specific about that until we actually see what happens in quarter 2.

And then turning just to capital allocation. Any kind of update there of how you're thinking about things? Particularly given stocks have pulled back there a little bit, cycle definitely looks like a little bit of concern, I mean, any way you're thinking about underlying acquisitions or investments in your own stock through the prism of what is maybe a tougher industrial market?

Well, so, Robert, as we think about capital allocation and we think about Ingersoll Rand, the first part that I want to start with is that we continue to have a strengthening balance sheet. Our process around cash flow, around managing investments has been good and will continue to be good. So when we think about capital allocation, and we talked about this in some of the prepared remarks, I don't think it's different than what we've said before. We're going to continue to invest in the business. And investing in the business can be CapEx, which we guided at $300 million for the year. It can be in new products, it can be in our sales force, but continuing to invest in the business, and that is really important to us. It's having that strong dividend, with growth in the dividend being equal to or greater than our net income. And then when you come to the remainder of the cash flow, I think what you think about is that we are going to deploy the excess cash flow. And how we deploy that last couple of pieces of it is highly dependent on what transpires from the M&A side and the timing of that. We don't have to do anything on M&A, but we do have a good active pipeline. As you can tell from the last 4 or 5 months, we've had some technology, some channel, some other things come through the pipeline that have turned out well for us. And what I'd like to see on the M&A side is our ability to grow earnings and to grow a long-term cash flow stream out of the M&A. And on share repurchase, you're right. Shares and the intrinsic value are showing a positive, and we'll see how that turns out. We have committed to offsetting dilution. We told you in the original guidance that we had modeled $500 million of share repurchase. But when I toggle between those 2, I really would like to see us work the M&A side, work the earnings and cash flow growth side of that, and then be really smart on share repurchase and other aspects of capital allocation.

Mike, you may have partially answered my question on kind of the project industrial comment, but I wonder if you could elaborate there. I was thinking industrial orders could have been stronger in the quarter. Obviously, you had kind of a pretty solid back half and there's some lumpiness there. But how do you see the trajectory in the Industrial business playing out, maybe kind of on the larger capital side of the business versus maybe some of the shorter-cycle elements?

Yes, let’s discuss two-thirds of the Industrial segment, which focuses on the compressor technology business. We experienced robust growth in services, and we anticipate that this will continue to outpace equipment growth, aligning well with our strategic focus. Additionally, we saw significant growth in short-cycle compressors, OEM work by selling components to other original equipment manufacturers, and in oil-free rotaries. The growth was impressive, particularly in North America and Asia, which are performing well regionally. However, we do encounter some variability with very large centrifugal projects, experiencing some delays due to macroeconomic uncertainties related to tariffs, but we expect recovery in this area too. North American manufacturing appears strong, with all sectors performing well. Processed gas and air separation are expected to show particularly strong performance this year as key economic indicators remain positive. Industrial production is at a two-year high, and the aerospace sector related to defense is projected to be favorable, suggesting a healthy market. Regionally, AP shows the strongest performance for us. While we believe China’s GDP growth may be tapering slightly from 6%, we still see solid growth in that market. For the remaining third of the industrial market, which is about $1 billion, we are witnessing strong demand in small electric vehicles, especially in relation to our consumer strategy. We also experienced solid, if not excellent, growth in our Industrial Products segment, which includes Material Handling, our tools, and our Fluid Management business, a high-margin area for us.

And then just shifting back to HVAC, and it probably really is more of a resi question. But was there or has there been kind of prebuying in the channel in front of kind of the next wave of price increases? And does that kind of distort things here as we kind of try to figure out Q2?

Yes, I don't think the price increase or the time they were given were that different than what the expectation would have been in the prior year. So there could be specific distributors that might have done more than they would have done. But as we look at inventories across the backlog, they're pretty appropriate for where they need to be at this point in time. So I don't see tremendous risk there.

And maybe just one other quick one. How about hedging? I mean, with materials whipping around the way they are, does strategy change? Do you want to hedge more? Do you want to hedge less? You obviously don't want to be kind of "betting" on these items. But any color there would be helpful.

Yes, Jeff, I believe you've hit the nail on the head. We prefer not to engage in speculation. However, I can share some insights about our current practices and potential future strategies. Currently, we have some visibility on steel but cannot lock or hedge it effectively. We have a visibility of around six months for pricing and three months for inventory. This helps us understand the steel market's pricing landscape. For copper, we actively lock prices and secure volumes with our suppliers throughout the year. As we enter each quarter, about 70% of our copper is locked, and we are at approximately 66% locked for the entire year. An important point is that while we provide volume commitments, we also receive pricing commitments from our suppliers. This means that any fluctuations in copper prices are managed by the suppliers, with financial hedges occurring on their end. There may be some pressure for us to take on a bit more responsibility due to changes in hedge accounting rules, and that is a possibility we are considering. However, even if we were to hedge copper or aluminum, we would still stagger our purchases to essentially engage in a dollar-cost-averaging approach for these commodities. Ultimately, I believe we'd arrive at a similar outcome with either financial hedging or the current locks in place. We are continually refining our approach and focusing on accurately projecting volumes and timing. I believe our process will remain consistent, allowing us to maintain visibility on our costs so that we can adjust pricing as necessary.

Maybe the first question just on what's happening in your Climate business in China. That was something you called out a few times last year as being a pretty big margin headwind. And you mentioned that the financials are looking slightly better there. So maybe flesh that out that a little bit. And also just strategically, how you're progressing with that market share push.

Yes, I will address your question and add some additional insights related to Steve Tusa's earlier inquiry about specific guidance or outcomes in various businesses. Our strategy is performing well, with exceptional organic bookings in equipment. To provide some context, our project pipeline visibility has increased significantly, with an impressive 100% year-over-year growth, meaning we have access to twice as many projects as last year. The number of proposals we've submitted has risen by 130%, indicating we are identifying even more promising projects to pursue, although they may be larger or longer-term projects that distribution did not focus on. Our direct team and company-owned resources are engaging with these projects effectively. We are also experiencing strong growth in our service sector, which is critical. The financial margins we anticipated are improving year-over-year as planned. I am confident we will see margins in 2018 that are comparable to 2017, but with a significantly higher revenue base. I believe that starting in 2019, we will benefit from favorable conditions as our service business expands.

Understood. And secondly, I guess, just within the Climate business, you did see an acceleration in the organic bookings growth in Q1 from late last year. I realize you don't want to get into too much detail, but was that all about Thermo King accelerating or the overall transport refrigeration business? Or did you also see some improvement in the commercial Trane side?

One versus the other was not remarkable in terms of what drove the business. So there wasn't sort of an outstanding performance in one business covering up for another. And getting back to the question that Steve asked a little bit as well. Over the last, say, 5 years, I've never seen a better linkage from strategy to execution as it relates to the ability for us to identify strategic growth programs, invest the talent and the resources into those and then get really good results, often a multiple of what the underlying growth rate is of the business. And they're mapping exactly to what we planned. And we provide so much detail on these calls, particularly in a tough pricing environment, all we do is put a bull's eye on the back of our salespeople out in the marketplace around sort of where we're penetrating and who we're beating. So it doesn't really help the company, which means it doesn't help the shareholder, for us to be providing too much of that. And it also invites a lot of short-term-ism into the way that people would think about the business, because a quarter, whether we have a blowout number or don't, really doesn't change the long-term dynamics of what we're trying to do strategically around growing the business. And so again, we thought long and hard about that. Apologize for the sell-siders who really use that to model but believe it's in the best interest long term, certainly for the company's shareholders, that we don't provide that much granular information on a go-forward basis. But back to your question, really good growth both in HVAC and in TK. The surprise to us has been the TK business, which is strengthening globally but also strengthening in North America, specifically around the trailer business that we talked about.

I had a question regarding the order growth in backlog, which might help us understand the second half of the year. Can you provide any insights into the margins related to the orders you are booking or what's in the backlog, especially in comparison to what we observed 12 or 18 months ago?

You would expect backlog margins to be higher due to increased pricing compared to the backlog margin. Considering that standard costs will remain relatively stable from the first half to the second half of the year, we will not adjust standards during the year. The key difference is the pricing being introduced. Additionally, we anticipate improved absorption resulting from higher factory volumes tied to increased revenue. Therefore, the margins in the latter half of the year are projected to be better than those in the first half, which explains our outlook for leverage and overall margin expansion for the full year.

Okay. Okay, great. And then just with some of the movements on the debt side in the quarter, any update in terms of how we should think about interest expense for the year?

Yes, in reference to the 8-K and the information we released, let me break this down into two parts: 2018 and the period after. For 2018, the benefit on interest expense is approximately $0.11. Specifically in Q1, our interest expense has increased slightly due to the interest from both the refinanced tranches and the new tranches over a brief period. Looking beyond 2018, our guidance indicates around $0.19, or $19 million.

Just following up on one of the earlier questions around price/cost. So at the beginning, there was a band of plus 30 to minus 30 for the year, Mike. It sounds like you're in the lower part of that range, but obviously comfortable with how the guidance is going to play out for the year and from an earnings standpoint. Is that the right way to interpret this?

Yes, in fact, what we talked about was the fact that typically we'd be plus 20, plus 30. We said, "Look, let's not be so precise because we've had so much inflation and it's so volatile. Let's say it's minus 30, plus 30." But within that window, we were confident at that point in time that we were going to able to get the leverage in the business that we had thought about and communicated to you by managing the entire P&L, and that's the intent. Now within that, we said, "Let's bias it toward the bottom end of that range. Let's play it safe. Let's look at minus 30 as probably being closer to the reality." And what we're seeing transpire in the marketplace with price is that we are certainly within the band that we've communicated, say, minus 30. If you look at the spot forecasts, you could say minus 20 today. But understand the volatility in that is moving quite a bit. So I feel good about being in that kind of minus 20, minus 30 bps range at this point, and that will evolve over the course of the year as these wild cards play out.

Okay. I know it's really early, but as we consider the impact of commodities into 2019, do you have any initial thoughts or insights? You still have time to implement some strategies from a productivity standpoint, so I'm just curious about your outlook for the next 12 months.

Yes, as volatile as it is right now, we're certainly looking at what's happening for the year. So it's not that we're not thinking about '19, but we'd be really stretching to prognosticate much at this point in time. We want to make sure we can call Q3 and Q4. So at this point in time, I'd hold back on comments there.

Almost everything has been answered for me, but just can you break apart the pieces of Thermo King? You usually give us a little bit of a better sense of what's happening across some of the pieces, and I just wondered if you could do that again.

It will take a moment because this is a diversified business. Let's first discuss the North America trailer segment, which is where some of the recent developments are. We are experiencing tight shipping capacity and a limited supply of drivers, contributing to the 15% industry increase I mentioned. Regulatory changes, particularly regarding electronic logging devices, are also having an impact. Additionally, the U.S. Tax Cuts and Jobs Act has positively influenced our outlook, which ACT has raised to 44,600. Previously, we were estimating around 41,000, which exceeds the initial plan of approximately 39,000. I believe the actual figure falls somewhere between 41,000 and 44,600. However, ACT may not have fully considered certain constraints related to cabs and inventory, so the number could be about 2,000 units lower. Overall, this is all positive news. In Europe, we anticipate robust performance in both the truck and trailer markets, though some markets are performing better than others. Notably, Russia accounts for about 15% of the market and is growing slightly faster than Europe overall, though any further sanctions there could introduce uncertainty. Generally, growth looks strong. The APU market is thriving, correlating well with Class 8 sleeper cabs. Furthermore, our bolt-on rate for units onto the sleeper cabs is increasing, aligning with our previous plans shared at last year's Analyst Day. The marine market is also performing well, with an uptick of over 220% in the most recent quarter. While it remains a smaller segment for us, the growth is promising. The bus, rail, and air segments present a mixed picture. Rail includes longer-term projects that are beneficial, while the bus segment focuses on city transit buses. The air segment is modest but noteworthy, with a 10% increase in the market for transporting biopharma in refrigerated containers via air. This is a positive indicator for those business areas, but in total, the bus, rail, and air segments represent around 10% of our overall portfolio. We are also seeing good growth in Latin America, particularly in Brazil, as well as continued solid performance in Asia.

And are the prices of acquisitions high enough at this point that we should expect the overall share count to drop a little bit more, or you guys are going to keep your kind of methodical approach and try to balance everything out?

The methodical approach really is just keeping intrinsic value in front of us as we're looking at an acquisition and trying to make the right long-term decision around the acquisition. So obviously, as the share price drops, it makes the intrinsic value greater. It makes acquisitions a little bit more difficult. But look, if what we see persists, the price of an acquisition should come down, too, as well. So look, let's just let this thing play out. But I think we've shown a very disciplined process over the past few years about what and why we buy and what we pay for. And I can tell you that what we've bought in 2017 is generating far greater EPS in '18 and '19 than share repurchase, but that's because we look at intrinsic value versus the acquisitions and make good decisions and integrated them well into the company.

I wanted to ask about the margin lock and understand how you anticipate investment spending will develop as we move forward. Will it possibly remain a 40 to 50 basis point headwind throughout the year?

Yes, I think on investment spending, let's call that similar to 2017 as we go through the year. I think what is important, Robert, on the investment spending itself is what that actually is going into. So we're continuing to work on new products. We're continuing to work on our operational excellence initiatives. There's a small amount of IT. But in terms of how we're going to do that throughout the year, it would look similar to 2017. And the changes that we may see as we go through this, and this is an important part of our process, is we've got an investment review board that looks at all of the different components of investments that we do and makes sure that we've got the right business cases, the right value creation for all those investments. And that's a really sound practice for us as part of our business operating system that may impact some of that timing somewhat, but I don't expect it to be terribly different.

I understand. I appreciate if you prefer not to elaborate further on this topic, but others have mentioned it. You initially projected Climate to be up 3% to 3.5%, having started with an 8% increase and orders rising by 11%. We're all trying to grasp if there's anything significantly different happening, or if your plan has accounted for these factors, or if there is some volatility in the shoulder season.

It gets very much to my point that strategy closely aligns with strategic growth programs and the product growth teams, as well as the success in these markets. In some cases, I think we're surprising ourselves with the growth here, which is great. It was a very strong quarter, and I'm pleased to have booked that and added it to the backlog. We'll see how quarters 2 and 3 progress.

I know we've covered a lot of ground here. I did have a follow-up question for Sue. In your answer to Jeff's question on inflation and steel, I think you said that you can't lock in the prices. But just if you could refresh us. My understanding, you engage in advanced purchasing so you basically pre-buy or commit 100% of the volume you expect each quarter and then ladder that out. Is that still the same practice? But aren't you locking that in for the quarter each time? So is that really locked in or not?

All right. So Deane, great question. On steel, what my comment was meant to be is, you cannot do a financial hedge or something of that nature on steel. However, it is a lot like a locking program, where we get visibility from spot prices and commitments, contractual commitments from the suppliers on steel that will go out 3 months. So we've got visibility to the pricing and then we've also got inventory. So we've got about 6 months of visibility to price increases or decreases. It's just a matter of there isn't a financial hedging mechanism that's out there on steel, which could be on copper and aluminum.

Great. That's helpful. And then for Mike, could you update us on the whole initiative around connected buildings? That was a big focus at the analyst meeting. What the take rate is, the number of buildings, the kind of investments you're making, but any color there would be helpful.

Yes, the whole digital strategy for the company is probably the largest investment, and we look through that across the company. If you look at product growth, it is definitely in the results that we're seeing around why the controls business was up as much as it is. And then specifically on the connected strategy and the growth rates there, we talked about sort of 30% compound growth rate, so we're continuing to see that take shape. We've just made an acquisition in the quarter around another company, a small company, a lot of intellectual property and many, many hundreds of thousands of connections through smart meter technology into our platform. So there is more investment happening there as well, and we're trying to extend and get a larger footprint. But the strategy is growing roughly 30%. You're seeing that show up in our controls business and it's intentional. That's about all I could say there.

Great. Thank you, everyone, for joining the call. As always, Shane and I will be available to take your questions today, tomorrow and in the coming days and weeks. We look forward to seeing several of our large investors on the road in the upcoming weeks as well. And I hope everyone has a great day. Thank you.