Trane Technologies plc (TT) — Q1 2022 Earnings Call Transcript

Thanks, operator. Good morning, and thank you for joining us for Trane Technologies first quarter 2022 earnings conference call. This call is being webcast on our website at tranetechnologies.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. Joining me on today's call are Dave Regnery, Chair and CEO; and Chris Kuehn, Executive Vice President and CFO. With that, I'll turn the call over to Dave. Dave?

Thanks, Zach and everyone, for joining us on today's call. Let's turn to slide number 3. I'd like to open with a few comments on our purpose-driven strategy, the engine that enables us to deliver differentiated shareholder returns over time. Our strategy is firmly rooted in our purpose to challenge what's possible for a sustainable world and aligned to the mega trends that are only getting stronger. We are seeing the impact of climate change on the world every day, including more extreme weather events and far-reaching effects on air quality, water quality, food production, and human health. The science is clear. There is no time to wait. The world must take action now to limit global warming and mitigate the effects of climate change. That's where our purpose meets our strategy. Trane Technologies is already taking action to dramatically reduce emissions through innovative solutions that drive electrification, energy efficiency, and emissions reductions for commercial buildings, homes, and transport. We have set aggressive science-based emission reduction targets that continue to push our innovation further and faster. Customers continue to choose us as their partner in achieving their sustainability goals while improving performance and efficiency. Our relentless approach to innovate, strong customer focus, and purpose-driven culture enable us to consistently outgrow our end markets. This, in turn, helps us drive strong margin and powerful free cash flow to deploy through our balanced capital allocation strategy. The end result is strong value creation across the board – for our customers, for our team, for our shareholders, and for the planet. Moving to slide number 4. While we'll cover the details of the quarter and our outlook throughout our discussion today, the primary message I'd like investors to take away from today's call is that the company has never been in a stronger position to deliver highly differentiated financial performance and shareholder returns over the long term. Our end markets are strong. And our innovation leadership is at the apex of powerful secular mega trends of energy efficiency and decarbonization, which is enabling us to win customers at an unprecedented pace. Our business operating system remains at the core of everything we do and is delivering strong price realization to offset the impact of inflation, which is running at multiples of even the highest historical levels. And our balance sheet, liquidity position, and ability to deliver strong free cash flow provides a solid financial foundation. We have exceptional firepower and optionality to not only navigate near-term macro challenges but to flourish as they abate. Our strong performance in the first quarter is ahead of our initial guidance expectations on both incremental price to offset higher inflation and on volume growth. While it's still early in the year and the macro environments remain very dynamic, our performance in Q1 serves to increase our confidence that we're on pace to meet or exceed our full year guidance. Our booking levels remain extremely high, reflecting strong share gains in virtually every area of our business, with supply chain challenges impacting throughput in the near term. The absolute booking levels we've delivered over the past year have been extraordinary. There was a tendency to focus on bookings growth trends, but growth trends may be misleading when absolute numbers move step functions higher than any historical reference period. We encourage investors and analysts to consider both absolute bookings and bookings growth to get a fuller picture. Our first quarter provides a prime example. Organic sales were up 12%, while organic bookings were up about half that amount, up 6%. A fairly normal reaction to bookings growth being half the level of revenue growth might be to assume that the book-to-bill ratio would be negative and that backlog would be lower as a result. However, given our tremendous bookings growth in Q1 of 2021 of over 30%, absolute bookings in the first quarter of 2022 were still extremely high at $4.3 billion. Even with strong revenue growth of 12%, absolute revenues in the first quarter of 2022 were $3.4 billion. It may be counterintuitive, but bookings exceeded revenues by more than $800 million. Our book-to-bill was extremely strong at 129%, and our backlog grew more than 50% year-over-year. Backlog also grew by $800 million or 15% sequentially from Q4 to Q1. Given extremely high levels of bookings throughout 2021, we believe this is an important area to watch to gauge strength as we move forward. With $16.8 billion in bookings and $14.1 billion in revenues in fiscal 2021, the dynamic I referenced as an example from Q1 will be present throughout the year. As I look at our business, the strong secular trends, our leading innovation, unprecedented customer demand, record backlogs, and the financial health of our company, I'm very bullish about the future. We have all the fundamental ingredients to deliver differentiated financial performance and strong shareholder returns over the long term. Please turn to slide number 5. On Earth Day, we released our 2021 environmental, social, and governance report. The report highlights our notable progress toward our science-based greenhouse gas emissions reduction targets, diversity and inclusion commitments, and other sustainability goals. I am proud of the progress we made last year. We exceeded or met nearly all of our annual targets on our glide path toward our 2030 sustainability commitments. We reduced carbon emissions, energy use, waste, and water. In addition, we increased the representation of women in leadership and workforce diversity reflective of our communities. I encourage you to read the full report. It's available on our website. Building on the momentum captured in our 2021 report, I'm happy to announce that we recently learned that our 2050 net-zero targets were validated by the science-based target initiative. At this time, we are the first company in our industry and one of only 11 companies globally to have 2050 net-zero targets validated. This is another example of how we are leading and challenging what is possible for a sustainable world, and we encourage like-minded companies to join us. Looking forward, I am confident we will continue to innovate, take bold actions, and transform the world for a better tomorrow today. Please turn to slide number 6. Customer demand for our climate-focused innovation continues to grow. We delivered another quarter of robust organic bookings, up 6% in the first quarter. Organic revenues were also strong, up 12%. Supply constraints are impacting each of our segments, with particular tight supply as we move up the food chain on product complexity. Generally speaking, the more intelligent and complex the product, the more chipsets they require and the more constrained the supply in the near term. Given extremely high levels of demand and backlog more than double historical norms, unconstrained revenues would be significantly higher in every segment. As mentioned previously, our bookings in the quarter totaled $4.3 billion, far exceeding our revenue of $3.4 billion, which were in part constrained by global supply chain and other macro challenges. With these robust bookings, our backlog grew to a record $6.2 billion. Our Americas Commercial HVAC business continues to deliver extremely strong bookings. Over the past four quarters, bookings growth has averaged nearly 30%, and Q1 bookings were up approximately 35%. Strength was broad-based, with applied and unitary each up more than 50%. Service bookings were also strong, up mid-teens. Demand for our comprehensive solutions remained strong and contributed to our low-teens organic revenue growth in commercial HVAC Americas. The residential HVAC markets also remained strong. Our residential HVAC team delivered mid-single-digit bookings growth and low-teens revenue growth in the quarter. As expected, Transport Americas bookings were down in the quarter on tough prior year compare and because we intentionally constrained demand in order to manage inflationary risks. Unconstrained demand would be much stronger, but customers understand the dynamics and are working closely with us on slots. Bookings remained at healthy levels, with bookings in excess of revenues in the quarter and adding to backlog sequentially from Q4. Revenues were strong, up mid-teens. Turning to EMEA. We continue to see strong demand for our innovative products and services that help reduce energy intensity and greenhouse gas emissions for our customers. EMEA commercial HVAC bookings were up low teens and revenues were up low single-digits. As expected, transport bookings were down on tough prior year compares. Similar to our America Transport business, we are intentionally constraining demand in order to manage inflationary risks. Absolute bookings remained at healthy levels, with bookings in excess of revenues and backlog up sequentially from Q4. Revenues were strong, up high single-digits. Our Asia Pacific team delivered strong bookings and revenue growth of 14%, supported by broad-based growth in China and across the region. Now I'd like to turn the call over to Chris. Chris?

Thanks, Dave. Please turn to slide number 7. Organic revenue growth in the quarter was driven by both strong volume growth and continued strong price execution. Turning to margins. We drove strong core incremental margins of approximately 30%, on solid volume growth of 5%. Volume growth was stronger than expected due to our outstanding performance by our teams and partnership with our suppliers in what remains a choppy supply chain environment. Strong price execution through our business operating system also enabled us to neutralize the impact of higher inflation on a dollar basis, but it was about a 100 basis point headwind to margins in the quarter. Productivity was significantly impacted by continued supply chain challenges, including choosing to incur expedited freight costs and spot buys, consistent with our customer-focused business model. In addition, we continue to make strong incremental business reinvestments, supporting our sustainability-focused strategy. All in, adjusted EBITDA and operating margins declined 70 basis points. Adjusted EPS grew 11%, driven primarily from higher adjusted operating income. Please turn to slide number 8. We discussed the key revenue and margin dynamics for the enterprise on the prior page. The dynamics impacting revenue and margins were similar across each of our business segments, with volume growth, strong price realization, incremental business reinvestments, and innovation and macro challenges impacting productivity and cost inflation as consistent drivers. Our Americas segment delivered strong price execution, slightly ahead of material inflation and offsetting expected negative impacts from negative price/cost in both our EMEA and Asia Pacific segments. Consistent with our prior guide, we expect price/cost to improve throughout 2022 in each region. And we expect to be price/cost positive on a dollar basis for the full year for the total company. Now I'd like to turn the call back over to Dave. Dave?

Thanks, Chris. Please turn to slide number 9. As we've discussed throughout the call, underlying demand for our innovative products and services have never been higher, with unprecedented levels of bookings and backlog across our businesses. Commercial HVAC Americas has significantly outperformed the broader markets over a number of years through relentless innovation for our customers. We're driving unprecedented demand, with orders up nearly 30% over the past four consecutive quarters, which is indicative of our clear market leadership. And we're exiting the first quarter with another quarter of record backlog, up more than 70% year-over-year and more than double historical norms. End markets remain strong, with a variety of economic indicators pointing to growth in 2022. Unemployment is low. And indicators like the Architectural Billing Index, which has been over 50 since February of 2021, remain favorable. Demand remains strong in data center, warehouse, education, and healthcare. Every day we see customers establishing their own sustainability targets, creating decarbonization road maps and helping them to achieve their targets with our customized system-based approach. We're helping our K-12 customers deploy federal stimulus funds to improve the indoor air quality of schools. We see both decarbonization and indoor air quality as multiyear tailwinds for our business, given our deep customer relationships and expertise. Demand for our residential products remains strong. We entered the second quarter with tailwinds from record backlog and expected strong price realization. We see headwinds from lapping tough growth compares from 2021. Turning to Americas Transport. AC projects continued market growth through their forecast horizon of 2023. I'll talk more about transport outlook in our topics of interest section. Turning to EMEA. While we have muted expectations for market growth, with a volatile geopolitical backdrop continuing, demand for our sustainability-focused systems and services remain strong, and we continue to see good opportunities for market outgrowth. Turning to Asia. We are monitoring the COVID lockdowns in China and their broader impact on the region. Outside of Shanghai, we have a plant impacted by the lockdowns that provide equipment or components to support our customers in China and the rest of Asia. Our guidance assumes China reopens mid-May. And any revenue impact due to the China lockdowns during Q2 will be recouped in the second half of the year. For the year, we continue to see underlying strength in China's data center, electronics, pharmaceutical, and healthcare markets. Outside of China, the picture is mixed, with COVID-related lockdown still impacting market expansion in some countries. Our direct sales model is differentiated in the region and provides good opportunities for market outgrowth in both equipment and services. Now I'd like to turn the call back over to Chris to outline our guidance for Q2 and full year 2022. Chris?

Thanks, Dave. Please turn to slide number 10. Based on the market outlook Dave just outlined and our strong bookings and backlog, we are on track to deliver strong financial performance in 2022. We are updating our full year organic revenue growth guidance to approximately 10%, primarily to reflect additional strong price realization to offset persistent material inflation. Our adjusted EPS outlook remains unchanged, between $6.95 and $7.15. We continue to expect a stronger second half, with an improving supply chain and product redesigns coming online that will help us serve our customers better and provide added resiliency to our supply chain. Our updated operating leverage outlook of approximately mid-teens contemplates both additional price realization and additional material inflation. We continue to expect price/cost to be slightly positive for the year on a dollar basis. We expect free cash flow to remain strong and equal to or greater than 100% of adjusted net income. Our outlook includes capital expenditures of approximately 2% of revenues and high ROI projects in support of our profitable growth objectives and our sustainability commitment. These high ROI projects include manufacturing automation, supply chain resiliency, as well as investments to further decarbonize our operations. Our free cash flow outlook also includes modest investment in working capital, with a particular focus on strategic inventory to support continued growth. Please turn to slide number 11. While we traditionally provide annual guidance, given the dynamic macroeconomic environment, we believe it may be constructive to provide an outlook for the second quarter based on what we see today. For the second quarter, we expect core organic revenue growth of approximately 10% to 12%. As mentioned previously, our second quarter Asia Pacific revenues are expected to be negatively impacted by the lockdowns in China by approximately $80 million to $100 million, a headwind of approximately 2% to 3% for the total company. Our guidance assumes China reopens mid-May. And any revenue headwinds due to the China lockdowns during Q2 will be recouped in the second half. Net, we expect our organic second quarter revenues to be up high single-digits and expect continued strong price realization. At this stage, we expect to offset inflation with price on a dollar basis, which carries a heavy margin headwind for the quarter. We see macro supply chain challenges continuing to hamper productivity. We also expect continued expedited freight costs and spot buys as we focus on meeting our customers' needs for sustainable solutions. As we discussed on the prior slide, our full-year outlook contemplates a stronger second half, with an improving macro environment. We'll continue to update our full-year outlook as the year goes along. Please go to slide number 12. We remain on track to deliver $300 million of run rate savings from business transformation by 2023. Importantly, we continue to invest in these cost savings and high ROI projects to further fuel innovation and other investments across the portfolio. We've highlighted some of our innovation for decarbonization on Slide 21 of this presentation for your reference. Please go to slide number 13. We remain committed to our balanced capital allocation strategy, focused on consistently deploying excess cash to opportunities with the highest returns for shareholders. First, we continue to strengthen our core business through relentless business reinvestment. Second, we're committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve. Third, we expect to consistently deploy 100% of excess cash over time. Our balanced approach includes strategic M&A that further improves long-term shareholder returns and share repurchases as the stock trades below our calculated intrinsic value. Please turn to slide number 14, and I'll provide an update on our capital deployment in 2022. In the first quarter, we deployed $506 million in cash, with $350 million of share repurchases and $156 million to dividends. Our Board also authorized an additional $3 billion for share repurchases, bringing our total remaining share repurchase authorization to $4 billion as of the end of the first quarter. Turning to M&A. We completed a small channel acquisition in April, and our M&A pipeline remains active. All in, we're on track to deploy approximately $2.5 billion in cash in 2022, inclusive of $1.9 billion between M&A and share repurchases. Our strong free cash flow, liquidity, and balance sheet continue to give us excellent capital allocation optionality and dry powder moving forward. Now I'd like to turn the call back over to Dave. Dave?

Thanks, Chris. Please go to slide number 16. Global transport markets are expected to remain healthy through 2023. ACT has recently moderated their expectations for transport growth in North America for 2022, largely driven by expected OEM trailer supply chain constraints. European forecasts have moderated somewhat also, reflecting current OEM supply constraints and uncertainty related to the conflict in Ukraine. Weighted average transport market growth in America is 8%, down about four points. EMEA market transport growth is forecasted to be flat, down about three points from our previous outlook. After clear share gains in truck, trailer, and APU globally in 2021, we're expecting global outgrowth in 2022 as well. Please go to slide number 17. We've updated the transport growth outlook slide for North America in the slide deck for reference and additional transparency. ACT continues to call for a nine-year average for North America trailers in the mid-40,000 unit range through 2023, with the pandemic in 2020 being the only significant outlier. Please go to slide number 18. Energy efficiency, decarbonization and sustainability megatrends are only growing stronger. We are uniquely positioned to deliver leading innovation that addresses these trends, and accelerates the world's progress, supported by our business transformation and our engaging uplifting culture. Despite a number of persistent macro challenges, Q1 was a record quarter for us, which provides a solid foundation as we move into the rest of the year. While it's still early in the year, our first quarter performance and our outlook for the second quarter have us well positioned to meet or exceed our full year guidance. We're seeing unprecedented levels of demand for our innovative products and services. And our backlog has never been stronger. We're executing our business operating system well. And expect to continue to successfully navigate macro challenges with a customer-first mindset. We believe we have the fundamental ingredients to deliver strong performance across the board in 2022 and beyond, and to continue to drive differentiated shareholder returns over the long term. And now, we'd be happy to take your questions, Operator?

Hey, good morning everybody.

Hey, Scott. How are you doing?

Good morning.

Good. Thank you. Kind of a big picture question here. I mean, this – the energy independence theme in Europe is center stage or I think taking – or getting a lot of attention here. How does that change the HVAC landscape? I mean, are you seeing more incoming related to trying to drive a little bit more energy efficiency there? Is that a real driver yet of demand?

Absolutely, I mean, we're seeing unprecedented demand right now as you our results in the first quarter. And a lot of it has to do with our new innovations around products that are helping our customers decarbonize, which is just a massive opportunity in the future.

Yeah. I think actually – I mean, I think what I've kind of meant, Dave, is it incrementally make it – I mean, demand has been strong in Europe, but is it incrementally increasing just in the last few months since the Ukraine invasion?

We're still seeing strong growth in Europe. There are regulations coming into effect that will restrict fossil fuels in certain countries, with Germany being the latest to implement such legislation. Many of our products align with this trend, and we are now on our fifth generation thermal management system. This system combines a boiler and a chiller, enabling customers to enhance their decarbonization efforts by phasing out fossil fuels. We are excited about this growing opportunity and continue to innovate. This trend is not just limited to Europe; we are observing it on a global scale.

Okay. Given your stock price and the overall market dynamics, should we anticipate a significant increase in buybacks in the second quarter?

Scott, this is Chris. What I would say is, we see a lot of value in our shares today. And frankly, we saw a lot of value in our shares three months ago. We take a long-term view in terms of stock valuation and looking at our intrinsic value. As we noted on the prepared remarks, we have a lot of firepower with respect to repurchases, $3 billion new authorization provided by our Board here in the first quarter puts total capacity around $4 billion here at the end of the first quarter. So we really like the position we're in. The balance sheet has got a lot of capacity to do both M&A and repurchases. So we're not limited. The guide on the year is $2.5 billion roughly of deployment, with about $1.9 billion of share repurchase and M&A. And we'll continue to execute that quarter-by-quarter as we go through the year. But our priorities remain consistent in how we allocate our funds and our cash. We see a lot of value in the shares. We have a lot of firepower. And look, I think we're really on track for the full year here to deploy that cash.

Sounds good. Thank you. Good luck, guys.

Thanks, Scott. Appreciate it.

Thank you. Good morning, guys.

Hey Joe, how are you?

Good morning, Joe.

Doing well, guys. Thanks for the question. Just the first one, I've been asking this to basically every company. But the China lockdown exposure, the $80 million to $100 million, just how has that progressed in 2Q? And clearly, like you're assuming the reopening in mid-May. That's not too far away. Just give us kind of like your confidence that you feel like that's pretty well ring-fenced at this point.

Yes, let me start with a broader perspective. We have maintained a manufacturing strategy focused on regional production for several years. The lockdown affecting the Shanghai area is impacting our operations. However, it's important to note that about 90% of our supply chain aligns with this manufacturing strategy, meaning most of our production is concentrated in that region. We expect the factory to resume operations within the current quarter. As we mentioned earlier, this pause will likely lead to a revenue loss of around $80 million to $100 million in this quarter. We plan to recover this in the latter half of the year. We're beginning to see some encouraging signs of activity returning to the area. For now, our projections indicate that we should reopen by the middle of this month.

Okay. That's helpful, Dave. And I guess maybe my follow-on there is, just the recoup of the backlog in the back half of the year and then also the pricing that is in your backlog today that you're building. How do you get comfort that, number one, you will be able to recoup and there isn’t potential lost revenues, or loss backlog there? And then secondly, on the pricing dynamics, just given the inflationary backdrop that we're in right now, that you guys are pricing accordingly and the margins will come through accordingly?

Yes, I'll begin by discussing our ability to recover. We have significant capacity in our facilities, so we are confident that once we resume operations, we can ramp back up effectively. Currently, we have a smaller workforce at our facility, with the necessary permissions in place to ensure that all of our equipment is operational. It's crucial that our precision machines remain well-tuned, and we are proactively maintaining them. Therefore, when we receive the green light to proceed, we will be prepared. We believe we can make up for the backlog in the latter half of the year. Chris, would you like to address pricing?

Yes. Sure. And I'll talk about the firmness of the backlog too. Joe, we don't see any risk right now on the backlog. Everything appears to be firm. From a pricing perspective, we're on our second round of price increases here in 2022. We wound up at three rounds roughly of price increases in 2021. Certainly, from say 90 days ago, material inflation in the quarter in Q1 and certainly on a full year basis is going to be higher than what we thought 90 days ago. But we're seeing stronger price realization. The second round of price increases is giving us confidence that we've got the opportunity to be flattish in the second quarter and be price/cost positive on the full year. On the backlog in terms of pricing, as we think about our longer live, let's say, applied systems orders, those orders, given that they're 6, 9, 12 months out, will generally have a price escalation clause inserted in there. So there's some protection in that regard. In our residential business, not only through price increases we've done, same on the commercial side. But the price increases we've done, we've also repriced the backlog. So it's given us an opportunity to reset that pricing when we see a material change in inflation. And then last, but not least, on the transport portfolio, we've had price increases as well there. But we're also really intentionally managing the demand and the bookings, making sure we're only opening up the bookings for a quarter when we've got good line of sight to what the cost is going to be in that quarter. So, we're intentionally kind of limiting demand at this point. And I would say, for example, we don't have order books mostly open in the fourth quarter this year, would be an area where we're kind of pausing until we get closer to understand the cost environment. But we're not seeing demand destruction at this point at all with the price increases we've had to put in place. In fact, we really look at them as inflation-based price increases. We're really not out here to price guess, we're just trying to offset the inflation that we've got. Hopefully, that helps.

Yeah, very helpful. Thanks guys.

Thanks Joe.

Hi, good morning, and thanks for taking the questions here.

Good morning, John.

Yes. Thank you. So, I guess if we could focus on the strength in the Americas. One of your competitors had some issues around light commercial and other ones seemed like they had some supply chain issues with controls. I guess can you kind of talk about if you're seeing any market share shifts or maybe what you think you outgrew the market or what the market did, blended for the Americas?

In the Americas, our commercial HVAC business is experiencing robust end markets, characterized by low unemployment and a positive Architectural Billing Index for 14 consecutive months, which is a strong indicator for the next six to nine months. Both applied and unitary bookings increased by over 50% in the quarter, reflecting significant demand. We anticipate this trend will persist, with widespread growth across various sectors such as electronics, data centers, education, healthcare, and office spaces. I monitored the verticals last week and could not identify any that were performing poorly. The decarbonization of the built environment and indoor air quality continue to support our business. In the residential sector, which constitutes roughly 20% of our operations, we also had a solid quarter with a 6% growth in orders, especially impressive given last year's growth exceeded 40%. Regarding market share, it’s challenging to assess in a constrained environment, as order share and shipping share can yield disparate insights. Our product and backlog are predominantly focused on applied complex products, which are typically more affected by constraints. Products requiring more advanced technology and chipsets are facing short-term limitations. However, we remain optimistic about our long-term market share gains and enthusiastic about our innovations and their impact in the marketplace.

Great. And then maybe if we think about the guidance construct. I think a couple of times you said meet or exceed. Obviously, still a lot of year left. You put the FX headwind now in the numbers. So what's kind of maybe coming in a little bit better to offset that as you think about the portfolio? Thank you.

Thank you, John. You're correct. For the full year adjusted EPS, we are projecting between $6.95 and $7.15. We've included about $0.05 of headwind from foreign exchange in that projection as well. However, we are confident we can counterbalance that. Since we're only in the first quarter, which is typically the slowest for HVAC companies, we are pleased with our results thus far. The quarter has turned out to be stronger than we anticipated when we provided our guidance about 90 days ago, giving us greater confidence for the full year. We’ve also raised our full year revenue forecast by approximately 10%, based on the positive price realization we are observing. As we conclude the first quarter, we still have three quarters to go, and we will update everyone during the Q2 earnings release when we will be halfway through the year. By then, we will have a clearer understanding of how the full year is shaping up. The performance in the first quarter has allowed us to mitigate some risks for the latter half of the year. We took proactive steps regarding pricing early on, which is encouraging. We expected to be okay in this area, but the results have been slightly better than anticipated. This increases our confidence in our ability to maintain a positive price/cost balance on a dollar basis for the full year.

Great. Thank you and good quarter. I’ll pass it along.

Thanks, John. Appreciate that.

Hi. Good morning, guys.

Hey, Andy. How are you?

Hey, Andy. Good morning.

Good. How are you? So maybe you could just give us a little more color into how you're looking at resi HVAC in 2022? You said strong quarter. You said in the past, resi construction would be up low single-digits. And I think, using your words, Dave, you said replacement won't fall off a cliff. But books were up mid single-digits and revenue at start of the year up low-teens, as you said. So can you give us a little more color on your outlook now and how you're thinking about inventories in the channel?

Yes. It's a good question. Not 300, but order rates remained strong in the first quarter, up 6%. And that was a bit of a surprise to us considering we were up 40% the prior year. So the demand continues to be strong. Our independent sell-through was strong. The inventory in the channel is about where we expect it to be. In the first quarter, we had growth in the new construction channel, although it's a smaller portion of our business. We'll watch interest rates there and see what happens. But to use your words, we don't see it falling off a cliff, the replacement cycle. Again, resi is about 20% of our business. So even if the replacement cycle did drop 10%, which we don't see it happening, it would be about a 2% drop for the enterprise. And the amount of opportunities that we are seeing in the decarbonization opportunities in both our commercial HVAC business and our Thermo King business on a global basis will far exceed that.

Thanks for that Dave. And then, I think, you said last quarter that you would be upside down on price versus cost by $30 million to $40 million in Q1. But it turns out you were relatively flattish. I think you mentioned the accelerated price realization. Was this really just going in and repricing your backlog? Wasn't the mix help you at all? And then does it really give you more confidence in sort of staying ahead in terms of that sort of modest green for the year in price versus cost?

Yes, Andy. It does give us confidence on the full year basis. You're right. We guided negative price cost in the first quarter, and we wound up realizing flattish. Certainly, some additional volume coming through allows for maybe a little bit more price to come through. But I would tell you that the price execution by our teams has been very strong. I know these are not easy conversations to have with customers. We hear that all the time from our businesses and our leaders. The fact is though we're trying to just offset this persistent inflation. So in the quarter, it was a little bit more inflation, a little bit more price. We got it to flattish. And given our comp on the first half of the year, very strong price a year ago with moderate inflation is where our thoughts were. We could have some headwinds in the first half of the year, giving us confidence we're going to be flattish in the first half of the year on a dollar basis for price cost.

Yes. Our business operating system is currently being utilized throughout the enterprise. We anticipate future developments, and the teams are taking proactive measures. Regarding your question about product mix, it did contribute positively in the quarter. We are observing an improvement in mix, which is encouraging because it reflects much of our innovation.

Appreciate it guys.

Thanks, Andy. Have a good day.

Thank you.

Hi. Good morning.

Hi, Julian.

Hi. Maybe just wanted to start off perhaps with the volume outlook, I think you talked initially a few months ago about volumes being kind of flattish in the first quarter or even down. And you ended up, I think, plus 5% or so. And so, I just wanted to understand kind of what drove that volume upside? And then as you look at the balance of the year, what are we expecting in terms of kind of volume versus price? Do you see that 5% of volume slowing down, for example, because of resi HVAC or things like transport with the ACT adjustment?

Sure. I'll begin, and then I'll have Chris share his thoughts on the pricing aspect. Regarding volume, what we noticed in the first quarter is that our demand is limited by supply. If our supply were not constrained, we would be shipping and invoicing significantly more. In the first quarter, we strategically purchased some chipsets in the open market and made spot buys, which we believe was a wise investment to maintain our customer base. We seized an opportunity and it resulted in increased volume during the first quarter. Can this trend continue for the rest of the year? As we mentioned in the fourth quarter, the supply chain is expected to be unstable in the first half of the year. However, we are more optimistic about the second half. We are working closely with our suppliers to understand their limitations and commitments to us. Additionally, we have some self-initiated redesigns set to launch in the third quarter, which boosts our confidence for the latter half of the year. Do you want to discuss pricing a bit?

I would add to Dave's point about being aggressive and taking advantage of opportunities that this approach will likely continue into the second quarter. We'll assess what's available and try to improve upon it. Regarding pricing, we saw a stronger realization in the first quarter and have already announced a second round of price increases for this year. We remain flexible based on developments with material and freight inflation throughout the year. As Dave mentioned, we are optimistic about the second half, thanks to our self-improvement initiatives and redesigns, which give us confidence in achieving stronger volume growth. This should lead to better incremental gains and hopefully reduce the inefficiencies that have been an issue for us since the second half of last year and into this year.

Thanks a lot. And just on that second point, yes, just looking at kind of what's implied for the back half. As you said, it looks like you're looking at sort of maybe 40%-plus kind of half-on-half operating leverage, year-on-year, something like in the 30s for the back half on leverage. Just wanted to check those numbers were roughly okay. And then to your book, Chris, that's a mix of what price cost, is the assumption that the margin headwind on price cost by Q4 is about zero? So that's part of it. And then you also have some of those volume inefficiencies cleaning up.

Yes. I believe that in the second half, we certainly expect our incrementals to be stronger than in the first half. We'll see how things develop as the year progresses. Given the volume we anticipate, we expect incrementals to exceed 30%. We’ll also assess productivity and the impact of inflation. For the full year, we expect the price/cost relationship to remain a challenge, even if we are positive in dollar terms. The calculations may prove difficult throughout the year. However, we do anticipate stronger leverage in the second half. On a full year basis, we aim to achieve organic leverage in the mid-teens range based on current observations. We will provide an update after the next quarter's earnings release following another performance report. In the first quarter, we've been very pleased with what our teams have accomplished in procurement and engineering to discover solutions, and I know they are continuing their efforts today.

Thanks very much.

Thank you.

Thanks Julian.

Hey good morning guys.

Good morning.

Just kind of continuation of Julian's question there on what sort of the margin kind of cadence maybe is from here. I know you guys have talked about kind of longer-term 25% incrementals. But as we kind of work through maybe the worst of this kind of inflation wave where pricing costs are both high and drive down margins and some of the supply chain interruption, do we get to have this period of kind of above-trend incrementals for a while, or are you still kind of sticking with 25% as the longer term number?

We aim for 25% as our long-term target. Last year, we achieved an increment of 30%, partly due to our proactive pricing strategy and strong volume. However, this year presents challenges with price and cost dynamics, which are negatively impacting margins in the first quarter and likely throughout the year. Depending on how material inflation plays out, our industry typically maintains pricing well. If we experience deflation, which isn't anticipated this year, and if supply chains continue to improve, we might see strong volume increases that could balance out price and cost challenges. Long-term, we maintain our 25% target. Additionally, we're committed to investing in innovation and new product development in both this quarter and Q2, with plans to reinvest some of our incremental gains back into the business to help achieve our long-term goal.

Got it, that's helpful. And then on the applied orders, Dave, I think you mentioned that those were up more than 50%. Any way to sort of break down that on the replacement side? I would imagine that's even stronger still. And how much of that is sort of higher bill of material or kind of scope versus higher volume?

I don't have the exact split between repairs and retrofits versus new installations yet. However, I can tell you that our performance has been strong across all sectors, including data centers and electronics. This reflects the significant innovations we've introduced to the market. We have customers who are choosing us because of the solutions we provide, which go beyond just chillers to include control systems, building controls, and connectivity to our products. Our ability to run AI algorithms on data stored in data warehouses helps enhance the efficiency of buildings, data centers, and hospitals. This whole system is operating at a high level, and our order rates clearly indicate this trend. The team is very energized. I recently visited one of our sales offices, and I can confidently say that our teams have never been more enthusiastic about the innovations we offer to engage with customers and secure new business, along with the overall strength they observe in the market. It's an exciting time, and we are optimistic that the supply constraints will improve in the latter half of the year. We believe this will help us address our significant backlog of $6.2 billion, of which 90% is related to our commercial HVAC business. We will start shipping products and fulfilling customer needs.

Great. Thanks, guys. Best of luck.

Thanks, Josh.

Hey, guys. Good morning.

Hey, Steve. Good morning.

Good morning.

Thank you for providing more clarity on the price and cost impact. This information is very helpful for our models, and I appreciate the precision.

No problem.

Yes, no problem.

Second of all, on the commercial HVAC orders, I thought you said applied and unitary were both up. Did you say north of 50% or north of 15%? I didn't quite catch that.

50%, 5-0.

If commercial HVAC orders were up 35%, does that imply that services would have been below that? Yes.

Exactly. So services, think about services as 50-50, right? 50% of our business is services. Our services were up double digits, so low teens.

Okay. And then what are you guys assuming for orders? How does that order trend, as we move throughout the year? Not necessarily asking for precision. But like does the 6% accelerate? Does it go to flat? Are you expecting any kind of negative order comps here in the next couple of quarters?

Yes, the comparisons will be challenging. Last year, our order rates increased by over 30%, almost every quarter. So, they become difficult. However, if we look globally, commercial HVAC is likely to show slight growth, while Thermo King has different dynamics at play. We're intentionally limiting some incoming order rates to manage inflationary risks, which may lead to a slight decline. Overall, we could see flat performance, maybe a change of plus or minus 1% or 2% on a global scale. Chris?

Yes.

Okay.

Thank you. If you kind of think there's a scenario, if bookings are flattish in 2022 versus, say, 2021, that's the $16.8 billion that Dave referenced before. We've got about 10% revenue growth approximately on a full-year basis. Kind of do that math. It would tell you that the backlog should grow by over $1 billion here just by the end of 2022. So we entered 2022 with record backlog. And we thought, well, maybe that could moderate or even come down. I think the way we could see it today is that that backlog could be even higher by $1 billion or more as we go into 2023. So it's looking like it's should be a very strong year through the balance of this year and then ultimately as we start 2023.

Great. I won't say thank you, but I will say a good execution, congrats.

Thanks, Steve.

All right. Thanks.

Thanks. Good morning, everyone.

Hey, Nigel, how are you?

Good morning.

Yeah, thanks. You've covered a lot of ground. I want to address the remarkable growth in the commercial HVAC backlog. In the past, we've seen some larger multiyear orders coming in. I'm curious if we are currently seeing some of these big retrofit orders in the backlog or if it consists mainly of a wide range of smaller orders.

There's nothing quite like securing a significant ESCO job. This reflects broad-based growth across various sectors. When you consider the decarbonization efforts, the trends in the education sector, and improvements in indoor air quality, there are favorable conditions in many areas. We've been noting this for some time, and it's evident in our order books.

And is the conversion really gated by, obviously, supply chain and capacity, or are customers putting in orders for multiyears here or getting in line longer than they normally would?

Yeah. Longer than they normally will just because of our extended lead times. But nothing that I would say is extraordinary. It really is a supply constraint.

Okay.

If we had unlimited supply, we'd be shipping a lot of product right now.

And then my follow-on question is really around the supply chain. It seems like you've got a pretty good handle on the chip supply. But I think one thing we've seen is a lot of quarterly volatility. Rockwell yesterday got tripped up, had a good first quarter, not through the second quarter, JCI. As you ramp up into the stronger 2Q and 3Q periods, how much paranoia and visibility do you have on that supply? I'm just wondering, obviously, we're now into April. You've got bigger May. What gives you the confidence that you're going to get tripped up by, I don't know, something happening in the next couple of months?

Well, I'm not very paranoid as a person, so I won't use that term. But it really has to do with working with our suppliers. And it's just amazing open communication, understanding what their constraints are, understanding what our needs are. We have some of our, what we're calling self-help redesigns. We're simplifying some of our designs to help our suppliers have more throughput to us, whether it be with wire harnesses is a great example. And those are the kind of things that we've been executing on. A lot of those are going to come on in the back half of the year. So we've seen surprises before, but we're pretty confident that the back half is going to be better than what we've seen here, at least in the first half, which remains choppy. And our team is just doing an excellent job of managing this day-to-day. And if they have a problem, they triage it, they overcome it. We have incredible processes that we've set up now. And we're getting really, really sophisticated at executing when a problem does arise.

Okay. Thanks.

Sure Nigel.

Hi, guys. How are you? Thanks for fitting me in.

Hey Andrew. How are you?

Good morning.

Just a question on, sort of, thinking about interest rates and the business model. Just, sort of, talking to folks in the channel, it seems that low interest rates impacted people's ability to carry more inventory, right, because floor financing is relatively inexpensive despite significant pricing on the resi side, right? A lot of folks are offering financing. Once again, rates are low. So instead of buying outright, you finance. You feel better about your purchase on the resi side. With interest rates going up, how do you guys think about changes to the business model? And how much impact has low interest rates had on the channel over the past several years? An open-ended question, but just wondering if you guys have given any thought to that? Thanks.

Yeah, Andrew. I would say the short answer is, in the last three, six months, we're not really seeing much of a change in terms of demand based on changes in interest rates. There are financing options that are out there selling to the consumer and maybe coming at a little bit of a higher cost to a distributor today. But it's not changing the idea around the record demand and ultimately serving customers. So I would say we don't see that changing the business model. Looking backwards or even looking out over the next year, we don't see that really changing.

Yeah. And Andrew, I would just add that even with interest rates, and I guess, we'll find out at 2 o'clock at least, East Coast time today, what the Fed decides to do. But they're still pretty low rates comparably to historical norms.

Right. That makes sense. I have a follow-up question. Execution has clearly been strong this quarter, and we understand the reasons behind the lack of chips in Milwaukee. Regarding the transition, where do we stand? How much visibility do we have for the year? Additionally, how much pull-forward do you anticipate from 2023? Thank you.

No problem. As far as the SEER transition, we don't see a big pre-buy. I think it really has to do with the way this year change is being executed with the south, at least at the AC level, it's an installed base. So it's not a manufacturing date, the North is a manufacturing date. So think of it more as a phase in, phase out of inventory that we'll see in the South. We're actually really good at this with all of our innovation. We're constantly doing phase in, phase outs within our own plants. So we're taking those chapters out of our business operating system and helping our distributors manage their inventory in a proactive way. We don't see a big pre-buy and we're certainly more than ready for this transition to higher SEER products.

Terrific. Thanks a lot.

No problem.

Hey. Thank you. Good morning, everyone.

Hey, Deane. Good morning.

Just a quick clarification, if we could. And we've seen your competitors do this, but not opening the 4Q order book till you get a better read on the material cost. Was that a TK specific?

Yeah. Specifically, to Thermo King.

Right. And then what happens to customers in that situation? They just – you risk losing an order there? Do they wait – just what are the competitive dynamics?

No. I think it's more about explaining to the customer that we're trying to ensure that, one, we can price it properly. But they're probably also getting constrained on another – from another OEM as well, whether it be a trailer or a tractor. So we're trying to help them marry that demand up. So slotting in this industry is not new. And it's not only Thermal King. It's also trailer as well as tractors that we're seeing some of that happen. So we're working with our customers. They know – these are – we have some pretty loyal customers in our Thermo King business, as you can imagine, with the innovations that we have in our products. So we haven't seen customers move away from that. They understand the reason why, and they're working with us as that dynamic continues to persist.

That's helpful. And just lastly, are you still executing the laddered purchasing of steel, copper, aluminum in the quarter where you would have 100% purchased ahead of time in the current quarter, 80% next quarter? Is that still the dynamic? And are you able fill those goals?

Yeah, Deane. For copper and aluminum, we are laddering out purchases and locking in quantities. But think of it as one quarter out, we're probably around 75%, 80% locked copper and aluminum, two quarters out. You're probably in that 60-ish, 50-ish percent range. And then three quarters, four quarters, that drops to about 25%, 30%. So we've continued to execute that through that here in this environment the last several years. We think that's a good process for us now to speculate steal with our forward buy and our mill by programs. We're generally locking in price for about six months. So looking out, any changes in price today would really have an impact for us really in the fourth quarter.

That's real helpful. Thank you.

Great. I'd like to thank everyone for joining on today's call. As always, we'll be around to answer questions in the coming days and weeks. And we look forward to helping you to see you soon on the road, and be safe. Thank you.