Trane Technologies plc (TT) — Q1 2023 Earnings Call Transcript

Thanks, operator. Good morning, and thank you for joining us for Trane Technologies' first-quarter 2023 earnings conference call. This call is being webcast on our website at tranetechnologies.com, where you'll find the accompanying presentation. We're 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 our 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, Zac, and everyone, for joining us on today's call. I want to begin with a few thoughts on our purpose-driven strategy, which enables us to drive differentiated financial results and shareholder returns over the long term. Our strategy is aligned to powerful megatrends like climate change, which continues to have serious and far-reaching effects on the environment, the economy, and human health. Urgent action is needed to limit global warming and preserve our planet for the next generations. That's where Trane Technologies is uniquely positioned to lead. We just released our latest ESG report, which highlights how our innovation is helping our customers decarbonize their operations, save energy, and improve performance. We have reduced our customers' carbon emissions by 93 million metric tons since 2019 towards our goal of reducing emissions by 1 gigaton or 1 billion metric tons by 2030. These bold ambitions drive our relentless focus on innovation, and our innovation creates tremendous demand for our sustainable solutions. This enables us to deliver a superior growth profile, strong margins, and powerful free cash flow. The end result is long-term value creation across the board for our team, our customers, our shareholders, and for the planet. Moving to Slide number 4. Our global team continues to execute at a high level and delivered another quarter of strong performance, showcasing the power of our diverse, resilient portfolio. Organic revenue was up 9%. Adjusted operating margins expanded by 140 basis points, and adjusted EPS grew 26%. Absolute booking levels continue to be extremely strong, as evidenced by our book-to-bill ratio of 117% in the first quarter. We added $400 million to our backlog, driving record backlog of $6.9 billion at year-end 2022, up to $7.3 billion at the end of the first quarter. Demand continues to be particularly strong in our long-cycle commercial HVAC businesses, where global commercial HVAC bookings were up more than 35% on a 2-year stack. And Americas commercial HVAC bookings were up nearly 40% on a 2-year stack. We've been encouraging investors to look at absolute booking levels and backlog in addition to growth rates to gain a more complete understanding of the strength of our business. Q1 is a good example of why that is important. Our enterprise book-to-bill of 117% was led by commercial HVAC in all regions and demonstrates ongoing exceptional levels of demand for innovative products and services and continued backlog build. These strong results position us well for continued profitable growth in 2023 and 2024 with improving visibility. Our backlog of $7.3 billion is more than 2.5 times historical norms. Further, we expect backlog to remain elevated throughout 2023 and anticipate entering 2024 with backlog in excess of $6 billion. To be clear, $6 billion in backlog is a scenario we believe represents the floor. The intent is to accomplish two goals: first, give investors a high degree of confidence we will meet or exceed the floor scenario. The second is to give investors a high degree of confidence that the floor scenario will put us in a very strong position entering 2024 with backlog as a percentage of forward revenues significantly higher than historical norms. Our strong balance sheet, liquidity, and financial position continue to provide us with excellent capital allocation optionality. Year-to-date, we've deployed $720 million to dividends, share repurchases, and M&A, and we expect to deploy approximately $2.5 billion in 2023. On the M&A front, we acquired a leading industrial process cooling technology company in EMEA and committed to acquire a precision temperature control cooling company in the life science vertical in the Americas. Overall, the first quarter played out essentially as expected and gives us confidence in raising our full-year guidance for revenue and EPS growth. We continue to expect free cash flow to be equal to or better than 100% of adjusted net earnings. Chris will discuss our guidance in more detail later in the presentation. Please go to Slide number 5. Demand for our innovative products and services continues to be broad-based across our segments, highlighting the strength of our global portfolio. Our book-to-bill in the quarter was not only strong at the enterprise level but exceeded 115% in each segment as well, contributing to elevated backlog across the portfolio. Revenue is also robust in each segment, with particular strength across our commercial HVAC businesses. In the Americas, our book-to-bill ratio exceeded 115%, led by commercial HVAC. The commercial HVAC team delivered standout results with strong absolute booking that exceeded mid-teens revenue growth. Revenue growth was strong in both equipment and services, up high teens and low teens, respectively. Our Americas residential business performed largely in line with our expectations at this early stage in the year. Bookings and revenue continue to normalize as we approach the cooling season and distributors manage their inventory positions. Still, our book-to-bill was roughly flat in the quarter. Sell-through revenues across our channel and our independent wholesale distributors (IWDs) were flat year-over-year. Our Americas transport refrigeration business performed consistent with our expectations for the first quarter with mid-single-digit revenue growth. We expect this business to outperform the end markets, which are expected to be flat for the year. It's also worth noting that we expect quarterly bookings for both Americas and EMEA transport to be lumpy throughout the year, the timing of order books, customer order patterns, and elevated backlogs. In our EMEA segment, our commercial HVAC business delivered another standout quarter. Bookings were robust, and revenues were up more than 25% with strength in both equipment and services up nearly 40% and high single digits, respectively. Our transport refrigeration business also had a very strong quarter with revenues up mid-single digits. We expect this business to outperform the EMEA transport refrigeration markets, which are expected to be down low single digits to mid-single digits for the year. In our Asia-Pacific segment, the team also delivered strong results with revenues up high single digits, supported by broad-based growth in China and across the region. Commercial HVAC was again a standout with low single-digit revenue growth led by services, which was up nearly 25%. Now I'd like to turn the call over to Chris. Chris?

Thanks, Dave. Please turn to Slide number 6. This slide does a nice job highlighting our overall performance in the quarter, which was strong across the board. Organic revenues were up 9%, adjusted EBITDA margins were up 100 basis points, and adjusted EPS was up 26%. At an enterprise level, we delivered strong organic revenue growth in both equipment and services, up high single digits and low teens, respectively. Our high-performance flywheel continues to pay dividends with relentless investment in innovation driving strong top-line growth, margin expansion, and EPS growth. Please turn to Slide number 7. We discussed the key revenue dynamics for the first quarter, so I'll focus my comments on margins. We delivered strong margin expansion in each of our business segments and have highlighted the key margin drivers on the right side of the page. In each of our regions, strong price realization, volume growth, and productivity combined to more than offset continued supply chain challenges and persistent inflation in the quarter. As we've highlighted previously, the supply chain is slowly improving, and we expect this trend to continue throughout 2023. As an enterprise, we delivered about 6.5 points of price and about 2.5 points of volume in the quarter, which is largely in line with our expectations. We delivered strong volume growth in our commercial HVAC businesses in each region accompanied by strong leverage, which was partially offset by lower volumes in our residential business as those markets continue to normalize. As we discussed previously, we've earmarked approximately 30 basis points for incremental business reinvestment to accelerate the timing of key projects. This is above our average run rate of approximately 40 basis points annually for a total of approximately 70 basis points in 2023. While investment spending was less than 70 basis points in the first quarter, it was in line with our expectations based on the timing of projects. We expect to ramp up to 70 basis points in the second quarter, and there is no change to our full-year guidance of approximately 70 basis points. Now I'd like to turn the call back over to Dave. Dave?

Thanks, Chris. Please turn to Slide number 8. We presented this slide on our fourth-quarter earnings call to help provide color on our key markets. Overall, we had a very strong first quarter as expected, and our positive outlook for our segments and our end markets is largely unchanged. We see strong core demand for our sustainability-focused solutions continuing. We see the stacking effect of support of policy and regulatory changes that play to our unique strengths as a leading climate innovator as tailwinds for either early to mid-innings or future multiyear opportunities. We see the effect of tight supply chain slowly but steadily improving, and we see strong execution of our business operating system and unprecedented backlog supporting resiliency and improving visibility into 2023 and 2024. In our Americas segment, our overall outlook is relatively balanced between commercial and residential. We see our residential business continue to normalize through Q2. Our bias on our prior revenue estimates of the business being plus or minus low single digits for the year is now towards the lower end of that range or flat to down low single digits. While this may present a modest headwind to the second quarter, we see strength in our commercial HVAC business more than offsetting this on the full year. Our transport refrigeration business performed as planned in the first quarter, and we continue to expect to outperform the market for the year. In our EMEA segment, the first quarter was strong and in line with our expectations for both businesses, and our outlook for the year is unchanged. Likewise, for our Asia-Pacific segment, Q1 performance was strong, and our outlook for the full year is unchanged. Now I'd like to turn the call back over to Chris. Chris?

Thanks, Dave. Please turn to Slide number 9. We're off to a strong start to the year and we continue to see slow but steady improvement in our supply chain. Additionally, bookings and backlog continued at high levels providing us with improving visibility into future revenues. All in, we're confident in raising the low end of our full-year revenue and EPS guidance for 2023. We're raising our full-year organic revenue growth guidance to between 7% and 8%, up from our prior guidance of 6% to 8%, reflecting strong results in the first quarter and improving visibility on the year. We're raising our adjusted EPS guidance range to $8.30 to $8.50, up from $8.20 to $8.50. We're also expecting to deliver free cash flow equal to or greater than net earnings. Other elements of our guidance remain largely unchanged with a few modest exceptions, mainly one additional point of M&A and associated impacts, higher interest expense related to debt refinancing in the first quarter and expected pension expense in 2023. Please see Page 18 of the presentation for additional details related to guidance to assist you with your models. As we've highlighted before, we paid close attention to our investment peer group and target top quartile revenue growth, EPS growth, and free cash flow conversion as part of our annual planning process, and we monitor our progress throughout the year. We believe our full-year guidance places us in the top quartile of the peer group on these metrics for 2023. In addition to our full-year guidance, we believe it may be useful to provide a high-level construct regarding how to think about Q2 and the cadence of earnings. For the second quarter, we expect revenue growth in the high single-digit range, which reflects a step down in pricing sequentially, given very high levels of pricing realized in 2022. It also reflects continued normalization and inventory optimization across our residential distribution channels, as Dave referenced earlier. Adjusted EPS is expected to be between $2.50 and $2.55, which includes approximately 30 basis points of incremental investment spend in the second quarter versus the first quarter, as I discussed earlier. This EPS range is also consistent with our three-year average for second-quarter earnings as a percentage of full-year earnings, which is approximately 30% at our full-year EPS guidance midpoint of $8.40. Please go to Slide number 10. We remain on track to deliver $300 million of run rate savings from business transformation by 2023, including an incremental $60 million in 2023. We continue to invest these cost savings and high ROI projects to further fuel innovation and other investments across the portfolio. Our continuous improvement mindset is an integral part of our business operating system, and it's designed to drive gross productivity each year to offset other inflation. While it's been extremely difficult to realize meaningful levels of productivity in recent years given the supply chain and other macro challenges, productivity has been improving as supply chains slowly recover and is contributing to our 25%-plus organic leverage target in 2023. Please go to Slide number 11. 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 12, and I'll provide an update on our capital deployment for 2023. Year-to-date through May, we deployed $720 million in cash with $170 million of dividends, $250 million and $300 million to share repurchases. We have significant dry powder with $2.9 billion remaining under the current share repurchase authorization, and our shares remain attractive trading below our calculated intrinsic value. Our M&A pipeline remains active, and we have committed or deployed approximately $500 million year-to-date to bolt-on leading technology acquisitions and equity investments, two of which Dave mentioned earlier, including a leading industrial process cooling technology business which closed on May 2 and will complement our portfolio in our EMEA commercial HVAC business. All in, we're on track to deploy approximately $2.5 billion in cash in 2023. Our strong free cash flow, liquidity, and balance sheet continue to give us excellent capital allocation optionality moving forward. Now I'd like to turn the call back over to Dave. Dave?

Thanks, Chris. Please turn to Slide number 14. The key takeaway for our Thermo King business is that the transport refrigeration market forecasts for both North America and EMEA remain unchanged, and we expect to outperform each market in 2023. Our performance through the first quarter is on track to meet these expectations. The slide shows key data points on the markets and on Thermo King specifically to provide additional transparency and reference information. Please turn to Slide number 15. Act has updated their long-term forecast for refrigerated trailers, and they are projecting strong demand through 2028. The data supports the view we've been highlighting for some time now that this is a strong mid-40,000 unit market plus or minus a few percentage points. One key takeaway is that ACT has increased their 2024 forecast to 42,000 units, up from 40,000 units, which represents a 7% decline versus an 11% decline. In 2025, ACT forecasts the market to increase 7% and return to 45,000 units and to continue growing low single digits through 2028. Both our Americas and EMEA Thermo King businesses are poised to continue to outperform their end markets through leading innovation and strong execution. We believe this is a GDP-plus-plus business for us over the long term. Please turn to Slide number 16. In summary, we are positioned to outperform over the long term. Energy efficiency, decarbonization, and sustainability megatrends continue to intensify, driving increased demand for our innovative products and services. We are delivering leading technology and innovation to address these trends and accelerate the world's progress, underpinned by our engaging uplifting culture. Our strong first-quarter performance, diverse and resilient portfolio, and unprecedented backlog give us confidence in raising our full-year revenue and EPS guidance and reaffirming our full-year free cash flow conversion guidance. We believe we have the right strategy, the best team, and a solid foundation in place to deliver strong performance in 2023 and differentiated shareholder returns over the long term. And now we'd be happy to take your questions. Operator?

You guys always give a lot of great detail and answer a lot of questions, which is helpful. But I haven't really heard you talk about mega projects specifically. And when I think about kind of these giant semi fabs and the EV facilities and everything that is on the list that folks are talking about, is this stuff starting to move into your backlogs? Are people starting to spec out the HVAC needs in those facilities? And if so, I'm just kind of guessing these are super complicated. I have to imagine a semi fab requires some pretty incredible engineering to get the cooling right, and perhaps you guys have an advantage in that regard. So I'll just open it up to that.

We have significant strength in the high-tech industrial sector that we have maintained for several years. We are beginning to see the early stages of large orders, particularly in the fab plant area. The CHIPS and Science Act is still forthcoming, and once it takes effect, we expect to see even more of these major projects coming to fruition. We have noticed some activity in the EV battery plants as well, which has proven to be beneficial for us. While we categorize all of this under high-tech industrial, it has certainly been a strength for our company. These operations are complex and require detailed engineering; they are not always as straightforward as one might assume, and there are unique challenges involved. Our expertise in this area gives us a distinct advantage, and we will continue to perform well moving forward.

This might be an ambitious idea, but regarding AI and the cooling of chips, when discussing the transition from 5-kilowatt to 100-kilowatt scenarios, there's significant heat involved. I've heard there are many opportunities in this area, as the cooling solutions for these chips—whether through full liquid cooling or other hybrid methods—are still being explored. Are you involved in developing technologies related to chip-level cooling?

Yes, we are indeed focused on immersion cooling, which is at the forefront of technology. We have made an equity investment in a company named Liquid Stack, whose expertise lies in this area. We are collaborating with them, and we are definitely at the forefront of this technology.

Dave, commercial HVAC bookings growth has remained really strong, low teens growth in EMEA despite maybe a little bit slowing against tough comps as you talked about in the Americas. Have you seen any slowing in any of your main commercial HVAC verticals in the Americas? Or is it really just tough comps? And then would you say the main difference in EAME is the strength of your thermal management system out there? And if it is, where are you in that buildout? And where are you in terms of bringing it into the U.S.?

Commercial HVAC has been strong globally for us, and the trends around decarbonization are intensifying. We had a solid start to the year in the Americas, with order rates increasing in the low single digits and a growing backlog. In EMEA, the team is performing at a high level, particularly with our differentiated thermal management systems, which are winning over customers. The commercial HVAC business in EMEA saw a 20% increase in 2022, and we were up 25% in the first quarter, with equipment orders approaching a 40% rise. The team is executing well, and margins in Europe remain very strong. Last year, we discussed acute supply chain issues in Europe, but now we're seeing productivity improvements that have eased those concerns. Overall, we are performing exceptionally well in EMEA, the Americas, and Asia-Pacific, where order rates have increased in the low teens across the board, both in China and beyond. We're off to a fantastic start in 2023, with significant demand for our commercial HVAC products.

And I want to follow up on your comments on sort of the EMEA margin. Maybe for Chris, you talk about price versus cost benefit in Q1 for the year. I think you mentioned previously the 2% to 2.5% carryover price embedded in 2023. Has that gone up a bit? And as Dave mentioned, is it really you're comping against sort of easier supply chains or better in EMEA and Asia, and that's sort of the big reasons why the margins were much stronger in those regions than versus the Americas? Or are you investing maybe more in the Americas versus those other regions?

Andy, it's a great question. If I go to EMEA margins first, I mean, if I go back a year ago, we saw very acute supply chain issues impacting that region and really unfortunately holding back revenue growth and lowering volumes. It also came with the product we get out the door, a lot of additional cost to serve our customers. And a year ago, it was very difficult to get leverage in that region. What you're seeing coming through here in the first quarter, and you guys will see this in the 10-Q that gets filed, you'll see 9 points of price in EMEA and about 6.5 points of volume. And with that volume came strong leverage, and we're starting to see some productivity come through within a slowly but improving supply chain. So I think about the margins around productivity improvements on a year-over-year basis, stronger volume with good incrementals, and pricing continues to remain strong in the region as well. So really nice start to that team. I think you mentioned a question on maybe price overall for the company. Enterprise-wide on the full year, we're probably still in that 200 basis points to 300 basis points on a full-year price. And I would bias our full-year revenue growth more to the volume side than to the price side on the full year.

I wanted to start by discussing the backlog outlook and orders. One option could be to avoid reporting orders when they decrease in a quarter. However, if we consider the overall situation for the year, how do you view the book-to-bill ratio? I'm trying to gain a better understanding of your comments regarding the $6 billion backlog at year-end potentially being a baseline figure. Can you provide any insights on how you're approaching book-to-bill by region or between commercial and transport markets?

Yes. Our order rates for the first quarter were mostly stable, but our backlog grew by $400 million. We had a significant backlog at the end of 2022 at $6.9 billion, and it's now increased to $7.3 billion. We will start 2024 with a very high backlog. We're using $6 billion just to show the strength of it. Typically, the backlog represents about 20% of future revenue, and we will be well above that as we enter 2024. Looking at the book-to-bill, if you do the simple calculations based on our midpoint revenue, yes, it might decrease a little from what we are currently seeing. However, the first quarter was outstanding and stronger than we anticipated, particularly in our commercial HVAC sector. Our commercial HVAC orders increased by 35% year-over-year in the first quarter. Demand is very strong right now, and we are also expecting tailwinds from upcoming mega projects related to the CHIPS and Science Act and the IRA as they begin to take effect hopefully in the fourth quarter. This will provide additional support going into 2024 and beyond.

Then my second question would just be on the Americas operating margin for the year. So I suppose one, I think some investors may have thought maybe you'd have higher operating leverage in the first half and the sort of mid-20s number because of price cost tailwinds to margins and the last sort of bout of transformation, savings as well as the good volume growth. So I understand the sort of investment reference that Chris had made. Anything else going on in that Americas margin? And also, when we're thinking about second half operating leverage in the Americas, does that stay at that mid-20s rate that you've got in the first half? Anything sort of moving around there?

Julian, this is Chris. I'll jump in. Yes, the Americas saw a nice margin expansion in the first quarter, 90 basis points operating margin expansion, about 50 basis points EBITDA margin expansion really led by our commercial HVAC business. We saw declines in residential in the quarter, and Thermo King was right in line with our expectations, plus or minus. So I think it's really just the combination of the mix in the quarter, where residential volumes were down but we saw very strong growth in commercial HVAC. I think on the guide, as we've guided Q2 and then raised the low end of the guide on both revenue and earnings on the full year, would suggest maybe some leverage, it's a little lower second half versus first half. But I'll tell you, we're very confident in our full-year guide. I think the performance in the first quarter was very strong. And at the same time, we've got a strong backlog entering into the second quarter. And as Dave talked out, the guide for the backlog going into 2024 we expect to be very high as well. So we have a lot of confidence in the full-year guide. The first quarter, it's really our smallest quarter of the year. It's about 17% of our earnings on a full-year basis. And let's get into the cooling season and we'll update you in a couple of months. But we're really happy with where we started.

I just wanted to ask if you're observing any signs of price elasticity in the residential channel, considering that volumes are slightly lower across the industry, or if there are any competitive downward price movements.

Gautam, it's Chris. I'll start. Look, I think pricing continues to be strong, and as we expected in the quarter for residential. We're ready for the cooling season with the inventory we have on hand, but we're not seeing anything from a price elasticity perspective that you're referring to. Things remain to be very disciplined as we see today, and we're ready for the cooling season.

And just a quick follow-up on the M&A pipeline, if you could talk about what kinds of things you're looking at. And is it more of what we've seen before with technology add-ons, anything sizable in the pipeline that might be attractive?

Yes, Gautam, I'll start on that. At the end of the day, we have the opportunity to position ourselves as a major global HVAC player. In the first quarter, we announced MTA, which Chris discussed, and we actually made another announcement yesterday. This is a prime example of our strengths. We have a technology in industrial process cooling in the EMEA region that performs well at the enterprise level, though the revenue is currently less than 1% for the enterprise. The margins are good, and they align well with our strong scale. Our robust channel allows us to integrate these acquisitions quickly. We will evaluate all opportunities carefully while maintaining discipline, and we will continue to implement the successful strategy we have been following.

So look, we talked a lot about the backlog. Clearly, the trends there are impressive in terms of what that means for the revenue story. I guess I'd like to talk a little bit about how backlog margins have trended. And I guess where I'm coming from is some of what the answers have already touched on is these opposing forces where supply chain and price cost, it seemed like they should probably be improving in the backlog. But you also have some of these larger projects, where I would imagine in commercial HVAC, maybe a lower margin upfront and you get paid more on that longer tail of things like service. How would you carve that for us as you're thinking about the margin in backlog today and maybe where that trends?

Josh, it's Chris. I'll start. We see the backlog is still over 90% nonresidential. So that would be primarily commercial HVAC plus our transport businesses globally. But price/cost, we like the margins in backlog. But remember that price scenario, that's going to be a tougher comp as we work throughout the balance of the year. Just to remind investors, we really led with price in 2022. And so we're going to have a tough comp as we work throughout the year on incremental price. Our product management teams have done an outstanding job staying ahead of inflation over the last couple of years, and we were price cost positive in the first quarter on a dollar basis and a margin basis. So I think that's an opportunity. But again, that headline price number is going to be a tougher comp as we work throughout the year. We have a lot of confidence in the 25% or better operating leverage on the full year, and that's going to come from multiple parts of the bridge, right? We're confident that 20 to 30 basis points of price over cost. The first quarter start gives us confidence on that on a full-year basis. But we expect to see good incremental on volume, some productivity return as supply chains normalize and really leverage all parts of the P&L to go drive the performance for the year.

And then I guess just sticking with the same kind of follow-up on some of the questions around some of these bigger projects. How do you think about the crowding out between more of the policy-led stuff and stimulus versus private? Obviously, a lot of focus on the higher interest rates and maybe tougher liquidity situation coming from the regional banks. And I don't know how relevant that's going to be for like HVAC retrofit. But I guess, the wrench can only turn so fast, and we still have labor bottlenecks. Is there a crowding out that you guys think happens on kind of the IRA stuff maybe versus more private demand here over the next year or 2?

We haven't experienced that so far, Josh. It's a valid question. Ultimately, we view these as opportunities ahead of us. Regarding labor shortages, we have implemented numerous programs to effectively train our employees from the ground up, which is improving our situation significantly. We are not worried about being unable to meet demand. Our account managers and sales team are well-prepared and focused on the most promising sectors to generate demand, and we're already seeing positive results. Our order rates are exceptionally high at this moment. Our team’s performance in EMEA has also been impressive, leveraging various opportunities, including those related to the IRA, as well as other policies in Europe that are currently boosting demand, and we are positioned to take advantage of these developments.

I wanted to ask on commercial HVAC demand. Obviously, orders can reflect a bunch of things, comps, lead times. But when you were speaking with customers, do you sense any easing of demand, whether it's the result of macro uncertainty or just higher cost of financing?

Chris, good question. Look, we haven't seen that yet. And in fact, we continue to see very strong demand. And I think the whole megatrends around decarbonization continue. And the world is getting warmer, and we need to take action and more of our customers realize that, and we have some solutions out there right now that can have a dramatic impact on how we decarbonize the built environment. So we have not seen anything slowing down right now. And that really is on a global basis for our commercial HVAC business. If you look at the Americas, we play across all verticals. I think there's like 14 different verticals that we track. Maybe there's a little bit of softness in the office, but there's a lot of strength in high tech that we talked about earlier. Education continues to be strong. Europe, we've been strong really across many verticals with our solutions there. In Asia-Pacific, again, very strong start to the year. So we haven't seen any slowing yet, Chris, but it's a great start to the year for Trane Technologies, and it gives us a lot of confidence in our full-year guide.

Appreciate that. And then following up on price cost. The company had been running ahead or kind of staying price cost positive. When we see the year-to-date reflation in metal, does that change how you're thinking about incremental price later in '23 as you try to kind of maintain that staying ahead on price cost into '24?

Yes. Let me jump in, Chris. So it's a dynamic market around Tier 1 metals, and we started the year 3, 6 months ago, thinking we could be in a really deflationary environment, and that really hasn't proven through. As I said earlier, our product management team members have done an outstanding job thinking about cost inputs, value to the customer, and staying ahead on price. We remain confident that we're going to be price/cost positive on the year. The start in the first quarter gives us a lot of confidence on the 20 to 30 basis points price/cost spread that we have in the full-year guide. We know that pricing gets to be a tougher comp as we work throughout the year. But we remain nimble. If there's further movement of inflationary commodities or we continue to see some inflation certainly in Tier 2 around wage and energy, which we have baked into the guide. But if things were to become more inflationary, we have the nimbleness in the company, and I think the proven track record that we've priced effectively. So we have a lot of confidence on where we're going to be on the full year and ultimately just staying very nimble to what happens in the marketplace.

So Dave, just maybe I'll start on resi HVAC. So it's interesting to see it flat, but your organic growth this quarter was down mid-single digits. I'm assuming pricing had to be up. So first, did I get my math right? It seems like volumes were probably down double digits, direct volumes were down double digits in the Americas. So my question is, is that right? And then secondly, what kind of line of sight do you have to that improving and what's embedded in the guide?

Yes, your calculations are mostly correct. On a revenue basis, we experienced a decline in the mid-single digits, while unit sales were down in the mid-teens. Pricing in the business was positive, albeit slightly below our company average, which is a change we've not seen for some time. However, we do have strong comparisons within the residential business. The sell-through rate, which is our focus for this segment, was flat, indicating that we don't anticipate a drastic decline. Although inventory levels at our independent wholesale distributors may be a bit elevated, we expect them to normalize by the second quarter, and there’s nothing concerning about that. Our business is poised for a lot of innovation, supported by strong brands, excellent products, valuable distributors, and a skilled management team. Since it's still early in the year and just the first quarter, we're looking forward to seeing how the cooling season unfolds. We aren't expecting any significant downturn in the business. Our guidance is well-founded and instills confidence in our projections moving forward.

Going back to the margins in EMEA, I know you had an easier comparison due to some issues from last year, but achieving a 17% margin is impressive. The start of the year looks very strong. My question is whether this will serve as the baseline for the rest of the year, considering that we expect revenue and volumes to increase in the remaining three quarters. Is this essentially the minimum margin we can expect in EMEA for the year?

Yes, Joe, it's Chris. Our expectation for the region is that they will achieve 25% or better organic leverage for the full year. Q1 is off to a good start, but as you mentioned, it’s easier to compare than the significant challenges we faced in the business a year ago. The supply chain improved towards the end of 2022, and in the fourth quarter, we experienced strong revenue growth in EMEA from our commercial HVAC business, which had been significantly impacted by supply chain issues before. We are very confident that the team can deliver this year, and the backlog is continuing to grow with their innovative products. Let's see how it unfolds, but we are confident that we will achieve strong margin improvement for the year in the region. Additionally, TK EMEA markets are projected to decline in the low to mid-single digits, but we expect to outperform. Overall, we anticipate a strong year for the EMEA segment.

Joe, you're right. It's a great start for our team, and I'm very proud of what they have been able to achieve. It's fantastic.

Congrats on the execution on the quarter.

Appreciate it.

Thanks.

So 9% price in EMEA, I know we can wait for the Q, but what was it in the other two segments?

Yes, Steve, it's Chris. So it was a little over 6 points in Americas. So think of that as 6 points of price in the Americas, pretty much in line with the enterprise. EMEA, we said 8.9 points of price, and Asia was around 4 points of price in the quarter.

In the second half, there are some unusual comparisons from last year, particularly with the dynamics in China. Europe experienced a strong second half in terms of volume. While I understand you prefer not to provide quarterly guidance, you projected high singles, and it appears you're maintaining that pace in the first half. Are there any unpredictable comparisons for the upcoming second half, or is it expected to be stable? Additionally, could you provide insight into the non-U.S. businesses and your expectations for organic growth on a year-over-year basis in the third and fourth quarters?

Yes. As we approach the fourth quarter, let me start with Asia. Due to the lockdowns in the second quarter of 2022, we experienced muted growth then. However, the business managed to recover well in the third and fourth quarters last year. Asia may face some tougher comparisons in the second half because of how earnings and COVID lockdowns progressed in China last year. Regarding EMEA, the commercial HVAC segment had significant supply chain challenges through the third quarter last year. While we are not completely past these issues, improvements were noted in the fourth quarter and have continued into the first quarter as well. I hope this trend continues to provide a positive impact for the business year-over-year. However, as the year advances, we anticipate encountering some headwinds in the fourth quarter. On the other hand, for TK in the Americas, the latter half of the year will be challenging due to very strong growth we experienced in the third and fourth quarters last year. Although there may be tough comparisons in the second half for some businesses, we are confident in the strength of our commercial HVAC operations and maintain our full-year guidance.

I just wanted to clarify some of these resi numbers. So you said revs down mid-singles. The sell-through comment being flat, is that revenue or is that units?

That will be revenue, Steve. That would be revenue.

So basically, like through your independence, your volume was down probably more like, I don't know, like 20% or something like that, just through the independents?

They certainly normalized their inventory in the first quarter. We've seen that happen. Like I said earlier, inventory may be a bit high, but it really depends on how the cooling season kicks off. It's the first quarter. right? And as you know, this is the smallest quarter. We'll wait until the cooling season starts, and hopefully, it starts real soon.

How's April so far?

I think the cooling season hasn't started yet, so we're still in this transitional period of the year. However, it's projected to get quite warm in May, so we'll see how things play out.

Just one follow-up on resi and then just a different topic on the M&A from you. Just the price in resi below the 6.5% range, little surprised to hear that given the year change and the mix effect associated with that. Maybe you're not including mix when you say price, or perhaps you're still selling a lot of older units in the quarter. Could you just clarify a little bit what's going on there?

Jeff, you're right. We're not including the price benefit from the SEER change in that price number. We consider that as part of volume. So this would be more pure on a year-over-year basis.

Put that as mix, Jeff.

We'll call it mix. And then just on the deals, a 2% revenue impact right on the $16 billion revenue base last year, that's $320 million of sales you're guiding for the partial year on deals, right, on $500 million expended. That sounds like a pretty good chunk of revenue for that amount of dollar spent. So maybe just a little color on the margin rates in these businesses. Do I have that math right? What percentage of the year do you expect what you just announced to actually be in the year? When does this stuff close?

Yes, Jeff, it really is the contribution of three acquisitions that's leading to that roughly 2 points of revenue growth from M&A in 2023. One relates to the ALCO acquisition we closed in October of last year, so you've got about 9 months of that revenue coming through in 2023 that we're calling out as inorganic. Fourth quarter would be a comp would just be part of our organic results. Dave just mentioned, we closed on MTA just yesterday. It is an industrial process cooling business in EMEA. So we'll start picking up the revenues from that business, also a partial year. Think about it as 8 months of revenue this year. And then the pending acquisition that we've announced in the life sciences vertical in the Americas, that's not closed yet. We expect that to close sometime in the second quarter. We made an estimate of that here in the full year. So all in, it's the combination of those three businesses that's getting us to roughly 2 points of revenue growth. And look, the contribution margin in year one, it's low just given the integration costs. But we have a great track record of taking bolt-on acquisitions and bringing them into our channels, selling through with our robust sales forces and ultimately really driving very strong returns in subsequent years. So in the year, it's about $0.03 positive on an EPS basis with that leverage. And ultimately, we'll see how it kind of plays out for the year, but it's still positive and slightly accretive by the year.

Dave, I’m not sure about your area, but it's still quite cold here. So make sure to take care of yourself this week.

It's warming up, Nigel. It's warming up.

Okay, it's coming, it's coming. So obviously, one of your competitors is making a pretty big splash in European residential markets. How do you characterize the importance of Trane being a player in European residential heating specifically? I'm not saying a multi-billion dollar deal, but do you see opportunities to be a player there in a smaller scale, perhaps?

Yes, great question. I mean, we really like our portfolio in Europe. You think about it in the commercial HVAC space where we play, we're having a lot of success. We have differentiated offerings that we're able to provide to our customers. And you see the results. I mean, our thermal management systems there, we've eliminated or significantly reduced the need for fossil fuel for heating in all geographic climates. And you could see the team's results. And like I said earlier, our revenue in 2022 was up 20%, first quarter was up 25%, equipment revenue, 40%. So we're going to continue to execute on our strategy in Europe. We're having a lot of success. The team is high-powered and performing extremely well. And we have so much innovation that's coming through the pipeline that I get excited just talking about it. And as I said earlier, we get the opportunity to look at a lot of M&A deals being a global HVAC player, and we'll continue to do that and we'll continue to be disciplined. And we'll make sure we make the right investments for Trane Technologies and our shareholders.

And then maybe it's Chris. We're kind of up to the end of the $3 million program transformation savings. Is this it? This is the end of the kind of the big part of your move? Or do you see the potential for like another wave perhaps of initiatives?

Nigel, thank you for your question. We are on track to achieve an additional $60 million in savings this year. We are reinvesting these savings back into the business through innovation and development in our portfolio, which also boosts our confidence in achieving 25% or better operating leverage for the entire year. The company has a history of lean operations, and going forward, there will always be chances for us to improve operational efficiency and reduce costs. Another potential area for improvement is addressing productivity challenges we've faced over the past few years, particularly in relation to supply chain issues and higher customer service costs. Dave has mentioned previously about spot buys and our exposure to those market dynamics, which present great opportunities for us to refocus on productivity and counteract inflation. We have already observed some positive changes in our commercial EMEA business in the first quarter, and we will monitor how this progresses throughout the year. I will provide more updates as the year unfolds, but I am genuinely enthusiastic about our productivity prospects and the additional opportunities we have to reduce costs in our operations.

Question about indoor air quality. Has the whole urgency around that theme faded? And understandably, you've showcased all the decarbonization benefits and climate change, and that makes perfect sense. But has the driver of indoor air quality, is that faded at all? Because originally, you were talking about a 200 basis point lift for quite a period of time.

It's a good question. We've incorporated indoor air quality into our applied systems. Having been in this industry for a long time, I can tell you that a decade ago, discussions about indoor air quality were primarily focused on the healthcare sector. Now, those conversations happen across all sectors. While it may not be widely covered, it's still an important topic that we discuss with our customers, and they often bring it up with us as well. Everyone is now aware of the significance of indoor air quality, the necessity of fresh air exchange, and the need to balance this with energy consumption. We have effectively assisted our customers in navigating these issues. So, it remains an essential aspect of our business and our offerings, and it is a priority for many of our customers.

Yes. And I see that with the education stimulus spending that it's usually one of the top priorities. And then second question on the incremental 70 basis points of spending reinvestment. Can you give us some examples of where that's going and a sense of the returns?

Yes, we are very enthusiastic about the digital space and the electrification of our portfolio. We are also focused on optimizing our operations through automation, among other initiatives. Our innovation pipeline is quite strong and plentiful. Three times a year, I participate in an in-depth review of our innovation pipeline. Those four hours are often the most rewarding of my quarter because it’s thrilling to engage with our engineers and discover their inventions and the potential benefits they can bring in terms of decarbonizing the built environment, helping our customers save on energy expenses, and enhancing indoor air quality. Our initiative is thriving at the moment. We are committed to investing in our business, and we have a proven history of success in this area, which we plan to continue in the future.

Deane, I'd add on the investment side, we had a normal level of investments in the first quarter, wanted to highlight that into the second quarter; we do expect that level of investments to ramp up to 70 basis points. We still see that being around 70 basis points for the full year, but that will be a ramp-up into Q2 as we just continue to see very strong projects, as Dave outlined. And let me come back to just a comment on EMEA as well. I know a lot of questions around EMEA margins, maybe just to highlight, in the first quarter, we saw growth both in commercial HVAC and in the Thermo King business. Important to know that the Thermo King markets in Europe are expected to be down low to mid-single. So we're probably not expecting to see that outgrowth in Thermo King each and every quarter of the year. That's going to be an area we'll see how the year plays out. But nice to see both businesses deliver in Q1. But that will be a little lumpy and choppy as we think about Thermo King for the balance of the year.

Thank you for joining us on today’s call. We will be available to answer any questions you may have today and in the coming days and weeks. We will also be attending a couple of conferences and look forward to seeing everyone in person at various events soon. Thank you, and have a great day.