Trane Technologies plc

Good morning, and thank you for joining us for Trane Technologies' first quarter 2020 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 two. 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 FCC 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 Mike Lemach, Chairman and CEO, Chris Kuhn, Senior Vice President and CFO, and Dave Regneri, President and COO. With that, please go to slide three, and I'll turn the call over to Mike.

Mike? Thanks, Zach, and thanks, everyone, for joining us on the call today. Under normal circumstances, I'd start today's call with a brief overview of our global business strategy and how that's enabled us to deliver strong financial results to our shareholders. But today, we're living through anything but normal times, so suffice it for today's call but although we've got a new look and feel under our new train technologies branding, our long-term strategy is unchanged. With that in mind, I'm going to move directly to slide four and into the heart of our presentation today. The focus of our call today is less about earnings in the quarter, or even in 2020, and more about the long-term health, strength, and positioning of train technologies as a pure-play climate control company as business conditions adapt and eventually improve in a post-COVID-19 world. The depth and duration of the downturn and subsequent recovery is a multivariate equation that's impossible to solve. None of us have ever experienced anything like this in our lifetimes, and we can't effectively draw conclusions from historical reference points because there aren't any. Social distancing has never been part of a recession vernacular, and it provides layers of complexity to our daily life that has far-reaching personal and professional impacts. that we're learning about and trying to adapt to as we go. And for some, these impacts are more devastating and more personal than others. As a global leader in our field, working with thousands of customers and suppliers and touching the lives of exponentially more people, how we lead through this crisis and the things we prioritize matter deeply. The implications of leading companies' actions are far-reaching. Major employer acting with a singular short-term profit focus can take down a community. Community can take down one or dozens of companies, and the unintended consequences can keep rolling downhill, exacerbating an already very challenging situation. We strongly believe the right course of action for our employees, our customers, and our shareholders is to lead authentically, steadily, and with a sense of purpose. We will remain true to our strategy. maintaining world-class employee safety, acting with uncompromising ethics and integrity, supporting the communities in which we live and work, and steadfast in our commitment to building a more sustainable world. These are the fundamental building blocks that drive sustainable, differentiated financial performance for our shareholders now and in the long term. With this context in mind, our core operating principles through this downturn are clear. First, protecting the safety and security of our people is paramount. And here I'll start by saying that we have retained more than 95% of our talented workforce annually for over a decade. And a strong and talented employee base is the most important factor in creating great customer experiences and shareholder returns. We have benchmark levels of employee engagement. which is core to our culture and values, and this is a differentiator that is often overlooked. Each time we survey our employees, the top three things that our people identify with our culture of engagement are our sustainability purpose and the belief that one company can change an industry and the industry can change the world. Second, it's the ethics and values we live and lead by. And third, it's safety. In fact, with regard to our safety record, I don't know of another company today with a better safety record than our own within or anywhere outside our industry. Safety and respect for others are at the core of our value system. We went into the downturn as the premier climate control company, and a relentless focus on continued high employee engagement will enable us to emerge on the other side of this downturn even stronger. Since the crisis, we've gone a great lengths to keep our people safe across the globe. It's not just about strict PPE protocols, dramatically increasing cleaning and disinfecting. We're implementing employee active screening and safe distancing protocols. It's about fundamentally rethinking the way tens of thousands of people conduct their work in our offices, factories, and warehouses, and then reconfiguring them for safe distancing through actions such as reconstructing and rebalancing production lines, radically adjusting material and workflows, and investing in new equipment to adjust for new lifting and positioning requirements, and in every facet of how our people work and move through our facilities. We are also actively helping our employees and communities with financial assistance through this challenging time, through supporting national and local community organizations, and through our employee-funded train technologies, helping hands fund. We are in a strong financial balance sheet and liquidity position and will continue to generate powerful free cash flow. We will utilize our strength to play aggressive offense throughout the downturn. We have a strong management team, a proven operating system, and confidence we can execute our downturn scenario playbook to limit decrementals in line with our gross margins. We announced the RMT transaction with Garden of Denver early in 2019. By mid-2019, well ahead of the pandemic, we created an office of transformation that reports directly to me, blueprinting the organizational design and developing transformational margin improvement opportunities for the pure play train technologies of the future. A stack of projects related to these margin improvement opportunities are progressing well, and many are already underway. We're looking forward to discussing these opportunities in detail at our analyst day, which is still slated for the fall, whether that's in person or virtually. The Transformation Office also oversees our stranded cost reduction programs, and this downturn has created an opportunity to accelerate the elimination of stranded costs. We have now identified $90 million in permanent structural cost savings that we expect to take effect in 2020, with run rate savings in 2021 of 110 million. Lastly, I personally find it useful to continue to look at the future through a holistic sustainability lens. First, sustaining the health, welfare, personal development, and future of our talented people around the world. Next, keeping our communities safe, healthy, and thriving. And finally, of course, Business sustainability, which means managing the business for the long term, including the opportunity we have to invest and build our capabilities, even in this downturn, so we can emerge with an even wider competitive advantage. We have a tremendous opportunity to make this happen. In fact, looking back at the last downturn in 2008, we couldn't be in a more different and preferential position in comparison or better suited to capitalize on our advantages. Now I'd like to turn the call over to Dave to discuss COVID-19 and our proactive response to the crisis in more detail. Dave?

Thanks, Mike. Please go to slide number five. During the quarter, the pace at which the COVID-19 pandemic changed the economic landscape is unparalleled, moving from region to region, impacting our employees, customers, and communities as it spread. For trained technologies, we began in early January forming crisis management teams to confront the pandemic with employee safety as our number one priority. As we moved into February, we closed all our facilities in China. We proactively began addressing employee safety. As Mike alluded to on the previous slide, the safety measures were more than just providing PPE. We took a holistic look at how we work. our teams proactively reconfigured our facilities to address the pandemic. We changed the way production lines flow, the placement of machine operators, and created physical barriers where necessary. We implemented active screening, staggered break times, increased cleaning measures and frequency of cleaning measures, and expedited PPE. By March, as we ramped up production in China, With protective measures in place, the work of reconfiguring our facilities moved to EMEA and the Americas. We proactively sent employees home and ensured their pay would be held whole to reduce the number of employees in our facilities to deliver essential customer orders only. This increased the safety for our employees and greatly reduced our facility output to provide time to implement the necessary safety measures fully in each facility. To be clear, these safety measures were not limited to our plants. We proactively addressed employee safety in our distribution centers, offices, and parts stores. All facilities were in scope. By the time April began, our plants in Asia Pacific completed their ramp-up. Our plants in EMEA and the Americas began to ramp their production, and we expect most plants will be fully ramped early in May. Throughout the quarter, our supply chain crisis management team proactively worked with our suppliers as they addressed their own COVID-19 challenges. The team continues on a daily cadence to manage potential risks. This team has done an excellent job. As we move into May, we are running with new line rates and protocols and adjusting to meet customers' demands. Please go to slide number six. From the start, trained technology has been addressed in the crisis by bringing expertise, technology, and services to bear on critical applications for hospitals and other healthcare facilities, like clinics, research laboratories, and pharmaceutical production. By ensuring proper air treatment, filtration, ventilation, and decontamination, we're helping to keep patients and healthcare workers safe and more comfortable in the most challenging situations. We're providing and maintaining indoor air quality through solutions such as trained catalytic air cleaning systems, which remove pathogens from air streams, and negative pressurization systems to isolate infections. Our remote monitoring, controls, and building intelligence solutions are increasingly important in an environment of social distancing. These technologies enable technicians to remotely monitor, inspect, and troubleshoot systems to keep critical environments running safely and efficiently. Our transport refrigeration solutions are protecting the cold chain and helping to ensure the safe and reliable delivery of perishable food, medicines, and other critical goods. Through telematics, we're putting data to work with the ability to track and trace deliveries across fleets, monitor the location of assets, and the temperature of individual deliveries in transit. Please turn to slide number seven. Trane Technologies has been addressing the impact of the pandemic on our communities. Established a number of years ago in response to natural disasters and funded by donations from our own employees, the Trane Technologies Helping Hand Fund is providing financial assistance to our own team members around the world dealing with financial hardship as a result of the pandemic. According to our Feeding America partners, food donations in this environment have declined by nearly 60%. In response, through our Train Technologies Foundation, we made a $100,000 contribution to Feeding America, and our team stepped up to help out with the effort. In one example, our Thermo King and Commercial HVAC Americas team joined forces with Feeding America and the Hand Up International to host two drive-through pantries in Lynnhaven, Florida, providing more than 120,000 pounds of food to nearly 6,000 people. Additionally, teams are upgrading operating rooms, air handlers, preparing patient isolation areas, and expanding COVID-19 treatment facilities for hospitals in record time. I am proud of how our team focused on employee safety and supported our customers and communities in response to this crisis. And I am confident they will continue to address the challenges presented by the pandemic as we move forward. And now I'd like to turn it over to Chris to discuss our balance sheet and liquidity position. Chris?

Thanks, Dave. Please turn to slide number eight. As Mike mentioned at the outset of the call, we are operating from a position of financial strength as we move through uncharted territory in 2020. We have a strong balance sheet, excellent liquidity, and have maintained solid investment grade ratings over many years. Additionally, our consistent track record of delivering free cash flow of equal to or better than 100% of adjusted net income over time, with a five-year average of 107%, including an outstanding year in 2019, which delivered 118%, further bolsters our strong financial position. The timing of the close of the reverse Morris Trust transaction with Garner Denver on February 29th of 2020 and the receipt of $1.9 billion in cash also provided significant liquidity. Owing to the rapid pace, both organizations tirelessly worked to finalize the transaction in 10 months' time. That money has been received and is reflected in our March 31st cash balance. In addition to cash on hand, we have full access to our revolving credit facilities. The first $1 billion facility expires in March of 2021 and we expect to refinance this prior to maturity. The second $1 billion facility matures in April of 2023. Even if we were to fully utilize both facilities, we would remain well below our primary debt covenant of 65% debt to capital. Both facilities were undrawn at March 31st and remain undrawn today. Lastly, we run a relatively CapEx-like business model, so our capital requirements are pretty modest at around 1% to 2% of revenues. Now I'd like to turn the call back over to Dave to provide details and color on what we saw in our end markets in the first quarter. Dave?

Thanks, Chris. Please turn to slide number nine. Broadly speaking, our HVAC markets remained healthy in the first quarter with pre-pandemic bookings and revenues largely in line with our full year expectations. As the pandemic progressed across the globe, bookings and revenue were heavily impacted, first in Asia Pacific, followed by EMEA, then the Americas. In each region, our proactive safety measures temporarily limited our uptime and our utilization. Despite the pandemic, our commercial HVAC, America's Business, delivered strong, broad-based growth with bookings up mid-teens and revenue up mid-single digits. We saw strong demand in data centers and from institutional customers across education, government, and healthcare. Our residential HVAC business also saw strong demand with bookings up mid single digits. With strong bookings growth in commercial and residential, America's HVAC backlog was up double digits versus first quarter of 2019. The majority of the backlog is applied systems, which typically have lead times of six to 12 months. Our transport business was heavily impacted by the pandemic in each region. accelerating declines already expected from the correction cycle that began last year. I'll give a more detailed update on our transport business later in the presentation. With the COVID-19 pandemic impacting EMEA for most of March, our team saw low single-digit declines in both bookings and revenue. Despite the pandemic, Europe commercial HVAC bookings and revenue were up low single digits. During the quarter, Asia Pacific was hit first and hit hardest by the pandemic, with bookings and revenue down double digits. Given the pervasive impacts of the crisis, I'll give additional insights to our end markets later in the presentation based on order patterns we saw in the month of April. And now I'll turn it back to Chris to discuss the results for the quarter. Chris?

Thanks again, Dave. Please go to slide number 10. The onset of the COVID-19 pandemic significantly impacted our first quarter financial results as we took actions to protect employees and customers. As Dave mentioned on the previous slide, prior to the pandemic, our global revenues in the first quarter started off largely in line with our full year expectations. However, pandemic impacts limited our global equipment and service revenues by approximately $150 million in the quarter, with almost two-thirds of the impact in Asia Pacific, contributing to our 5% organic revenue decline. Adjusted EBITDA margins were down 60 basis points in the quarter, primarily due to margin impacts from the volume declines related to both the pandemic and the transport correction cycle. Negative product mix in the Americas more than offset positive price versus cost, as we delivered mid-single-digit revenue growth in commercial HVAC as compared to approximately 30% revenue declines in transport. We implemented proactive cost controls across the business and accelerated our stranded cost reduction actions, contributing to a $16 million reduction in unallocated corporate costs and positive productivity versus other inflation in the quarter. Please go to slide number 11. During Q1, we delivered enterprise deleverage within gross margin rates on lower volume by managing all elements of the P&L, including our decisive actions to accelerate cost reduction programs. Within the Americas region, our transport revenues were down approximately 30% as the correction cycle in the end markets was accelerated by the pandemic. America's margins were heavily impacted by both the volume and mixed impacts of the transport revenue declines. Given the size of our Americas operations, Our commitment to proactively invest in employee safety and security in our plants, distribution centers, offices, and parts stores added necessary costs and reduced absorption in the quarter, negatively impacting margins. Margins in EMEA and Asia Pacific were both impacted by top-line headwinds related to the pandemic. In each region, swift action and strong execution of cost reduction programs limited deleverage to within gross margin rates. Please go to slide number 12. As Mike discussed in his opening remarks, given the onset of COVID-19, we're aggressively stepping up our efforts to remove $100 million in stranded costs related to the reverse Morris Trust transaction we closed in Q1. After announcing the transaction in April last year, we quickly mobilized a margin improvement and transformation office by midsummer. to focus on these cost reductions, which gave us a nice head start in determining the best, most value-accretive ways to eliminate these costs while simultaneously improving the overall capabilities and margin expansion opportunities across our businesses. They quickly moved to implement zero-based budgeting processes and principles across the company. Entering 2020, we set a cost reduction target of $40 million in a year of the total $100 million in stranded costs. We looked for opportunities to accelerate the pace of savings in the first quarter, and with the onset of COVID-19, saw an opportunity to push ourselves further. To date, we've identified savings of approximately $90 million to be realized in 2020, more than double our original target. Further, heading into 2021, The actions we will have taken in 2020 should yield permanent run rate savings of approximately $110 million in 2021. Of the total $90 million savings in 2020, we expect about $70 million to come from corporate unallocated expenses and approximately $20 million to come from the segments. Lastly, we previously disclosed we would incur one-time costs of approximately $100 million to $150 million to permanently eliminate the $100 million in stranded costs. And the table on the bottom right of the slide shows our status to date. We spent approximately $31 million in Q1. We'll update you quarterly on our progress. Please go to slide number 13. We remain committed to balanced capital deployment going forward, as we have consistently done for many years. Given the unpredictability, of depth and duration of the downturn related to COVID-19, we wanted to highlight the modest adjustments we have made for 2020, and equally important, highlight the things that have not changed. As Mike outlined, we are going to manage through this downturn from a position of financial strength. We see this as a time to lead and a time to aggressively invest in our most important asset, our employees. We also see this as a time to aggressively invest and to solidify or extend our market-leading positions through value-accretive investments that will make us an even stronger company coming out of this crisis than when we went in. Importantly, we expect to maintain our dividend at current levels for 2020 and have already paid the quarterly dividend for the first quarter and declared the quarterly dividend for the second quarter. We expect to pump the brakes on share repurchases in the second quarter while maintaining optionality down the road. Regarding debt obligations, we committed to and paid $300 million in April to retire debt at maturity, and we expect to pay down the next debt obligation of $300 million at maturity in February of 2021. We will continue to evaluate strategic value accretive M&A. Lastly, we expect to maintain a strong investment-grade credit rating. This offers us continued optionality as markets evolve. And now I'll turn it back to Dave to give an update on current Q2 trends. Dave?

Thanks, Chris. Please go to slide number 14. During the month of April, we've seen global orders down approximately 20%. Looking across the regions, orders in the Americas and EMEA were both down over 20%. Asia-Pacific orders were also down, but under 20%. as China demand is near prior year levels. Given the normal seasonality of our business and continued deterioration in economic indicators, it is unknown if these order trends will further deteriorate, stabilize, or improve. In the Americas, demand for our commercial applied products has been more resilient, particularly for essential end markets, including warehousing, data centers, and healthcare. Unitary demand has been softening. Broadly speaking, during a downturn our service and parts businesses typically see strengthening demand as customers choose to extend the life of their HVAC equipment rather than replace it. Since this downturn is driven by a pandemic, traditional HVAC services and parts demand have been limited due to access constraints at customer sites. Conversely, The pandemic has driven additional demand for our intelligence services, which include remote building monitoring and indoor air quality offerings. In the residential market, approximately 80% of our sales are replacement units. Impacts from the pandemic have caused declines in consumer confidence and increases in unemployment, our two main replacement market indicators. Though the overall demand is down, we are seeing orders for both lower SEER products that appeal to value customers and higher SEER products that appeal to customers looking to improve indoor air quality as more people are working from home. I'll speak about our transport market outlook on the next slide. Our EMEA markets are seeing similar disruption to what we are seeing in the Americas, with France, Italy, Spain, and Portugal being significantly impacted. In Asia Pacific, China demand is near prior year levels, while market demand in India, Singapore, Malaysia, and Japan remain restricted. From an operations standpoint, we continue to proactively invest in employee safety across our facilities. Our plants in Asia have ramped up, and our Americas and EMEA plants are ramping as we speak. Since China was the first area to be significantly impacted by COVID-19, we have received questions asking what lessons we've learned from our efforts in this region. Our number one learning was that early proactive safety measures are absolutely paramount, and we have rolled out these measures globally. Second, Consistent, focused supply chain cadence is critical to support equipment production and service delivery. Those processes have been effective and implemented globally. And our final learning is that no two countries are the same. At this stage, it is unclear if other countries will track to a similar recovery path as China, given the varied regional response to the pandemic. As we highlighted in our earnings release this morning, we're temporarily suspending our formal guidance and expect to reevaluate for Q2 earnings. Please go to slide number 15. COVID-19 has created obvious disruptions in the majority of our end markets as outlined on the prior slides. The near-term impacts on the transportation markets have been even more significant. On our Q4 call, we provided a good level of detail on our expectations for the transportation market in 2020. Today, I would like to dive a little deeper and provide market forecasts for North America and EMEA for each of the major product categories with truck, trailer, and APU broken out separately. The COVID-19 impacts on the transport markets in 2020 are pronounced. with dramatic forecast reductions across all major product categories in both North America and EMEA. For North America, the trailer forecast has dropped from down 25% in January timeframe to down 46% as of a week ago. The North America APU forecast has moved from down 33% to down nearly 60% for 2020. while the truck forecast has dropped from down 3% to down nearly 20%. Likewise, Europe truck and trailer forecast declines have nearly doubled as well. Additionally, while we don't have the same level of reliable, detailed forecasts available for the other businesses, including marine, bus, and rail, these markets are down similar numbers as well. As you might expect, COVID-19 has dramatically slowed global demand in food distribution, which support hard-hit businesses like restaurants. And long-haul trucking has been significantly impacted by the slowing of the overall global economic demand and cross-border shipping. Aftermarket parts is showing resilience, and demand is expected to continue to be solid as companies look to extend the life of their existing fleets. In terms of the timing of the pandemic impacts on transport, we were generally seeing encouraging booking rates through the first two months of the year that supported our initial transport outlook for 2020 that we provided on our fourth quarter earnings call. As we moved through March and the pandemic started shutting down major portions of the economy, booking rates dropped significantly, consistent with the updated forecast view on the slide. Today in April, we're seeing very slow bookings, as most trucking companies have hit the pause button on activity to reflect the significant downturn in the economy and across major sectors of the refrigerated truck, trailer, and APU markets, as I discussed earlier. The forecast for the second quarter for North America trailers, for example, is down approximately 80% from 2019. April to date, our bookings across Transport Americas for equipment is down about 80%, which is consistent with that outlook, while aftermarket is relatively flat with prior year. The ACT forecast has been revised lower several times since the pandemic hit, so it's really too early to call how 2020 ultimately will play out. As states reopen, and economic activity gradually returns to normal, we expect demand to significantly pick up from current levels as well. ACT initially called for a market correction in 2020 and then a return to growth in 2021, and that still seems directionally correct, although COVID-19 impacts are likely driving a deeper and more prolonged market correction and a more cautious and gradual return to growth. And now I'll turn it back to Mike.

Thanks, Dave. Please go to slide 16. A strong financial condition, balance sheet, and liquidity enables us to operate from a position of strength throughout the COVID-19 crisis as demonstrated through two significant revenue downturn scenarios, the first down 15% and the second down 25%. And to reiterate, because I've heard there has been some confusion on other company earnings calls, These are not our forecasts. They're just scenarios. We want to have a response under any scenario given the tremendous uncertainty that exists in the near term. And we want to assuage investor concern by showing a break-even free cash flow analysis in the minus 25% scenario. What's important to note, however, is that in both scenarios, we have the financial strength to weather the storm, pay dividends, and continue to follow our core principles. We are going to remain true and uncompromising to our purpose-driven sustainability strategy and our core values, including employee safety and well-being and corporate citizenship in our communities. Anyone who knows our company and our culture knows that this is something we believe in at our core. It's who we are, and it's how we win. It's what has driven strong shareholder returns over the past decade since the last downturn and what we believe is a proven formula for sustainable, strong shareholder returns in the future. We're also going to play aggressive offense. We see this downturn as an opportunity to invest, expand market share, extend our leadership as the premier climate control company, and to emerge from the crisis even stronger than when we went in. We're going to continue to execute our playbook and take appropriate cost actions but we are going to be very strategic in our application. Our objective isn't to maximize 2020 earnings, it's to build the trained technologies of the future and to win big over the long term. Please go to slide 17. Our long-term strategy remains unchanged and is underpinned by strong secular sustainability megatrends. Our end markets, our strategy, and our products and services are all tied to the undeniable facts that the world is getting warmer, cities are becoming more densely populated, and the demand for fresh food is accelerating. Fundamentally, we excel where these global megatrends and sustainability intersect with our innovation and capabilities, which drives high demand for our products and services. And while short-term demand may be impacted or pushed out, longer term, the challenges these secular megatrends present will not abate and require leadership and action post-COVID-19. We also know that the post-COVID-19 world will evolve and adapt to the new reality and experiences we've gained through this crisis. Accurate design, installation, service, and monitoring of HVAC systems will be more important than ever to ensure proper filtration, ventilation, air flows and pressurization in high-density areas, and especially in critical environments like hospitals, food and pharma, office buildings, hotels and homes, buses, and other modes of mass transportation. Remote monitoring, diagnosis, and artificial intelligence-based service models have the potential for exponential growth and new service models will emerge. These are just a sliver of the potential opportunities we see now, and we intend to evolve, adapt, and capitalize on them. In the near term, we strongly believe it's imperative that premier companies like Trane Technologies lead through this crisis authentically, steadily, and with a sense of purpose. We will remain true to our strategy, built on the fundamental building blocks that drive sustainable, differentiated financial performance for our shareholders now and in the long term. We also see this downturn as an opportunity to invest, expand market share, extend our leadership, and to emerge with an even stronger culture and a stronger company than ever before. Even in the current crisis, we're confident and excited about the future of trained technologies and our ability to bring all of our considerable resources to bear to deliver strong, sustainable returns for our shareholders. I want to thank our dedicated employees around the world for supporting all that is essential to fight this pandemic and all the frontline caregivers that are heroically battling for all of us every day. And with that, Chris, Dave, and I will be happy to take your questions. Operator?

To ask a question at this time, please press star, then the number one on your telephone keypad. We will limit questions to one question and one follow-up. We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Scott Davis from Melius Research. Your line is open.

Hi. Good morning, guys. Hope you can hear me okay.

We can. Good morning.

Well, good morning. Thanks for the detail. It's super helpful, but I'm kind of intrigued by this whole indoor air quality theme overall, and I guess the question really is, do the building owners care? Is there a sense of urgency outside of, obviously, hospitals have always cared, but when you think of the you know, the other categories that you sell into? Is there, you know, are your phones lighting up that people say, wow, we need to do a retrofit project here? Or is it just too early to really say?

Yeah, Scott, it's too early to say, but we're looking at just sort of human behavior and the lasting effects of what a pandemic, you know, would do to society. And we see a little bit happening through our lens in China, although you can't draw exact parallels between the two. You know, one thing for sure is, that the ability to really monitor indoor air quality and to design and make sure that from a maintenance perspective and all the controls and automation that go into making sure that it's effectively working, I think you're going to see sort of more density per square foot of all that and perhaps codes that in some parts of the world, which may have not been up to a particular standard, I think will change. As will food transportation codes and standards change, I think, going forward as well. So, you know, probably when you get through this, it puts an importance. And I think particularly as buildings become tighter and tighter in terms of their design, I'm talking about the envelope of the building, it's so critical to make sure that you're having fresh air exchanged in the building. You know, a typical building, depending on what it does, might have half a dozen to dozens of 100% air changes in an hour. And the ability to make sure that that's happening and that you're killing, you know, pathogens, you know, where you can in the system or pressurizing appropriately or diffusing air or diluting air is going to be even more critical. So I think it bears a lot of opportunity going forward. I mean, it's hard to – we need to get through this right now, but I think the other end of it probably has more opportunity than not.

Okay, good. And then I'm just kind of curious of the confidence that you have in your backlog. I would assume a certain percentage of your backlog includes things like hotels and stuff like that that I would think are at risk of not just delays but cancellations. So perhaps just a sense of what your confidence in the backlog is overall.

Scott, this is Dave. I'd say we're pretty confident in our backlog, especially in the HVAC space. A lot of it is in the applied world. We haven't seen A lot of cancellations there. We actually haven't seen very many at all. It's pretty normal. Our TK backlog, a little bit more concerned with that. We have seen some cancellations, but it's pretty low right now. So overall, I'd say we're pretty confident around the globe in our backlog, and we haven't seen anything that would lead us to believe that that won't happen.

Yeah, Scott, you think about... You mentioned hotels, but you could throw light retail. That's a small part of our business. Retail is an example. We've never, over the last decade, focused much on national accounts at all as an example. If you think about our relatively high share in unitary and light unitary, the smallest share by design we would have would be in retail. If you go into hotels... The place where we play in hotels is sort of in the lobby and in the common areas and, you know, in the larger and more complicated spaces. We really don't play in sort of individual rooms, and so the vacancy of a hotel isn't going to matter. If the hotel is open, you know, we're going to be providing equipment and services. So that is a little different. You know, maybe a decade ago I would have said we would have had more focus on retail and national accounts, and that's changed over the decade.

Your next question comes from the line of Jeff Sprague from Vertical Research. Your line is open.

Thank you. Good day, everyone. Best of luck with the new training. Thank you, Jeff. A couple questions. Yeah, my pleasure. Just first on the kind of working through the scenarios and what you're planning to do, just want to be clear, the comment about managing the decrementals around gross margin, would require extra actions. Are you planning to take those actions, or are you suggesting to us that, you know, none of us has a crystal ball, but pick our revenue scenario and we should expect your decrementals to be around your gross margin rate?

Yeah, that's a great question. And the first thing I would tell you is that, you know, anybody that thinks they're going to forecast a number is only going to be surprised when the forecast, you know, meets the real world at the first minute. So the notion of really doing scenario planning is something that we've been living with for a long, long time. And although we would have done scenario planning in the past, it would have been around a general recession. So a pandemic is something new with regard to just the behavioral changes and the way that, say, in our case, buildings would even be closed or limited in terms of access for service. And so the pandemic has offered really sort of a different scenario. But once you move through the initial pandemic phase, and we think through to Scott's earlier question, you know, where the opportunities lie going forward, it's more useful than to think about scenarios, you know, in what Altman now has done, all the depth and duration of that recession. So, you know, for us, we've looked at, I would say, in increments of five points of revenue decline, you know, what are the series of actions that we would need to take on top of the actions already taken, and And having a playbook to do that, give us some confidence that we can maintain a reasonable amount, gross margin, decrementals would be in line with that. But in doing that, we don't think there's an opportunity that we're even doubling down in areas of innovation or doubling down in areas of productivity, because the key to this for us is, you know, we entered this thing, I think, with a pretty wide gap relative to some of the competition, and we want to come out of this with an even wider gap. And we've never been in a better position, you know, from a liquidity and a talent and a technology perspective to be able to do that. So it would be a tragedy not to really invest. But we can do things at once. We can manage the decrementals, and we can continue to really double down on the important investments for growth and productivity.

And as an unrelated kind of follow-on second question, Mike, you mentioned M&A, you know, kind of prominently in your process. Can you give us a little thought of what you're interested in on a standalone basis here?

Yeah, it's all M&A, and so the ideas that we would have be really defined by the strategy, and that hasn't changed around They tend to be, you know, really in buckets. It's the easy bolt-on technologies that need a channel or it's the channel that doesn't really work. You know, those are easy for us to do. I would tell you that that is something that we're still very active with. I think, you know, more transformative things that a company could do like ours. I think the bid ask is wider. in this environment, liquidity and the balance sheet to be able to look at those sorts of things, if in fact, you know, the bid-ask narrows. So we would keep all options on the table. And again, this is about, you know, in 08, Jeff, our timing was unlucky. You know, we caught a large acquisition and had a hung bridge loan in April, and we couldn't have been in a worse position. between announcing and closing the RMT transaction in 10 months, our luck couldn't have been any better. And so we really need to capitalize on, you know, that good fortune and make sure that we're parlaying that into a really good future for the long run.

Great. Thanks a lot. Thank you.

Your next question is from JP Morgan. Your line is open.

Hey, guys. Good morning. Hey, Steve. Good morning. What was in total Thermo King down on REVs for the quarter?

Americas, I think, was down about 30%. About 10%. 15%, I think it was.

Okay. Got it. And I think you guys had said that single-digit growth in commercial, was that the total?

We talked about the EMEA. The media was driven by the Middle East. Actually, Europe was up by the pandemic as it obviously hit there first, and it was down double digits.

Right. And global services, you mentioned it was weak. kind of across the board? What was that for globally, just services?

It was down in Asia Pacific. Globally, it just didn't actually flattish in the American market. And we have had some disruption getting on job sites, whether it be service agreements, whether it be break-fix. We have had some disruption. But with that said, Steve, I want you to take away, we've also saw some opportunities on it with our... And, you know, we've been at it a long time, getting buildings connected, and we have over 20,000 buildings. Really seeing the benefit there. Customers are really seeing the benefit of being able to have those buildings serviced remotely and diagnosed if there's something wrong. As Mike said... Indoor air quality in buildings is obviously there's a lot of talk about that. It's a very important aspect of our business. We're really good. And as office buildings around the world start ramping back up, our customers.

All right, one more quick one just on the earnings bridge. Kudos to you guys for giving us. some sub-segment detail. Mike, thanks for that. But you guys don't give the earnings bridge anymore. What was kind of price material inflation on a margin basis year over year this quarter?

Yes, Steve. This is Chris. We were positive on a price and a cost basis on the margin bridge. And to your comment, I think that margin bridge has really served us well in the past when we've had especially the last couple of years, higher tariffs and higher inflation. Consciously going forward, we want to make sure we can tell the story of what's happening on a quarterly basis. So we want to make sure we do that without the confines of a bridge. But to your question, price cost was positive in the quarter. Productivity was positive versus other inflation, although that's where we also saw some of the investment in our COVID-19 measures.

Okay, thanks.

Your next question comes from the line of Andrew Kaplowitz from Citigroup. Your line is open.

Hey, good morning, guys. Thanks for all the color. Good morning, Eddie. Good morning. Mike, China back to flattish demand year over year is relatively quick. Can you give us more color on the type of demand you're seeing? Is it more the indoor air quality products and services buildings need to be serviced, or is it more delayed larger orders coming back?

Yeah, I'm going to give that to Dave here, but let me kick off just a thought kind of going forward. Our business in China really is institutional, large commercial equipment with a growing service business. That service business is a quarter to a third of the mix, which, of course, was heavily impacted. So we recognize revenue when we ship like a chiller, or we recognize revenue when we complete a service engagement and bill the client. There's very little progress billing or percent complete accounting that would go on to smooth that out. So it would look outsized for us because we weren't shipping chillers. I mean, conversely, the backlog of chillers to ship you know, in China, it's fairly substantial. And I think what Dave will tell you is that, you know, we're seeing it return back to prior levels at this point.

Yeah, I mean, we have the incoming order rate for April was actually, as we're still rolling up the numbers here, it looks like it's going to be a little bit favorable to last year. There is probably some pent-up demand there. I would tell you, though, that as we track our pipeline, And this is the orders that haven't yet been booked, but they're actively being quoted. The pipeline is actually starting to show positive movements as well. And that's really what we start looking at is the pipeline, because that's a really good indicator as to what future activity would be. We're still watching it, but, you know, April was a good sign, and we'll certainly have a lot of attention to it in the rest of the quarter.

So that's very encouraging. I did want to follow up on services. You know, you mentioned it being flat in Q1, a little disappointing. Is services going to outpace the 20% decline that you're talking about for Q2? And do you see services starting to snap back as economies start to turn on? Or is it too early to see that at this point?

Yeah, no, I mean, it may be a little bit early to see that. But first of all, your first question, yeah, we do see services outperforming the equipment in the second quarter, so it will not be down 20%. We expect that to be more in the flattish range. Your second question, do we see opportunities in services? Absolutely. One of the things that, as we talk about our playbook, if we have a downturn, one of the things that we're protecting is our expertise in service, really around our service technicians. We're kind of ring-fencing that to say that's an area we're not going to go if we're going to try to cut costs. We're protecting that because we know that as the economy snaps back and individuals start going back to offices to work, indoor air quality is going to be super important. And how you're able to help those customers understand indoor air quality and have solutions for them, we're really going to leverage our service business in that way.

Andy, I would say that, you know, clearly a service business is not an antidote to a pandemic. It is an antidote to recession. And as we move through pandemic concerns into whatever the new normal would be going forward for building occupancy and services, absolutely we would expect to see, as we have in every downturn, every recession, you're going to see capital extended. And here in particular, you're going to have large commercial, large institutional customers looking at making sure that airflow, air changes, diffusion, dilution, pressurization, filters are all going to be in tip-top shape. So, you know, really for us, I think that that's going to, to Dave's point, require every technician we've got, and it's going to require more connected buildings because customers are going to want that service as opposed to people that don't need to be in your building, right? I mean, there's no point in coming out to a facility if you don't need to. If you can diagnose it first in advance and maybe even fix it remotely, which often we can do, that's going to be an opportunity. And that's a great way for us to deliver service at even higher margins than physically delivering services. Thanks, guys.

Be well. Thank you, Andy.

You too. Your next question comes from the line of Julian Mitchell from Barclays. Your line is open.

Hi, good morning. Maybe Hey, maybe just the first question on the decremental margins. So I understood that firm-wide you're aiming for that or think you can hold the line at that sort of 30%-ish level like you had in Q1. But clearly, I think mix can play a massive role in swinging that round. Your America's decrementals in Q1 were quite a bit higher than the gross margin, for example. So maybe help us understand what mix assumptions you have for the balance of the year and whether you are very confident that you can offset swings in mix with cost actions.

Yeah, Julian, first of all, in America, you're talking about a $40 million revenue differential, so the absolute dollars are relatively small for the size of the business. Actually, the documentals there, the first cause was not the mix with transport or the mix of service. It was really the response we took with regard to the COVID crisis. And just to give you a sense, if you ever wonder if we actually walk the talk in terms of what we say about our values around safety, we always think about March being half of the quarter, and we always think about the last week of March being half. half of March. And so a quarter of our quarter, if you follow all that math, is the last week of March. We actually pulled the and on cord March 23rd and shut down all of our factories in Europe and in the Americas and prioritized only the orders that were essential going into fighting COVID. And that would have ranged, you know, in 10 to 15% of the orders. We had a couple of factories where for a short time it might have been 40%. of the orders. During that time, of course, you lose that absorption, but when we sent people home, we sent them home and topped up their pay to make sure they were paid their full wages, the equivalent. So any gap with any unemployment benefits would have been topped up. We made all the wage increases around the globe for any hourly associate or any service technician proceeded as planned. So we didn't delay those. We actually put them through as planned We reclassified our medical plan so that COVID testing and preventive care would be at no cost to employees and that telemedicine visits would be added at no cost to our employees. We amended our 401K plan. So not only did we not cut our 401K match, we amended our plans to make sure that people could take out up to $100,000 in delayed loan repayments for a year. We provided backup child care and elder care programs for people with minimal, very small co-pays so that they could come to work or take some of the stress off. We extended our employee assistance program with programs for financial, emotional, legal, other support and hardships. And so all those things are things we took, but the biggest cost was taking some 25,000 jobs and literally reconfiguring all the lines and workstations and then making sure we had all the PPE in before people came back to work. And so all of that was so that we can go faster in the long run and people would feel safer. And when people feel safe, they come to work. There's not absenteeism. We're not shutting down factories to clean them. And that is where the cost came in. So, you know, you look at the job in Asia or the job in Europe and the leverage in the teens and look at the Americas on the small revenue, you know, kind of a decline of $40 million. And I don't want anybody to read too much into that. So before we start talking about taking costs out, of which we've got all the actions loaded, and we can talk about that if you'd like, you know, you have to think about sort of doing the right thing, which is what we did and what we always would do and we will do, and I would make that decision every single time if given that decision again.

Thank you. That's reassuring to hear. Maybe just one quick follow-up, and maybe it's for Mike or for Chris. On slide 16, you've got the helpful scenarios laid out. If I look at, say, scenario one, sales down about 15%, you know, flow through the decremental you have talked about, so maybe it's a 30% drop in EBIT or EBITDA. It looks like in that scenario, the free cash flow decline is maybe a bit heavier than the operating profit decline. Just wondered if if I had that correctly, and whether I did or not, what you're assuming for working capital within those cash flow scenarios.

Well, I'll start, Julian, just Mike. I would tell you that if you go back to the 2009 timeframe, I want to say we were three times, 3x, 3x plus cash to net income. So we know how to you know, get cash, you know, out of the business in a significant downturn. So, you know, I would look for extraordinary operating cash flow in a down 25 scenario, just so, you know, if you go back to the 09 timeframe, you get a proof positive on that point. So I'm not sure if that analysis that you're doing would be Correct in that regard. Chris, do you want to add to that?

Yeah, I'll add. I mean, there's maybe a little bit of what I call a little conservatism in the numbers as well. We're still investing capital at the normal levels you would have at 1% to 2% of revenues in both of those scenarios, Julian. Whether the investments in employees or capital or otherwise, that cash is there to go fund. So we can certainly talk offline, but I think that's a reasonable scenario for us right now, a little bit of conservatism in there. Perfect. Thank you.

Your next question comes from the line of John Walsh from Credit Suisse. Your line is open.

Hi. Good morning. Hi, John. Good morning. I wanted to go back to the service conversation and maybe find out how much of that business is really driven by contractual service versus, you know, needing to get onto the site and generating some type of spare part or something to drive the revenue?

Yeah, John, it's a good question. Contractual basis, our service business is about 30%, okay? And within that 30%, there's lots of different service contracts that we have. We have a whole portfolio of different contracts. So some include parts, some do not. So there is some parts demand there. that's generated from that 30%. Then you move into the break-fix world where it's broken, they give us a call, we come out and we fix it. And then you also have a planned maintenance where you'll actually proactively plan with the customer to do a major replacement or a major overhaul on a piece of equipment.

John, it breaks out to about even thirds on the service business, if you look at it that way.

Yeah, a third, a third, a third. Okay, thank you for that. And then, you know, obviously in the Americas, depending on what state you're in, there's different rules around construction. But curious, once again, staying on the service topic, what you see in those states where there's a big shelter-in-place order and, you know, only essential work is getting done versus, you know, states where the restrictions might not be as stringent, are you seeing a real big bifurcation in how the businesses are acting in those? Is that a way to think about going forward?

Yeah, John, what I'd say, you know, more than anecdotally is if somebody's calling for service in the Americas right now, they're going to be in a critical infrastructure, a critical essential role. So, you know, we're not getting phone calls from somebody, you know, that's not operating or not running. So, you know, we're in hospitals, we're in pharma, we're in food and bev, you know, we're in, you know, data centers would be huge. That's the places where we are today.

Great. Thank you for that.

And I don't know of any state really that's blocked sort of that essential activity. So, you know, even the most stringent states, obviously, you know, healthcare and such, you know, we're in there servicing.

Great. Stay healthy. Take care. Thanks. Thanks.

Hey, Jason, we have another question. Okay. I don't know if anyone can hear us, but that'll wrap up our call for today. We'll be around for any questions that you may have. Please feel free to reach out to myself or to Shane, and we look forward to speaking with you soon. Thank you.