Trane Technologies plc

Good morning. Welcome to the Trane Technologies first quarter 2023 earnings conference call. My name is Brent and I will be your operator for the call. The call will begin in a few moments with the speaker remarks and the Q&A session. At this time, all participants are in a listen only mode. If you would like to ask a question during the Q&A session, please press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star 1. In the interest of time, please limit yourself to one question and one follow-up question. Thank you. It is now my pleasure to turn the call over to Zach Nagel, Vice President of Investor Relations.

Thanks, Operator. Good morning, and thank you for joining us for Train Technologies' first quarter 2023 earnings conference call. This call is being webcast on our website at traintechnologies.com. where you'll find the accompanying presentation. We're 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 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 Regneri, Chair and CEO, and Chris Kuhn, Executive Vice President and CFO. With that, I'll turn the call over to Dave. Dave?

Thanks, Zach, and everyone for joining us on today's call. 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 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 one gigaton, or one 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 four, 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 140 basis points, and adjusted EPS grew 26%. Absolute bookings 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 two-year stack, and America's commercial HVAC bookings were up nearly 40% on a two-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 two and a half 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 five. Demand for our innovative products and services continue 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. Revenues were 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 bookings 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 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-teens 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 six. 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 teams, respectively. Our high-performance flywheel continues to pay dividends, with relentless investment in innovation driving strong pipeline growth, margin expansion, and EPS growth. Please turn to slide number seven. 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, 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 eight. 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 supportive 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 multi-year opportunities. We see the effect of tight supply chains 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 America 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 nine. We're off to a strong start to the year, and we continue to see slow but steady improvement in our supply chain. Bookings and backlog continue 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 pay 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-low 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 in 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 are 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've deployed $720 million in cash, with $170 million to dividends, $250 million to M&A, 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 2nd and will complement our portfolio and 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 thermal cane 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 Thermal 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 forecast the market to increase 7%, in return to 45,000 units and to continue growing low single digits through 2028. Both our Americas and EMEA Thermal 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 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 gives 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?