Trane Technologies plc (TT) Earnings Call Transcript & Summary

First off, thank you, everyone for joining. I'm Chris Snyder, Multi-industry Analyst here at UBS. I'm very excited to be joined by Dave Regnery, Chairman and CEO at Trane; and Chris Kuehn, CFO. So I think Dave is going to start with a couple of prepared remarks.

Sure. Well, thanks, everyone, for coming today. Thanks, Chris, for the conference and the invite. This is certainly a great event so far. So glad to be here in New York. I don't know if I like all the smog that's here or fire, but -- my plane was delayed last night, but now I realized. Look, at Trane Technologies, our purpose is to challenge what's possible and innovate for a sustainable world. And the mega trends around decarbonization and sustainability continue to intensify. And the unfortunate event that's occurring right now is global warming continues to increase. And there's an article out in the paper today about the Arctic Ocean will no longer have ice in it by 2030. That's pretty -- that's right around the corner. So we need to take action and we need to take action now if we're going to curb the global warming that's occurring. And at Trane Technologies, we have technology that exists today, and I'm sure we'll get an opportunity to talk about it here in a few minutes, with technology that exists today that can dramatically reduce the carbon footprint for the built environment, dramatically reduce it. So we had a very strong first quarter. Our revenue organically was up 9%. Our book-to-bill was 117%. Our EPS growth was 26%. We ended the first quarter with a backlog of $7.3 billion, which is more than 2.5, 3x what we would consider to be normal. We're very well positioned to ensure our guide will be hit in 2023, and we're going to be very well positioned as we enter 2024. So with that, I'll turn it over to you, Chris, and we'll go from there.

Thank you. So I think if we kind of step back a year or 2 from now, I don't think most in the market expected, not only this level of demand, but also just the way the demand has been sustained. So obviously, a lot of mega trends that are out there. But I guess my first question to you is, have you been surprised by the magnitude and sustaining that demand?

Yes. I guess the short answer is no, okay? I mean the mega trends that are happening around decarbonization are real. I mean, I have the opportunity to sit with many of other CEOs around the world. And I would tell you that the message is clear, we need to take action. And it used to be thought of years ago that lighting was the low-hanging fruit, right? That was the easy -- let's just change the lighting, it will have a dramatic impact on the demand side. A lot of lighting projects are complete, not all, but a lot are complete. HVAC and the technology that we've been able to deploy is the next opportunity in front of us. 40% of all the energy in the building is for heating and cooling, 15% of all greenhouse gas comes from heating and cooling buildings, and we have the capability of significantly reducing that. So you take the mega trends around decarbonization and what's happening. You take the innovation that we've been able to create around that, then you have a tailwind of policy or policy stacking that's occurring really on a global basis, whether it be ESR funding here in the United States, IRA that's in front of us, CHIPS and Science Act that's in front of us and other policies or the carrot or the stick as policy goes in Europe, those are all additional tailwinds to our business. So am I surprised? The short answer is no. But really, the biggest opportunity is still in front of us.

I appreciate that. I mean, you kind of called out the book-to-bill, you called out organic revenue growth. There's a lot that are impacting these numbers. Obviously, supply chain has kind of been all over the place. But I guess kind of my question is, when you talk to customers and when the salespeople talk to customers, does it seem like demand is beginning to soften or deteriorate?

Well, they don't let me talk to a lot customers.

That's the point what I like.

I do talk to customers actually, but the answer is no. I mean what we have to do -- there's a lot of demand out there, and it's -- I'll speak specifically about our commercial HVAC business here in the Americas, okay? We follow like 14 different verticals. We're diversified in all of those verticals. And yes, there are some verticals that are weaker than others, Office for sure, but then you have other verticals where we're seeing tremendous demand right now. Think about what's happening in the industrial, the high-tech industrial with EV battery plants coming online or what's happening with data centers? What's happening in the education vertical? Those are all verticals that are very, very strong right now. And one of the advantages that we have as Trane Technologies is really our direct sales force. And because we have a direct sales force, we're able to pivot to where the opportunities exist. So yes, office might be down, and I think office is -- to say office is down, you got to be careful with that because there's -- if you subset office, you'll find out that Class A buildings is actually in demand right now. There's a lot of activity there. BMC are in retrofit capabilities right now or they're trying to be. But there is some demand still there. And the other thing I would add is that we have a Service business that represents 30% of our entire enterprise revenue, 30%. And it is extremely, extremely resilient. So that is also a catalyst to our business right now.

No. Yes, I'm absolutely -- you kind of started off in your prior remarks talking about climate change and global warming. So obviously, the advantage of more energy-efficient HVAC as it helps the environment, helps companies achieve their ESG goals that almost all of them have now. But what about the financial profile and the returns? Anything you could talk to that, that the companies are benefiting from as they upgrade their system?

Yes. We developed -- I'll talk about Europe. We developed what we call Thermal Management System in Europe. So let me just explain to you a little bit about what that is. So the conventional way in heating and cooling a building is you have a heating plant, we call that a boiler, and you have a cooling plant, we call that a chiller. These 2 plants operated independently. And what we did, because we like to think of things at a system level, we said, let's combine that into one system. And when we did that, we deployed 4 different technologies as part of that system. So the first is heat pump, right? So I think we all know what a heat pump is, but just to make sure, when you're heating a space, you're really removing heat from it and you usually take that heat and you put it out into the atmosphere. If you need heat, you go out outside to the ambient air and bring the heat in. So we took that technology. There's another technology called simultaneous heating and cooling. So in a building, oftentimes you have the need for both cooling and heating at the same time. If you ever went into a mechanical room, which I've done a lot, you'll find that the boiler is running the same time that the chiller is running. It's ludicrous, right? Because you're just rejecting the heat. Let's reuse that heat, so we call that simultaneous heating and cooling. Then you take that with a cascading system, and I would need more time to explain you what a cascading system is, but it basically allows you to operate in any climate on a global basis. So regardless of how cold it is outside, you could still extract enough heat to make this system work, right? And you take that and you wrap it around with sophisticated controls. And that's kind of where the secret sauce is, it's in the controls. You create a Thermal Management System. Thermal Management Systems are 3 to 5x more efficient than this conventional heating and cooling plant, 3 to 5x. If you look at it on the financial returns, if you come at it from the cooling side, like say, I need to replace my chiller plant, you could get a payback that's probably in the less than 3 years, probably in the 2.5-year range. Think about the financial returns, 2.5 years. These systems are so efficient that I was at a conference a couple of weeks ago, and the consensus was people won't pay for green. And I'm like, well, they pay for our green because, by the way, there is a financial return associated, it's green for green, right? And when you think about that concept, that's why we're able to take this technology and really scale it throughout Europe. And we're having a lot of success. And you can see that in our first quarter results. I mean, our Equipment business in Europe was up 40% in the first quarter, right? So this technology is being adopted. It's just not being adopted fast enough for what we have to do to really curb the global warming that's occurring.

Green for Green sounds like a great headline for a note. I wish I thought of that.

I think someone wrote a book. Just...

Fair enough. The -- you kind of talked about the opportunity within buildings, I think it's at 40% of the emissions coming from the HVAC.

Energy.

Energy. When we think about the ability for that to be sustained, I think everyone kind of understands okay, you're outgrowing whatever kind of construction index we'd look at, but is there a way to think about the duration of that opportunity? Kind of how long can that kind of secular outgrow the macro?

Yes. It's a great question. And the way I look at it is I think there's -- and this number may be a little bit dated, but I believe there's like 400 billion square feet of commercial space on a global basis. 400 billion. And if you add residential into that, you get to a number that's really hard to get your head around. It's in the trillions. So there's a lot of built environment that's in front of us. And I think for the first time and maybe at least -- I've been with this company a long time, but we're now getting the tailwinds of policy behind us. So not only do we have great financial returns -- great solutions, great financial returns for those solutions. We have policy that's actually becoming more and more of a tailwind. So this is going to take a while, unfortunately, to build out and to scale. And a lot of it has to do with knowledge of what's available today. And we always want to talk about like what's coming, like carbon capture and can we put carbon capture in buildings. And yes, we move a lot of air. And at this conference, I was at last week, we talked a lot about that. At the end of the day, putting in a Thermal Management System, it's really low-hanging fruit, right? It has a return today and it could have a dramatic impact. Let's scale that so that we can at least have that impact today. And people say, why isn't it scaling faster? And it really has to do with knowledge about what -- people don't know what's possible. If you're running a building, right, and your boiler breaks, you call Trane Technologies and say, hey, my boiler broke, probably not. If you knew it was possible with the Thermal Management System, hopefully, all of you will now call me. But if you didn't know that, you're going to call and you're going to go with this conventional way of heating and cooling a building. It's crazy, but we all need to be -- a knowledge about what's happening so we can have an impact. I'll tell you, this is a funny story, but I'm building a house right now in North Carolina, right? In North Carolina, I'm building a house. And I told my builder, right? This is custom builder, so he works for me or at least I think he does. Then I tell him I say, Ken, I'm going to put in all -- I don't want any fossil fuel in my home or I want to minimize it, right? So I'm going to put in for the generator. I said, but I want to put in 20 SEER heat pumps. And he looked at me and he goes, they're going to be disappointed. I was like, why am I going to be disappointed? Now, I live in North Carolina. He goes, well, those heat pumps, if it gets below 30 degrees outside, you're going to be cold inside, I'm like, where did you get that data from? How old is that data? He knows what I do. I'm like how does that happen, right? And so now he's -- I convinced him, right, and we put the system and he's like, I can't believe how well this system works. So now he's out selling it to others. But well, we got to find a better way to explain to people what's possible. But we're all going to be disappointed as to what's going to happen to the next generations that would live here.

Yes. No, I appreciate that. You kind of talked about some of the policy. Obviously, a lot coming through IRA, CHIPS Act, just broader reshoring trends and policies supporting that, rising minimum efficiency -- a lot. Can you just talk about what that means for the company being that -- historically, you've kind of been viewed as the leader on innovation, and are those benefits already starting to accrue to the business? Or do you see them still mostly ahead of you?

I see both. I think some of them certainly are there. The whole -- you mentioned a bunch there, right? Policy, we talked a little bit about reshoring -- rebalancing is happening before our eyes. That started to happen. There's a long tailwind there. I mean, people forget that we've been integrating into Asia, China specifically for over 50 years. That just doesn't switch like at the snap of a finger here. So there's going to be a long tail there. And I don't think anyone is going to be pulling out of those areas. They're just going to be rebalancing and manufacturing in other areas of the world as well. But that's a tailwind that's going to happen. Decarbonization is going to continue to be a tailwind. So it's kind of a mixed bag. Some of it -- if I go to policy, right, that's a great example, right? If you look at ESSER funding, right, which is for the education vertical, we're probably in the mid-innings of that. I look at IRA, and I'm saying we're in the first inning, right? Because there hasn't even been the rebate side of that's decided by state you're getting a little bit of a tailwind right now from the tax credit you'll get as you file for your 2023 tax. But so it's a little bit. If I look at CHIPS and Science Act, I mean, that's in front of us, right? I mean, to put a -- from design to when a microprocessor plant starts to produce, it's close to 4 years. So a lot of that is still in front of us. So there's a tremendous opportunity in front of us.

I appreciate that. When we kind of think about demand and try to think about orders alongside that, the order run rate has been a bit over $4 billion or so a quarter. Do you think that is reflective of demand in the market? Or do you think it's still maybe running ahead just because while lead times have compressed, not all the way back?

Well, for sure, lead times are extended for the industry and for us. They will eventually normalize over time. Supply chain is dramatically better than it was 18 months ago. but it still has a way to go to improve. So yes, I mean, at the end of the day, there is a little bit of inflation just because of the extended lead times, but -- and it will normalize over time. I keep telling people you need to really look at what's the order rates, what's the backlog and what's the revenue, right? Look at all 3 of those. Don't just look at one because you're going to get the wrong answer. So it will normalize over time. But the opportunities that lay in front of us, okay, is just tremendous as to what has to happen.

Yes. I appreciate that. On the big U.S. mega projects, as a former shipping analyst, Reshoring is always something I've been I've been focused on. The numbers are pretty crazy and U.S. manufacturing construction up 100%. A number that you've just never seen before. Can you talk about the Trane's opportunity within industrial? And then also, at what point does the company start to benefit from that? These are huge projects. And when do people start ordering or looking for the HVAC?

Yes. I think -- well, if you look at microprocessing, right? So think about the CHIPS Act. So think about it from planning to start up, and these are averages, which are always dangerous, okay? So -- and I'm not an expert in this field, but it's about 4 years. And think about HVAC equipment being on site 12 months before startup. So first production 12 months, back it up 12 months, that's when the equipment would be installed and then you could back up the ordering process from there. These are very sophisticated systems for a microprocessor plant. So -- and this is really kind of our sweet spot. These are highly engineered and you want them to be, right, because you want to optimize vis-à-vis how they're going to be using their manufacturing space. So these are projects that we do a lot of. And that -- I mean, I know that everyone is waiting for a CHIPS and Science Act. We've been strong in this vertical for a number of years. So microprocessor plants on a global basis. We're always working on those that -- so it's not like this is like, there was nothing and now it's going to start. There was always a pretty high base there. It's now going to accelerate as you have what's happening here in some of this reshoring or rebalancing that's happening. Another one is EV battery plants. Again, a lot of cooling capacity required, a lot of moving of air, very sophisticated systems. Look at what's happening right now. You have every auto company, you could think of with an EV platform right now. And a lot of them are partnering with people like LG Chem and they're building facilities here. And they're building them local, they're building them where they're manufacturing. And again, there's a sophistication there that's part of those systems that we've been able to really dial in. And the other one is data centers. I mean, data centers are -- that curve is going up, and I don't see it slowing down. So again, very sophisticated systems. We love working with data center customers, and I was telling a group earlier today, I can never mention any of them by name or I think I go to jail. But I love working with them because they really -- they're very sophisticated buyers, and they really push technology with us. And they like working with us because we have a lot of expertise. We have a whole separate business around data centers, and we have it really dialed in from a technology standpoint, but we're able to work with some of these big companies, and we come up with solutions that we didn't even think were possible. And then we could obviously scale those to others. So anyways, it's tremendous opportunities with these "mega projects" as they're being called and don't think that those just dry up in 18 months or 4 years, right? This is a continuous process. Question, I think.

[indiscernible]

2 or 3 extra data centers?

Yes.

We see a lot of demand in data centers, okay? And this data center world is very secretive. That's why I'm not allowed to say the names. They don't like anyone else to know where their data centers are going. So -- but we obviously have the privilege of getting some of their longer -- and they want to plan out, right? So they want to make sure that we're ready. This is a critical element to make sure that data centers can operate efficiently or operate at all. So we do get a little bit of foresight as to what's happening out there. I think it's going to continue to grow. I mean, AI is going to consume even more data than what we're seeing today. It's not going to stop. And -- but anyway, I think the projections will go up.

My question is [indiscernible]

4 weeks, I won't have enough intelligence to say in 4 weeks, but I would tell you that it's been the chatter. I wouldn't call it chatter. I would just say there's been a lot of demand there for a long time, and there's -- the projections going forward is it's going to continue to grow.

If we kind of compare Trane to competitors in the industry, there's a track record of outgrowth. It seems, from my vantage point, a lot of it is driven by innovation and spend and investment there. Would you argue that the advantage of innovation is more important than ever, just whether it's more focused on efficiency, better returns via efficiency, how do you think about that?

Yes. I mean, I think there's a system of things that makes Trane Technologies a great company. And innovation is part of that. It's a big part of it, right? Being able to relentlessly invest in the business, good times or bad times, and not taking a year off or taking a quarter off, but relentlessly investing. And Chris could talk to you about how we're projecting our long-term leverage and how we're always going to make sure we have enough to reinvest in the business because that's -- I was told early in my career, if you stop inventing you stand still. If you stand still, you get caught, right? We're not going to stand still because we're never going to get caught, right? So we're going to continue to pump dollars into innovation. It's part of who we are. But I would also tell you, it's a system of things, right? It's an operating system that we've been honing for the last 10 years that allows us to take best practices and scale them on a global basis. We manufacture things, right? I tell our teams, I want you to be the best manufacturer in the world, right? Think about lean, think about how you operate, right? We make things, right? We make things at the end of the day. We want to be the best at that. We have an operating system that allows us to do that. We have an operating system around our Service business that allows our Service business to be -- I don't talk a lot about it because I don't want to create road maps, but our Service business has grown, compound annual growth rate over the last 6 years, high single digits. That includes the pandemic here. We didn't have access to many buildings, right? High single digits over the last 6 years. It's our direct sales force, right? Think about having the advantage of having a direct sales force where you're constantly in contact with your customers, you're constantly understanding what their needs are. You're constantly looking for feedback as to how you can help them, right? If you go through distribution, that's really hard. Trust me, I've run distribution businesses in my career. That's hard. It's hard to understand what the customer really wants versus what the distributor thinks they want. So it's a difficult equation. So that's part of our advantage. But if I had to say one thing that differentiates us and I'm very passionate about this is the culture that we have as our company. And the fact that all 40,000 of our employees think every day that we can make this world a better place because of our purpose, that's what attracts talent to Trane Technologies. And next week, I actually -- it's one of the best weeks that I have in the year because I get to talk to all of our interns. So I did this last year, and it turned out to be a bigger deal. And I didn't realize we had what 600 something or 700 interns. But -- so I get to do that next week. I love just talking and getting the feedback of the interns as now they would have been on board now for 3 or 4 weeks, but what do they think of Trane Technologies and what's their impression of our culture and -- it's just -- it's very enlightening for me to have those conversations. So I'll give everyone an update after I have my conversation. But last year, the year before, I had all the interns and this is a pretty funny story. I didn't realize we had 700. So I had all these IT people running around my office. And I was like, what the heck is going on. This is just a Zoom call. And they're like, yes, there are 700 people on it or whatever, so they had it orchestrated. So I was getting all these questions, and I started it out saying that, look, I want you to think of this as a long interview, right? I want you to have fun, but this isn't college, right? Sort of like me talking to my kids, right? And so then at the very end, and this -- it was like -- sometimes you have calls and you don't get any questions. There -- too many hands were up for me to answer, right? But I said, look, I got to go to another meeting, but I'll take one more question. The last question comes in, it's -- I forgot who it was, but there's, Mr. Regnery, you can call me Dave, He says, okay. He goes, well, I just have one question for you, because I want you to know that you said this is a long interview for us. I want you to know that this is a long interview for Trane Technologies. And I want to make sure that everything you've just been talking about is really who you are. And I was like, I'm pretty confident you're going to be applying for a job. So anyway, it's just great. So I'll let you know how it goes this year, but...

Pretty bold at...

But that's okay. That's a culture that we want, though. We want this. That's why I say, I'm so proud of our culture because it's built around -- we want diversity of thought. We want diversity of how we solve problems, right? And it's not just saying we're going to hire to have diversity. It's how you inclusively include diversity into everything you do. And that just doesn't happen by accident, right? There has to be some -- we have a process around that, because we love processes and we love our operating system. But we've built out a whole -- think of it as a chapter around how you make that successful. So that's what -- to me, that's what differentiates Trane Technologies.

I appreciate that. I want to ask on Service, you kind of brought it up a couple of times, it feels like obviously a good opportunity for a lot of the big players. One thing that I kind of find interesting is that I think the value, the prop makes a ton of sense, yet everyone seems to have a relatively low share of the market. I guess, why has it been kind of so hard to kind of like build material market share there? And why does it feel like it's starting to flip now?

Yes. I don't talk externally a lot about our Service business because I'm so proud of what we've been able to do. But a business that's grown over the last 6 years, high single digits, including a pandemic here. And the reason why I don't talk is that I don't want to create road maps because -- and I can tell you about the road maps I created around heat pumps and Thermal Management Systems, which, okay, we are where we are, but I'm not going to do the same thing about our Service business. But look, we have an operating system around our Service business. It's growing nicely. I think our Service business is transitioning to a -- the equipment is not operating properly to the equipment or the building is using too much energy. And that's happening as you're becoming -- from a digital standpoint, as you're becoming more connected, whether it be to the asset or to the building or to the campus and think about how you're taking the data as an asset and aggregating it and learning from it through AI tools. And that's where the Service business is really transforming. The other thing I would say is, the product that's being sold today versus a product that was sold 5 years ago, they're dramatically different and the sophistication of the equipment is totally changed. So if you had equipment that had 1 or 2 microprocessors in it, it now has 50. Everything is connected. So the sophistication that's required to work on that, it's similar to your car. I mean when I was a kid, I used to work on my car, I opened the hood now. I don't even know about anything, isn't it, right? So it's very similar. So you have to have a very sophisticated technician work on these pieces of equipment.

I appreciate that. Maybe one for Chris. The company -- I believe last quarter backlog in the $7 billion ballpark, if my memory serves. You guys are saying $6 billion kind of plus, which is -- obviously, there could be a range associated with that. But when we see that anticipated backlog burn or that guided backlog burn over the rest of the year, does that include some level of demand deterioration? Or is it really just a function of supply chains compressing and orders kind of falling with that?

We ended the first quarter with a backlog at $7.3 billion. We grew at $400 million in the first quarter. And that's the 2.5 to 3x normal level, Chris, than we would have had pre-pandemic pre the mega trends that Dave is speaking to. We put out a scenario which was $6 billion of backlog at the end of 2023. And what would you need to believe for us to land at $6 billion which would -- really the math is order rates down 6% on a full-year basis based on our guide for revenue. First quarter, we were relatively flat on orders, right? We had minus 1% at the enterprise level, book-to-bill was 117% in the first quarter, and we grew backlog, as I mentioned before. So we believe we're going to enter 2024 with a much stronger backlog than $6 billion. It was meant to be a scenario. But over time, the backlog should normalize a bit as lead times come in, we're not there today. And we're -- going out the next 12 months, we would tell you we're going to be in an elevated backlog position for some time. Think of that backlog, though, that's 90 -- over 90% is non-residential, right? So think of our commercial HVAC business and our Thermo King businesses represent more than 90% of that backlog. Okay.

Yes. I appreciate that. I mean, the company has done a really good job through all of this on price/cost. What are kind of the expectations there going forward? What -- how does the company think about incremental price? And then what are you seeing on the cost side?

Yes. I mean, Dave mentioned before, the business operating system, one of the things that differentiates the company, and this is a clear example of throughout 2021 and 2022 us staying ahead on significant inflation and remaining price/cost positive. That wasn't the case back in 2017, 2018, when you saw tariffs instigate inflation, we are behind for 4 or 5 quarters in price/cost on a dollar basis. So self-healing, improvement in that period of time, and then we hit the next inflationary area and now we had the first quarter, price/cost positive on a dollar basis and on a margin basis. So look, our target for the year on price is in a 200 to 300 basis point range. I'm hoping we don't need to be in a position to raise prices 3 to 4x a year like we've had to do the last 2 years, but that's the power of the business operating system. It's taking the inputs, evaluating pricing for value with our customers and making sure we're going to stay ahead. Target for the year is 20 to 30 basis points of price over cost. Should we start seeing commodities pull back? I think that presents an opportunity. I'd say commodities keep to be -- they're kind of bouncing around in a range here in the last 6 to 12 months. So we have a lot of confidence we're going to deliver on that price cost spread.

And we see, I think, the guide still like roughly 25% or so kind of incrementals, which is normalized levels. It does feel like price/cost is a tailwind. I have to think that just productivity and efficiency is going to improve. So those are obviously tailwinds to incrementals. What are some of the offsets that are pushing it back just into that kind of normalized range?

Well, we said 25% plus, right? So it could be better to be fair. But what Dave was talking about before with innovation, just if I could, just let me spend a little bit time on the long-term financials. Think of incrementals in the 30% plus range. And then we like reserving 5 points of those incrementals back to investment and back to innovation, okay? So we're going to do that this year, and we're still going to be -- we're targeting 25% or better in terms of incrementals. But I think productivity is a future opportunity. We may start seeing that a little bit this year, a much higher cost to serve customers the last 2 years, and it's not only buying chips on the spot market. It's expediting freight, overnight, to make it to your factory in time. It's -- units not becoming fully completed and they're first run through in the factory. You have to put them to the side and you bring them back again, that's a lot of cost, and it's the right thing for us to do to get product out, but that's a significant opportunity for us, Chris, as we go forward to unleash and recover some of that productivity going forward. But in terms of whether some of the headwinds, look, labor, inflation from a Tier 2 perspective, energy inflation, Tier 2, those are areas we're watching very closely that have been inflationary here, really balancing out some deflation against the inflation.

I appreciate that. I think -- I don't think there's much kind of concern on the secular opportunity. I think everyone kind of agrees that Trane will continue to execute. Some of the concerns that we've heard in the market around inventory in the channel, maybe a rocky start to kind of the spring selling season. Like how do you guys kind of feel about some of those potential headwinds which could -- in some way, maybe dampen all the great secular...

Yes. I think you're referring to our residential business, which just make sure everyone is grounded, it's about 20% of the total portfolio. And we're about 50% independent wholesale distributors and 50%, we act as the independent wholesale distributor. So we're talking about 10% of the company. And yes, as I said on the first quarter call, inventories are a bit elevated, and they'll normalize. And I would tell you that, that inventory has been normalizing now for probably the last 3 quarters, and it will continue into Q2. But don't -- let's not judge our residential business on the first quarter of any year, okay? It happens to be the lightest quarter and the cooling season hasn't even started yet. So we'll see where the year plays out and -- our residential business is a great business. It really is. I know it's -- I tend to get more questions -- at least -- but recently, I haven't got a lot of questions on it. But it is a great business, and we're pumping innovation into that business as well. And a lot of times, people don't understand some of the innovation that's happening there and think about IRA and what the opportunity is going to be in front of us there. That will be a tailwind to that business. We've developed some really cool, no pun intended there, but real cool hybrid systems for the heat pump application, where you'd get away from having to rewire your home and if someone is interested I could explain to you in a little more detail. But there are going to be some great opportunities. And the other thing that's happening in residential business is as products are getting more sophisticated, meaning they're at higher SEERs, you have more intelligence that's being built into the product. So in the past, residential really was electromechanical. It's now going to microprocessors and as you have microprocessors, there's just a tremendous opportunity. And we know how to do this because of our commercial business as to how you can extract value out of that because you're now going to have data, and you're going to be able to have this system operate at a totally different level than electromechanical system. So that's pretty exciting as to what's happening there. But again, it's 20% of our business. The part that we were referring to -- Chris was referring to was, inventory is 10% of our business, and it will normalize over time as I said in the first quarter, and that will continue through at least the second quarter for sure.

I appreciate that. And then maybe then next on commercial and new construction, which I know similarly is a much smaller percent of the business than the headline commercial exposure, given the aftermarket service upgrades. Has demand been impacted at all by the [ tightening ] lending standards, which have now been in place for I guess, almost 8-plus kind of months?

How time flies, right?

I'll start. Through the first quarter, Chris, we did not see that. Short answer is no. I think part of it is the power of the paybacks on these systems, the green for green, right? If you've got a component that's even just 7 years old and now come back 7 years later, and the efficiency in those units are 50% or stronger, more efficient today than they were then. And you can drive paybacks that on the higher end seem to be around 3 years, if not maybe 2.5 years, those are still very strong projects that not only meets the needs if someone is trying to decarbonize. But if you're looking at the uncertainty of what fossil fuel costs will be in the future, let's make that investment today. So through the first quarter, we did not see any kind of hastening of demand due to tightening of lending standards.

I appreciate that. And when we get kind of similar questions, and I talk about the paybacks are good, that's obviously supporting demand. The pushback from investors is -- well, that wasn't the way it was historically. Usually, in a downturn, there's just a CapEx pullback and I'm not worried about -- I worry about paybacks when I feel more comfortable. I guess -- has that been the case in prior downturns, they all predate me. And is that logic...

Are you saying they don't predate me?

Well, I think -- let me start. I mean there's a couple of other factors happening here, too. There's obviously regulation, and we're in New York City and there's Local Law 97, that maybe there's a little bit of a stick approach here that if you're not going to decarbonize and reduce your energy efficiency, there was going to be fines or penalties. So companies that are thinking about maybe getting ahead of that and not paying that type of money, I think they're going want to make sure they reserve some CapEx for that. At the same time, a lot of companies have made commitments around 2030, 2040, 2050 goals. And I'll steal a line from what Dave has shared, it's kind of easy to make that commitment. It's really hard to now put the plans in place to get there. And if you've got physical property in your portfolio, and we know 40% of heating or emissions are really coming from buildings, right? You got to deal with that in your portfolio, I think those are tailwinds for us today that would not have been there maybe in the last cycle. The decarbonization focus and then the regulation part of it, whether it's a tailwind for the carrot or the stick. I think those are things that are playing into the factors today.

Appreciate that. On commercial, it sounds like from a high level, demand kind of steady, firm. You called out office is one that is getting worse. So just kind of interested, which ones are actually getting better?

High-tech industrial, for sure, data centers, if you want to call that a vertical, I know it's not part of office, believe it or not, but it will be separate. Industrial, in general, is very strong. This reshoring or rebalancing whatever words you want to use is real, it's happening. Those are certainly very strong right now. And we're also seeing strength in education. Don't forget about education, right? The ESSER funding there -- we're mid-innings. We have another couple of years in front of us on that. So that's been very strong for us. And health care has been strong. So -- and we're still seeing a lot of tailwinds even though no one wants to talk about it anymore. Maybe they want to talk about it, after yesterday, here in New York, but indoor air quality, right? I mean we still see a lot of -- this is all built into our applied systems right now. And that's a conversation that happens on a regular basis. So there's a lot of strength. And Europe has performed extremely well. So we have strength across our portfolio there. And even in Asia, we haven't talked about Asia, but very strong first quarter, very strong 2022. And we have a great team there, and they're continuing to innovate as well. They're now -- it's funny, we had a call yesterday on we have these innovation reviews because I love innovation. So every SBU, Strategic Business Unit would report on their innovation, we had a great call with the team in Asia and what they're working on. And it's just such an exciting time, and it's such a -- I've never been a CEO of another company, but I'm glad I'm the CEO of Trane Technologies because we have so many opportunities in front of us, and it's just such an exciting time to be a part of this change that's happening around the world. And I'm glad that Trane Technologies is helping to lead this change. And we had this crazy vision. I know we only have 10 seconds, but we had this crazy vision a few years ago that one company could change an industry, and that industry could impact the world, and we're seeing it happen. So -- and I'm proud to be the leader of that company that's helping that change happens. So thanks, everyone, for coming today, and really appreciate you learning more about Trane Technologies.

Thank you, guys.

Thanks, Chris.

Thank you.