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Edited Transcript of CARR.N earnings conference call or presentation 8-May-20 12:30pm GMT

Q1 2020 Carrier Global Corp Earnings Call

Jun 4, 2020 (Thomson StreetEvents) -- Edited Transcript of Carrier Global Corp earnings conference call or presentation Friday, May 8, 2020 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David L. Gitlin

Carrier Global Corporation - CEO, President & Director

* Samuel Joel Pearlstein

Carrier Global Corporation - VP of IR

* Timothy R. McLevish

Carrier Global Corporation - CFO & Executive VP

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Conference Call Participants

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* Carter Copeland

Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense

* Charles Stephen Tusa

JP Morgan Chase & Co, Research Division - MD

* Deane Michael Dray

RBC Capital Markets, Research Division - MD of Multi-Industry & Electrical Equipment

* Gautam J. Khanna

Cowen and Company, LLC, Research Division - MD & Senior Analyst

* Jeffrey Todd Sprague

Vertical Research Partners, LLC - Founder & Managing Partner

* Joshua Charles Pokrzywinski

Morgan Stanley, Research Division - Equity Analyst

* Julian C.H. Mitchell

Barclays Bank PLC, Research Division - Research Analyst

* Nigel Edward Coe

Wolfe Research, LLC - MD & Senior Research Analyst

* Vladimir Benjamin Bystricky

Citigroup Inc, Research Division - VP

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Presentation

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Operator [1]

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Good morning, and welcome to Carrier's First Quarter 2020 Earnings Conference Call. This call is being carried live on the Internet, and there is a presentation available to download from Carrier's website at ir.carrier.com.

I would like to introduce your host for today's conference call, Sam Pearlstein, Vice President of Investor Relations. Please go ahead, sir.

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Samuel Joel Pearlstein, Carrier Global Corporation - VP of IR [2]

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Thank you, operator. Good morning, and welcome to Carrier's First Quarter 2020 Earnings Conference Call. With me here today are Dave Gitlin, President and Chief Executive Officer; and Tim McLevish, Executive Vice President and Chief Financial Officer. Except as otherwise noted, the company will be speaking to results from operations excluding restructuring costs and other significant items of a nonrecurring and/or nonoperational nature often referred to by management as other significant items.

The company also reminds listeners that the earnings and cash flow expectations and any other forward-looking statements provided in the call are subject to risks and uncertainties. Carrier's SEC filings, including Carrier's registration statement on Form-10 and the reports on Forms 10-Q and 8-K, provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. This morning, we'll review our financial results for the first quarter of 2020, share what the remainder of 2020 could look like under a few scenarios, and we'll leave time for questions at the end. (Operator Instructions)

With that, I'd like to turn the call over to our President and CEO, Dave Gitlin.

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [3]

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Okay. Thank you, Sam, and good morning, everyone. I hope that you and your families are all healthy and safe. Our thoughts go out to everyone affected by this crisis, and our thanks go to the front line workers who are fighting this pandemic. I would also like to recognize the incredible efforts of our entire team at Carrier, which has continued to deliver essential products and services to our customers during these challenging times. I have been so impressed with our 53,000 employees. They have stepped up in a truly profound way, and I couldn't be more proud of this phenomenal team.

Clearly, a lot has changed since we last spoke to you in February. Therefore, we are going to structure our comments as follows: first, I'll take you through the impact that COVID-19 is having on our business and how we are addressing these dynamics head on. Tim will then run you through our first quarter financials as well as provide more detail on our approach to managing our liquidity, cash and balance sheet. And then I'll provide more color on the remainder of 2020.

Starting with Slide 2. In response to COVID-19, we jumped into gear early and aggressively. We started daily leadership team meetings that continue today, and we established 4 priorities that have guided our decision-making.

Our first priority is the safety of our employees. Our office employees are generally working remotely while our factory personnel have largely continued in the workplace to support our customers given the critical nature of our products and services.

In our factories, we have gone to tremendous lengths to keep our people safe by implementing an extensive range of safety protocols, and we are now applying those best practices to our offices as we begin to transition office employees back to the workplace.

Our second priority has been to maintain business continuity to deliver essential products and services to our customers. Like other manufacturers, we did experience temporary closures in some of our 49 factories.

In China, where we have 9 factories and about 1,300 suppliers, all of our sites were operational within a couple of weeks after the February 10th reopening after the Lunar New Year, and our output from our sites -- from our local suppliers has been close to 100% for the past month. We have had short-term factory closures in India, Malaysia, Mexico, the EU and the U.S., but our team has done a superb job of minimizing the length of the occasional site closures and supporting our customers.

While we continue to experience episodic supplier challenges, our supply chain team has been managing these issues as they arise. Our third priority is to effectively manage our costs and preserve cash. Tim will cover this topic in more detail, but I'm pleased with our proactive approach and early results.

We accelerated and increased savings through Carrier 600, which is our plan to eliminate $600 million in cost over 3 years. Between our overdrive expectations on Carrier 600 for this year, together with other onetime cost actions, we will be driving $425 million in cost actions this year. For example, we have implemented a 15% pay cut for our senior leadership team, including myself, reduced the Board of Director pay, instituted a 15-day furlough, suspended merit increases. We're driving down expected incremental public company costs by about $25 million for the year, and we are aggressively managing our discretionary spend.

We will also be reducing our CapEx from our initial plan of $350 million to $400 million to $200 million to $225 million. Though we are aggressively containing spend, we continue to invest in areas that are critical to our growth agenda, including R&D, sales and digital, all critical to our core strategy to get to sustained mid-single-digit growth levels.

On the cash side, we are comfortable with our liquidity position. We started with $1.3 billion in cash on April 3, and we are confident in our ability to generate more than $1 billion in free cash flow this year. We have access to a $2 billion revolver if needed. So we have a strong cash position and are carefully managing it.

Finally, our fourth priority has been to ensure that we emerge from this pandemic stronger by accelerating implementation of our strategic imperatives. And I'll give you more color on that on the next slide. So turning to Slide 3.

It highlights how we're positioning Carrier for long-term success. Starting with our organization culture of focus and values. This truly is a new Carrier with a very different feel to it, both internally and externally. We recently launched The Carrier Way, which lays out our vision, values and behaviors. Our culture is focused on customers, winning, growth, agility, innovation and empowerment. We are breaking down barriers to enable our people to be more externally focused and empowering them to drive our long-term growth agenda.

On people, we have made great progress in assembling a world-class leadership team with both external hires and promotions of internal talent. We launched the new Carrier operating system, which is both nimble and disciplined, and we are doubling down on our ESG commitments with a laser focus on our commitment to the environment through not only our own factories, but also more innovative energy-efficient products. And we've supplemented our focus on the environment with initiatives that support the needs of our communities by playing our part in the fight against this pandemic.

For example, we designed and produced our new OptiClean negative air machines in just a few weeks, and early feedback from the hospitals on our prototype units is very positive.

Turning to our strategy and growth pillars. These remain unchanged. We continue to deliver against our 3 strategic top line priorities funded by Carrier 600. In the first pillar, growing our core, we remain well positioned within each of our segments building off of our #1 or 2 market positions. We are also adding 500 net sales employees, while we continue to make key strategic R&D and digital investments.

We've had significant wins across the portfolio, including our largest order ever of 19DV chillers for data centers in Indonesia, an exclusive long-term resi deal with Fischer Homes in the U.S., and very significant wins across our refrigeration and F&S portfolios.

In our second pillar, extending our products and geographic coverage, as a vote of confidence in our CO2 technology that we're using to enter warehouse refrigeration, we were selected to provide the cooling for the Beijing Olympics ice rink, and we secured a VRF win for the Sanya Olympic village apartments in China for 3,500 heat pumps and 1,000 condensing units.

And in the third pillar, driving aftermarket and digital, we have a dedicated aftermarket team in place. We indicated that we'd get to a 30% conversion rate in commercial HVAC by the end of next year, and we are on track to do so this year. We're rolling out structured tiered offerings customized to customers' needs, and we have leaned forward on digital as a differentiator through remote monitoring, diagnostics and prognostics.

We've had some key aftermarket wins including a 4-year chiller service agreement with the Hong Kong International Airport for 52 chillers across 17 buildings and support for Tim Hortons China operations that is projected to scale to 1,500 stores over the next 10 years.

And on the right side of the slide, we're very proud of our essential and vital role in society. We support air conditioning systems and hospitals and nursing homes and the delivery of food and pharmaceuticals safely around the world. Looking ahead, as countries and regions around the world are preparing to reopen economies in society, we intend to play a critical role in anticipating and creating the new normal. For example, indoor air quality will be critical. We're putting the V back in HVAC, and our unique electrostatic systems can filter microscopic-size contaminants. Carrier will be a leader in transitioning buildings around the world from sick to healthy buildings. Adjusting food safety in the new normal will be paramount, and we have been making tremendous progress on holistic cold chain solutions.

In our Fire & Security business, touchless and traceability will be very thematic in the future. With our touchless BlueDiamond solution, we can eliminate 80% of typical contact points in an office building by enabling employees to use their cellphones instead.

So with that, let me turn it over to Tim to discuss 1Q cost and cash, and I'll come back to discuss our best sense of 2020. Tim?

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Timothy R. McLevish, Carrier Global Corporation - CFO & Executive VP [4]

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Thank you, Dave. Good morning. Please turn to Slide 4, where I will walk you through our Q1 results. But before I start, I want to point out that as we move from being a division of United Technologies to becoming a fully independent public company, some of the numbers we report will not have a perfect comparison with last year's. The Form-10 carve-out statements adjusted for that in some circumstances, but not all. We'll try to help you understand those noncomparables with explanations, but it may be a bit messy and will continue to be so for the remainder of the year. With that caveat, let me jump into the results for our first quarter.

Despite significant macroeconomic headwinds in the back half of the quarter, it started out about how we had expected and reflected a solid start to the year. Sales of $3.9 billion were down 10% from last year, 9% organically, which adjusts for a 1% FX headwind. We reported at Investor Day that we faced difficult year-on-year comparisons in each of our 3 segments. In HVAC, our residential results last year reflected a strong furnace season due to abnormally high shipments ahead of a new FER regulation. In Refrigeration, our North America truck and trailer business came off a cyclical peak in Q1 last year. And in F&S, we wound down our residential intrusion business, creating a year-on-year decline in 2020.

Additional pressure came from the warm winter this year and resulting softness in residential furnace sales. These items accounted for about half of our Q1 decline. The remainder resulted from the impact of COVID-19 on our business in the latter part of the quarter. It first hit China, where about 8% or $1.5 billion of our revenues are derived. This had a material detrimental effect, with domestic China sales down approximately 40%. And in addition, a good part of our global factory production and supply chain sources come from China. We did, however, manage through that disruption without a material impact on our rest of world business. But then later in the quarter, the virus moved west into Europe and then on to the Americas. This pandemic accounted for about $230 million of our revenue decline in the quarter. Our teams have worked tirelessly to keep factories operational and productive to serve our customers around the world. And they continue to do so.

Moving down the P&L. GAAP operating profit was $315 million. Adjusted operating profit of $436 million was down 16% from last year. But this adjusted number is still not comparable. Our Q1 included about $24 million of public company costs that were not included in the same quarter of 2019. Absent the impact of that, the comparable year-on-year decline was 12%. And of course, it was heavily impacted by COVID-19. While we're not happy about the negative signs here, a 12% decline for comparable adjusted operating profits versus a 9% decline in organic revenues shows we were able to offset a lot of the typical decrementals, largely preserving our operating margin. Our Q1 GAAP EPS was $0.11, and adjusted EPS was $0.35. Since we were not a public company last year, the year-over-year comparisons of EPS are not meaningful.

I'm pleased to report that our free cash flow was favorable to last year by over $200 million. Q1 is typically a seasonal user of cash, so bringing it in almost flat reflected a solid start to the year. The decline in net income was more than offset by favorable working capital results and aided by some deferred tax payments. All things considered, our performance in the first quarter was solid with good mitigation of a very difficult environment. Let's now look at how the segments performed. Please turn to Slide 5.

HVAC was down 9% organically. Within it, North America residential was down 11% organically, with roughly half the decline due to last year's FER-driven accelerated gas furnace shipments, and the other half to slow shipments this year due to the unseasonably warm winter. Overall, furnace sales were down 30% year-over-year. The commercial business was down 8% organically, as a 5% decline in light commercial and 20% decline in applied, driven by weakness in China and Europe that was only partially offset by a flattish services business and strength in ALC and NORESCO. Refrigeration sales were down 14% organically, with North America truck/trailer down close to 30%, Europe truck/trailer down around 15% and container down around 7%.

A difficult truck/trailer comparison for the quarter was expected, as I mentioned earlier, but the results did deteriorate as the quarter progressed. Commercial refrigeration was down 13% organically, with weakness in both Europe and Asia. The Fire & Security segment was down 5% organically, with the products business down 4% organically. This was attributable to COVID-related project delays and shutdowns in Asia and Europe, but was partially offset by growth in our longer-cycle businesses, water mist and gas suppression, and also growth in global access solutions.

The field business was down 5% organically due to March lockdowns across regions, with particular weakness in Hong Kong, Australasia and France. In this world of uncertainty, we're focused on controlling the controllables, and that includes aggressive cost containment actions.

Slide 6 provides a breakdown of our cost programs. In February, we told you that we expected to achieve $175 million of savings from our Carrier 600 this year, and that we would invest $150 million of that back into the business to support our growth strategies. The current environment shifted some of our priorities to aggressively reduce cost, yet to preserve critical investment initiatives. The actions that we're taking are expected to generate $425 million of cost improvement this year, including accelerating Carrier 600, reducing our planned investments, and implementing an aggressive cost containment program. First, we will accelerate Carrier 600 and expect to deliver an additional $50 million in 2020 for a total of $225 million. Second, we have scaled back our investments in the year by $75 million in a very surgical manner. We are preserving the investments and initiatives that are most critical to our growth strategy to ensure we are well positioned as we exit this crisis. We have also initiated a $300 million cost containment program for 2020. Lastly, while COVID-19 affects volume and the drop-through of margins, it also disrupts our factories and other areas of our cost base. We're anticipating a $200 million nonrecurring headwind this year on things like factory absorption, supply chain disruption, expediting costs and inefficiencies caused by precautions for the safety of our employees.

The $425 million of cost actions more than offsets this impact and our net savings are $250 million, up from the $25 million we laid out at Investor Day in February. Dave mentioned our top priorities for 2020, one of which is to maintain ample liquidity. Please turn to Slide 7, and I'll walk you through that.

I mentioned earlier that we performed well from a cash flow standpoint in a quarter that is typically a big user of cash. Our working capital usually seasonally spikes in Q1 as we start building for the spring/summer selling season. We managed it tightly this year and delivered better cash than planned by over $200 million. We started the quarter with a cash position of $952 million and ended it with a balance of $768 million. This resulted from a neutral free cash flow and a use of $184 million from other investing and financing activities, including a small debt repayment and the effect of foreign exchange. And at spin, UTC returned us approximately $560 million of cash, so our opening balance sheet started with just over $1.3 billion on April 3. From this base, we will continue our efforts to preserve and enhance our liquidity. We will intensify our focus on all the components and levers available to us. This will include tightly managing working capital, expanding and driving the program we began in Q1. We have also done a deep scrub of our CapEx budget for the year and cut it by 40% to 50%. It is now $200 million to $225 million, down from the $350 million to $400 million we had originally planned. In paring it back, we have prioritized those projects targeted at our strategic priorities for growth and those projects which have high returns and a quick payback. We will also assess the timing and amount of a dividend. Our Form-10 identified a possible dividend scenario that was appropriate at the time, but the environment we face today is much different from what it was then.

With this foundation and these actions, we expect good free cash flow for the year, and it will add to our available cash. In addition to our cash position, we have a $2 billion revolving credit agreement with a strong bank group. That revolver remains undrawn and fully available to us. And finally, I will remind you that we have no debt maturities until 2023. So we feel quite good about our liquidity and are confident we have access to the capital we need to weather the storm and to operate and grow the business.

With that, let me turn it back over to Dave to discuss how we're thinking about the balance of the year.

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [5]

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Thanks, Tim. So what does this mean for our expectations for the full year? For our scenario planning in this uncertain global economy, we looked at 3 key indicators to frame our thinking: first, macroeconomic projections like GDP; second, indicators more directly tied to our business like new housing starts; and third, order trends. At a macro level, starting with GDP, our current guidepost for 2020 assume U.S. GDP declines about 25% in the second quarter and 5% to 10% for the full year. Expectations for Europe are similar. We assume China shows growth in Q2 and accelerates from there. When we look at macro indicators specific to our segments, we assume headwinds from lower replacement volumes as unemployment rates impact homeowner purchases, U.S. housing starts being down 10% to 20% this year and continued softness in non-resi construction starts in North America and Europe as we see from leading indicators like the Architectural Billings Index.

And in our Refrigeration business, the forecast declines in North America and Europe truck/trailer will be even steeper than we had originally forecast. ACT forecasts North American truck/trailer production to be down 45% this year and European truck/trailer is likely to be down 20% to 30%. Container drops are likely to be far more muted. So then on Page 8, let me share some color with you on orders.

We start with our China experience. Q1 orders were down 40% year-over-year, with February being the lowest month, down 50%. In the category of good news, the China recovery has been very positive. Our daily order rates returned to precrisis levels in mid-April, and our April orders in China were flat overall. The recovery has been a bit spotty and 1 month doesn't make a trend. But for us, China's decline and then its recovery were both quite steep. Our current thinking about the U.S. and EU is that the decline will be a bit shallower, but the recovery will be longer.

For us, orders declined earlier in the EU than in the U.S., but we also expect an early recovery. Orders in 1Q were down 10% in Europe, but were down 5% in the U.S., and that accelerated into April with Europe down 30% and the U.S. down 25%. Based on a slower recovery in the EU and U.S. versus China, our internal planning assumes recovery of orders to more typical levels as we get into later 3Q and early Q4.

So what does this all mean as we frame 2020? Turning to Slide 9. You could think of the numbers that you see here as guideposts as we look at various scenarios playing out globally. We see sales between $15 billion and $17 billion, adjusted op profit between $1.7 billion and $2 billion, and free cash flow over $1 billion. Also, with respect to the scenarios behind the sales decline for the whole company, you should think about the HVAC segment decline fairly aligned with the percentage range that you see here, with Refrigeration facing a bit more headwind and F&S is expected to be a bit at the better end of the range. Given that 80% of our sales are in the U.S. and Europe, we expect the steepest declines to occur in 2Q with improvements from there. So we have done our best to analyze the rest of the year for ourselves and for you, and we will continue to update you as this very fluid situation evolves. And though the coming months are inherently uncertain, what I do know with great confidence is that we'll get through this crisis. And over the long term, megatrends such as climate change, global urbanization and the shift towards digitalization and operating in the new normal will remain tailwinds for our business. And this takes me to our last page on Page 10.

We remain confident that the game plan that we laid out for you on February 10 will drive the results that you see here. We are getting real traction on the 3 pillars of our top line strategy, which will propel sustained mid-single-digit top line growth. We are tenaciously driving Carrier 600 to invest in growth and to help drive margin expansion to enable high single-digit EPS growth on a steady state basis. And we are laser-focused on driving working capital improvements needed to support free cash flow equal to net income. We have a clear road map to success. We remain committed to executing on our plan with urgency, conviction and effectiveness.

And with that, we'll open us up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question or comment comes from the line of Steve Tusa from JPMorgan.

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Charles Stephen Tusa, JP Morgan Chase & Co, Research Division - MD [2]

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Just on kind of the bridge a bit. Thanks for the color on kind of the guidepost. The -- any kind of color on price cost and what you kind of expect to run through what you're seeing out there for the year.

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [3]

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Yes. On the price side, Steve, we're still looking at overall price tailwind, but it's going to be minor. It's going to be in the range of $4 million. We actually saw $4 million in the first quarter. It's probably $20 million for the full year. Keep in mind, we're coming off a couple of years of a lot of price tailwind. It was north of $200 million in 2018. It was closer to $175 million last year. But we do think there's going to be a little bit more price challenges in the overall system, but we're still looking at some net tailwind from price. And then Tim took you through the cost side, we're going to be very aggressive. You saw that we upped our Carrier 600 for this year from $175 million to $225 million. We're being very aggressive, especially on the supply chain side, where we got some tailwind from commodity pricing, but a lot of aggressiveness on the negotiations and resourcing activity. And we're also certainly seeing a lot of headwind in the factory productivity. But we are really going after G&A in this climate.

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Charles Stephen Tusa, JP Morgan Chase & Co, Research Division - MD [4]

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Right. And then just lastly on the balance sheet. A little bit better cash. I think that's an incremental positive, but you're still going to end with some pretty high leverage. And I think there's a covenant out there that you guys have. Can you just talk about what that covenant is and how -- kind of how much of a hard line it may be, like how concerned should we be about that? And any actions you're willing to kind of take in the intermediate term other than just generating cash to shore up the balance sheet.

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Timothy R. McLevish, Carrier Global Corporation - CFO & Executive VP [5]

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Yes. This is Tim, Steve. So yes, we do have a covenant that covers both our revolving credit agreement and our term loan. And it is -- I mean it's -- I think it's attached to the Form-10. You can see that it says that it's first measured in our third quarter, at the end of our third quarter, and the covenant is 4x debt to EBITDA. According to the projections that what you see in our scenario planning, we do anticipate that we will be in compliance with the covenant at that point, and we're expecting that it only gets better from there. We have some cushion. So we're not unduly concerned about that. But obviously, we want to ensure that we have liquidity, and you can assume that we're taking actions to ensure that we have access to that.

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Charles Stephen Tusa, JP Morgan Chase & Co, Research Division - MD [6]

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Okay. And what if you do breach it? Ultimately in the next several quarters, you're wrong in your projections?

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Timothy R. McLevish, Carrier Global Corporation - CFO & Executive VP [7]

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Let's just say we're going to make sure that we don't. I mean it would -- I mean obviously it would preclude us from access to our revolving credit agreement, and it would put our term loan in some -- and I guess in default, but we will assure that we're not going to run into that problem. We've already initiated actions. You can be assured that we've already taken precautions. We're not going to put ourselves in jeopardy.

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [8]

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Yes, Steve, it's Dave. First of all, it's net debt, that ForEx multiple. And also, like Tim said, behind the scenes, we are working it. So I think we're in pretty good shape. We're managing it quite well.

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Timothy R. McLevish, Carrier Global Corporation - CFO & Executive VP [9]

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I would point out further to what Dave just said, it's net debt. And as -- and EBITDA as adjusted. There are some carve-out exceptions to it. So again, we're comfortably in compliance with it. But again, we want to make sure.

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Operator [10]

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Our next question or comment comes from the line of Nigel Coe from Wolfe Research.

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Nigel Edward Coe, Wolfe Research, LLC - MD & Senior Research Analyst [11]

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Yes. So no big surprise that we're seeing CapEx getting cut in this environment and some of the investment spending is pushing to the right. Can you maybe just talk about where you are down back a little bit on the investment spending and the CapEx and whether we should think of this as more of a push as opposed to a pull?

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [12]

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Yes. I would say, Nigel, it's probably more of a push. We did scale back on investments like automation. We're really focused on keeping the shops running. So to have industrial engineers in the shop, figuring out how to implement automation is not ideal timing. So we did push some of our automation spend. We are doing ERP consolidation. We pushed that to the right. So a lot of the discretionary actions like that, that don't necessarily affect growth, we have pushed out. We've been pretty tenacious at preserving investments that affect our growth agenda. So our view is that a kind of like outfielder, it's easier to run forward than backward. We came out, we were aggressive. We saw what was happening. We've made the right cuts to the budget. We'll see how the year progresses. If things open up a little bit. We'll pull some of the investments we pushed out into next year, we'll pull back into this year. But we've really gone to great lengths to preserve investments that have the highest paid -- payback that are going to protect our growth agenda.

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Nigel Edward Coe, Wolfe Research, LLC - MD & Senior Research Analyst [13]

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Great. And then you gave a number for new housing starts in the U.S., down 10% to 20%. And then you talked about replacement demand being down. I struggle to think about how to think about replacements in this environment given where unemployment is. What's your view right now on resi replacement?

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [14]

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Yes. I mean, look, it's probably down in the 15% range or so as we look at it. There were 3.8 million Americans last month that did not pay their mortgages. So it's going to be a tough climate for at least a while. But where there's demand, there's demand. And there may be a little bit of movement to a little bit more parts buy for the next few months to replacement. We haven't actually seen that just yet. But we do think there's going to be a little bit of a headwind on the replacement cycle. But we'll see as we get into the summer months, if employment, of course, the numbers remain extremely challenging right now. But as folks come back to work and society starts to reopen, we'll hopefully start to see a little bit more traction there.

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Nigel Edward Coe, Wolfe Research, LLC - MD & Senior Research Analyst [15]

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And then just a quick one on free cash flow. Is that all-in free cash? Or is it some kind of concept of adjusted free cash flow? Is that including one-timers?

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Timothy R. McLevish, Carrier Global Corporation - CFO & Executive VP [16]

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No. The free cash flow is -- I mean it's free cash flow. It's traditionally -- it's operating cash flow, GAAP operating cash flow plus capital expenditure -- or less of capital expenditures.

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Operator [17]

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Our next question or comment comes from the line of Jeff Sprague from Vertical Research.

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Jeffrey Todd Sprague, Vertical Research Partners, LLC - Founder & Managing Partner [18]

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Just a couple. First, just on the CapEx push, Dave. So it does sound like you're not doing anything to damage the growth plans. But I would think this also then pushes out some of your underlying productivity plans, right? So you're taking temporary actions to contain costs, but automation and ERP was a big part of kind of future productivity. Can you just elaborate kind of on the interplay between those factors?

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [19]

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Yes, Jeff. When you look at productivity, it was a key element, and it is a key element of Carrier 600. But I will tell you that only a piece of that is automation. There's another piece that just comes from really application of the Carrier operating system. So it will have a short-term impact. I actually think what you're going to see with the new normal is you're going to see people leaning more forward on automation as you get out into the end of this year and into future years. So look, we're going to free up the investments on automation as we get towards the end of this year into next year because I think it's going to be really critical to our overall story. We hadn't really baked ERP consolidations into our overall cost savings number. So I don't see that impacting Carrier 600. It impacts overall productivity and some of the manual nature of what we do. But we'll have to catch up to those investments next year.

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Jeffrey Todd Sprague, Vertical Research Partners, LLC - Founder & Managing Partner [20]

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And perhaps it's early to talk about a different number. But with this kind of acceleration, does -- is Carrier 600 on the path to being $700 million, $750 million, something like that?

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [21]

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Well, it is early. A couple of months doesn't make a trend. But look, I'm confident -- I've always been confident in the Carrier 600 number, and I think there's room to overdrive it. But we'll see how the rest of the year plays out, and we'll update that as we get out into the end of next -- in the end of this year.

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Jeffrey Todd Sprague, Vertical Research Partners, LLC - Founder & Managing Partner [22]

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And then just finally. So then on the dividend, we should expect that's kind of sort of on hold until you get past this Q3 kind of covenant and make sure you've kind of cleared the decks there.

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Timothy R. McLevish, Carrier Global Corporation - CFO & Executive VP [23]

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I think that would be directionally fair, Jeff. You recall that back in our Investor Day that we said that we would expect a $550 million dividend. We thought that was a competitive dividend in a normal circumstance. Obviously, we're not under normal circumstances, and preservation of cash and addressing our high leverage is high priority right now. And so we're deferring a little bit the decision and the level. I mean, in this environment, we perhaps will or we likely will consider reducing that amount and still be competitive from a yield standpoint, from a payout standpoint. But yes, you should anticipate to hear something in the near future. But again, it's not likely to be at the same level that we talked about at Investor Day.

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Operator [24]

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Our next question or comment comes from the line of Julian Mitchell from Barclays.

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Julian C.H. Mitchell, Barclays Bank PLC, Research Division - Research Analyst [25]

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Maybe just trying to stick to the one question rule. Perhaps focusing on margins for a second. So I think at the midpoint of the scenario plan, you've got about maybe 25%, 30% decremental margin dialed in for the year. Maybe just help us understand how you see the role of mix within that as transport refrigeration probably one of the businesses that falls the fastest this year in sales terms. And then also related to that, should we expect the decremental margins to be widest in the second quarter? Or you're assuming that decrementals are pretty level over Q2 to Q4.

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Timothy R. McLevish, Carrier Global Corporation - CFO & Executive VP [26]

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Yes, Julian, it's Tim. Say, as we -- as you know, we usually think of what we call it a drop-through rate decremental. Usually, I like to think of it as incremental. But unfortunately, in this environment, we talk about decrementals. That's about 28%. What you saw in the first quarter actually was much favorable to that, but that was largely because we had the better part of 10 percentage points worth of benefit from cost reduction in the quarter, about $40 million lower cost, and that contributed to a much lower drop-through. And interestingly, our sales in China were hit during the quarter, the hardest of ours, and China tends to carry lower general margins through, and we benefited by about 4%. So that's why you see the 14%. You actually may not see the 14%, you may see a 19%. But remember, we talked about a $24 million stand-alone cost. That's the first quarter component of the $107 million that you ultimately see for the full year.

I will also point out that I think you may have seen from UTC's release yesterday numbers that are a little bit different. They have about $20 million difference in profits. So if you adjust for that, there are some unusual things where it was different from us to them, they may have -- you may have construed at 24% from them.

As we think about the rest of the year, again, going back to the 28%. Yes, I would say second quarter is likely to be the hardest hit quarter. And the deeper the drop in revenues, it makes it difficult. We aren't just scaling back production. We're shutting the lines down. We're closing shifts. We're, in some cases, closing factories and you go deeper in to the cost pool there. And I would expect that to be in the second quarter. We will experience some mix degradation. The reverse of what you saw, I mean, some of our higher-margin businesses, the residential HVAC and others will be hit. How I simply think about rest of year decrementals, though, is that we have -- we'll be hit by 2 or 3 points with JV income because there's no offsetting revenue component to the drop in earnings that we're anticipating. And then all other of the cost, the factory disruption, et cetera, is largely covered -- that and the margin mix is covered by our cost reduction. So we anticipate, if you look at the projections, we'll probably be about 30%, couple of points worse than the normal 28%.

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Operator [27]

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Our next question or comment comes from the line of Deane Dray from RBC Capital Markets.

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Deane Michael Dray, RBC Capital Markets, Research Division - MD of Multi-Industry & Electrical Equipment [28]

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And let me also say congrats on the debut. I'm not sure anyone was expecting quite as a tough environment as you've had to face in your debut here. But I appreciate all the color and all the actions that you're taking.

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [29]

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Thanks, Deane.

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Deane Michael Dray, RBC Capital Markets, Research Division - MD of Multi-Industry & Electrical Equipment [30]

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If we can start, just -- we've heard the expression, this too will pass. Looking ahead, could you expand on the comments or the examples you were giving on how the buildings of the future are going to change? We've heard some similar comments from your competitors this earnings season about air purification, touchless credentials and so forth. But are these just thoughts? Or are these actually starting discussions with customers? How close are you to marketing and actually getting orders for this type of the new normal buildings?

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [31]

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Well, thanks, Deane, for the question. Actually, it's absolutely underway. We've been in discussions, and we've actually seen real progress with customers, whether it's the State of Florida or with hospitals where we've distributed our new OptiClean negative air machines. We're coming out of the gates fast on this one because we believe it's critical not only for our business, but it's critical for society. There are a shockingly number -- high number of sick buildings out there. And one of the characteristics of a sick building is the ventilation system. You look at the room I'm in right now, you would expect a certain number of air changes per hour, say, in the 10 to 15 range. And many buildings around the world have stagnant air and they don't have the number of changes per hour. You look at the filtration system in many buildings as you have the return air going to through a filtration system, you'd expect it to be able to filter out contaminants at a 0.1, 0.3 micron level, and many filtration systems don't have that. We have that with our electric static filters for homes, UAV or HEPA filters in commercial buildings. Many buildings don't have that. You want your ducts cleaned every 3 to 5 years, and that doesn't happen. So as we look at the transition to healthy buildings, I think you should expect that Carrier is going to be front and center on that. It's very real. And it's the same in our other 2 segments.

You mentioned touchless. In our Fire & Security business, we already have a BlueDiamond app that can eliminate a lot of the touch points as, say, you go from your car to your office building, there's usually 8 to 10 touch points. And like I said in the earlier remarks, we can eliminate 80% of that as you go to open the turnstile or you press the elevator button or you adjust the HVAC controls in your office or on your floor. There's a number of touch points that we can eliminate that are going to be critical. And it also is combined with the traceability element. So as employers want to be able in the workplace to trace folks, we have an app that can co-mingle with the other parts of the app to be able to track people in the workplace.

And the other segment that we have in our refrigeration business, the entire cold chain is going to be just foundationally and fundamentally different. So you look at how people get their food today in a place like China, and there's a significant number of wet markets, and we have farmers' markets here in the U.S. and in Europe. But you're going to see a lot more home delivery of goods. The cold chain is going to be critical for that and pharmaceuticals, and we're working on some telematics and other what we believe to be quite cutting-edge innovative solutions to really connect the entire cold chain. So we think we can play a real pivotal role in the new normal.

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Deane Michael Dray, RBC Capital Markets, Research Division - MD of Multi-Industry & Electrical Equipment [32]

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Appreciate all that color. And just a quick clarification from Tim, if I could. Just with regard to capital allocation and cash preservation, the expectation was that Carrier was going to have investment-grade rating with the expectation you'd be paying down debt. So what's the outlook in your discussions with the rating agencies? Are they giving you some leeway here in terms of the path of deleveraging?

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Timothy R. McLevish, Carrier Global Corporation - CFO & Executive VP [33]

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Well, it's still our intention to maintain investment grade. We have been in conversations with the agencies. As I said, we're -- they recognize that short-term liquidity is critically important in this crisis situation with the uncertainty about the economy. We've been in regular discussions with them and I think they are supportive of our game plan. And I think we'll be just fine.

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Operator [34]

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Our next question or comment comes from the line of Carter Copeland from Melius Research.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [35]

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Dave, I just -- I wondered if you could talk a little bit about the portfolio. I mean these sorts of discontinuities and changes have a tendency to make you kind of think about the business in different ways. And I know the sort of optionality around the long-term appearance of the business is something you thought about. You kind of mentioned tangentially at the Investor Day. I wonder how this whole crisis may be changing that thinking, if at all.

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [36]

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Yes, Carter, what I'd tell you is that what we said at Investor Day remains consistent today, that our #1 priority is on execution. We really feel very strongly that we can unleash tremendous value just by doing what we said we were going to do. As we get sales consistently in mid-single-digit range and we get EPS at the high single-digit rate, and we get cash flow about equal to net income.

We know that, that consistent track record of performance will have a significant impact on the overall valuation of Carrier, and then we're playing from a position of strength. So our #1 priority is focus on execution. Our #2 priority is to really take a very dispassionate look at our current portfolio. And of course, we've been doing that since for quite some time. And we said that we would put our current portfolio through a very specific set of criteria. Are we the rightful owner? Does it strategically fit? Does it meet the financial criteria that we've set out for ourselves? And if it doesn't, we'll be dispassionate and do the right thing about divesting those parts of the portfolio. I think once you make that decision, you will, of course, have to look at the current environment and decide if you're going to do something like that, when would be the right time. And this is not the ideal time to do something like that. But we'll look at the right time if there are parts of the portfolio that we decide don't meet the criteria that we've set.

And then in terms of that third category, overall, more strategic types of transactions. That is not our priority right now. We know that our peers have made themselves more pure plays, as have we. But our focus right now is on that first category of execution and on the second category of the real portfolio analysis that we've been going through. And we'll deal with that second.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [37]

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Okay. Great. And Tim, I wanted just a quick clarification. Thanks for the color on truck/trailer. Can you tell us what the container orders look like, both maybe end of the quarter or April trends?

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [38]

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Yes. Carter, it's Dave. Container orders have actually been pretty steady. So we're going to see how things play out. But when we look at overall container orders, and there's been a couple of months where it's been positive, a couple of months where it's been negative. Overall, Q1 was down 7%, I believe. When we got into April, it was positive. So on balance, it's probably flat to down just low single digits right now.

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Operator [39]

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Our next question or comment comes from the line of Josh Pokrzywinski from Morgan Stanley.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [40]

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So I understand we've covered a lot of ground here already and appreciate the color. I guess in regards to some of the cost actions in Carrier 600, how do we think about operating leverage on the way out? Tim, you talked about kind of the 28% target number. Obviously, a lot of things moving around, some temporary, some pull forward of the total. How should we think about exit rate, incrementals being above or below that target number just as some of these temporary costs come back?

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Timothy R. McLevish, Carrier Global Corporation - CFO & Executive VP [41]

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Yes, I would generally -- again, a lot of the recovery from a higher decremental came from the cost actions that we identified as kind of a this year impact. Again, Carrier 600 is kind of separate from that. We took these to offset the higher decrementals with the disruption and so forth. So I would expect that we should be coming out of this as we increment back up at a similar rate, 28%, give or take 1% or 2%.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [42]

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Got it. That's helpful. And then just related to that, I guess, supply chain was a part of Carrier 600. Obviously, everyone's taking a harder look at their supply chain today with some of the interruptions. Anything that changes with respect to that or needs to be reshuffled?

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Timothy R. McLevish, Carrier Global Corporation - CFO & Executive VP [43]

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No, when you think about supply chain, we've talked about, about 55% of the savings will come from supply chain, and we're still on that level. It's going well. Remember, David said there's probably 6,000 suppliers and we're going to consolidate and probably cut it in half. As we become more meaningful, we're able to partner better, we get some better pricing, we get some better terms. That's a big component of it, and that's tracking very well.

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Operator [44]

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Our next question or comment comes from the line of Gautam Khanna from Cowen.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD & Senior Analyst [45]

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Congrats on the first quarter. I'm curious when you look at the commercial HVAC and Fire & Security backlogs, what do you perceive to be kind of at-risk perhaps serving industries that are going to be kind of very hard hit by the recession, so whether it's hospitality or what have you. Just could you give us some framework on parts of the backlog that might stretch for an extended period, even when you have site access again? Any sort of framework for that?

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [46]

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Thanks, Gautam. This is Dave. The one piece of good news is that our sequential backlog in the first quarter was up. It was up about 6% in HVAC and about 1/3 of that in resi and 2/3 in commercial HVAC. So the backlog position did improve in the first quarter. We look at -- to the extent that there's any shift from the left to the right, it's really -- we think it's going to be relatively minor. We're talking a month here and there. We feel that there are some construction sites that are -- once they come back on, there's going to be really some pent-up demand.

What we -- our experience in China was this, was that after folks came back from the Lunar New Year, that was factories were allowed to open February 10. Basically, all of our factories, they were generally online as you got into that February 20 time frame. And we started -- we had the backlog and we started to ship the backlog. What followed was a lot of the construction sites that had the migrant workers in China, they were quarantined a little bit longer. And then they started to receive the backlog. And then that was followed by new orders ticking up as we got into April. And we think it will be a similar phenomenon is that as the construction sites come back on-site -- back online in the U.S. and Europe, they'll start to take delivery of the backlog. There may be some pushout a month here or there. But frankly, some of -- some places like universities or education has been taking this opportunity with folks out to actually accelerate some of the construction. So some is being accelerated. Some will naturally get pushed out. But where it gets pushed out, we're talking maybe weeks or a month or 2 here. It's not going to be significant.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD & Senior Analyst [47]

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Okay. And just a follow-up for Tim. Could you actually disaggregate the $425 million of cost into structural versus variable? I don't know if you said that in the opening remarks, but...

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Timothy R. McLevish, Carrier Global Corporation - CFO & Executive VP [48]

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Yes. So I just go down on the chart of the $425 million. The Carrier 600 and the $50 million incremental will be a structural. That will be enduring. The investment, if you recall, we said that our investment this year originally was going to be $150 million. We expected it to scale back to an incremental $100 million next year and then $50 million before we will go back to normal. This $75 million that we pulled out will be pushed in, likely invested next year, so we'll kind of push out that schedule a little bit. And the $300 million is really onetime actions. It was furloughing most -- all of our salaried employees. It was deferring merit. It was cutting back on. Obviously, it wasn't hard to cut back on travel because there isn't any travel anyway, but it's reducing services, supplies, et cetera. That will likely -- I mean it won't be caught up, but it will be -- it's not a structural change. It will come back.

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Operator [49]

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We have time for one final question. Our last question will be from the line of Vlad Bystricky from Citigroup.

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Vladimir Benjamin Bystricky, Citigroup Inc, Research Division - VP [50]

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Can you talk about -- within the Fire & Security business, just how much of the overall business is driven by regulatory or statutory requirements and should, therefore, be more resilient? And can you also talk about in that business, what restrictions on building access and social distancing measures could potentially mean for productivity in the field business?

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [51]

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Yes. Thanks for the question. We look at -- there's a piece of the fire portfolio you think -- fire's a much bigger piece than the security piece. And there's a piece of the fire that's regulatory in nature. If you look at -- we look at the Fire & Security portfolio in 2 aspects. There's the products piece and then there's the Chubb piece. Products is about 60%, Chubb is about 40%. Within the 40% that's Chubb, you have a monitoring and installation and a services piece. And the services piece is where you do see some regulatory, and that has generally held up during this downturn better than the installation piece, which got hit pretty hard in the March time frame into April, especially in Europe.

On the product side, some of our businesses like Edwards, that's held up quite well because there is a regulatory piece of that. And we've actually seen -- we actually saw growth increases in parts of our Edwards business and others that, like GST, where we have a regulatory piece in China. Some of the security portfolio is less regulatory in nature. But what's interesting there is we are starting to see a lot more demand for some of our products that are going to be critical in this new normal. So as hotels start to think about how they're going to gear up in the new normal, we're in discussions with a number of them with our Onity system, where folks can bypass the front desk, go directly to their room and use more touchless type applications. We're seeing that with real estate brokers for our Supra business. So even though it's not regulatory, some parts of the security portfolio could be quite compelling in the new normal. And we're in some pretty interesting discussions as folks -- as some of our key customers gear up for the new normal.

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Vladimir Benjamin Bystricky, Citigroup Inc, Research Division - VP [52]

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Okay . That's very helpful. And then just maybe one last one for me. I know the order information you gave was very helpful. I guess just going forward, the U.S. and EMEA were actually pretty similar in April. So as we go through the year, do you expect the U.S. and EMEA to continue sort of trending in similar directions? Or are there differences in the COVID-19 responses and protocols that could push for more divergence amongst those 2 regions?

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [53]

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Quite honestly, it's hard to say because it's even hard to generalize the U.S., and it's hard to generalize Europe. When we look at Europe, Germany has been coming on back online quite well recently. We see the automotive manufacturers coming back. We feel good about Germany. Spain and Italy have been coming back online over the last 2 to 3 weeks in a fairly positive way. France is more delayed. 80% of the construction sites in France are still not operational. So I think France will be lagging, and probably the U.K. lagging behind Germany and some of the others. And you're probably going to see a bit of a mixed bag in the United States as different states come online at different times. I think if you were to compare the 2, our experience so far over the last few months is that the U.S. has generally been 3 to 4 weeks behind Europe in terms of on the way down and on the way back up.

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Operator [54]

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I'm showing no additional questions in the queue at this time. I'd like to turn the call back over to management for any closing remarks.

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David L. Gitlin, Carrier Global Corporation - CEO, President & Director [55]

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Well, I'd like to thank everyone for taking the time to join us today. Please know that Sam is at the ready for your questions, and we appreciate your time and attention this morning. So thank you very much.

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Operator [56]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.