Earnings Call Transcript - CARR Q1 2022

Operator, Operator

Good morning, and welcome to Carrier's First Quarter 2022 Earnings Conference Call. This call is being carried live on the Internet, and there is a presentation available to download on Carrier's website at ir.carrier.com. I would like to introduce your host for today's conference, Sam Pearlstein, Vice President, Investor Relations. Please go ahead, sir.

Sam Pearlstein, Vice President, Investor Relations

Thank you, and good morning, and welcome to Carrier's first quarter 2022 earnings conference call. With me here today are David Gitlin, Chairman and Chief Executive Officer; and Patrick Goris, 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 non-recurring and/or non-operational nature often referred to by management as other significant items. The company reminds listeners that the sales, earnings and cash flow expectations and any other forward-looking statements provided during the call are subject to risks and uncertainties. Carrier's SEC filings, including Forms 10-K, 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. We will leave time for questions at the end. Once the call is opened up for questions, we ask that you limit yourself to one question and one follow-up to give everyone the opportunity to participate. With that, I'd like to turn the call over to our Chairman and CEO, Dave Gitlin.

David Gitlin, Chairman and CEO

Thank you, Sam, and good morning, everyone. I'll start with a summary of our Q1 results on Slide 2. Q1 was another strong quarter for us, and I am proud of how our team continues to execute in the face of global challenges. We delivered 12% sales growth, excluding the impact of Chubb. Organic orders growth remained strong at 10% and our backlog is up almost 30% organically versus last year. Adjusted operating profit was up 7% compared to last year and up high teens, excluding the impact of Chubb. Price/cost was neutral in the quarter, better than expected. Free cash flow was a larger-than-expected outflow in the quarter, mainly due to supply chain shortages impacting inventory levels. We continue to expect to generate $1.65 billion of free cash flow this year. We remain focused on the priorities that you see on Slide 3, above-market organic growth, margin expansion, strong free cash flow and disciplined capital allocation. This slide summarizes our value creation framework as presented at our recent Investor Day, which not only forms the basis for our updates to our investors but also drives our priorities via our internal goal alignment process. I recently spent a week in Europe and a week in Asia and saw first-hand how our people globally are driving results tied to these priorities. From our world-class operations in our Singapore container factory to the tremendous innovation from our colleagues in Hyderabad and New Delhi, to the discipline and energy in our sites throughout Poland, it was encouraging to see the power of focus, culture and talented empowered teams coming together to provide solutions for our customers. I'll address our progress on the key elements of this value creation framework starting with growth on Slide 4. We continue to lean into the opportunities provided by the secular trends presented at our Investor Day that we are confident will drive above-market growth despite macro uncertainty and supply chain challenges. On healthy indoor environments, we saw $125 million worth of orders in Q1, and our healthy buildings pipeline is now $850 million, up more than 20% sequentially from the fourth quarter. We continue to play offense on ESG and sustainability. The combination of the upcoming Toshiba acquisition and our newly announced European heat pump design center of excellence position us favorably to enter the attractive European residential heat pump market. This will complement our leadership in global commercial heat pumps. As an example, our low GWP heat pump chiller orders in Europe were up over 30% in the first quarter. Electrification is equally critical in transport refrigeration, where we recently added Woolworths, Australia's largest supermarket chain. We now have more than 10 countries where our Vector eCool all-electric reefer units are in service. In terms of digitalization, our key focus remains on rapid adoption of our Abound and Lynx platforms. We've incorporated energy monitoring and alert reporting capabilities into our Abound platform and achieved key wins across verticals, including education, retail and industrial. There are now over 750 million square feet monitored by Abound. This includes an important recent win with Harvard's T.H. Chan School of Public Health. Our digital capabilities are receiving more widespread recognition. For example, within the Abound platform, our CORTIX solution recently won several key awards, including the 2022 Artificial Intelligence Excellence Award organized by the Business Intelligence Group; and the AI Breakthrough Award's 2021 Best Predictive Analytics platform. CORTIX offers predictive insights and autonomous actions to optimize equipment performance and building operations, and is currently connected to over 300,000 pieces of building equipment from multiple OEMs. This is a good example of how our digital platforms deliver customer value across a diverse installed base. We have also expanded our Lynx capabilities, including asset tracking, prognostics and temperature alarms, and we remain on track to have 100,000 Lynx subscriptions by the end of this year. We remain confident that the increasing middle class will continue to drive demand for our products in countries such as India, where income levels are increasing and penetration levels of our portfolio of solutions remain low. In addition to the tailwinds from these secular trends, we continued to accelerate growth in our core businesses through innovation and differentiation, which you can see on Slide 5. After releasing 21 new products in Q1, we remain on track for more than 125 new product introductions in 2022. Our innovation pipeline is centered around our core strategy of healthy, safe, sustainable and intelligent building and cold chain solutions. One example is that we recently introduced a smoke and carbon monoxide detector with embedded indoor air quality sensors with all the data connectable to smart home ecosystems. Our R&D efforts on disruptive technologies are progressing well. One example is our traction on the Department of Energy's challenge to improve the efficacy of heat pumps at cold ambient temperatures. Our unit is currently under test at the Oak Ridge National Labs. We have demonstrated the expected performance with a better-than-required coefficient of performance at ambient temperatures of 5 degrees Fahrenheit using our forthcoming low GWP refrigerant. We are working to commercialize our solution to increase adoption of heat pumps over oil and gas fuel heating systems in colder regions. I am pleased to announce that we have a new Chief Technology Officer. He recently led Honeywell Aerospace's 10,000 engineers and previously held critical roles at BorgWarner and Bosch. His experience driving customer solutions across a broad range of cutting-edge technologies at the intersection of hardware and digital position him perfectly to help take our innovation efforts to the next level. Another critical growth driver for us is aftermarket and recurring revenues, which you see on Slide 6. After 11% growth in 2021, aftermarket sales were up high single digits in Q1. Across Carrier and within each segment, we have detailed KPIs across the vectors that you see here: parts capture; service coverage; digital solutions; and healthy and sustainable offerings. We remain committed to delivering on our full year KPIs, including having 70,000 chillers under long-term agreements and 20,000 connected chillers by year-end. So, our growth drivers remain encouraging. Turning to margin expansion on Slide 7. At our Investor Day, we committed to over 50 basis points of margin expansion per year with 2022 projected to be closer to 75 basis points, and we exceeded that in the first quarter, growing adjusted operating margins by 110 basis points. We remain on track to deliver the $300 million of gross productivity savings that we committed to for 2022. Related to that productivity improvement, we are very purposeful about building a more resilient supply chain and we are tracking to our commitments around dual sourcing of critical components and increasing factory automation.

Patrick Goris, Chief Financial Officer

Thank you, Dave, and good morning, everyone. Please turn to Slide 8. As expected, reported sales were down due to the Chubb divestiture. Organic sales growth was better than our high single-digit Q1 guidance, with all segments growing organically. Residential and light commercial HVAC growth was stronger than expected, with residential up over 20% and light commercial up over 30% compared to last year. Both price and inflation were higher than we anticipated and price/cost was neutral. Productivity and higher JV income also contributed to strong adjusted operating profit, which was up 7% compared to last year despite lower reported sales. Core earnings conversion, excluding the impact of price/cost, was well over 50%. Adjusted EPS of $0.54 was also better than the guidance we provided in February given stronger sales, margins and a lower share count. For your reference, we added an adjusted EPS bridge in the appendix on Slide 19. Free cash flow was a use of $258 million versus the use of $100 million we guided to on our Q4 earnings call. The primary driver was an increase in inventory. We continue to operate with higher safety stock and missing components are delaying shipments. We still expect to generate $1.65 billion in free cash flow for the full year, but this will be more back-end loaded as we expect supply chain conditions to improve in the second half. Let's turn to Slide 9 and cover our segments performance. HVAC organic sales were up 18% driven by continued very strong growth in residential, light commercial and our ALC/Controls businesses. Residential movement and field inventories for splits and furnaces were both up low single digits. Light commercial distributor movement was up double digits in the quarter with field inventories up modestly versus prior year. Within Commercial HVAC, Applied and Controls grew double digits. Adjusted operating margins were up 120 basis points compared to last year, mainly due to volume leverage and mix. Price/cost was slightly positive for this segment as better-than-expected price realization more than offset higher material and freight costs. We expect this segment to remain price/cost positive this year. Moving to Refrigeration on Slide 10. Organic sales were up 1% in the quarter, a bit lower than expected due to supply chain challenges mostly affecting truck and trailer. As expected, container was down mid-teens compared to a record quarter last year. Truck and trailer was up mid-single digits. Commercial refrigeration was up mid-single digits, driven by solid growth in EMEA, and Sensitech continues to do well and was up double digits. Adjusted operating margins were down 130 basis points compared to last year, mainly due to lower volume and price cost. Price realization is improving in this segment and is expected to be neutral in Q2. Moving on to Fire & Security on Slide 11. Excluding Chubb sales from the first quarter of 2021, Fire & Security segment sales were up 8% with strong broad-based growth this year. Adjusted operating margins expanded 160 basis points in the quarter, mainly as a result of the Chubb divestiture. Price/cost was neutral in this segment, better than expected. Slide 12 provides more details on orders performance. Total company organic orders were up about 10%. As expected, Residential HVAC orders were down modestly in the quarter, with Light commercial orders about double last year's levels. Commercial HVAC orders also remained very strong, with backlogs for this business up over 30% compared to last year. Refrigeration orders were flat in the quarter. Transport orders were down modestly as we continue to actively manage our Q4 order book for the truck and trailer business. The backlog remains up about 30% in both transport and commercial refrigeration compared to last year. Order intake for our Fire & Security products remain very healthy, up about 20%. Growth was widespread throughout the portfolio. As you can see on the right side, we saw continued strong orders growth in all areas of the world. Order strength continued in all regions in April, with the exception of China, which was down year-over-year. Moving to an update on capital deployment on Slide 13. We had quite some activity in Q1. We collected $2.9 billion from the Chubb sale, repurchased about $740 million worth of shares and paid down $1.15 billion worth of debt. In addition, we announced the acquisition of our JV with Toshiba for about $900 million. We continue to expect this acquisition to close by the end of Q3. Integration planning for the acquisition is progressing. Our actions continue to strengthen our credit metrics and provide plenty of flexibility for value-add capital deployment. We continue to target $1.6 billion of share repurchases for 2022 and expect to issue $400 million of yen-denominated debt prior to the TCC acquisition. Total debt reduction for 2022 remains $750 million, consistent with what we shared with you in February at our Investor Day. Now moving on to guidance on Slide 14. We had a good and better-than-expected start to 2022. But with just 1 quarter behind us, we are maintaining our guidance for organic sales growth, adjusted operating margin, adjusted EPS and free cash flow. From a calendarization perspective, we expect the lockdowns in Shanghai to impact Q2's sales by about $100 million, mainly in commercial HVAC and truck and trailer as both businesses have a manufacturing footprint in that area. This assumes businesses open up in the next few weeks, and we currently do not expect this to impact our full year. With that, I'll turn it back to Dave to Slide 15.

David Gitlin, Chairman and CEO

Thanks, Patrick. We are pleased with a strong start to the year. Our backlog gives us confidence about continued strong growth, and the team continues to overcome unexpected macro challenges to deliver results for our customers and our investors. With that, we'll open this up for questions.

Operator, Operator

Your first question is from Josh Pokrzywinski with Morgan Stanley.

Josh Pokrzywinski, Analyst

So I guess, just maybe first question on the commercial side, where you saw some momentum. Dave, do you feel like some of the stuff we've been talking about here, maybe more structurally on whether it's indoor air quality or some of the stimulus money going into education, is hitting the system? Or are we still kind of on the other side of just easy COVID comps and kind of getting back to work there?

David Gitlin, Chairman and CEO

No, I think it has a lot to do with the secular trends and some of the initiatives that we've launched. You look at K-12, our orders were up 50% in the first quarter, which is, as you know, Josh, significant. Our pipeline grew 25% sequentially. So, we're starting to see SR2 and SR3 funds being released in K-12, and that's encouraging. Aftermarket was up double digits in our HVAC business. Controls was up north of 20%, which has been a big focus area for us. And then when we look more broadly at the underlying business itself, we now have seen, I think, 14 straight months where ABI was north of 50%. So, orders continue to be very strong. The global applied business was up 15%. North America was up over 20%. So, when we look at ALC, Controls, aftermarket trends, healthy buildings where the pipeline is now at 850 and then K-12, a lot of these underlying trends that we've talked about are coming through.

Josh Pokrzywinski, Analyst

Got it. That's helpful. And then just on the residential business, we're kind of price-on-price-on-price at this point in terms of the marketplace. I think you mentioned in terms of the movement versus sell-in. Inventories are at healthier, if not a little higher than usual. How should we think about kind of the sensitivity point to that end consumer for what is a pretty significant dollar increase in the price? Are you seeing any kind of pushback or elasticity of demand there?

David Gitlin, Chairman and CEO

Not yet. What we are seeing is, I guess really, record levels of price realization. We said that residential for us in the first quarter was up over 20%, more than half of that from price. So we have announced about 5 price increases in the last couple of years. And by the way, we have to because of the input costs that we're seeing. So really, what we're doing is dealing with the inflationary pressures we have through trying to stay out in front of it through price increases. But clearly, for residential, we watch movement very carefully. That was generally in line with field inventories, both up kind of in that low single-digit range if you focus on splits and furnaces. And orders were down modestly, but we expected that orders have been fine here in April. So there's a lot of pent-up demand for residential. Price realization has been strong. And then, of course, as we get into the back half of the year, we'll have to see how the switchover takes place as folks gear up for the 2023 introduction.

Julian Mitchell, Analyst

Maybe just to start off with the sort of price versus cost dynamic. So I think before you guided something like $1 billion of cost headwinds and $1 billion or so of price for the year. Just wondered sort of any updated thoughts on those two points and maybe what the impact from those two items was in the first quarter.

Patrick Goris, Chief Financial Officer

Yes. Patrick here. Clearly, Q1 performed better than we anticipated, achieving neutral instead of negative results. Looking at the full year, we previously indicated $1 billion in price and $1 billion in inflation. Considering the current quarter and our observations, it seems we may exceed the $1 billion mark slightly. Thanks to the price increases we've announced, we are on track for that $1 billion. However, we've also noticed a rise in some input costs. For now, we are still aiming for a neutral price-cost balance for the year, but it appears pricing will likely surpass $1 billion, as will inflation.

Julian Mitchell, Analyst

Thanks, Patrick. And in the first quarter, the cost headwind was, what, a few hundred million or so?

Patrick Goris, Chief Financial Officer

It was north of $300 million.

Julian Mitchell, Analyst

And then just my follow-up would just be around that Refrigeration business and kind of the slope for getting the margins kind of where you want them to be in that sort of 40 basis points plus range. What are the main drivers for that? How quickly do we see that margin catch up?

Patrick Goris, Chief Financial Officer

Our expectation is that the first quarter will be the lowest point for margins in Refrigeration. A significant factor affecting margins in Q1 was price and cost, which presented about a 150 basis point headwind for that segment. We anticipate that price and cost will become neutral starting in Q2, which should help improve margins compared to the current situation, where it poses a more considerable challenge. The positive aspect is that we have observed improvements in price realization in Refrigeration. Since the second quarter of last year, the price realization has consistently improved each quarter, and in Q1, it was nearly double what it was in Q4. Therefore, we believe we are on the right path.

Andrew Obin, Analyst

I have a question about interest rates and inventory distribution. A commentary noted that the reason the distribution can maintain a substantial inventory is due to low floor financing costs. With interest rates rising, and considering you have a very large distributor, is this becoming a topic of discussion with your distributors? There's a concern that, regardless of the strength of the market cycle, they might opt to carry less inventory simply because the interest payments will increase over time.

David Gitlin, Chairman and CEO

No, that has not been a major focus area for our discussions with our distributors or our dealer channel. What we're seeing in residential right now reflects the trends we've observed over the last couple of years. There is a general anxiety about residential, but the best we can do is stay closely connected with our channel partners to understand their perspective. They are generally observing a strong consumer market, with the same trends that drove a 10% growth two years ago, followed by 20% growth last year, and over 20% in the first quarter, continuing. Housing starts were up about 10% in the first quarter. The work-from-home trend is evolving into a hybrid work environment. We at Carrier continue to see market share gains, with about 100 basis points of share gained over the past year, which continued into the first quarter. There is increased demand for higher-end units, but the challenge is that the more advanced the units are, the more they rely on chips, leading to supply chain issues. Many of the underlying trends remain stable. The primary discussion we have now revolves around the transition occurring in the second half of the year as we prepare for the 2023 units, especially in the South, where this is an unprecedented change regarding installation dates. Distributors and dealers in the South are aiming to end up with zero inventory of current units while ensuring they have enough inventory to support the first quarter. This transition is unprecedented and could yield positive outcomes as we move into the latter half of the year, but we need to see how it unfolds. The good news is that Chris and Justin are in daily contact with our channel partners, and we're doing our best to meet their needs. However, availability will still pose challenges for many of our customers due to some delays on our part. That said, I can confidently say we have been performing better than others, and our improved availability has also helped us gain market share.

Andrew Obin, Analyst

No, that's a great answer. I really appreciate it. Just a follow-up question. You mentioned a heat pump opportunity in Europe. Could you just size what the market TAM is? And what could this be for Carrier over time?

David Gitlin, Chairman and CEO

We are very optimistic about the European heat pump market. On the commercial side, we are confidently leading the market for commercial heat pumps in Europe, backed by excellent technology and strong channel partners. We've recently added Giwee to our network and will be introducing Toshiba in the coming months. In the first quarter alone, commercial heat pump orders increased by 30%, aided by the launch of a new low GWP air cooled chiller product last year. Our focus now is to expand into the residential heat pump sector in Europe, where we currently do not have a significant presence. We plan to invest in this area, as we expect a substantial growth, with projections of around 30 million new residential heat pumps being added in Europe by 2030. Although we're not currently a major player, our plans include incorporating Toshiba, leveraging Giwee, and establishing a heat pump center of excellence through our Riello business in Italy, which already has an established channel. Thus, we are prioritizing the residential heat pump market in Europe moving forward.

Nigel Coe, Analyst

Good quarter, good start of the year. Sorry, I joined the call a little late, so I apologize if this has already been discussed. Are we still tracking to $1 billion of price realization for this year? And I know that $1 billion you had in the plan and captured the April 1 price increase. But do you have any more price increases in the plan for this year?

Patrick Goris, Chief Financial Officer

Yes, Patrick here. We mentioned earlier that based on what we've announced so far, we're confident that we'll achieve $1 billion or more in price this year. Given our performance in Q1, it seems likely that we'll exceed $1 billion this year. However, we also expect that inflation will be higher than the $1 billion we anticipated a quarter ago. Therefore, we believe both price realization and inflation will surpass $1 billion. The positive aspect is that with the prices we've announced, we're confident in achieving at least $1 billion in price realization this year. This is based on announcements, not yet realized amounts, of course.

David Gitlin, Chairman and CEO

What I would add, Nigel, is that when we talk price, I think a lot of our investors assume we fixate on residential. What we're seeing with prices it's across the portfolio. Jurgen and his team in Fire & Security, Tim and his team in Refrigeration, all pushing price in a very concerted way with I would say, more effectiveness than we've ever seen in our history. So clearly, Chris and the team in overall HVAC have done very, very well on the price side, which gives us great confidence in our numbers for the rest of the year. But it really is across the portfolio.

Nigel Coe, Analyst

David, that's great. You mentioned the price/cost was negative in Refrigeration. Can you clarify whether that was for the entire segment or just for transport refrigeration? This also suggests that HVAC performed positively for the quarter; could you confirm that? Additionally, regarding the overall price/cost, if you were neutral in the first quarter, why wouldn't your performance be better than neutral for the full year? I believe the plan is to be neutral, but given that the first quarter is arguably your toughest comparison, why wouldn't it be stronger?

David Gitlin, Chairman and CEO

It's early. The short answer is that we expected Q1 to be negative, as you mentioned, but it turned out to be neutral. This gives us confidence that our aggressive pricing strategies are promising for the rest of the year. However, we must also monitor inflation, which carries a lot of uncertainty. Anyone's ability to predict inflation over the next few quarters is questionable. We'll keep a close watch on it. Currently, we feel positive about our price-cost situation for the year, but we need to stay vigilant and allow a few more months to see how developments unfold.

Nigel Coe, Analyst

That's fair. And sorry, what was residential price in the quarter?

Patrick Goris, Chief Financial Officer

We said residential was up over 20% overall sales, more than half of that driven by price.

Steve Tusa, Analyst

You guys had mentioned a couple of other items for the bridge. I think it was like a $300 million productivity number or something like that. Any changes on anything else moving around on as far as the annual bridge concerned? And then what was that number in the first quarter?

Patrick Goris, Chief Financial Officer

Steve, no change for the overall year. We still continue to target $300 million of productivity, $100 million of reinvestment. And productivity in the first quarter was over $50 million.

Steve Tusa, Analyst

Okay. And then anything more on the second quarter as far as seasonality? I mean you mentioned the $100 million or so in China shifting out? And anything else in Q2? Or should we expect a somewhat normal seasonality?

Patrick Goris, Chief Financial Officer

I'd say somewhat normal seasonality, Steve. I will say that last year, you may recall, the margins in HVAC were exceptionally high, I think they were almost 19%. We do not expect HVAC margins to be that high in Q2. We expect margins in HVAC to be up a little bit compared to Q1, but not to the extent that it was last year. And we expect our overall margins in Q2 to be maybe a few basis points below what it was last year.

Steve Tusa, Analyst

Yes. And sorry, what is normal seasonality? I think these days, I don't know what normal is. But how do you guys see normal seasonality like maybe first half, second half when it comes to EPS? What is that typically?

Patrick Goris, Chief Financial Officer

Q2 EPS is anticipated to be higher than in Q1, largely due to an increase in volume, which typically rises during Q2 and Q3.

David Gitlin, Chairman and CEO

No, the current strategy is that we will be introducing the 2023 product really focused on the South starting in the next few months. So as we start getting into August, the products that they'll be receiving in the South will be the 2023 products because that's what they have to gear up to start selling right on January 1. We'll introduce that the new product for the North as we get closer to the end of the year because they'll be stocking inventory of today's units because that's data manufacturing in the North in the third and fourth quarter. So introduced the '23 product earlier for the South later for the North, and then we'll have to see the cut-over. We all watch inventory levels and movement levels, I would tell you, Steve, very, very carefully. And they remain generally in balance with what we expected. So we watch inventory levels not only with our distributor partners, but also what's being stocked in the dealer network as well. And we haven't seen anything alarming. We do expect year-end inventory levels to be down year-over-year, depending, of course, on what happens with movement in inventory over the next 6 months or so. But our expectation is year-end inventory levels would actually be down year-over-year. And we're going to stay super close with our partners on this transition.

Steve Tusa, Analyst

When you start selling those at about 10% higher or whatever the amount is, you would view the associated revenue increase as a mix rather than a price change, correct, when you incorporate those into the channel?

Patrick Goris, Chief Financial Officer

Well, movement, we've been seeing low single digits, not 10% on prices.

Joe Ritchie, Analyst

Could you please provide more details about China? You mentioned that in April, the orders turned negative, which I assume is linked to the lockdowns. I understand there's a $100 million headwind for the second quarter. Can you share more about the potential range of outcomes and what you're currently observing on the ground?

David Gitlin, Chairman and CEO

We're closely monitoring the situation in China. It's essential to us as part of our growth strategy, contributing to 8% of our sales. Our main concern at the beginning of the year was around real estate, but fortunately, only a third of our sales come from this sector, and less than 10% of that is in the multifamily residential area, which is where much of the focus has been. In reality, this segment represents less than 0.5% of our overall sales. Recently, the lockdowns have profoundly affected our operations, especially in Shanghai, where we have four factories and numerous suppliers. We have applied for permission to reopen under special circumstances and are monitoring the situation closely. It's a challenging environment, and the overall management of the situation raises concerns. Our focus is on remaining compliant and advocating for a quick reopening, which is also affecting logistics. We believe this is a temporary setback. As noted, it might cost us a few hundred million dollars this quarter, but we expect a recovery as we move into the third quarter. Historically, we have demonstrated an ability to bounce back swiftly after shutdowns, and we anticipate a similar outcome in China. Most of our products for China cater to the local market or the Asia Pacific region, with minimal exports to the U.S. We are pushing hard for a rapid reopening in Shanghai, which is vital for both China and the global market.

Joe Ritchie, Analyst

Yes. That was super helpful. I guess maybe one quick one, a quick follow-up on China. And then just if you're thinking about the kind of like proper decremental margin on the lost revenues? Is it kind of like a 25% to 30% range? And then the follow-on question, just on margins. But clearly, you're off to a better start than the annual guide. And so just any possible cadence that you can kind of give us throughout the year on kind of margin expansion to get to that 75 basis point number by year-end.

Patrick Goris, Chief Financial Officer

I'll start with the second half of your question, Joe. We believe that the margins for Q2 and Q3 will be higher than Q1, while Q4 will be slightly lower than Q1. This is our current outlook from a margin standpoint. As I mentioned in response to Steve's question, we think that Q2 margins might be a bit lower than last year’s. Regarding the specifics about China, we haven't disclosed our incremental or decremental margins in that region, so I can't provide details on that.

Deane Dray, Analyst

I'd like to keep the spotlight on some of the troubled geographies. I saw you took a $9 million impairment charge in Russia. What does that represent in terms of your investment, either assets receivable, people. And then for EMEA, orders up 10% to 15%, but there is concern now about slowing, and how much have you baked in that into your guidance?

Patrick Goris, Chief Financial Officer

Yes, Deane, I'll take the first one very quickly. Yes, you're right, we brought off $9 million of assets related to Ukraine and Russia. In essence, that is, we believe, all, if not most of our assets in that part of the world. So basically, we decided to look at all the assets we have in that part of the world and wrote these off. There might be a little bit of a hangover in Q2. But if it is, it's going to be in the few million dollars. We don't expect it to be higher than that.

David Gitlin, Chairman and CEO

Deane, on Europe. Keep in mind that last year when we had Chubb, it was close to 30% of our sales. And now without Chubb, it's closer to 22% of our sales. So Europe has become less exposure for us. What I will tell you is that we're watching this very carefully, but Q1 orders were very strong. They were up double digits. April orders have continued to be strong for us in Europe. So there's no tangible signs of weakness. But obviously, with everything going on in the world, we'll continue to watch it quite carefully.

Deane Dray, Analyst

That's helpful. And then as a follow-up, can you update us on any lost sales or past due because of supply chain issues. In the fourth quarter, I think it was $300 million to $400 million, you couldn't ship. What would be the comparable number this quarter? And you talked about missing components. We know that's an issue everywhere. But can you give any color in terms of which components and especially on the semiconductor side?

David Gitlin, Chairman and CEO

Yes. The number of overdue shipments due to customer demand is similar to what you mentioned for the fourth quarter, in the few hundred million dollar range that we could ship if we didn't face supply chain issues. A major part of our challenges stems from chips; two-thirds of our issues are related to them. The recovery of chip supply isn't fast enough and continues to be a significant pain point for us. However, I believe our team is taking the right steps, which gives us some optimism as we head into the second half of this year and into next year. We're enhancing our direct relationships with key chip manufacturers like TI, Microchip, and STMicro, and they are doing their best to support us despite pressure from other customers. Additionally, we are redesigning many of our critical chips. By the end of this quarter, we aim to have 30% of our essential integrated circuits redesigned and 50% by the end of the year. This redesign will give us more flexibility as we focus on chips that are actually available. While we wait for our chip manufacturers to ramp up production in 2023, we are keeping a close eye on supplier on-time delivery and production stoppages, which have remained consistent. There are some signs of improvement, but chip shortages are affecting not just us but also our suppliers. This is the most crucial factor we need to monitor regarding availability.

Deane Dray, Analyst

That's great. I just would like to point out, it sounds to us like some of the fastest redesign pace that we've heard that OEs are trying to do. So it sounds like you're making good progress there.

David Gitlin, Chairman and CEO

We have a dedicated team working on this globally. It's unfortunate because we have had to reassign engineers from new product introductions to redesigning chips. Our engineering and operations teams are taking the right actions, but recovery is not happening quickly enough.

John Walsh, Analyst

Good start to the year. Maybe shifting gears a little bit. Question around the Fire & Security margin expectations for the balance of the year. Clearly, Q1, much better than you guys initially thought. I think it was actually guided down year-over-year in Q1. I didn't hear the 16% again for the full year, but assume that probably is still in the right ballpark. Just maybe help us understand how the rest of the year looks for Fire & Security from a margin perspective?

Patrick Goris, Chief Financial Officer

Yes, John. As you mentioned, we had a strong start to the year. When I assess the margins compared to our expectations, the volume was slightly better in that segment, but the main factor was price and cost. The price and cost in that segment exceeded our expectations. So, while we had a good beginning to the year, it is still premature for us to revise our full-year outlook. There is clearly positive pressure on our margins in this segment, but it is still early in the year. As I noted earlier, we are continuing to face rising inflationary challenges. So, to summarize, we had a good start, better-than-expected price and cost performance, and we are on track for a bit better than the 16%, but it is too early to adjust our guidance.

John Walsh, Analyst

Got you. No, that makes sense. And then maybe just a question around if you're seeing any market share shifts. I know one quarter is tough to kind of extrapolate, but applied, you've put up some really good growth. Curious if you think you're gaining share. I know that was an initiative. And then one of your competitors on Light commercial, I guess, kind of walked away from some new build stuff. I'm curious kind of what you're expecting there, and if you're seeing any market share shifts in either of those businesses?

David Gitlin, Chairman and CEO

Yes. In the light commercial segment, we have clearly gained significant market share while also increasing prices. Over the last year, we achieved more than 400 basis points of share growth, which continued into the first quarter. In Q1 alone, we gained over 100 basis points in share. I am proud of the team in the light commercial sector because their success has been driven by pricing strategies, operational performance, innovation, and strong customer retention. Overall, the team is executing well in a robust market. As for the applied segment, it appears to be relatively stable; we have noticed some share gains in China and North America, while Europe might not be performing as well as anticipated. Overall, I would say that applied share was likely flat in Q1.

Tommy Moll, Analyst

I wanted to continue on the global applied HVAC business, so up mid-teens in the quarter, which is good to see. But what commentary can you give us about which parts of the world were on the stronger versus weaker side of that trend? And then as you think through for the rest of 2022, how do you see those trends unfolding? Or does the business feel like it's accelerating or kind of holding a good level of activity? How do you see that unfolding?

David Gitlin, Chairman and CEO

Yes. In the first quarter, Tommy, North America was the strongest. That was up around 20%, Europe was around 10% and Asia was around 10%. So overall, around 15% in the first quarter. We've sort of said high single digits across the board for the rest of the year, but we're going to have to keep an eye on it. China is the biggest watch item right now. China would probably be down for us in the second quarter because we do have a couple of facilities in Shanghai that we need to get reopened as soon as possible so we can support our customers. The good news on Overall Applied is; Number one, the underlying trends that we talked about at the beginning of the call, the underlying demand remains very strong. ABI metrics, as we mentioned, stays very strong. Aftermarket for HVAC up over 10%, the ALC/Controls business, high margins, really differentiated product lines that doesn't get enough credit, up double digits. So a lot of strength, especially in some key verticals like data centers and warehouse, education, health care, commercial buildings coming back online. So a lot to like there. I would tell you the one thing we got to watch very acutely right now is China. We have a strong cash position and the ability for more mergers and acquisitions. We're actively working on potential deals in line with our focus on sustainability, aftermarket opportunities, and overall trends. If the right opportunity arose, we could pursue a deal exceeding $1 billion if it made sense. We're excited about our Carrier ventures and have recently announced significant partnerships with OhmConnect and AddVolt, focusing on energy management and battery technology for our reefer unit. Our team, led by Jennifer Anderson, is exploring several promising investments, and we will take action when appropriate. These investments are usually around $5 million, and we'll proceed when we identify the right opportunities. Patrick, do you have anything to add?

Vlad Bystricky, Analyst

I wanted to explore the strong performance you're observing in the K-12 market. You mentioned that orders have increased more than 50% year-over-year. Could you elaborate on how this market is changing with the availability of federal funds? Are you noticing a wider variety of orders, or are there larger, longer-term district-wide deployments that are gaining momentum?

David Gitlin, Chairman and CEO

Yes, we're observing a shift towards system-level sales. Recently, we achieved a significant success in Ohio, where we sold a comprehensive range of solutions, including HVAC and building management systems, along with UV light upgrades for a school. This shift includes selling numerous OptiClean units and specialized solutions, reflecting a move towards more sustainable, system-level approaches. The school district recognizes that ventilation is crucial for indoor air quality, particularly as 1 in 13 children in schools have asthma. This is vital not only for preventing COVID and the spread of airborne illnesses but also for assisting with asthma management and cognitive performance. Research indicates that improved ventilation and lower CO2 levels positively impact testing scores in schools. Consequently, the schools we collaborate with are seeking more structural, sustainable solutions. The good news is that with the release of SR3 funds, they now have the financial resources to make these long-overdue investments. We plan to increase our automation hours from 3 million to 6 million by 2026, based on approximately 30 million manufacturing hours. This will represent a significantly higher percentage of our total hours. It's important to consider the variable costs we are reducing by replacing them with automated hours, which comes with an investment. However, we are also experiencing benefits in quality and other areas from these automation investments, and we anticipate continuing this trend at a strong pace.

Jack Ayers, Analyst

This is Jack Ayers on for Gautam today. I guess kind of just going back to the first question, I believe, on the residential HVAC cycle. I guess if you could maybe just provide your perspective on kind of what you're seeing. I know you guys got pretty good price yield this quarter. I guess like is there any concern going forward on the consumer behavior, maybe mixing down buying parts versus full system replacement. I guess just any color there would be helpful.

David Gitlin, Chairman and CEO

We've seen no evidence of that. We closely monitor this market, which evolves rapidly. We've observed a strong interest in our higher-end Infinity systems rather than any indication of mixing down. There's no sign of components being replaced instead of entire systems. We'll need to keep an eye on this, particularly as we move into the higher SEER units, which may require more comprehensive system changes. Additionally, with a new refrigerant coming in 2025, we might see further system-level adjustments. However, at this point, we've seen no evidence of a shift.

Tommy Moll, Analyst

You mentioned when you started selling those in and they're like 10% higher or whatever they are, you would consider the related revenue increase as mix as opposed to price, correct, when you layer those into the channel?

Patrick Goris, Chief Financial Officer

Yes. Yes, good point. The price of the new units we've said will be 10% to 15% higher than today's unit. So yes, that plays in.

Operator, Operator

Thank you. And this concludes our Q&A session for today. I will pass it back to management for any final remarks.

David Gitlin, Chairman and CEO

Okay. Well, thank you, everyone. First, thanks to our team here at Carrier, our more than 50,000 people globally. Really proud of how the team has started this year and continues to execute despite the headwinds that get thrown our way. So very proud of our team, and thanks to all of you for joining. And of course, Sam will be available for any follow-up questions.

Sam Pearlstein, Vice President, Investor Relations

Thank you.

Operator, Operator

And with that, ladies and gentlemen, we conclude our program for today. Thank you for participating, and you may now disconnect.