Carrier Global Corporation

Good morning, ladies and gentlemen, and welcome to Carrier's fourth quarter 2022 earnings conference call. I would like to introduce your host for today's conference, Sam Perlstein, Vice President of Investor Relations. Please go ahead, sir.

Thank you, and good morning, and welcome to Carrier's fourth quarter 2022 earnings conference call. With me here today are David Gitlin, Chairman and Chief Executive Officer, and Patrick Orr, Chief Financial Officer. We will be discussing certain non-GAAP measures on this call, which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to GAAP figures in our earnings presentation, which is available to download from Carrier's website at ir.carrier.com. 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. Once the call is open 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.

Thank you, Sam, and good morning, everyone. Our Q4 results for sales, earnings, and cash flow were all in line with our expectations, as you can see starting on slide two. We delivered organic sales growth of 5% supported by another quarter of double-digit growth in light commercial and commercial HVAC, global truck and trailer, and aftermarket. Pricing remained strong and our realization continued to offset inflationary headwinds. Supply chain improvements continued. allowing for reduction of our past due shipments with further improvements anticipated in 2023. Our backlog, which ended up mid-single digits year over year, up 40% on a two-year stack, and up 2x from 2019, remains at very healthy levels. Adjusted operating margins of 10.1% were flattish compared to last year, despite a 70 basis point impact from the consolidation of the Toshiba joint venture. We made great progress on our productivity initiatives in the quarter and achieved our full year target of $300 million in savings. Adjusted EPS was 40 cents in the quarter at the high end of our guidance range. We generated about $1 billion of free cash flow in the quarter ending 2022 with $3.5 billion of cash, allowing us to continue to play offense with capital deployment as we head into 2023. Moving to slide three. I am proud of our team's accomplishments last year. We delivered on our full year outlook for sales, adjusted operating margin, and adjusted EPS while significantly advancing our strategic priorities. We drove 8% organic sales growth, adjusted operating margin expansion of 60 basis points, and adjusted EPS growth of about 15% when we exclude the impact of the Chubb divestiture. But we did fall short of our original 1.65 billion free cash flow guide as we discussed in October, resulting from supply chain and related inventory challenges. We did deliver on our revised guidance of 1.4 billion as a result of our strong Q4 performance. So our track record of delivering results without surprises continues, and our team is poised to continue to deliver in 2023, in part because of key secular trends that drive demand, as you can see on slide four. Our customers continue to look to us for healthy and sustainable solutions, and we have differentiated offerings that meet their needs, particularly in the fast-growing heat pump space. Our North America residential heat pump sales grew 35% in the quarter, and our European commercial heat pump sales were up 30%. We expect those areas to only grow stronger as the Inflation Reduction Act and the Repower EU initiative propel increased adoption. Additionally, Toshiba's innovative and leading inverter technology continues to impress. When combined with our multi-rotary compressors, heat pump efficiency and capacity dramatically improve. Toshiba's technology and expertise are also helping us penetrate the attractive and growing residential heat pump market in Europe. Our position in transport electrification is also market-leading. We have units operating in 15 countries and plan to ramp significantly with more than half of refrigerated transport units sold to be electric by 2030. The healthy building trends continued to be a positive in the quarter as orders were up over 80% and our pipeline increased to over $1 billion. For the full year, healthy building orders were up about 50%. K through 12 also remains encouraging with our pipeline up about 60% year over year. And with almost two thirds of the federal government's ESSER funds yet to be allocated, we expect further acceleration into 2023. As we continue to distinguish ourselves as a climate systems and solutions company, we remain focused not only on achieving our own ESG goals, but also helping our customers achieve theirs as well. We recently increased our previous aggressive 2030 net zero targets, committing to set greenhouse gas emission reduction targets in line with the science-based target initiative criteria. Additionally, Carrier continues to be recognized in the ESG space, including distinguished recognition in London where our customer's heating network will provide a 50% reduction in carbon emissions to network participants. We also continue to perform on our aftermarket growth objectives, as you can see on slide five. When we became a standalone public company in early 2020, we emphasized increasing aftermarket growth rates from historical low single digit levels. And last year, we produced another year of double digit aftermarket growth. Our focus remains on providing differentiated digital solutions through our Abound and Lynx platforms and connecting not only our new products, but also our significant install base. Our Bound technology now monitors over 1 billion square feet, and we recently onboarded over 100 commercial office sites for a key large-scale customer. We recently released the Bound Net Zero Management, which provides customers with an easy way to view, track, and analyze energy usage and emissions data across their global footprints and proactively identify conservation measures. We've made similar progress with our innovative LINX platform and launched several new capabilities in the quarter. We expanded our reefer health capabilities to include early refrigerant leak detection and launched a managed services LINX fleet offering for a major grocery retail chain in the US. We achieved our goal of having 70,000 chillers under long-term agreements by the end of 2022 and expect to increase that by another 10,000 in 2023. Importantly, we also achieved our objective of having 20,000 connected chillers and plan to connect another 10,000 this year. We recently announced a strategic collaboration agreement with Amazon Web Services to jointly build, market, and sell Carrier's digital solutions. Not only are we delivering on our financial and strategic imperatives, we are also making great progress on our portfolio optimization and executing on our capital deployment priorities as you can see on slide six. You'll recall that at the time of our spin, we carried approximately $11 billion of debt on our balance sheet in cash of about $1 billion. Over the course of just two and a half years, we have reduced our net debt levels nearly in half from that $10 billion level to $5.3 billion, while increasing our strategic organic growth investments by over $300 million. We have also completed a number of compelling acquisitions highlighted by the consolidation of Toshiba Carrier. All acquisitions have been strategic and core to our business, focused on enhancing sustainability leadership, accelerating aftermarket growth, driving digital and technology differentiation, and expanding adjacencies and geographic coverage. We've also been disciplined in evaluating our existing portfolio to ensure each business is core and that we are the best owner. As a result, we optimized our portfolio by completing the sale of Chubb and our shares, completing the sale of Chubb and our shares in Bayer while also reducing our minority joint venture count from 41 to 29 since spin. In addition to our portfolio moves, we've been disciplined and proactive with our other capital deployment actions. We have steadily and consistently increased our dividend and have completed about 2 billion in share repurchases, excuse me, since spin. All of this to say we have made great progress over the last few years, but that does not mean that we are done. We are always evaluating acquisitions in our current portfolio for potential opportunities for simplification and value creation. We will remain steadfast in our commitment to keep evaluating our portfolio as we enter 2023 and beyond. Patrick will cover our 2023 guidance in more detail, but I will emphasize a few highlights on slide seven. Focus remains very thematic for us. All of our 52,000 team members are aligned on our key priorities, and those priorities remain consistent. Carrier 2.0 is a term that we have been using internally, which represents a very purposeful shift from a primary focus on selling equipment to now using digital and innovation to provide our customers with sustainable and healthy outcomes throughout the lifecycle of our product and service offerings. The result will be our continued pursuit of higher margin, high aftermarket growth rates. We remain focused on reducing costs and expect to get another $300 million in productivity in 2023. We are clear-eyed about the broader economic challenges and uncertainty in 2023, and have done our best to calibrate macro factors in our guidance that you see along the left of this slide. We expect to deliver solid organic growth, strong margin expansion, excluding TCC, and high single digits to low double digits adjusted EPS growth. Strong free cash flow and a very healthy balance sheet enable us to play offense on capital deployment. With that, let me turn it over to Patrick. Patrick?

Thank you, Dave, and good morning, everyone. Please turn to slide eight. In short, Q4 was very much in line with our expectations and the guide we provided. Reported sales were $5.1 billion, with 5% organic sales growth driven by about 8% price, with volume down a couple of points. I'll provide a bit more detail on a future slide, but in essence, we saw continued strong organic growth in HVAC, fight on security, and global truck and trailer, which was partially offset by a very weak quarter in container, and to a lesser extent, commercial refrigeration. The Chubb divestiture reduced sales by 10% in acquisitions. Substantially, all Toshiba carrier increased sales by 8%. Currency translation was a headwind of 4%. All segments were price-cost positive or neutral in the quarter. Q4 adjusted operating margin was about flat compared to last year, driven by a 70-bit margin headwind related to the TCC acquisition. Strong productivity almost completely offset the margin headwinds related to the lower volume and the TCC acquisition. Adjusted EPS of 40 cents was consistent with the upper end of our full-year guidance range. For your reference, we have included the year-over-year Q4 adjusted EPS bridge in the appendix on slide 20. One billion dollars of free cash flow in the quarter was also as expected and we generated about 1.4 billion for the full year. Moving on to the segments starting on slide nine. HVAC reported sales included a 16% benefit from the TCC acquisition. HVAC organic sales were up 9% driven by low single digit growth in residential over 40% growth in light commercial and mid-teens growth in commercial HVAC. Sales growth was driven by both price and volume. Residential movement was down about 10% in the fourth quarter, and quarter and field inventory levels ended up higher than the flat year-over-year levels we targeted. Residential HVAC growth was driven by price as volume was down mid-single digits. Commercial HVAC had another very strong quarter with double-digit sales growth in applied equipment, aftermarket, and controls. All regions grew double digits. Adjuster operating margin was up 60 bps with volume, price, cost, and productivity more than offsetting a 100 bps margin headwind related to TCC. Full year operating margin for this segment was 15.2%. In line with the guide we provided post the TCC acquisition, which had about a 70 bps dilutive impact on 2022 for this segment. Transitioning to refrigeration on slide 10. Organic sales were down 7%, and currency translation was also a 7% headwind. Within transport refrigeration, North America truck and trailer sales were up low teens, and European truck and trailer was up high teens. This continued strong performance was more than offset by container, which was down about 50% year over year, driven by demand softness, as well as a tough comp in the prior year. This is the second consecutive down quarter for the container business, and historical down cycles for this business have lasted about four quarters. Commercial refrigeration was down high single digits year over year. as our European food retail customers continue to be pressured by inflation and energy prices. Adjusted operating margins for this segment were up 60 bps compared to last year, despite lower sales, with the margin headwind of lower volume more than offset by productivity and price cost. Full year operating margin of 12.8% was slightly ahead of our 12.5% guide, and expanded over 70 bps compared to 2021 despite lower sales as our refrigeration team managed price cost and delivered strong full year productivity to offset the impact of lower volume. Moving on to fire and security on slide 11. As expected, the Chubb divestiture had a significant impact on reported sales. Organic sales growth was 6% driven by price with volume down low single digits. Operating margin was short of our expectations for this segment due to continued high supply chain and logistics costs and operational performance challenges. As a result, full year operating margin of 15.2% for this segment was short of our 16% operating margin guide. Slide 12 provides more details on backlog and orders performance. As our backlogs normalize in some of our shorter cycle businesses, such as residential HVAC, we expect order trends to adjust accordingly. We've seen that trend over the last few quarters and in Q4 particularly. As you can see on the left side, total company organic orders were down roughly 10% for the quarter and up compared to 2019 and 2020. Backlog ended the year up mid-single digits compared to last year, with backlog growth in HVAC and fire and security partially offset by backlog reduction in refrigeration. As expected, residential HVAC orders were down in Q4. Light commercial demand remained robust as orders were up mid-teens in the quarter. The backlog is up well over 2x for that business. Commercial HVAC saw double-digit orders growth for the eighth consecutive quarter. The commercial backlog is now up 35% compared to last year and extends well into 2023. Refrigeration orders were down roughly 10% in the quarter, driven by market weakness in container and commercial refrigeration that was only partially offset by global truck and trailer. North America truck and trailer continued to have strong orders in the quarter, up over 100% compared to last year. Global truck and trailer backlog is up high single digits as the strength in North America offset order weakness in Europe. Container orders were down about 50% compared to a very strong fourth quarter last year. Commercial refrigeration orders remain weak and reflect market softness. Finally, demand for our fire and security products was mixed. Orders were positive in roughly half of the businesses, including residential fire and access solutions. Fire and security products backlog is up almost 30% year-over-year, with double-digit growth in all the businesses except residential fire in the Americas. Overall, we entered 2023 with strong backlogs and continued strong order trends in commercial and light commercial HVAC and North American truck and trailer. Businesses experiencing softer order intake include container, commercial refrigeration, and residential HVAC. Now moving on to our 23 guidance on slide 13. We expect reported sales of about $22 billion, including organic sales growth of low to mid-single digits. Almost all the organic growth will be priced as we expect volume growth to be flattish. We expect currency translation to be about a point headwind, while acquisitions, primarily the impact of Toshiba Carrier, will contribute about 6% to the growth. Adjusted operating profit is expected to be up compared to 2022, with operating margin at about 14%, including a 50 bps dilutive impact from Toshiba Carrier. We expect high single-digit to low double-digit adjusted EPS growth in 2023. I WILL PROVIDE MORE COLOR ON THAT ON THE NEXT SLIDE. WE EXPECT A 23% ADJUSTED EFFECTIVE TAX RATE AND FULL YEAR FREE CASH FLOW ABOUT $1.9 BILLION OR ABOUT 100% OF NET INCOME. OUR FREE CASH FLOW GUIDANCE ASSUMES APPROXIMATELY $75 MILLION OF CASH RESTRUCTURING PAYMENTS AND ABOUT $100 MILLION TAX HEADWIND SINCE CONGRESS HAS NOT RENEWED THE FULL EXPENSING OF RND. As shown on the right side of the slide, we expect mid single digit organic growth in HVAC as continued strong growth in light commercial, commercial HVAC and aftermarket are more than offset flat residential. Reported HVAC sales growth should be in the low team, in the low double digits, given the additional contribution from seven more months of consolidating Toshiba carrier. In refrigeration, We expect flattish organic sales as continued strong growth in global truck and trailer is offset by container and commercial refrigeration. For fire and security, we expect low single-digit organic growth. We expect the HVAC segment operating margin to be similar in 2022 despite absorbing about 100 bps of pressure from the consolidation of Toshiba and expect operating margin expansion in refrigeration and fire and security. Let's move to slide 14, adjusted 2023 EPS bridge at our guidance midpoint. Our operating profit is expected to be up about $200 million despite flattish volume growth. Price cost and gross productivity combined are an expected operating profit tailwind of $500 million with $200 million coming from price cost and $300 million coming from gross productivity. Annual merit adjustments and investments amount to about $200 million in total. And we expect about a $50 million additional headwind of TCC integration costs. There are some other minor, smaller moving pieces, but that all adds up to roughly $200 million in increased adjusted operating profits. Core earnings conversion. which excludes the impact of acquisitions, divestitures, and effects, is about 35% at the guidance midpoint. Moving to the right on the bridge, some modest savings on net interest expense and a lower share count offset the expected higher tax rate and currency translation headwinds. That gets us to our midpoint of about 255 for next year, or 9% growth compared to 2022. As usual, we provide estimates of other items in the appendix on slide 19. On slide 15, you'll see that our capital allocation priorities remain the same. In 2023, we expect about $400 million in capital expenditures. We recently announced another significant dividend increase, and our dividend payout ratio is about 30%. Finally, we target $1.5 to $2 billion in share repurchases in 2023. Before I turn it over to Dave, let me provide some additional color on the first quarter. We expect a six cent headwind from a higher effective tax rate of about 25% compared to 16% last year. In addition, we expect our first quarter to be the weakest quarter from an organic revenue growth perspective with organic sales growth flat and volumes down. This reflects continued growth in the HVAC and fire and security segments and a decline in the refrigeration segment driven by container and commercial refrigeration. We expect residential HVAC to be down mid-single digits in Q1. Recall that our Q1 22 residential HVAC sales were up an industry-leading 23%, so certainly a tough comp for that business. Overall, We expect revenues in Q1 to be a little over $5 billion and adjusted EPS to be between 45 and 50 cents. We expect first half adjusted EPS to be about 45 to 50% of full year earnings, the reverse of 2022. And as usual, free cash flow will be more weighted to the second half. We expect organic revenue growth to sequentially improve after Q1 with easier comps in the second half of 2023. With that, I'll turn it back to Dave for slide 16.

Thanks, Patrick. We delivered strong performance in 2022, and we are targeting another strong year this year as we continue to execute and control the controllables. We continue to see opportunities to use our strong balance sheet to create value for our customers, shareholders, and the planet for future generations to come. With that, we'll open this up for questions.

Thank you. Ladies and gentlemen, to ask a question, you will need to press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. To be fair to everyone, please limit yourself to one question and one follow-up.

Please stand by while we compile the Q&A roster.

And our first question coming from the line of Julian Mitchell with Barclays. Your line is open.

Hi, good morning. Just wanted to start with maybe, good morning, maybe start with the first quarter outlook there.

So it sounds as if you've got maybe the operating margins firm-wide down, you know, perhaps sort of 200 to 300 points or so year on year. I just wanted to check if that's the case, and is the bulk of that downdraft really coming in HVAC, presumably? And if it is, kind of what's the confidence that you can get back to full year margins in HVAC being flattish, given the headwinds in resi for the year?

Julian, good morning. Patrick here. The margins in Q1, we expect them to be down about 200 basis points. And there are really three elements to it. One, acquisitions, and that is HVAC specific, expected to add over $500 million of revenue, but with very little operating profit contribution. Two, volume mix, as I mentioned, is expected to be down in the first quarter. That's not, that is really, not just in residential HVAC, but is also impacting, of course, the refrigeration segment. That's a secondary contribution to the 200 bps or so margin contraction in Q1. The third element is price cost. We expect price cost to be close to neutral in Q1, which actually is a headwind to margins in the first quarter. And that is across the three segments. So that gets to about a 200 bps margin contraction in the first quarter. In the second quarter, we would expect to return to year-over-year EPS growth.

That's helpful. Thank you. And maybe just following up, Patrick, on the HVAC segment overall for the year. So I think you talked about flattish margins there at sort of 15% plus. in that business, and you've got organic sales guided up about mid-single digit for the year. Maybe just clarify for us what you're expecting there on your residential volumes, perhaps, within that guide, and then any sort of weighting on things like the productivity savings, but just trying to understand where you get the offset in that HVAC margin. if there's a mixed headwind and the TCC margin headwind as well.

Well, Julian, let me start with a little bit of color on kind of resi and what we're seeing across the mix between resi light commercial and commercial. And then Patrick can give a little bit of color on the margins themselves. We do expect for resi in 2023, we're expecting flat sales, flattish sales. But we get there with volume being down potentially high single digits offset by mix and price. So when you think about resi, we're looking at new construction potentially down 20%, 25%. Now, remember, that's only about 20%, 25% of resi. But some of our customers are saying it could be much better than that. Some are saying it's in that range. So we'll have to see as we get into the second half of the year. But we've calibrated. residential new construction down 20%, 25%, and replacement down mid-single digits. We are seeing that offset that gets us to plattish sales for the year driven by mix and price. So we have some price carryover. We've just announced a new price increase of 6% that's effective in March. We're going to mix up this year, as you know, because of the new SEER units that are coming in that we're pricing 10% to 15% higher, and we're also seeing a mix-up as we transition to heat pumps. Also in the mix is that we do see a strong year for light commercial, which was, as Patrick said, up 40% in the fourth quarter. That continues to be very strong. And our backlogs in commercial with a nice mix with aftermarket up double digits, controls up double digits, helping that piece. Patrick, maybe comment on the full year.

On the margins, Julian, we're comfortable with the margin outlook for HVAC in 2023 of about 15%. Dave mentioned about the aftermarket. But I did also mention that price cost is expected to be a tailwind for us of $200 million in the year. That dials in some benefits from what we call deflation. A lot of that sits in the HVAC segment. In addition, I mentioned that we're focused on delivering another $300 million of productivity in 2023. We did the same in 22. And of course, given the size of the HVAC segment, a sizable size, of course, is in that segment as well. So we're comfortable with those 15% margins for the full year. Great. Thank you.

Thank you. Thank you.

Thank you. One moment, please, for our next question. And our next question coming from the line of Joe Ritchie with Goldman Sachs. Your line is open.

Thanks. Good morning, guys. Hey, Joe. Good morning. Can we touch on that price-cost neutral comment in 1Q? I guess that's a little surprising to me, just given that, you know, price was probably, you know, there's probably a good carryover effect occurring from 2022. And then from a cost perspective, I'm just wondering, is there like higher cost inventory that's coming through? Is it a function of like the merit increases being more front-end loaded? Just any more color you can provide on that price-cost neutral in 1Q would be helpful.

Yeah, and the short of it is, and it's mostly in HVAC, is the first quarter of 2022, we were left in at some really attractive pricing from a steel point of view. And the year-over-year impact is actually a net negative for us. As I mentioned to Julian just earlier, we are dialing in a benefit from deflation. That kicks in the second quarter of 2023. In Q1, we still have a headwind, particularly in steel, that affects HVAC.

Got it. That's helpful, Patrick. And then I guess I'm just going to stick on margins and just want to understand, you know, some of the operational challenges that you guys faced in the fire and security business this quarter. And then also, as I kind of think about the 2023 guide, it doesn't seem to imply that much margin growth in the segment. So just maybe just kind of talk us through what some of the issues are and how those are supposed to rectify in 2023.

Yeah, if I look at the margin performance in finance security, it was up year over year in the fourth quarter by 60 basis points. And the way you can think about it is the absence of Chubb is a tailwind to margins. Volume mix and price cost was a slight headwind to margins. The net was still a margin expansion of 60 basis points. The margins were lower than what we expected. Supply input costs and higher supply chain costs than what we expected. Two, inventory is not aligned with where the business is today. And that has some operational impacts which we experienced in the fourth quarter of the year. And so we have to work through that. And that is what we expect for 2023. And therefore, we expect with minimal volume growth in 2023 to have margin expansion in fire and security. The revenue growth we expect in fire and security in 23 is mostly price-driven, less volume-driven.

Got it. Thank you. Thank you, Joe.

Thank you, Juan. One moment, please, for our next question. And our next question, coming from the lineup, Jeff, with Vertical Research Partners, your line is open.

Thank you. Good morning, everyone. Good morning, Jeff. Dave and Patrick, that color you gave on resi obviously encompasses what's going on with field inventories. But maybe you could elaborate a little bit more on how inventories ended versus your expectation and how you think they kind of normalized over the balance of the year.

Yeah, Jeff, we had a target of getting field inventories at the end of last year flat to where they ended 21, and they were actually a bit higher than we had targeted. Not excessively higher, but just, I would say, a bit higher. And we do think that there will be destocking as we go through the year. Obviously, when you're in the first quarter, there's some level of stocking that happens in anticipation of the season. So we think that destock happens throughout the year. You know, when we actually, it's kind of interesting, when we talk to our channel partners, there's still significant demand out there. You know, there's what happened in Florida where we have some of our home builders continuously pushing on us for more products. So we have a bit of a mix taking place where there's demand for the new product. Obviously, everything in the south that we're shipping is the new product. And we started that early. They're starting to ramp in the north to get the new sewer units. There's still demand from some of our key home builder customers, but we do recognize that there is some still destocking that's going to take place through the course of the year. So we'll have to see how the year plays out. You know that this business can swing based on a variety of factors relatively quickly. So we think we've been conservative in how we've handicapped the year and then We'll have to see how these next couple of quarters play out.

And then can you just elaborate a little bit more on what you're expecting on TCC? We get kind of the arithmetic of the headwind on margins as it comes into the fold. But in terms of your internal improvement plan there, Dave, moving margins up over time and what kind of actions you're taking to drive that?

Yeah, I will tell you, you know, we were in Japan and very pleased with the progress that SAFE and the team are making on TCC. You know, we've said that we expect margins, you know, EBIT Roth margins to be in the mid-teens as we get out, you know, five years after the acquisition. We are certainly on track for that. We had said 100 million of synergies. I have a lot of confidence we're going to beat that number. And, you know, if you look, if you kind of get rid of all the noise of eliminating the minority income that we were picking up and the integration costs, you know, right now you're in the low teens as just a standalone business. So that team is making a lot of progress. Technology, best in class. You know, we talked about the rotary technology, the inverter technology. We're using that technology to penetrate the attractive residential heating space. in Europe. There could be applications in North America. Our prospects in China with TCC look extremely strong despite some of the macro uncertainty in China. Japan, we've had to come in aggressive on pricing, rightfully so, and we've been doing that. And there's a lot of cost takeout opportunities, especially in supply chain, where we see the team really looking at aggressive supply chain synergies between the two companies. So I'm very pleased so far.

And by aggressive pricing in Japan, we mean increases.

Yeah, aggressive, I mean, yes. Good point. Yeah. Thank you. Thanks, Jeff.

Thank you. And our next question coming from the line of Nigel Cole with Roof Research. Your line is open.

Thanks. Good morning, everyone.

So it looks like – Good morning. Good morning. Good morning. Good morning. So it looks like low to mid single digit contribution from pricing. So would that be what, 3% to the gross pricing of maybe $600 million for the full year? Is that in the right zone? I'm just curious, how much do you think is coming from carry forward from 2022 actions versus contribution from some of these price increases you're layering in in the first half of this year?

Nigel, the ballpark number you have there, it's in the ballpark. $600 million of carryover in pricing. Most of that, in total pricing, most of that is carryover. We have some new price increases that we've announced as well. We've dialed, of course, some of that in, and we're looking at additional price increases as well.

I'd add, Nigel, you know, it's fluid. We came into the year, and over the last few weeks, we've announced... new price increases that we feel that were appropriate resi announced a six percent price increase for north america light commercial north american commercial we're looking at um up to eight percent recent price increase uh we're gonna raise prices in both north american truck trailer european truck trailers probably in the low to mid single digit range so um you know we watch uh inflation trends we watch our elasticity curves but We do think it's appropriate that we are going to need continued price increases, certainly in the first half of this year.

Normally, if you announce a price increase of, say, 6%, you capture maybe 2% when you net off the normal promotions and maybe some discounts and volume discounts. That hasn't been the case in the last couple of years. I'm just curious, what sort of capture rate do you expect going forward? But maybe if you could just also break down as well how you see the refrigeration segment in 2023. There's a lot of moving parts there. Just curious, with the easier comps you're seeing in the back half of the year, both commercial and transport, how you see the full year playing out within that segment?

Yeah, let me start on pricing realization, a little bit of color on refrigeration, then Patrick will add to the phasing of the year. You know, look, our realization rate on pricing was very high last year, as you know. You know, we came into the year thinking that we'd get a billion of price, and when all was said and done last year, the number was closer to a billion six. So we've seen very high realization rates in pricing, and we would expect that to continue as we go into 23. On refrigeration, I'll tell you at a high level, you're looking at a bit of a mixed bag. North American truck trailer has been very strong. We saw order rates in Q4 over 100%, and that's still without opening the order book effectively for the second half of this year. And they were up 40% for the full year last year. European truck trailer has, you know, we've calibrated that business, we think, well, but, you know, they performed extremely well last year. I think the thing that we're tracking in the refrigeration business is is the container business, which we know was light. Patrick mentioned you're usually looking at about a four-quarter cycle. We're coming off two of down sales. We expect another couple, so we expect to see that start to improve as we get in the second half of this year. And commercial refrigeration was a bit light, but there will be pent-up demand for commercial refrigeration. Some of the supermarket chains in Europe have been squeezing their budgets. They can't do that forever, so We do think that as we go through the year, we start to expect to see commercial refrigeration come back. And I'll tell you, I know that both us and our key peer, who we have a huge amount of respect for, are both claiming that we've gained a lot of share in truck trailers. So mathematically, we both can't be right. But I will tell you that when we look at it customer by customer, we look at our order rates, I can tell you with huge confidence that we've gained share in truck trailer in Europe and in the United States and globally. We feel very good about that business, and we feel good about the snapback as we get into the second half as we start to see the recovery in container and our commercial refrigeration business.

Nigel, a couple of comments on refrigeration. Think of Q1 organic sales being down mid to high single digits, Q2 down mid single digits, and then basically returning to mid single digit growth in the second half of the year. And that is all related to what Dave just mentioned earlier about container, four quarters that we assume to be down, two more to go. Same with commercial refrigeration. And we see continued strong performance in particularly North America truck and trailer. And so that is how we've dialed in the plan for refrigeration, which we expect to be flattish from a full year perspective on an organic sales basis.

That's great, Kaz. Thank you very much. Thanks, Nigel.

Thank you. And our next question coming from the line of Josh Buckley-Winsky with Mark and Stanley Yelanisopan.

Hey, good morning, guys. Hey, Josh. Good morning. Dave, so we've covered a lot of ground on the productivity – I'm sorry, on the demand front. Maybe just shifting over to productivity. I know we don't really talk about like carrier 700 or whatever kind of iteration we're on these days as much now since the last analyst day and kind of have this price-cost productivity formula. Just wondering how versus that $100 million net a year you would think about it for this year and kind of the totality of the pipeline in front of you. Do you feel like you've gotten through a lot of the opportunities since the initial separation? What's still left to go?

We have a huge ways to go, Josh. What happened is we came out of the gates. We had good productivity. Then we saw over the last year a lot of the supply chain headwinds that were fairly unexpected that really hurt a lot of industries. So now as we're starting to come out of that, I think we see significant opportunity. What Patrick said effectively was 300 of productivity plus 200 of price cost positive for a total of five between those two. When we look at it, we think logistics is a big opportunity for us this year. We're starting to see rates come back to more traditional levels for containers coming from Shanghai to LA. We see global logistics. We've paid a lot in high logistics costs In spot buys for electronics, our spot buys for electronics are significantly down month over month, quarter over quarter. We expect that to continue. We think there's a great opportunity with our Tier 1 suppliers. We had been very aggressive on Carrier Alliance, and then we really had to slow some of that activity because our focus became getting parts to feed the lines in the shops, and now we've got to get back into our focus on having partners that we can rely on for the long term that share our desire for joint growth. So we look at it. We see opportunities for productivity in the factories, continued takeout of G&A. You'll recall that we used to be 9.5% as a percent of sales. We got down to 7% at the end of last year. More transfers of work to low-cost places like Europe, going to Eastern Europe, and all things direct material, which is a big percentage of our direct buys. We got away from calling it Carrier 700. We said 2% to 3% productivity forever, and we think we're in early phases of what are significant opportunities for cost takeout.

And, Judge, our guidance is very much aligned with what we shared at Investor Day, $300 million of gross productivity offset by about $200 million of investments and merit and a net $100 million falling through the bottom line. That's in our guidance.

Got it. That's helpful. I appreciate that number, Patrick. And then just shifting gears over to some of the stimulus out there, how do you guys think about some of the opportunities for IRA, whether residential or commercial this year?

Well, we look at the IRA, you know, it's still kind of going through final comments. We see that getting fully implemented towards the middle of the year, but the opportunity there is very significant. You know, you have the 25C tax credits, which can provide a homeowner up to $3,200, you know, really looking at $2,000 for a heat pump. And what was really significant there was they made that in the current drafting, especially in the key parts in the south, that's eligible for the two-stage heat pumps, which means that it really provides a meaningful incentive for a customer not only to shift from cooling only to heat pumps, but also to a two-stage heat pump, which could be significant. It used to be that 30% of our split sales were heat pump. We're now at 35%. we're seeing our growth rates continue to start with threes. And you're seeing 30%, 35% in North America, 30% for commercial heat pumps in Europe. So we think that the Inflation Reduction Act will be meaningful both in residential, but also for commercial. They doubled in that 179D, they doubled the commercial building tax credit up to $2.50 to $5.00 per square foot for energy efficiency systems. So we think that will be meaningful as well. And then there's a whole significant amount of incentives as you get into Europe. Europe effectively dodged a bullet because of the warm winter that it had this past winter, but the supplies are not going to be what they need as they head into the winter of 2023. And that's going to drive significant demand for heat pumps in both residential, which is a space that's very attractive that we're looking to continue to penetrate, And commercial heat pumps were number one in Europe. Good call. I'll leave it there.

Thanks, Josh.

Thank you. And our next question coming from the line of Brad Lindsey with Mizuho Group. Your line is now open.

Hey, good morning, all. Morning.

I wanted to come back to the refrigeration segment. Appreciate all the sales detail there. Was hoping you might be able to put a finer point on the profitability of that weaker container and commercial refrigeration. I imagine that profit profile is much lower, but any way to frame that or provide some context would be great.

The container business is a really attractive business within refrigeration. Our enormous installed base also enables us to go after significant aftermarket, given the 1 million plus units that are out there that we're trying to connect and drive aftermarket revenue. Commercial refrigeration today has lower operating margins, and so they're below 10%. They're probably close to 5% into 10%. But we've taken out a lot of costs, and so as we focus on productivity, irrespective of volume growth, once volume starts to turn, we expect there to be attractive incrementals in commercial refrigeration. So underlying profitability from an operating margin significantly lower than the overall average of the segment, but once volumes kick back in, given the work that we have done, we would expect to see attractive incrementals there.

Got it. Thanks. And then just shifting over to the gross productivity, you noted the $300 million. Patrick, you said $50 million off that Toshiba. What are the balance of those investment priorities? And then, you know, are those signed and sealed for 2023, or is there an opportunity to flex those up and down as needed?

Yeah, go ahead.

No, go ahead. Look, our priorities really center around our shift to Carrier 2.0, which is really around aftermarket, enabling technologies, digital capabilities. So, We have been very purposeful in our plan setting to make sure that we have plenty of investment set aside for abound, for links, for connecting our devices out in the field. That's been our priority. And then all things technical differentiation when it comes to more energy efficient chillers and more energy efficient products, electrification in both heat pumps and in our truck trailer business. So as we do our water line process, there are some investments that we consider sacred because it's either part of our conscious strategic shift or because of differentiation for key product lines. Okay, great. I'll pass it along. Thanks.

Thank you.

Thank you. And our next question coming from the line of DeAndre with RBC. Your line is open.

Thank you. Good morning, everyone.

Good morning.

Hey, Dan. Hey, maybe we start with Patrick. Strong finish to the year on free cash flow, hitting expectations on the revised guidance. Kind of take us through the dynamics, especially on working capital. It sounded like you ended up with higher inventory. Where do you stand on, like, buffer inventory with supply chain issues, and how does that impact the outlook for 23 on free cash flow?

Well, we expect a million, a billion nine in 2023 for free cash flow, which actually does include a tailwind from reduced inventories. And so we know we ended the year with higher inventories than we intended in the beginning of the year. Frankly, it's the main reason why we missed our 1.65 billion targets for the year. So we ended the year, I think it's fair to say, with a few hundred million dollars of more inventory than we expected. I would not call all of that buffer inventory. Some of that, frankly, is related to the length of the supply chain and the lead times that are still not coming back to what we're used to. And so we're assuming that we'll see some continued improvement there in 2023, which will lead to about $100 million or so tailwind from lower inventories in 2023. versus where we end at the year in 22.

That's real helpful. And then, Dave, you had an interesting comment earlier on a question referencing elasticity curves. And it seems like during COVID, everything was inelastic. You saw no demand destruction anywhere. But maybe it's an impact of normalization. There could be some more competitive pressures. But just kind of take it through. some of your insights here on the elasticity curves and setting pricing, what the reactions are, because I don't know, maybe we've lost some muscle memory about how that is just part of the economics here.

Yeah. You know, look, we, in our residential business, we went through something like six significant price increases in the span of 18 months. So I think that what we've seen over the last couple of years is, AN UNUSUAL PACE OF PRICE INCREASES THAT WE'VE NOT ONLY ANNOUNCED, BUT THAT WE'VE ALSO REALIZED. WE DO THINK THAT AS YOU HEAD INTO 23 AND TO 24, YOU GET BACK TO MORE TRADITIONAL LEVELS. BUT IN THE FIRST HALF OF THE YEAR, WE'VE REALIZED THAT INFLATION IS NOT OVER. AND WE'VE HAD TO ANNOUNCE FURTHER PRICE INCREASES IN JANUARY THAT PERHAPS EVEN A COUPLE MONTHS AGO THAT WE MIGHT NOT HAVE ANTICIPATED BECAUSE the inflationary pressures continue to be there. So, you know, it's not equal in all segments. We think we'll probably get less pricing in the container segment right now than we will in commercial HVAC, light commercial, residential to some extent. Parts of our fire and security business, we probably across our brands have implemented over the last couple of weeks, 20 different price increases depending on the segment within fire and security and the brand. So, We'll watch it, but in the first half of the year, we believe that the inflationary pressures are still there and we need to price accordingly.

That's really helpful. Thank you.

Thank you, Dean.

Thank you. And our next question coming from the lineup, Steve Tussauds with J.P. Morgan. Your line is open.

Hey, guys. Good morning. Good morning, Steve.

Good morning. Can you just talk about the trend of what you see on transport refrigeration orders as well as light commercial orders? Those have been very strong. I know the light commercial market is up nicely, but obviously some very big numbers in the context of 50-week lead times in that industry. Just curious as to how you see that trending because there could be some you know, perhaps unusual activity in that market in particular, but maybe how you see those orders trending over the next, you know, several quarters here.

Yeah, I'll start, Steve, with light commercial. Light commercial has just been extremely strong. We saw orders were up in the mid-teens in the fourth quarter. If you look at overall 2022, orders were up 45%, and demand is still strong for things like K-12, value retail, fast, casual, and quick-serve restaurants. So all trends seem extremely positive. The issue we have continues to be with light commercial keeping up demand, where we're implementing second shifts, and our focus is supporting our customers. The issue we have right now, as far as the eye can see, is not a demand one in light commercial. On the transport side, orders were up extremely strong in the fourth quarter in North America, even with us trying to control opening the order book for the second half of 23. North American orders were up 2x, North American truck trailer. Europe truck trailer was down a bit. I would say mid to high single digits, I believe. We have, of course, seen orders very light in the container space, which is why we've calibrated that business down, certainly in the first half of the year. But what's really encouraging is the North American truck trailer piece, the demand remaining very robust there.

And then just one follow-up on the resi side. So you ended the year with inventories just a bit above what you expected in the channel. What signals are you looking for here for demand this year? How confident are you in your distributors projections to, you know, make the assumptions you're making. I mean, how wide is the band of, of outcomes there in your view, given the situation with inventory, it just seems to me that like everybody is throwing out kind of flat to down, but when you kind of ask for the underlying, they, they talk about what happened in the fourth quarter, maybe what happened in January and any, you know, anything that's informing your view and, and maybe a little bit of a, of a ring fence around a band of outcomes there on volume?

Well, you know, it's a good question, Steve. Yeah, we tried to calibrate it, what I would say, conservatively. Now, we'll have to see when all is said and done if it turned out to be conservative, but we put volumes down high single digits for the year with, you know, when we looked at it, we said new home construction down 20%, 25%. I, you know, we have a couple of customers in particular that on their earnings call said that they expect to get to flattish for the year. So will the industry be down 20 to 25%? Perhaps we have outside share in the industry. So in many respects, we should go the way of the industry, but, um, you know, there's a wide range of outcomes there where could it be flat? Could it be down 30? You know, who knows anywhere in that, but again, that's 20, 25% of our residential business, the new home construction. And then on the replacement market, you've been around this longer than I have, but that can swing very significantly in a short cycle business because it's fundamentally a replacement business. And a few hot weeks in the summer, you're going to see demand really pick up significantly. So we think we calibrated volume correctly there, but we'll have to see how the rest of the first half plays out. Again, tough comps in the first quarter. But even just yesterday, we were doing a review of the resi, and demand continues to be there from many of our key customers, and some of our issues are just continuing to keep up with that demand.

Okay, great. Thanks a lot for the call. I appreciate it.

Thank you, Steve.

Thank you. And our last questioner in queue, coming from the line of Gautam Khanna with Cowan. Cowan, your line is open.

Hey, good morning, guys. Good morning. Good morning.

Could you tell us how far out your booking, quoting truck trailer orders?

Yeah, second half of the year. So we've, you know, we looked at it. We're just now opening our order book for the second half of the year. Okay. And was that in Q4 or now, in Q1? Now, I think we might have taken one discrete order for Q3 and Q4 for a specific reason, but basically we only opened our order book now for Q for the second half.

Okay. That's helpful. I was wondering if you could talk about inflation in the supply chain this year on your tier two components. So, you know, not commodities, but, you know, just an aggregate. What is the pressure you're facing from component suppliers and the like.

Well, I know they're not raw materials, but we do see on that piece we should see some benefit. They've been swinging quite a bit. I know that's not the heart of your question, but we sort of buck ourselves on the steel piece, which should be down from last year. Patrick mentioned we have the hangover from really good pricing in the first quarter of last year on steel. So as we get out of 1Q, we see the benefit of that. copper and aluminum down from last year. We did see a bit of an increase recently, but we still expect year over year benefit. And then what we're going to see with our tier ones is you probably have two categories. You have some that have gotten a fair amount of inflation from us and our peers over the last 12 months that will continue to try to push inflation. Then you'll have some that are thinking for the long term and trying to build long-term relationships with us and that we won't get the level of inflation because they will look at trying to take volume from those that continue to push inflation. So for those that, you know, really want to be on the journey with us for the long term, they will be the beneficiaries of volume that we will shift from those that are continuing to push inflation our way. So net-net, it is our job and I think our opportunity to really start to make a very conscious shift of our supply chain partners. And we were on that path. We had to pause it a little bit because of some of the supply chain challenges we saw last year. But I can tell you for sure we're going to get back on that path in a very aggressive way here as we go into 23.

And just last one, Dave. You talked about price and resi. I'm curious. Historically, and maybe what's your view on this cycle with respect to the minimum SEER, the 10% to 15% price point difference between the prior minimum, do you think that holds or does that fade over time? I'm just curious, how sticky is that pricing on the minimum SEER? And thank you. sticky.

Yeah, we have very high confidence that 10 to 15% for the new SEER units will be sticky. It's been sticky thus far. We think it will remain sticky as we go through 23 and beyond. And, you know, look, we've all taken slightly different approaches. We took the approach for the new SEER unit to do more redesign rather than less and look for more differentiation. And we've done that. We've driven more of a copper to aluminum shift we've driven a micro channel heat exchanger we've done a lot of aesthetic and fit and spacing and size so we've done a lot to make that our new sear unit a very very attractive and differentiated and one of the big things will be some of the controls features as well so we think that because of the value we're offering and because of what the customer is getting we think the pricing will be sticky

Thank you. Thank you.

Thank you. I will now turn the call back over to management for any closing remarks.

Okay. Well, thank you, everyone, for joining. We're excited about how we closed last year and even more excited about 23. And with that, we'll close the call. And please reach out to Sam for any questions. Thank you all.

Ladies and gentlemen, that's our conference for today. Thank you for your participation. You may now disconnect. Good morning, ladies and gentlemen, and welcome to Carrier's Fourth Quarter 2022 Earnings Conference Call. I would like to introduce your host for today's conference, Sam Perlstein, Vice President of Investor Relations. Please go ahead, sir.

Thank you, and good morning, and welcome to Carrier's Fourth Quarter 2022 Earnings Conference Call. With me here today are David Gitlin, Chairman and Chief Executive Officer, and Patrick Orr, Chief Financial Officer. We will be discussing certain non-GAAP measures on this call, which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to GAAP figures in our earnings presentation, which is available to download from Carrier's website at ir.carrier.com. 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. Once the call is open 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.

Thank you, Sam, and good morning, everyone. Our Q4 results for sales, earnings, and cash flow were all in line with our expectations, as you can see starting on slide two. We delivered organic sales growth of 5% supported by another quarter of double-digit growth in light commercial and commercial HVAC, global truck and trailer, and aftermarket. Pricing remained strong and our realization continued to offset inflationary headwinds. Supply chain improvements continued. allowing for reduction of our past due shipments with further improvements anticipated in 2023. Our backlog, which ended up mid-single digits year over year, up 40% on a two-year stack, and up 2x from 2019, remains at very healthy levels. Adjusted operating margins of 10.1% were flattish compared to last year, despite a 70 basis point impact from the consolidation of the Toshiba joint venture. We made great progress on our productivity initiatives in the quarter and achieved our full year target of $300 million in savings. Adjusted EPS was $0.40 in the quarter at the high end of our guidance range. We generated about $1 billion of free cash flow in the quarter ending 2022 with $3.5 billion of cash, allowing us to continue to play offense with capital deployment as we head into 2023. Moving to slide three. I am proud of our team's accomplishments last year. We delivered on our full year outlook for sales, adjusted operating margin, and adjusted EPS while significantly advancing our strategic priorities. We drove 8% organic sales growth, adjusted operating margin expansion of 60 basis points, and adjusted EPS growth of about 15% when we exclude the impact of the Chubb divestiture. But we did fall short of our original 1.65 billion free cash flow guide, as we discussed in October, resulting from supply chain and related inventory challenges. We did deliver on our revised guidance of 1.4 billion as a result of our strong Q4 performance. So our track record of delivering results without surprises continues, and our team is poised to continue to deliver in 2023, in part because of key secular trends that drive demand, as you can see on slide four. Our customers continue to look to us for healthy and sustainable solutions, and we have differentiated offerings that meet their needs, particularly in the fast-growing heat pump space. Our North America residential heat pump sales grew 35% in the quarter, and our European commercial heat pump sales were up 30%. We expect those areas to only grow stronger as the Inflation Reduction Act and the Repower EU Initiative propel increased adoption. Additionally, Toshiba's innovative and leading inverter technology continues to impress. When combined with our multi-rotary compressors, heat pump efficiency and capacity dramatically improve. Toshiba's technology and expertise are also helping us penetrate the attractive and growing residential heat pump market in Europe. Our position in transport electrification is also market-leading. We have units operating in 15 countries and plan to ramp significantly with more than half of refrigerated transport units sold to be electric by 2030. The healthy building trends continued to be a positive in the quarter as orders were up over 80% and our pipeline increased to over $1 billion. For the full year, healthy building orders were up about 50%. K through 12 also remains encouraging, with our pipeline up about 60% year over year, and with almost two-thirds of the federal government's ESSER funds yet to be allocated, we expect further acceleration into 2023. As we continue to distinguish ourselves as a climate systems and solutions company, we remain focused not only on achieving our own ESG goals, but also helping our customers achieve theirs as well. We recently increased our previous aggressive 2030 net zero targets, committing to set greenhouse gas emission reduction targets in line with the science-based target initiative criteria. Additionally, Carrier continues to be recognized in the ESG space, including distinguished recognition in London where our customer's heating network will provide a 50% reduction in carbon emissions to network participants. We also continue to perform on our aftermarket growth objectives, as you can see on slide five. When we became a standalone public company in early 2020, we emphasized increasing aftermarket growth rates from historical low single-digit levels, and last year we produced another year of double-digit aftermarket growth. Our focus remains on providing differentiated digital solutions through our Abound and Lynx platforms and connecting not only our new products, but also our significant install base. Our Bound technology now monitors over 1 billion square feet, and we recently onboarded over 100 commercial office sites for a key large-scale customer. We recently released the Bound Net Zero Management, which provides customers with an easy way to view, track, and analyze energy usage and emissions data across their global footprints and proactively identify conservation measures. We've made similar progress with our innovative Lynx platform and launched several new capabilities in the quarter. We expanded our reefer health capabilities to include early refrigerant leak detection and launched a managed services Lynx fleet offering for a major grocery retail chain in the U.S. We achieved our goal of having 70,000 chillers under long-term agreements by the end of 2022 and expect to increase that by another 10,000 in 2023. Importantly, we also achieved our objective of having 20,000 connected chillers and plan to connect another 10,000 this year. We recently announced a strategic collaboration agreement with Amazon Web Services to jointly build, market, and sell Carrier's digital solutions. Not only are we delivering on our financial and strategic imperatives, we are also making great progress on our portfolio optimization and executing on our capital deployment priorities as you can see on slide six. You'll recall that at the time of our spin, we carried approximately $11 billion of debt on our balance sheet in cash of about $1 billion. Over the course of just two and a half years, we have reduced our net debt levels nearly in half from that $10 billion level to $5.3 billion, while increasing our strategic organic growth investments by over $300 million. We have also completed a number of compelling acquisitions highlighted by the consolidation of Toshiba Carrier. All acquisitions have been strategic and core to our business, focused on enhancing sustainability leadership, accelerating aftermarket growth, driving digital and technology differentiation, and expanding adjacencies and geographic coverage. We've also been disciplined in evaluating our existing portfolio to ensure each business is core and that we are the best owner. As a result, we optimized our portfolio by completing the sale of Chubb and our shares, completing the sale of Chubb and our shares in Bayer while also reducing our minority joint venture count from 41 to 29 since spin. In addition to our portfolio moves, we've been disciplined and proactive with our other capital deployment actions. We have steadily and consistently increased our dividend and have completed about $2 billion in share repurchases, excuse me, since spin. All of this to say we have made great progress over the last few years, but that does not mean that we are done. We are always evaluating acquisitions in our current portfolio for potential opportunities for simplification and value creation. We will remain steadfast in our commitment to keep evaluating our portfolio as we enter 2023 and beyond. Patrick will cover our 2023 guidance in more detail, but I will emphasize a few highlights on slide seven. Focus remains very thematic for us. All of our 52,000 team members are aligned on our key priorities, and those priorities remain consistent. Carrier 2.0 is a term that we have been using internally, which represents a very purposeful shift from a primary focus on selling equipment to now using digital and innovation to provide our customers with sustainable and healthy outcomes throughout the lifecycle of our product and service offerings. The result will be our continued pursuit of higher margin, high aftermarket growth rates. We remain focused on reducing costs and expect to get another $300 million in productivity in 2023. We are clear-eyed about the broader economic challenges and uncertainty in 2023, and have done our best to calibrate macro factors in our guidance that you see along the left of this slide. We expect to deliver solid organic growth, strong margin expansion, excluding TCC, and high single digit to low double digit adjusted EPS growth. Strong free cash flow and a very healthy balance sheet enable us to play offense on capital deployment. With that, let me turn it over to Patrick. Patrick?

Thank you, Dave, and good morning, everyone. Please turn to slide 8. In short, Q4 was very much in line with our expectations and the guide we provided. Reported sales were $5.1 billion, with 5% organic sales growth driven by about 8% price, with volume down a couple of points. I'll provide a bit more detail on a future slide, but in essence, we saw continued strong organic growth in HVAC, fight on security, and global truck and trailer, which was partially offset by a very weak quarter in container and, to a lesser extent, commercial refrigeration. The Chubb divestiture reduced sales by 10% in acquisitions. Substantially, all Toshiba carrier increased sales by 8%. Currency translation was a headwind of 4%. All segments were price-cost positive or neutral in the quarter. Q4 adjusted operating margin was about flat compared to last year, driven by a 70-bit margin headwind related to the TCC acquisition. Strong productivity almost completely offset the margin headwinds related to the lower volume and the TCC acquisition. Adjusted EPS of $0.40 was consistent with the upper end of our full-year guidance range. For your reference, we have included the year-over-year Q4 adjusted EPS bridge in the appendix on slide 20. $1 billion of free cash flow in the quarter was also as expected, and we generated about $1.4 billion for the full year. Moving on to the segments, starting on slide 9. HVAC reported sales included a 16% benefit from the TCC acquisition. HVAC organic sales were up 9%, driven by low single-digit growth in residential, OVER 40% GROWTH IN LIGHT COMMERCIAL AND MID-TEENS GROWTH IN COMMERCIAL AGE BACK. SALES GROWTH WAS DRIVEN BY BOTH PRICE AND VOLUME. RESIDENTIAL MOVEMENT WAS DOWN ABOUT 10% IN THE FOURTH QUARTER AND QUARTER END FIELD INVENTORY LEVELS ENDED UP HIGHER THAN THE FLAT YEAR-OVER-YEAR LEVELS WE TARGETED. RESIDENTIAL AGE BACK GROWTH WAS DRIVEN BY PRICE AS VOLUME WAS DOWN MID-SINGLE DIGITS. COMMERCIAL AGE BACK had another very strong quarter with double-digit sales growth in applied equipment, aftermarket, and controls. All regions grew double digits. Adjuster operating margin was up 60 bps with volume, price, cost, and productivity more than offsetting a 100 bps margin headwind related to TCC. Full year operating margin for this segment was 15.2%. In line with the guide we provided post the TCC acquisition, which had about a 70 bps dilutive impact on 2022 for this segment. Transitioning to refrigeration on slide 10. Organic sales were down 7%, and currency translation was also a 7% headwind. Within transport refrigeration, North America truck and trailer sales were up low teens, and European truck and trailer was up high teens. This continued strong performance was more than offset by container, which was down about 50% year over year, driven by demand softness, as well as a tough comp in the prior year. This is the second consecutive down quarter for the container business, and historical down cycles for this business have lasted about four quarters. Commercial refrigeration was down high single digits year over year, as our European food retail customers continue to be pressured by inflation and energy prices. Adjusted operating margins for this segment were up 60 bps compared to last year, despite lower sales, with the margin headwind of lower volume more than offset by productivity and price cost. Full year operating margin of 12.8% was slightly ahead of our 12.5% guide, and expanded over 70 bps compared to 2021 despite lower sales as our refrigeration team managed price cost and delivered strong full year productivity to offset the impact of lower volume. Moving on to fire and security on slide 11. As expected, the Chubb divestiture had a significant impact on reported sales. Organic sales growth was 6% driven by price with volume down low single digits. Operating margin was short of our expectations for this segment due to continued high supply chain and logistics costs and operational performance challenges. As a result, full year operating margin of 15.2% for this segment was short of our 16% operating margin guide. Slide 12 provides more details on backlog and orders performance. As our backlogs normalize in some of our shorter cycle businesses, such as residential HVAC, we expect order trends to adjust accordingly. We've seen that trend over the last few quarters and in Q4 particularly. As you can see on the left side, total company organic orders were down roughly 10% for the quarter and up compared to 2019 and 2020. Backlog ended the year up mid-single digits compared to last year, with backlog growth in HVAC and fire and security partially offset by backlog reduction in refrigeration. As expected, residential HVAC orders were down in Q4. Light commercial demand remained robust as orders were up mid-teens in the quarter. The backlog is up well over 2x for that business. Commercial HVAC saw double-digit orders growth for the eighth consecutive quarter. The commercial backlog is now up 35% compared to last year and extends well into 2023. Refrigeration orders were down roughly 10% in the quarter, driven by market weakness in container and commercial refrigeration that was only partially offset by global truck and trailer. North America truck and trailer continued to have strong orders in the quarter, up over 100% compared to last year. Global truck and trailer backlog is up high single digits as the strength in North America offset order weakness in Europe. Container orders were down about 50% compared to a very strong fourth quarter last year. Commercial refrigeration orders remain weak and reflect market softness. Finally, demand for our fire and security products was mixed. Orders were positive in roughly half of the businesses, including residential fire and access solutions. Fire and security products backlog is up almost 30% year-over-year, with double-digit growth in all the businesses except residential fire in the Americas. Overall, we entered 2023 with strong backlogs and continued strong order trends in commercial and light commercial HVAC and North American truck and trailer. Businesses experiencing softer order intake include container, commercial refrigeration, and residential HVAC. Now moving on to our 23 guidance on slide 13. We expect reported sales of about $22 billion, including organic sales growth of low to mid-single digits. Almost all the organic growth will be priced as we expect volume growth to be flattish. We expect currency translation to be about a point headwind, while acquisitions, primarily the impact of Toshiba Carrier, will contribute about 6% to the growth. Adjusted operating profit is expected to be up compared to 2022, with operating margin at about 14%, including a 50 bps dilutive impact from Toshiba Carrier. We expect high single-digit to low double-digit adjusted EPS growth in 2023. I WILL PROVIDE MORE COLOR ON THAT ON THE NEXT SLIDE. WE EXPECT A 23% ADJUSTED EFFECTIVE TAX RATE AND FULL YEAR FREE CASH FLOW ABOUT $1.9 BILLION OR ABOUT 100% OF NET INCOME. OUR FREE CASH FLOW GUIDANCE ASSUMES APPROXIMATELY $75 MILLION OF CASH RESTRUCTURING PAYMENTS AND ABOUT $100 MILLION TAX HEADWIND SINCE CONGRESS HAS NOT RENEWED THE FULL EXPENSING OF RND. As shown on the right side of the slide, we expect mid single digit organic growth in HVAC as continued strong growth in light commercial, commercial HVAC and aftermarket are more than offset flat residential. Reported HVAC sales growth should be in the low team, in the low double digits, given the additional contribution from seven more months of consolidating Toshiba carrier. In refrigeration, We expect flat as organic sales as continued strong growth in global truck and trailer is offset by container and commercial refrigeration. For fire and security, we expect low single digit organic growth. We expect the HVAC segment operating margin to be similar in 2022, despite absorbing about 100 bits of pressure from the consolidation of Toshiba and expect operating margin expansion in refrigeration and fire and security. Let's move to slide 14, adjusted 2023 EPS bridge at our guidance midpoint. Our operating profit is expected to be up about $200 million despite flattish volume growth. Price cost and gross productivity combined are an expected operating profit tailwind of $500 million with $200 million coming from price cost and $300 million coming from gross productivity. Annual merit adjustments and investments amount to about $200 million in total, and we expect about a $50 million additional headwind of PCC integration costs. There are some other minor, smaller moving pieces, but that all adds up to roughly $200 million in increased adjusted operating profits. Core earnings conversion. which excludes the impact of acquisitions, divestitures, and effects, is about 35% at the guidance midpoint. Moving to the right on the bridge, some modest savings on net interest expense and a lower share count offset the expected higher tax rate and currency translation headwinds. That gets us to our midpoint of about 255 for next year, or 9% growth compared to 2022. As usual, we provide estimates of other items in the appendix on slide 19. On slide 15, you'll see that our capital allocation priorities remain the same. In 2023, we expect about $400 million in capital expenditures. We recently announced another significant dividend increase, and our dividend payout ratio is about 30%. Finally, we target $1.5 to $2 billion in share repurchases in 2023. Before I turn it over to Dave, let me provide some additional color on the first quarter. We expect a six cent headwind from a higher effective tax rate of about 25% compared to 16% last year. In addition, we expect our first quarter to be the weakest quarter from an organic revenue growth perspective with organic sales growth flat and volumes down. This reflects continued growth in the HVAC and fire and security segments and a decline in the refrigeration segment driven by container and commercial refrigeration. We expect residential HVAC to be down mid-single digits in Q1. Recall that our Q1-22 residential HVAC sales were up an industry-leading 23%, so certainly a tough comp for that business. Overall, We expect revenues in Q1 to be a little over $5 billion and adjusted EPS to be between 45 and 50 cents. We expect first half adjusted EPS to be about 45 to 50% of full year earnings, the reverse of 2022. And as usual, free cash flow will be more weighted to the second half. We expect organic revenue growth to sequentially improve after Q1 with easier comps in the second half of 2023. With that, I'll turn it back to Dave for slide 16.

Thanks, Patrick. We delivered strong performance in 2022, and we are targeting another strong year this year as we continue to execute and control the controllables. We continue to see opportunities to use our strong balance sheet to create value for our customers, shareholders, and the planet for future generations to come. With that, we'll open this up for questions.

Thank you. Ladies and gentlemen, to ask a question, you will need to press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. To be fair to everyone, please limit yourself to one question and one follow-up.

Please stand by while we compile the Q&A roster.

And our first question coming from the line of Julian Mitchell with Barclays. Your line is open.

Hi, good morning. Just wanted to start with maybe, good morning, maybe start with the first quarter outlook there.

So it sounds as if you've got maybe the operating margins firm-wide down, you know, perhaps sort of 200 to 300 points or so year on year. Just wanted to check if that's the case, and is the bulk of that downdraft really coming in HVAC, presumably? And if it is, kind of what's the confidence that you can get back to full year margins in HVAC being flattish, given the headwinds in the resi for the year?

Julian, good morning. Patrick here. Margins in Q1, we expect them to be down about 200 basis points, and there are really three elements to it. One, acquisitions, and that is HVAC-specific, expected to add over $500 million of revenue, but with very little operating profit contribution. Two, volume mix, as I mentioned, is expected to be down in the first quarter. That's not – that is really – not just in residential HVAC, but is also impacting, of course, the refrigeration segment. That's a secondary contribution to the 200 bps or so margin contraction in Q1. The third element is price cost. We expect price cost to be close to neutral in Q1, which actually is a headwind to margins in the first quarter. And that is across the three segments. So that gets to about a 200 bps margin contraction in the first quarter. In the second quarter, we would expect to return to year-over-year EPS growth.

That's helpful. Thank you. And maybe just following up, Patrick, on the HVAC segment overall for the year. So I think you talked about flattish margins there at sort of 15% plus. in that business, and you've got organic sales guided up about mid-single digit for the year. Maybe just clarify for us what you're expecting there on your residential volumes, perhaps, within that guide, and then any sort of weighting on things like the productivity savings, just trying to understand where you get the offset in that HVAC margin. if there's a mixed headwind, and the TCC margin headwind as well.

Well, Julian, let me start with a little bit of color on kind of resi and what we're seeing across the mix between resi light commercial and commercial. And then Patrick can give a little bit of color on the margins themselves. We do expect for resi in 2023, we're expecting flat sales, flattish sales. But we get there with volume being down potentially high single digits offset by mix and price. So when you think about resi, we're looking at new construction potentially down 20%, 25%. Now remember, that's only about 20%, 25% of resi. But some of our customers are saying it could be much better than that. Some are saying it's in that range. So we'll have to see as we get into the second half of the year. But we've calibrated. RESIDENTIAL NEW CONSTRUCTION DOWN 20%, 25%, AND REPLACEMENT DOWN MID-SINGLE DIGITS. WE ARE SEEING THAT OFFSET THAT GETS US TO FLATTER SALES FOR THE YEAR DRIVEN BY MIX AND PRICE. SO WE HAVE SOME PRICE CARRY OVER. WE'VE JUST ANNOUNCED A NEW PRICE INCREASE OF 6% THAT'S EFFECTIVE IN MARCH. WE'RE GOING TO MIX UP THIS YEAR, AS YOU KNOW, BECAUSE OF THE NEW SEER UNITS THAT ARE COMING IN THAT WE'RE PRICING 10% TO 15% HIGHER, AND WE'RE ALSO SEEING A MIX UP as we transition to heat pumps. Also in the mix is that we do see a strong year for light commercial, which was, as Patrick said, up 40% in the fourth quarter. That continues to be very strong. And our backlogs in commercial with a nice mix with aftermarket up double digits, controls up double digits, helping that piece. Patrick, maybe comment on the full year.

On the margins, Julian, we're comfortable with the margin outlook for HVAC in 2023 of about 15%. Dave mentioned about the aftermarket. But I did also mention that price cost is expected to be a tailwind for us of $200 million in the year. That dials in some benefits from what we call deflation. A lot of that sits in the HVAC segment. In addition, I mentioned that we're focused on delivering another $300 million of productivity in 2023. We did the same in 2022. And of course, given the size of the HVAC segment, a sizable size, of course, is in that segment as well. So we're comfortable with those 15% margins for the full year. Great. Thank you.

Thank you. Thank you.

Thank you. One moment please for our next question. And our next question coming from the line of Joe Ritchie with Goldman Sachs. Your line is open.

Thanks. Good morning, guys. Hey, Joe. Good morning. Good morning. Can we touch on that price-cost neutral comment in 1Q? I guess that's a little surprising to me, just given that, you know, price was probably, you know, there's probably a good carryover effect occurring from 2022. And then from a cost perspective, I'm just wondering, is there like higher cost inventory that's coming through? Is it a function of like the merit increases being more front-end loaded? Just any more color you can provide on that price-cost neutral in 1Q would be helpful.

Yeah, and the short of it is, and it's mostly in HVAC, is the first quarter of 2022, we were left in at some really attractive pricing from a steel point of view. And the year-over-year impact is actually a net negative for us. As I mentioned to Julian just earlier, we are dialing in a benefit from deflation. That kicks in the second quarter of 2023. In Q1, we still have a headwind, particularly in steel, that affects HVAC.

Got it. That's helpful, Patrick. And then I guess I'm just going to stick on margins and just want to understand, you know, some of the operational challenges that you guys faced in the fire and security business this quarter. And then also, as I kind of think about the 2023 guide, it doesn't seem to imply that much margin growth in the segment. So just maybe just kind of talk us through what some of the issues are and how those are supposed to rectify in 2023.

Yeah, if I look at the margin performance in finance security, it was up year over year in the fourth quarter by 60 basis points. And the way you can think about it is the absence of Chubb is a tailwind to margins. Volume mix and price cost was a slight headwind to margins. The net was still a margin expansion of 60 basis points. The margins were lower than what we expected. Supply input costs and higher supply chain costs than what we expected. Two, inventory is not aligned with where the business is today. And that has some operational impacts which we experienced in the fourth quarter of the year. And so we have to work through that. And that is what we expect for 2023. And therefore, we expect with minimal volume growth in 2023 to have margin expansion in fire and security. The revenue growth we expect in fire and security in 23 is mostly price-driven, less volume-driven.

Got it. Thank you. Thank you, Joe.

Thank you, Juan. One moment, please, for our next question. And our next question, coming from the lineup, just right with Vertical Research Partners, Yolanda Selfin.

Thank you. Good morning, everyone. Good morning, Jeff. Dave and Patrick, that color you gave on resi obviously encompasses what's going on with field inventories. But maybe you could elaborate a little bit more on how inventories ended versus your expectation and how you think they kind of normalized over the balance of the year.

Yeah, Jeff, we had a target of getting field inventories at the end of last year flat to where they ended 21. And they were actually a bit higher than we had targeted. Not excessively higher, but just, I would say, a bit higher. And we do think that there will be destocking as we go through the year. Obviously, when you're in the first quarter, there's some level of stocking that happens in anticipation of the season. So we think that destock happens throughout the year. You know, when we actually, it's kind of interesting, when we talk to our channel partners, there's still significant demand out there. You know, there's what happened in Florida, where we have some of our home builders continuously pushing on us for more products. So we have a bit of a mix taking place where there's demand for the new product. Obviously, everything in the southeast that we're shipping is the new product. And we started that early. They're starting to ramp in the north to get the new sewer units. There's still demand from some of our key home builder customers, but we do recognize that there is some still destocking that's going to take place through the course of the year. So we'll have to see how the year plays out. You know that this business can swing based on a variety of factors relatively quickly. So we think we've been conservative in how we've handicapped the year and then We'll have to see how these next couple of quarters play out.

And then can you just elaborate a little bit more on what you're expecting on TCC? We get kind of the arithmetic of the headwind on margins as it comes into the fold. But in terms of your internal improvement plan there, Dave, moving margins up over time and what kind of actions you're taking to drive that?

Yeah, I will tell you, you know, we were in Japan and very pleased with the progress that SAFE and the team are making on TCC. You know, we've said that we expect margins, you know, EBIT Roth margins to be in the mid-teens as we get out, you know, five years after the acquisition. We are certainly on track for that. We had said 100 million of synergies. I have a lot of confidence we're going to beat that number. And, you know, if you look, if you kind of get rid of all the noise of eliminating the minority income that we were picking up and the integration costs, you know, right now you're in the low teens as just a standalone business. So that team is making a lot of progress. Technology, best in class. You know, we talked about the rotary technology, the inverter technology. We're using that technology to penetrate the attractive residential heating space. in Europe. There could be applications in North America. Our prospects in China with TCC look extremely strong despite some of the macro uncertainty in China. Japan, we've had to come in aggressive on pricing, rightfully so, and we've been doing that. And there's a lot of cost takeout opportunities, especially in supply chain, where we see the team really looking at aggressive supply chain synergies between the two companies. So I'm very pleased so far.

And by aggressive pricing in Japan, we mean increases.

Yeah, aggressive, I mean, yes. Good point. Yeah. Thank you. Thanks, Jeff.

Thank you. And our next question coming from the line of Nigel Cole with Wolf Research. Your line is open.

Thanks. Good morning, everyone.

So it looks like – Morning, Nigel. Good morning. Good morning. Good morning. So it looks like low to mid-single contribution from pricing. So would that be what, 3% to the gross pricing of maybe $600 million for the full year? Is that in the right zone? I'm just curious, how much do you think is coming from carry forward from 2022 actions versus contribution from some of these price increases you're layering in in the first half of this year?

Nigel, the ballpark number you have there, it's in the ballpark. $500, $600 million of carryover in pricing. Most of that, in total pricing, most of that is carryover. We have some new price increases that we've announced as well. We've dialed, of course, some of that in, and we're looking at additional price increases as well.

I'd add, Nigel, you know, it's fluid. We came into the year, and over the last few weeks, we've announced... new price increases that we feel that were appropriate. Resi announced a 6% price increase for North America light commercial and North American commercial. We're looking at up to 8% recent price increase. We're going to raise prices in both North American truck trailer, European truck trailers, probably in the low to mid single digit range. So, you know, we watch inflation trends. We watch our elasticity curves, but We do think it's appropriate that we are going to need continued price increases, certainly in the first half of this year.

Normally, if you announce a price increase of, say, 6%, you capture maybe 2% when you net off the normal promotions and maybe some discounts and volume discounts. That hasn't been the case in the last couple of years. I'm just curious, what sort of capture rate do you expect going forward? But maybe if you could just also break down as well how you see the refrigeration segment in 2023. There's a lot of moving parts there. Just curious, with the easier comps you're seeing in the back half of the year, both commercial and transport, how you see the full year playing out within that segment?

Yeah, let me start on pricing realization, a little bit of color on refrigeration, then Patrick will add to the phasing of the year. You know, look, our realization rate on pricing was very high last year, as you know. You know, we came into the year thinking that we'd get a billion of price, and when all was said and done last year, the number was closer to a billion six. So we've seen very high realization rates in pricing, and we would expect that to continue as we go into 23. On refrigeration, I'll tell you at a high level, you're looking at a bit of a mixed bag. North American truck trailer has been very strong. We saw order rates in Q4 over 100%, and that's still without opening the order book effectively for the second half of this year. And they were up 40% for the full year last year. European truck trailer has, you know, we've calibrated that business, we think, well, but, you know, they performed extremely well last year. I think the thing that we're tracking in the refrigeration business is is the container business, which we know was light. Patrick mentioned you're usually looking at about a four-quarter cycle. We're coming off two of down sales. We expect another couple, so we expect to see that start to improve as we get in the second half of this year. And commercial refrigeration was a bit light, but there will be pent-up demand for commercial refrigeration. Some of the supermarket chains in Europe have been squeezing their budgets. They can't do that forever, so We do think that as we go through the year, we start to expect to see commercial refrigeration come back. And I'll tell you, I know that both us and our key peer, who we have a huge amount of respect for, are both claiming that we've gained a lot of share in truck trailers. So mathematically, we both can't be right. But I will tell you that when we look at it customer by customer, we look at our order rates, I can tell you with huge confidence that we've gained chair in truck trailer in Europe and in the United States and globally. So we feel very good about that business, and we feel good about the snapback as we get into the second half as we start to see the recovery in container and our commercial refrigeration business.

Nigel, a couple of comments on refrigeration. Think of Q1 organic sales being down mid to high single digits. Q2 down mid-single digits, and then basically returning to mid-single digit growth in the second half of the year. And that is all related to what Dave just mentioned earlier about container, four quarters that we assume to be down, two more to go, same with commercial refrigeration, and we see continued strong performance in particularly North America truck and trailer. And so that is how we've dialed in the plan refrigeration, which we expect to be flattish from a full-year perspective on an organic sales basis.

That's great, Kyle. Thank you very much. Thanks, Nigel.

Thank you. And our next question coming from the line of Josh Buckbewinski with Morgan Stanley. Your line is open.

Hey, good morning, guys.

Hey, Josh. Good morning.

Dave, so we've covered a lot of ground on the productivity – I'm sorry, on the demand front. Maybe just shifting over to productivity. I know we don't really talk about like carrier 700 or whatever kind of iteration we're on these days as much now since the last analyst day and kind of have this price-cost productivity formula. Just wondering how versus that $100 million net a year you would think about it for this year and kind of the totality of the pipeline in front of you. Do you feel like you've gotten through a lot of the opportunities since the initial separation? What's still left to go?

We have a huge ways to go, Josh. What happened is we came out of the gates. We had good productivity. Then we saw over the last year a lot of the supply chain headwinds that were fairly unexpected that really hurt a lot of industries. So now as we're starting to come out of that, I think we see significant opportunity. What Patrick said effectively was 300 of productivity plus 200 of price cost positive for a total of five between those two. When we look at it, we think logistics is a big opportunity for us this year. We're starting to see rates come back to more traditional levels for containers coming from Shanghai to L.A., We see global logistics. We've paid a lot in high logistics costs, in spot buys for electronics. Our spot buys for electronics are significantly down month over month, quarter over quarter. We expect that to continue. We think there's a great opportunity with our Tier 1 suppliers. We had been very aggressive on Carrier Alliance, and then we really had to slow some of that activity because our focus became getting parts to feed the lines in the shops, and now we've got to get back into our focus on having partners that we can rely on for the long term that share our desire for joint growth. So we look at it. We see opportunities for productivity in the factories, continued takeout of G&A. You'll recall that we used to be 9.5% as a percent of sales. We got down to 7% at the end of last year. More transfers of work to low-cost places like Europe, going to Eastern Europe, and all things direct material, which is a big percentage of our direct buys. So We got away from calling it Carrier 700. We said 2% to 3% productivity forever, and we think we're in early phases of what are significant opportunities for cost takeout.

And, Judge, our guidance is very much aligned with what we shared at Investor Day, $300 million of gross productivity offset by about $200 million of investments and merit and a net $100 million falling through the bottom line. That's in our guidance.

Got it. That's helpful. I appreciate that number, Patrick. And then just shifting gears over to some of the stimulus out there, how do you guys think about some of the opportunities for IRA, whether residential or commercial this year?

Well, we look at the IRA, you know, it's still kind of going through final comments. We see that getting fully implemented towards the middle of the year, but the opportunity there is very significant. You know, you have the 25C tax credits, which can provide a homeowner up to $3,200, you know, really looking at $2,000 for a heat pump. And what was really significant there was they made that in the current drafting, especially in the key parts in the south, that's eligible for the two-stage heat pumps, which means that it really provides a meaningful incentive for a customer not only to shift from cooling only to heat pumps, but also to a two-stage heat pump, which could be significant. It used to be that 30% of our split sales were heat pump, we're now at 35%. We're seeing our growth rates continue to start with threes. And you're seeing the same, you know, 30%, 35% in North America, 30% for commercial heat pumps in Europe. So we think that the Inflation Reduction Act will be meaningful both in residential, but also for commercial. You know, they doubled in that 179D, they doubled the commercial building tax credit up to $2.50 to $5 per square foot for energy efficiency systems. So we think that will be meaningful as well. And then there's a whole significant amount of incentives as you get into Europe. Europe effectively dodged a bullet because of the warm winter that it had this past winter, but the supplies are not going to be what they need as they head into the winter of 2023. And that's going to drive significant demand for heat pumps in both residential, which is a space that's very attractive that we're looking to continue to penetrate, and commercial heat pumps, where we're number one in Europe. Good call. I'll leave it there. Stay good.

Thanks, Jeff. Josh.

Thank you. And our next question coming from the line of Red Lindsey with Mizuho Group. Your line is now open.

Hey, good morning, all. Good morning. Wanted to come back to the refrigeration segment. Appreciate all the sales detail there. Was hoping you might be able to put a finer point on the profitability of that weaker container and commercial refrigeration. I imagine that profit profile is, you know, much lower. But any way to frame that or provide some context would be great.

The container business is a really attractive business within refrigeration. Our enormous installed base also enables us to go after significant aftermarket, given the 1 million plus units that are out there that we're trying to connect and drive aftermarket revenue. Commercial refrigeration today has lower operating margins, and so they're below 10%. They're probably close to 5% into 10%. But we've taken out a lot of costs, and so as we focus on productivity, irrespective of volume growth, once volume starts to turn, we expect there to be attractive incrementals in commercial refrigeration. So underlying profitability from an operating margin significantly lower than the overall average of the segment. But once volumes kick back in, given the work that we have done, we would expect to see attractive incrementals there.

Got it. Thanks. And then just shifting over to the gross productivity, you noted the 300 million. Patrick, you said $50 million offset to Toshiba. What are the balance of those investment priorities? And then, you know, are those signed and sealed for 2023, or is there an opportunity to flex those up and down as needed?

Yeah, go ahead. Look, our priorities really center around our shift to Carrier 2.0, which is really around aftermarket, enabling technologies, digital capabilities. So, We have been very purposeful in our plan setting to make sure that we have plenty of investment set aside for abound, for links, for connecting our devices out in the field. That's been our priority. And then all things technical differentiation when it comes to more energy efficient chillers and more energy efficient products, electrification in both heat pumps and in our truck trailer business. So as we do our water line process, there are some investments that we consider sacred because it's either part of our conscious strategic shift or because of differentiation for key product lines. Okay, great. I'll pass it along. Thanks.

Thank you.

Thank you. And our next question coming from the line of DeAndre with RBC. Your line is open.

Thank you. Good morning, everyone.

Good morning.

Hey, Dan. Maybe we start with Patrick. Strong finish to the year on free cash flow, hitting expectations on the revised guidance. Kind of take us through the dynamics, especially on working capital. It sounded like you ended up with higher inventory. Where do you stand on, like, buffer inventory with supply chain issues, and how does that impact the outlook for 23 on free cash flow?

Well, we expect a million, a billion nine in 2023 for free cash flow, which actually does include a tailwind from reduced inventories. And so we know we ended the year with higher inventories than we intended in the beginning of the year. Frankly, it's the main reason why we missed our 1.65 billion targets for the year. So we ended the year, I think it's fair to say, with a few hundred million dollars of more inventory than we expected. I would not call all of that buffer inventory. Some of that, frankly, is related to the length of the supply chain and the lead times that are still not coming back to what we are used to. And so we're assuming that we'll see some continued improvement there in 2023, which will lead to about $100 million or so tailwind from lower inventories in 2023. versus where we end at the year in 22.

That's real helpful. And then, Dave, you had an interesting comment earlier on a question referencing elasticity curves. And it seems like during COVID, everything was inelastic. You saw no demand destruction anywhere. But maybe it's an impact of normalization. There could be some more competitive pressures. But just kind of take it through. some of your insights here on the elasticity curves and setting pricing, what the reactions are, because I don't know, maybe we've lost some muscle memory about how that is just part of the economics here.

Yeah, you know, look, we in our residential business, we went through something like six significant price increases in the span of 18 months. So I think that what we've seen over the last couple of years is an unusual pace of price increases that we've not only announced, but that we've also realized. We do think that as you head into 23 and to 24, you get back to more traditional levels. But in the first half of the year, we've realized that inflation is not over. And we've had to announce further price increases in January that perhaps even a couple months ago that we might not have anticipated because the inflationary pressures continue to be there. So, you know, it's not equal in all segments. We think we'll probably get less pricing in the container segment right now than we will in commercial HVAC, light commercial, residential to some extent. Parts of our fire and security business, we probably across our brands have implemented over the last couple of weeks 20 different price increases depending on the segment within fire and security and the brand. So, We'll watch it, but in the first half of the year, we believe that the inflationary pressures are still there and we need to price accordingly.

That's really helpful. Thank you.

Thank you, Dean.

Thank you. And our next question coming from the lineup, Steve Tuzo with J.P. Morgan. Your line is open.

Hey, guys. Good morning. Good morning, Steve.

Good morning. Can you just talk about the trend of what you see on transport refrigeration orders as well as light commercial orders? Those have been very strong. I know the light commercial market is up nicely, but obviously some very big numbers. And in the context of 50-week lead times in that industry, just curious as to how you see that trending because there could be some you know, perhaps unusual activity in that market in particular, but maybe how you see those orders trending over the next, you know, several quarters here.

Yeah, I'll start, Steve, with light commercial. Light commercial has just been extremely strong. We saw orders were up in the mid-teens in the fourth quarter. If you look at overall 2022, orders were up 45%, and demand is still strong for things like K-12, value retail, fast, casual, and quick-serve restaurants. So all trends seem extremely positive. The issue we have continues to be with light commercial keeping up demand, where we're implementing second shifts, and our focus is supporting our customers. The issue we have right now, as far as the eye can see, is not a demand one in light commercial. On the transport side, orders were up extremely strong in the fourth quarter in North America, even with us trying to control opening the order book for the second half of 23. North American orders were up 2x, North American truck trailer. Europe truck trailer was down a bit. I would say mid to high single digits, I believe. We have, of course, seen orders very light in the container space, which is why we've calibrated that business down, certainly in the first half of the year. But what's really encouraging is the North American truck trailer piece, the demand remaining very robust there.

And then just one follow-up on the resi side. So you ended the year with inventories just a bit above what you expected in the channel. What signals are you looking for here for demand this year? How confident are you in your distributors projections to, you know, make the assumptions you're making. I mean, how wide is the band of, of outcomes there in your view, given the situation with inventory, it just seems to me that like everybody is throwing out kind of flat to down, but when you kind of ask for the underlying, they, they talk about what happened in the fourth quarter, maybe what happened in January and any, you know, anything that's informing your view and, and maybe a little bit of a, of a ring fence around a band of outcomes there on volume?

Well, it's a good question, Steve. We tried to calibrate it, what I would say, conservatively. Now, we'll have to see when all is said and done if it turned out to be conservative. But we put volumes down high single digits for the year with, when we looked at it, we said new home construction down 20%, 25%. I, you know, we have a couple of customers in particular that on their earnings call said that they expect to get to flattish for the year. So will the industry be down 20 to 25%? Perhaps we have outside share in the industry. So in many respects, we should go the way of the industry, but, um, you know, there's a wide range of outcomes there where could it be flat? Could it be down 30? You know, who knows anywhere in that, but again, that's 20, 25% of our residential business, the new home construction. And then on the replacement market, you've been around this longer than I have, but that can swing very significantly in a short cycle business because it's fundamentally a replacement business. And a few hot weeks in the summer, you're going to see demand really pick up significantly. So we think we calibrated volume correctly there, but we'll have to see how the rest of the first half plays out. Again, tough comps in the first quarter. But even, you know, just yesterday, we were doing a review of the resi, and demand, you know, continues to be there from many of our key customers, and some of our issues are just continuing to keep up with that demand.

Okay, great. Thanks a lot for the call. I appreciate it.

Thank you, Steve.

Thank you. And our last questioner in queue, coming from the line of Gautam Khanna with Cowan. Cowan, your line is open.

Hey, good morning, guys. Morning. Morning.

Can you tell us how far out you're booking quoting truck trailer orders?

Yeah, second half of the year. So we've, you know, we looked at it. We're just now opening our order book for the second half of the year.

Okay.

And was that in Q4 or now in Q1? Now, I think we might have taken one discrete order for Q3 and Q4 for a specific reason, but basically we only opened our order book now for Q for the second half.

Okay, that's helpful. I was wondering if you could talk about inflation in the supply chain this year on your tier two components. So, you know, not commodities, but, you know, just an aggregate. What is the pressure you're facing from component suppliers and the like.

Well, I know they're not raw materials, but we do see on that piece, we should see some benefit. They've been swinging quite a bit. I know that's not the heart of your question, but we sort of block ourselves on the steel piece, which should be down from last year. Patrick mentioned we have the hangover from really good pricing in the first quarter of last year on steel. So as we get out of 1Q, we see the benefit of that. copper and aluminum down from last year. We did see a bit of an increase recently, but we still expect year over year benefit. And then what we're going to see with our tier ones is you probably have two categories. You have some that have gotten a fair amount of inflation from us and our peers over the last 12 months that will continue to try to push inflation. Then you'll have some that are thinking for the long term and trying to build long-term relationships with us and that we won't get the level of inflation because they will look at trying to take volume from those that continue to push inflation. So for those that, you know, really want to be on the journey with us for the long term, they will be the beneficiaries of volume that we will shift from those that are continuing to push inflation our way. So net-net, it is our job and I think our opportunity to really start to make a very conscious shift of our supply chain partners. And we were on that path. We had to pause it a little bit because of some of the supply chain challenges we saw last year. But I can tell you for sure we're going to get back on that path in a very aggressive way here as we go into 23.

And just last one, Dave. You talked about price and resi. I'm curious. Historically, and maybe what's your view on this cycle with respect to the minimum SEER, the 10% to 15% price point difference between the prior minimum, do you think that holds or does that fade over time? I'm just curious, how sticky is that pricing on the minimum SEER? And thank you.

Yeah.

sticky.

Yeah, we have very high confidence that 10 to 15% for the new SEER units will be sticky. It's been sticky thus far. We think it will remain sticky as we go through 23 and beyond. And, you know, look, we've all taken slightly different approaches. We took the approach for the new SEER unit to do more redesign rather than less and look for more differentiation. And we've done that. We've driven more of a copper to aluminum shift. We've driven a microchannel heat exchanger. We've done a lot of aesthetic and fit and spacing and size. So we've done a lot to make that our new SEER unit very, very attractive and differentiated. And one of the big things will be some of the controls features as well. So we think that because of the value we're offering and because of what the customer is getting, we think the pricing will be sticky.

Thank you.

Thank you.

Thank you. I will now turn the call back over to management for any closing remarks.

Okay. Well, thank you everyone for joining. We're excited about how we closed last year and even more excited about 23. And with that, we'll close the call. And please reach out to Sam for any questions. Thank you all.

Ladies and gentlemen, that's our conference for today. Thank you for your participation. You may now disconnect.