Carrier Global Corporation

Good morning, and welcome to Carrier's Third Quarter 2023 Earnings Conference Call. I would like to introduce your host for today's conference, Sam Pearlstein, Vice President of Investor Relations. Please go ahead, sir.

Thank you, and good morning, and welcome to Carrier's Third Quarter 2023 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 statement. 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. I am very proud of our team for delivering another strong quarter, enabling us to, again, increase our full-year guidance. HVAC and fire and security sales were both up mid single digits with the overall company delivering yet another quarter of double digit aftermarket growth. Adjusted operating profit and adjusted EPS were both up over 20% year over year with adjusted operating margins up 240 basis points in the quarter. The HVAC and fire and security segments both delivered record adjusted operating margins in the quarter, approximately 21% and 18% respectively. Free cash flow performance also continues to be strong, positioning us for some upside for our full-year guidance. Bottom line is we continue to perform while we transform, as you can see on slide three. We are a team that is very clear-eyed about macro challenges. We are focused on controlling the controllables, driving operational excellence, being tenacious about customer centricity, out-innovating our peers, and consistently delivering on our commitments. With two months left in the year, we are confident that in 2023, we will deliver mid-single-digit organic growth, 15% adjusted EPS growth, margin expansion despite the negative impact from consolidating Toshiba Carrier, and strong free cash flow. Not only are we poised to close out 2023 on a strong note, we have significantly matured our productivity processes, so we will enter 2024 with even more rigor and detailed plans around our cost reduction activities, positioning us for further margin expansion next year and beyond. We also have confidence in continued growth driven in part by our aftermarket and recurring revenue traction, as you see on slide four. We're on track for 80,000 chillers under long-term agreements and 30,000 connected chillers by year-end. The attachment rate at Q3 was approximately 50%, nearly double pre-spin performance. Abound continues to gain market traction, exemplified by new, scaled customers committing to our Abound Healthy Air solution and Abound Net Zero management offerings in Q3. Additionally, we announced the launch of Lynx Logic, a new software-as-a-service application within our Lynx digital platform that helps predict and address supply chain disruption by automatically identifying trends, patterns, and issues in distribution networks and transportation lanes. customers clearly see the benefit of Lynx capabilities, and we now have over 100,000 paid Lynx subscriptions. Our playbook around digitally-enabled lifecycle recurring sales continues to yield encouraging results globally, as we are well-positioned for another year of double-digit growth in 2023 and beyond. Our other major growth theme is around driving differentiated solutions to ensure sustainability leadership. You see examples of that on slide five. We continue to introduce industry-leading products into the market that help our customers achieve their sustainability targets while decarbonizing the planet for generations to come. Carrier Transicle introduced the new Optimaline refrigerated container unit, which offers best-in-class energy efficiency versus the competition and is approximately 15% more fuel efficient than our prior unit. We also introduced a comprehensive new line of high and very high temperature heat pumps for use in industrial, commercial, and health care buildings, as well as district heating. These heat pumps reduce both carbon emissions and energy costs up to 80% versus traditional gas boiler applications. Additionally, our new zero GWP refrigerant air to water high efficiency heat pump will nicely complement Wiesman's offerings in the European market. And on top of these new product introductions, our existing business continues to gain momentum as European commercial heat pump sales were up 70% in Q3 and are up 40% year to date. Thanks to our sustainability product and service offerings, we are well on our way to achieving our scope three commitment of reducing our customers' greenhouse gas emissions by more than one gigaton by 2030. having achieved approximately 270 million metric tons of reduction since 2020. We have and will continue to invest a disproportionate amount of our R&D in sustainability differentiation. We are pleased to have been recognized by Time Magazine, Newsweek, and many others for our sustainability leadership. Excitingly, the combination with Biesemann Climate Solutions will further accelerate our mission of becoming the world leader in intelligent climate and energy solutions, as you see on slide six. Last month, we had the pleasure of hosting Max Wiesman, Chairman and CEO of the Wiesman Group, in our headquarters for a webcast event to discuss his views on the future combination. We are profoundly confident and excited in the value creation opportunities ahead of us. The trend toward heat pumps in Europe is unambiguous and will continue for many years to come. Max confirmed that European decarbonization is a trend that is not changing and is well supported by governments in Europe. While individual countries may adjust regulations and subsidy levels from year to year, we see a multi-year growth opportunity as those countries meet their commitments for emission reductions backed by EU and country-specific funding. Residential heat pump penetration in Europe is only about 8%. and 21 countries have subsidies to support 2030 and 2050 decarbonization goals. Wiesman Climate Solutions is also well positioned for continued share gains. Unlike some of its competitors, it has the advantage of providing solutions for all energy classes, heat pumps, gas boilers, hydrogen boilers, while some of its competitors are pure plate heat pump or boiler providers. It has a connected ecosystem of offerings for an electric home such as solar PV, batteries, and a differentiated digital platform while also driving increased subscription sales. A good example is the VitoCal 250A natural refrigerant air-to-water heat pump that won this year's award for the best heat pump in Germany. Wiesmann Climate Solutions is soon introducing a 19 kilowatts of output version that will now give it access to over 90% of the single-family home heating market. Additionally, the brand new VitoCal 250A Pro, also releasing a Q1, will offer heat pumps outputs of up to 40 kilowatts, ideal for multifamily and commercial buildings. And based on our experience with Toshiba Carrier and that acquisition and integration, which is going extremely well, we are certainly confident in the cost synergies and already see potential for revenue synergies, which go well beyond our deal model. In short, Wiesman Climate Solutions is the most attractive business in the most attractive segment in our space, and we cannot wait to come together as one business, which is likely to close the first week of January 2024. Lastly, a brief update on our business exits on slide seven. First, my thanks to our teams who are working quite literally around the clock and doing a superb job. We have many advisors who, together with our bankers, Goldman Sachs and J.P. Morgan on fire and security, and Bank of America on commercial refrigeration, are focused on maximizing the net proceeds and speed while ensuring a clean exit of these businesses. We are progressing very well with the prospective buyers for security, commercial refrigeration, and industrial fire. The interest level has been extremely high, and we expect to be able to announce signed agreements before the end of 1Q, hopefully sooner. The capital market transactions for the combined commercial and residential fire business is on track. These are superb assets with deeply committed and effective team members, and we remain very optimistic about the value that we will realize on these exits. With that, let me turn it over to Patrick. Patrick?

Thank you, Dave, and good morning, everyone. Please turn to slide eight. Sales in the quarter were $5.7 billion, with organic growth of 3%, a 1% tailwind from foreign currency translation, and a 1% net contribution from acquisitions and divestitures. The latter was substantially all driven by one month of Toshiba carrier before becoming organic at the beginning of August. Q3 adjusted operating profits of over $1 billion was up more than 20% compared to the prior year on 5% reported sales growth. Strong productivity and price costs helped us expand our adjusted operating margin by 240 basis points to 18.2%. That is despite a 30 basis point headwind related to the Toshiba carrier consolidation. Reported earnings conversion was 65% in the quarter. Core earnings conversion, that is excluding acquisitions, divestitures, and currency, was far higher than that. Adjusted EPS of 89 cents is up 27% year over year and includes a tailwind from discrete tax items in the quarter. Free cash flow of about $950 million was up 35% compared to last year. Year to date, we have generated over $1.3 billion in free cash flow compared to about $400 million during the same period last year, reflecting improved working capital performance and higher earnings. Overall, a good quarter and better than we expected, mainly as a result of better operating performance and the discrete tax items I mentioned earlier. Please turn to slide 9. Q3 was another good quarter for HVAC. Organic sales were up 4%, driven by high single-digit growth in commercial HVAC, 30% growth in light commercial, and double-digit growth in aftermarket. North America residential age vac sales were down low single digits in the quarter. Overall resi volume was down low double digits, and revenues continued to benefit from price realization and positive mix from the 2023 SEER transition. Destocking is expected to continue in Q4, and we expect North America residential age vac volumes to be down mid-teen for the full year. We expect field inventories to end 2023 also down mid-teens from the beginning of the year, which should position them at more appropriate levels heading into 2024. Offsetting lower expected residential volume in 2023, we now expect light commercial HVAC sales to be up about 30% versus about 20% in our prior guidance. Adjusted operating profit for the HVAC segment was up 33 compared to last year, on 7% reported sales growth, driven by productivity and price costs. Adjuster operating margin reached a record high and was up 410 basis points compared to last year, despite a 50 basis point headwind from the consolidation of Toshiba Carrier. You will see in the 10Q later today that there was a one-time $60 million tax benefit from a joint venture that is included in equity income. but that was more than offset by other discrete items in this segment. In short, excellent financial performance for this segment in the quarter. Moving to slide 10, the refrigeration. Reported sales were flat in the quarter with organic sales down 3%, offset by a 3% benefit from foreign currency translation. Within transport refrigeration, global truck and trailer sales were up high single digits, driven mostly by over 20% growth in European truck and trailer. Container continued to experience demand softness, however, and was down roughly 25% year over year. Commercial refrigeration sales were down about 10% in the quarter, but orders for this business returned to year over year growth. Looking ahead to Q4, we expect the container business, commercial refrigeration, and the entire refrigeration segment to return to organic sales growth. Adjusted operating margin for this segment was down 80 basis points compared to last year, mainly due to the lower volume in container and commercial refrigeration, which more than offset the benefits from productivity and price costs in this segment. Moving on to fire and security on slide 11. Just like HVAC, this segment had good financial performance in the quarter. Reported sales were up 2%, with 6% organic sales growth and a 1% tailwind from foreign currency partially offset by a 5% headwind from the KFI deconsolidation. Organic growth was broad-based with high single-digit growth in industrial fire and security and mid-single-digit growth in commercial and residential fire combined. Adjusted operating profit was up 13% versus the prior year Similar to HVAC, adjusted operating margins hit a record level, and we're up 170 basis points year over year, driven by volume, productivity, and price cost. Turning to slide 12, total company orders were down a little less than 10% in the quarter, mostly due to the declines in the shorter cycle businesses. Overall HVAC orders were down about 10% in the quarter, with expected declines in residential and light commercial HVACs. Commercial ASAC orders were flat against a difficult comp. Last year, orders were up 15% to 20%, and the backlog remains robust, up over 40% on a two-year stack and extends well into next year. Refrigeration orders were down approximately 15% to 20% in the quarter, largely driven by transport. Very strong orders growth in international trucking failure, up 60% year over year. was more than offset by over 50% order declines in North America truck and trailer. For North America truck and trailer, we opened the 2024 order book in Q2 of this year. For 2023, we opened the order book in Q3 of last year. On a year-to-date basis, North America truck trailer orders are up low single digits, which is probably more indicative of underlying demands. Commercial refrigeration and container orders in October give us confidence in the refrigeration segment's return to organic growth in Q4. Orders in fire and security were up around 5%, with particularly strong growth in industrial fire. We believe that lead times for the majority of our shorter cycle businesses across our three segments have normalized, with backlogs close to more typical levels. Our longer cycle backlog continues to grow year over year. Now moving on to guidance on slide 13. We expect full-year sales to come in around $22.1 to $22.2 billion, including mid-single digits organic sales growth. We are raising our full-year adjusted operating margin guidance to about 14.5%, driven by strong year-to-date performance. Within the segment, we are increasing our full-year HVAC adjusted operating margin guidance to about 16.5%, while maintaining our fire and security guidance at 15.5%. Refrigeration full-year adjuster operating margin is impacted by lower volume in container and commercial refrigeration, and as a result, will likely end up a little lower than 13%. We are increasing our full-year adjusted EPS guidance by $0.10 compared to our prior midpoint to about $2.70. We have included a 2023 guide to guide adjusted EPS bridge in the appendix for your reference. In essence, improved operational performance drives about half the increase. The balance is mostly driven by a lower expected adjusted tax rate. Our full year adjusted effective tax rate is now expected to be between 21.5% and 22% compared to our prior guidance of about 23%. As for free cash flow, WE NOW EXPECT TO GENERATE SLIGHTLY MORE THAN $1.9 BILLION IN 2023. BEFORE I TURN IT BACK OVER TO DAVE, LET ME GIVE YOU A COUPLE OF UPDATES. YOU MAY RECALL THAT WE WILL BE FUNDING THE WIESMAN ACQUISITION THROUGH A COMBINATION OF MIX, THROUGH A COMBINATION OF EQUITY, CASH ON HAND, AND DEBT. THE LATTER WILL BE A MIX OF TERM LOANS AND LONG-TERM DEBT. WE PREVIOUSLY SHARED THAT WE HEDGED THE CASH PORTION OF THE CONSIDERATION AGAINST CURRENCY In the third quarter, we entered into a number of interest rate locks to mitigate interest rate exposure on the expected issuance of debt with maturities 10 years and beyond. As a result, we do not expect a significant change in our cost of financing for Feesman compared to our original business case. We expect to be in the market for the bond offerings in Q4 in advance of an early January close. As we communicated previously, We will be very focused on deleveraging post-acquisition, and we'll use free cash flow and proceeds from the business exits to do so. We continue to expect to return to share repurchases as soon as our net leverage returns to about 2x. One last topic. I'd like to share our current thoughts on how we will provide 2024 guidance in February, given the acquisition and the four business exit transactions. We currently expect that our 2024 guidance will include a full year of Beesman Climate Solutions. The exact timing and the proceeds of the business exits are, of course, not known as of today. For context, there are specific rules that determine when a business can be treated as discontinued operations in the financial statements, and it is our current assessment that the fire and security businesses being exited will likely not qualify as disc ops for reporting purposes until all of the transactions have been executed. We do not expect commercial refrigeration to qualify for this cost. Therefore, we intend to provide guidance consistent with how actual results will be reported. This means that we will include the earnings of the businesses to be exited into our 2024 guidance. We will then adjust guidance as needed for the exact timing of the exit and the use of the proceeds. By the time we provide guidance in February, we expect to have a better sense on timing and proceeds for several of the business exits. With that, I'll turn it back over to you, Dave.

Well, thank you, Patrick. In closing, Carrier continues performing while transforming. We had another strong quarter, and more importantly, we again increased our outlook for 2023 with mid-single-digit organic growth, margin expansion, double-digit adjusted EPS growth, and strong free cash flow performance all broadly in line with the value creation framework that we shared with you at our latest Investor Day. So with just a couple of months more to go in 2023, we are, of course, already looking ahead to 2024 with continued confidence in strong top and bottom line growth and cash conversion. With that, we'll open this up for questions.

Thank you. If you'd like to ask a question, please press star 11. If your question hasn't answered and you'd like to remove yourself from the queue, please press star 11 again. Our first question comes from Dean Dre with RBC Capital Markets. Your line is open. Thank you. Good morning, everyone.

Morning, Dean. Hey, we're hearing some commentary about higher inventory in the channel of heat pumps in Europe, just all coming from some of the uncertainty about when some of these government stimulus programs will be passed. What's your sense of... channel inventory, and how does that play out?

Well, Dean, let me just first give you a little bit of color on just how Beesman Climate Solutions has been doing year to date. Look, their sales are up about 18% year to date. Heat pump sales are up over 35%. They've had strong margin expansion. They're still tracking to the financials that we had thought for this year. And when we look ahead, I can tell you that we are very confident in the overall earnings trajectory that we had put in our business case. Clearly, when you see governments adjust some of their regulations and subsidies from one year to another, you may see some impact on the adoption rate of heat pumps. I think what you'll see is what we all saw, which is backlogs got to very high levels. We saw it throughout our portfolio. I think every industrial company saw it, is that as we all face some of the supply chain issues, backlogs were elevated way beyond typical levels. I think that we'll see those backlog levels for Wiesman come back in line with what would have been historic levels. And I do think that when we look at countries like Germany and Italy, you will see some short-term movement in some of the order rates as those legislations play themselves out. But look, there's number one, there's no question in anyone's mind you're going to see this continued transition to heat pumps overall in Europe. And it doesn't take minor swings in oil and gas prices to even accelerate that. Second, they could not be better positioned to outgrow the market. We've talked consistently about their channel, their technology, their brand, and how differentiated they are, especially when I mentioned in my prepared remarks about them introducing new products, which exposes them to a completely new part of the market that they weren't in before when these products come out in one queue. And they have the advantage of having complete home energy management solutions. And in the background, it wouldn't surprise you that we will push very hard to overdrive on top and bottom line synergies. We've had a chance to spend a lot of time with Thomas Heim, the leader of that business, and his team. The more time we spend with them, the more excited we are and the more confident we are in the value proposition from that combination.

That's all really good to hear. And then second question, can you take us through some of the assumptions on what's going on in light commercial up 30%? What are the drivers and visibility there, please?

Yeah, look, I mean, sales were up 30%, as you mentioned, Dean, in the quarter. And I think when we look at the full year, we had thought light commercial was going to be up 20%. I think for the full year, it's going to be up 30% as well. So when we look at it, there are some verticals that just remain extremely strong. K-12 orders were up 25% in the quarter. The pipeline there is even up 50%. We still see strong demand at some of the value-based retailers. There are some verticals that will be under some level of pressure, things like warehousing and some of things like higher-end restaurants and office space, perhaps. But the overall underlying demand, especially in some of the key verticals, is strong. And the backlog is still elevated. Normally, you'd have kind of four to six weeks backlog. And our backlog, as we sit here today, extends into the second quarter of next year or so. We'll continue to watch inventory levels similar to what I said for Wiesman is that you did have, you know, demand that was and backlogs beyond historic levels. Those should normalize over time. We'll have to see as we get into next year. We're looking at the EPA ruling, which is date of manufacture with a three-year grace period. So there will be, you know, as we transition to 455, 454B there as well, but overall, A great year for that team, and I think that we're pretty well positioned as we head into the first quarter of next year. Thank you. Thank you.

Thank you. Our next question comes from Julian Mitchell with Barclays. Your line is open.

Thanks very much, and good morning. Just a first question around the North America residential HVAC market. So it looks like you're assuming perhaps that volumes there are down, you know, perhaps low double digit, high single digit in the fourth quarter. Wanted to check if that's correct and how you're thinking about the slope of that getting back towards zero next year. And also sort of When we think about next year, there's some discussion around the scope of the price effects tied to the refrigerants change, i.e., how much of your residential business might be affected by that change. Is it just the greenfield equipment, or it's also the replacement equipment as well? And I'm assuming furnaces and parts are unaffected by that. Any color on that, please?

Sure, Julian. Let me start with kind of the year and then give a little bit of color on what we see for next year in light of this recent EPA ruling. I think for overall this year, we're looking at resi being down mid-single digits with volume being down in the mid-teens. That would imply overall sales in the fourth quarter down about mid-single digits for resi. And I think that this is the quarter of – I think this is sort of the most – the end of a lot of the destocking that we've been seeing. So we want to end this year with inventory levels down at least in the mid teens versus where we ended last year. So our first priority is always being there for our customers, but we also want to be very purposeful in working with our channel partners on making sure that inventory levels going into 24 are at least down 15% versus where we ended 2022. I had the chance to be with about 100 of our key distributors on Tuesday in Dallas. We talked a lot about this and the regulatory changes, and I think we're all lockstep together to go end this year in a way that supports our customers and positions us for next year. I think when you look at the recent EPA ruling that's just come out over the last week, the good news is that The date of install ruling, what that's going to do is accelerate 454b systems demand. And we'll likely see more 454b sales in 24 than we previously thought. And that makes us favorable. And I will say that thanks to the great work of our team, we will technically and operationally be ready to cut in the 454b sooner to ensure that we comply. We also think that our ability to manage the cutover can be a competitive advantage because we were already accelerating this in order to reduce risk. We are encouraged that the EPA did clarify their, we are encouraging, I will say, the EPA to clarify their position because the way it's written, it would effectively allow dealers to replace the outdoor unit only with a 410A replacement if it's not part of a system level change. And that could be interpreted as allowing 410A sales indefinitely. And we don't think that was their intent. We've had a seat at the table with the administration, with the DOE, with the EPA, with bipartisan members of governors and the Hill. And we know what their intent is. And the way it's drafted, it's not consistent with the intent to transition to a more environmentally friendly refrigerant. Second, it will create a bit more complexity in the channel supply chain. So we are encouraging them to clarify their position a bit. And I think and we'll see how that plays itself out. But regardless, specifically to your question, Julian, You know, what we said on pricing for 454b stands, we said it would be up 15 to 20% over two years, in part because of our typical annual price increase, in part because of the extra costs associated with the system. I will tell you, keep in mind this year on, you know, we sort of break out price and mix, but if you combine those together for resi with the SEER change, we'll be up 10% on price and mix combined. So when we look specifically at 410a pricing, We will be raising price there as well, in part because of the increased carrying cost driven by the complexity of the ruling, but in part because we will see a reduction of supply in the U.S. for 410A, so we'll need to, you know, we'll have to deal with pricing to adjust for that. But we will also be looking at, when we look at 410A replacements for outdoor only, looking at treating that similar to how we would treat An aftermarket replacement, which would have limited warranty implications and we're still evaluating that, but we will look at that so net net EPA ruling more 54 be sooner it's overall good. A bit more uncertainty as we navigate this with our partners, but I don't think there's going to be a company more prepared to deal and address with this switch over.

That's very helpful. Thanks for that, Carla. And then just a quick sort of more financial question. The HVAC segment, I think, Patrick, you'd mentioned some maybe temporary sort of headwinds and tailwinds moving around in that third quarter profit number. So maybe just a finer point on that. And wanted to check that the guidance seems to embed a sort of low double-digit HVAC margin for Q4. and a sort of, you know, mid-20s operating leverage for the year as a whole, inclusive of the Toshiba impact. Just wanted to check that those are sort of roughly the right thought processes.

Yes, the answer to your last two questions, Julian, are yes on both counts. In terms of the HVAC margins, Sam pointed out that the transcript, the life transcript said that I that it's a $60 million tax benefit within JV income, within HVAC, it's 1.616. And that was offset by some discrete items that went the other way. But in summary, the large expansion of margins within HVAC, 410 this year over year, despite the headwind from Toshiba carrier consolidation, it's really driven by strong price costs and productivity. And that is the main driver that we see in that segment that also translates for the overall company. So some minor headwinds to that, as I mentioned, acquisitions, we always invest a little bit there, but the main driver is productivity and price costs.

That's great. Thank you.

Thank you.

Thank you. Our next question comes from Jeffrey Sprague with Vertical Research Partners. Your line is open.

Thank you. Good morning, everyone. Hey, Patrick, thank you for the color on how you're thinking about the guide. I just want to get a little bit more into the deal math, if we could. You're sitting on $3.9 billion in cash. I just wonder how much of that is sort of usable to consummate the deal versus cash that might be geographically stranded or other things. And I'm sure Beesman is generating cash here. Does that go out the door to them as a closing adjustment or Is that accessible to you, you know, to sort of fund, self-funded deal to some degree? And thirdly, just what are you looking at as kind of your blended funding costs based on the actions and locks that you took in Q3?

Yeah. I'll start, Jeff, with the cash that we have. So we have $3.9 billion at the end of Q3. We expect that to grow further by the end of the year. You can think of about a billion dollars of that generally is what we need to run the business, which would be, call it not accessible. We wouldn't plan on using that. The remainder of the cash we would intend to use for the acquisition. So that's one. Two, with respect to cash advertisement, the type of acquisition we've done is a lockbox mechanism, which is difficult for European deals. And in essence, it means that all the earnings and the cash generated within Wiesman as of January 1st of this year, 2023, remain within Wiesman, and we get access to that the day we acquire them. And so we do expect at the time of closing to have access to that cash and to use some of that cash again to pay down some of the short-term, the term loans we expect to use, for example, to fund the acquisition. The last question you had was, I think, was about the blended rate. We assumed back in April a little bit of a conservative rate overall at about 6% to finance the transaction. And based on everything we know now, some of the locks we've put in place, we think we're very close to that number. It would also mean that our overall cost of debt, weighted cost of debt post the transaction would be right around 4%. based on where interest rates are today.

Great. And just back to the earlier point, so there's a $116 million gain in HVAC segment results in the quarter, but that is fully or mostly offset by what exactly?

Jeff, $116 million tax gain within HVAC as equity income. That is all offset by some smaller items, so $1.6 million.

Okay, great. Thank you. I'll leave it there. Much appreciated. Thank you.

Thank you. Our next question comes from Joe Ritchie with Goldman Sachs. Your line is open.

Hey, guys. Good morning.

Hey, Jeff. Good morning.

Dave, can we maybe just talk a little bit about just the broader environment the market is freaking out, giving project financing concerns, higher rates environment, higher rate environment. What are your thoughts on all the mega projects that have kind of moved forward, ultimately what that means for your business, whether you've started to see any of that or a substantial amount of that into your orders? Just any thoughts around that would be helpful.

Yeah, look, I think it was interesting. You know, we saw ABI come out at 44 and exactly what you said, Joe, that there was, you know, that created a fair amount of anxiety, but there wasn't as much exuberance when it was, you know, over 50 for three of the last five months. And it went through a stretch where it was over 50, I think for almost a year straight. So I think, look, we take, we take those metrics with, I think a sober view, but a very, a look at, the agility that we have as a team to pivot to where the strength is. So we look at certain verticals that remain just extremely strong, and we see it that we still have in commercial HVAC extremely elevated backlog levels going into next year. And it's because that some of the orders we've seen in education, not only K through 12 with the ESSER funding, but also higher ed, very strong. Data centers, we look at some areas of industrial, not only in the United States, but even though real estate remains under a lot of pressure in places like China, commercial real estate in the United States under pressure. We see things like the CHIPS Act, and we see things like some of the EV-type spending we're seeing in China, very strong, and we're winning more than our fair share of a lot of that new construction. And that's driven by some of the regulatory environment, decarb trends. So, look, we take a very balanced view. I don't think a lot of people were thinking that light commercial would be up 30% this year, which it will be. I think going into next year, we'll go into next year, good backlog in commercial HVAC. We think that we're sort of bottoming them out in some of the resi space in the United States. We see aftermarket growth, double digits. We've done a really nice job with Abound and Lynx and the whole playbook around driving more recurring revenues to smooth some of the cycles. We've come a long way there. And then I think with some of our businesses like We went through a rough patch on a container, which we fully expected, and we see that starting to recover here in 4Q going into next year. So I think we'll have a very balanced view, but we'll go into next year looking with good backlogs in the longer cycle businesses. And we still see orders trends in some of the key verticals that I think position us for solid growth next year.

Got it. That's super helpful. And then maybe just a follow-up question, a more financial-oriented question on HVAC margins for 4Q. So, Patrick, thanks for all the color that we've got. We're all set on the $16 million impact this quarter. But just for 4Q specifically, I know that it's always a much lower volume quarter for the business. But the change sequentially from 20 plus percent to call it low double digits seems very substantial. Are there any other moving parts that we really need to take into consideration for 4Q versus the 3Q margins you just posted?

The biggest element, and what I'm going to share is from an overall company perspective, but it's the same, of course, for HVAC given the size of that segment. One, significantly lower sales sequentially due to the season. That includes, of course, Resi as well, some of the higher margin businesses. In addition, you heard us talk about ensuring that field inventories are right size. So there is some downtime in some of our facilities as well to ensure that we start out 2024 with appropriate levels of inventory. And then we continue to make some investments. And then JV income is seasonally lower as well in the last quarter of the year, as we see every year. I would say those are the biggest moving pieces, Joe.

Great. Thanks, guys.

Thank you.

Thanks, Joe.

Thank you. Our next question comes from Noah K. with Oppenheimer. Your line is open.

All right. Thanks very much. I want to follow up on the commercial commentary. So, you know, I look at the multi-quarter commercial orders trends kind of flattish here. How do you think about 4Q orders trends in commercial just based off of everything you just described?

Well, look, last year orders were up around low double digits. We'll have to see, excuse me, orders here in 4Q. It's too hard to tell just yet. But, you know, when you look at it, our backlog is up 40% on a two-year stack. So I think that when we look at it by region, Europe has been almost surprisingly resilient and We think about, I mentioned that heat pumps up 70% in the quarter for commercial heat pumps. So we see continued strong demand in Europe, especially for heat pumps. North America, we actually had much elevated lead time and backlog levels given a couple of operational issues that we had that are now significantly improving. The team's done a really nice job at making progress in some of our North American operational issues. So as that As that continues to improve and lead times eventually get back to more normal levels, we'll see orders start to increase there. And then China's kind of a mixed bag. You know, China's under a little bit of pressure, certainly on the real estate side. But as I mentioned, some of the infrastructure spend continues to be strong. We had a very recent win here for six chillers in China, included a lot of our automated system. We're pushing very hard on aftermarket connected devices there. So we'll have to see But I don't see a huge rebound here in China and 4Q, but hopefully as we get into next year, things start to stabilize a bit there on some key verticals.

Okay, thanks. And then, David, I think there's been so much ink written about this, but since you're closely tracking the performance of the vSpin business and given how well it's done year-to-date versus some of the headlines out there around heat pump demand, Just help us reconcile the strength of the company's performance year to date and what they're doing now to position for all these different regulatory changes and what really drives your conviction that they'll continue to see sales growth and strong performance in 24 and beyond.

Look, there's so much to like there. I mean, we've always known. that as countries change regulation subsidy levels, that will have quarter-to-quarter impacts. You know, we saw it in Italy last year that Italy had subsidy levels at 110% going back a couple years, and then they changed it to 90%, and that caused year-over-year headwinds and anxiety in Italy. That will smooth itself out over time, but if you're trying to predict what's going to happen as regulations change from one year to another, That will have some short-term swings, and I think that's what's being highlighted by some of Wiesman's peers. We're seeing in the German legislation that we do think that the regulation as written will go through. There's still a bit of a debate on the exact subsidy levels. Those subsidy levels will be debated, I think, November 6th and 7th in Germany levels. We expect those will all be promulgated and go into effect in January of next year. If you see an increase in subsidy levels, that will have a natural dulling effect on orders as consumers wait for those increased subsidy levels to go into effect. So that will, you know, will that have an impact potentially on one queue for, you know, one business from here to there? Of course it will. But when we step back, we say, is the transition to heat pumps in Europe here to stay? We are 100% confident in that. Is Wiesman the best positioned company because they are not a pure play either heat pump or boiler company? Yes, because they have not only mixed factories, they have mixed lines. So as boilers, if there's going to be more boilers next year than we had earlier anticipated, which I think there will be, they make great margins on boilers and they're able to swing their operational performance to support that. And then you look at all the other capabilities they bring to the table. When you combine with a world-class company, there are so many very obvious synergies and then a lot of hidden synergies as we apply their technology to our businesses across the world. And we bring in, say, for example, the carrier brand into their channel. Those are immediate revenue synergies that can offset, like if there's some 1Q heat pump headwind in Germany, you can look at all these other things, whether it's additional solar PV, battery cells, things like that, or revenue synergies. So we just feel so confident in the business, in the team, in the overall trajectory, and the overall earnings profile of that business.

Really appreciate the call. Thank you. Thank you.

Thank you. Our next question comes from Guadamcana with TD Cohen. Your line is open.

Good morning. Hey, what is it? In the resi business, are you guys seeing any evidence of trading down, you know, an increase in repair versus replace? We've heard some of the HVAC OEMs talk about that. I don't know if you've seen any evidence of that in the channel.

You know, interesting, Gotham, we have not. And I actually asked that question. We were, I mentioned that a couple days ago I was with our top distributors. It's something that when economies soften that you naturally look for, but we have not seen that. We haven't seen the mixing down. We haven't seen the trading down, replacing parts instead of entire systems. So, you know, for us, what we're doing is I think the team did a superb job in the switch over in the new SEER unit. We are now laser focused on positioning ourselves for the refrigerant change, which gives price and some both price and mixed benefits to offset some of the destocking that, you know, we saw throughout 23 that we'll see into 24. into the fourth quarter. But then I think when we start next year, a lot of that will be behind us as we position ourselves for the 454B switchover. So no, Gotham, we have not seen any material evidence of that.

Okay. Just to follow up to an earlier question on, you know, the pricing alongside the new units coming out in 25 or perhaps 24, as you mentioned. You know, just curious, do you expect order of magnitude, the pricing, on those units to be comparable to what you saw with the SEER change this year, or do you think it's, you know, enough cost is going to be designed out of the system such that we are not going to get, you know, whatever it was, 10 to 15% pricing lift ultimately, you know, I know that's kind of, there's been some talk about that, but I'm just curious, what's your best guess on kind of magnitude of pricing opportunity with that new unit?

yeah i think look you know there's been some skeptics on the you know whether we'd see the 15 to 20 percent over two years we're very confident in that you know we are going to um increase price in resi the normal um price that we would have done anyway we will continue to do that as we go into next year and we'll do it again in early 2025 as well and then on top of that you you are adding some cost to the system for things like leak detection and sensors and some parts of the controls, and it would only be natural for us to increase price based on some of the additional protections that we're adding to the 454B unit. So, you know, we came into this year expecting price and mixed benefit. I think it'll turn out to be even slightly higher than we thought, around 10%, and we expect to see kind of similar orders of magnitude on price mixed benefit with the 454B unit. Thank you.

Thank you.

Thank you. Our next question comes from Jeff Hammond with KeyBank Capital Markets.

Your line is open. Jeff Hammond, your telephone may be muted. Why don't we go on to the next one?

Our next question comes from Brett Lindsey with Mizuho. Your line is open.

Hey, good morning, all. Good morning. Yeah, I just wanted to come back to the business exit update slide. You noted the resi commercial fire, you know, public trading late spring. I was hoping you could just put a finer point on what the nature and structure of that transaction might look like as it moves to the public markets.

Fred, it could take a few different forms. Look, it could be a spin. It could be a split. The example there would be J&J Kenview. That was in the market recently. So that's an example that we've benchmarked. We're preparing for different scenarios. And look, we've talked about a clean exit. We've talked about accelerating buyback. We've talked about our commitment to our investors to pay down debt. And what we're doing with this public company exit is achieving, yes, all of the above. So we'll work on the specific form as we get into early next year. The prep is the same, effectively, either way. And I'm very proud of the team, because normally a lot of this work would take longer. But the team is heads down working around the clock so we can be ready for public trading in the late spring of next year.

OK, yeah, makes sense. And just to follow up on the international truck and trailer sales up over 20%, strong quarter, a bit of a moderation in the order book. What is your level of visibility based on backlog, based on incoming order rates as we flip the calendar here to 24?

Well, there's a couple of factors going on with international truck trailer. You also have a very rapid transition to electric going on there as well on truck. So I would tell you we were pleasantly surprised with the low double-digit kind of increase, the increase that we saw overall in international truck trailer. Orders were up 60% in the third quarter for our international truck trailer business, partly because of this transition to some of the electrification and partly because the team's done very well in supporting the customers and the overall market demand. We feel well positioned going into next year on European truck trailer, and even China's done well for us on the truck trailer side. And then North America truck trailer, despite people can sort of focus on some of the ACT numbers, but people said, look, 2023 ACT down mid-single digits for the year, our North American truck trailer will be up double digits. We're taking a sober look at what ACT is saying for next year, but there's a lot of countervailing forces between, again, the shift to electrification, price mix, and then this overall focus that we've had globally on length and more digitally enabled recurring revenues has yielded a lot of very strong results for us.

Appreciate the insight. Great quarter.

Thank you. Thank you.

Thank you. Our next question comes from Nigel Cook with Wolf Research. Your line is open.

Thanks. Good morning, guys. Thanks for the question. So I think you called out, we haven't explored this yet, but the Toshiba performance, I think you called out, I think it was on slide four, I think it was, maybe slide five, no, slide three, Toshiba carrier performance remains strong. And, you know, we know Europe right now is really weak. We know that parts of APAC is really weak. So just curious, What's driving the upside or performance at Toshiba Carrier?

Nigel, the financial performance at Toshiba Carrier has been really strong. A lot of that is driven by the synergies. We mentioned, I think last quarter, that we're increasing the cost synergies from the target of 100 million run rates to 200 million. It is helping us significantly expand our margins in that business. To your point, The sales in Europe for that business were a little lighter for global comfort solutions. But the performance overall for that business is really strong. And a key driver there is really all the synergies that the team is driving. And we're nowhere near the actual run rate yet. And so we expect to benefit from that for the next couple of years as that expands.

Okay. That's great. Thanks, Patrick. That's great to hear. And then just I hate to go back to a question that's been asked a couple of times, but obviously the HVAC margins this quarter were spectacularly strong, even when we back out the tax item. Obviously 4Q, and I think 4Q originally was meant to be sort of similar to 1Q. It looks like it's coming in maybe a little bit weaker than 1Q. So just wondering, I'm assuming price-cost would have been a factor in the HVAC strength. I'm just wondering why that's not carrying forward to 4Q yet. So again, I mean, I know it's been answered, but maybe just a bit more color there, please.

Yeah, actually, I think that the HVAC margins for Q4 will be very similar to our Q1 margins. So I think they're very much aligned there. And as I mentioned in one of my prior answers, what we're going to see in HVAC in Q4 is As we address the field inventories, we mentioned in our comments we want the field inventories to end about mid-teens down versus the beginning of the year. A lot of that is going to happen in Q4, so we're going to see more downtime in our factories than initially planned, and that's going to impact some of the margins, of course, in that segment. We do expect price, cost, and productivity generally to remain strong, but that is a headwind that we wouldn't have seen in a prior quarter, which is a destocking headwind. affecting our factories.

Okay. And would there be some incentives for spending to shift that inventory or is it just purely factory downtime? No.

This is factory. There are no incentives.

Okay. Great. Thanks, Patrick.

Yep. Thank you.

Thank you. Our next question comes from Joseph Nito Phillips with Jefferies. Your line is open.

Good morning, guys. It's actually Steve Volkmann here. We've got a lot going on this morning, obviously. Sorry about that. So my question is kind of a big picture one, Dave. Where do you think we are in the adjustment of the backlog? Does it go back to kind of historical levels or does it sort of settle in above historical levels? And sort of where are we in that process?

I think it goes back to historical levels. I think what happened over these last couple years is just very unique, that as you saw some of the supply chain challenges, and the underlying demand was strong, the consumer's been strong, you saw a lot of people getting in line to make sure that they had their orders positioned for when they need them. I mean, for example, light commercial. Light commercial for... the school year, a lot of those replacements they want to see happen during the summertime. So people were making sure that with the supply chain uncertainty, people were getting in the queue to have their position protected. I think what you've now seen is in the shorter cycle business, generally a return to more historical levels. With some of the longer cycle businesses, like for us, commercial HVAC, we're still, you know, again, we're backlogged up 40% on a two-year stack. We're still at elevated lead times and elevated backlog levels. I think that you would expect that to start to normalize, but if the underlying demand, which depending on the vertical remains strong, you'll continue to see very strong growth in some of those key businesses. So I think there will be a leveling. That's why we don't get overly fixated on quarter to quarter orders because they can swing wildly much more than they ever would have in the past. We talk about them being up 40 or down 40%. We don't swing with those We look more at our backlog levels and our lead time to make sure that we see the strength that we expect to see.

Got it. And do you think we'll get sort of more normal by the end of 24, or does it take longer than that?

No, I think that's about right. I mean, I think that some of the shorter cycle stuff is starting to get there. You know, we're seeing more normal lead times in RESI. I think that's going to happen for Visa McClimate Solutions, that they'll start to get They're backlogged back to more normal levels as you get into like the 1Q type timeframe. And then it just goes back to basics. So I think when you look at sort of the longer cycle stuff, yeah, that's sort of by the end of 24. The shorter cycle stuff is essentially there.

Super. And then, Patrick, as this happens, is there a chance to generate net income or free cash flow above net income for another year?

If we, it will, of course, it will depend on what's happening with our working capital. And I think so far this year, we've done really well compared to the, obviously compared to last year, generally a whole lot more. We would have to make a significant additional dent into working capital. Clearly, that's our objective, but obviously not ready to commit to that before February when we provide guidance for next year.

Great. Thank you, guys. Thank you. Thanks, Steve.

Thank you. And our last question comes from Andrew Obin with Bank of America. Your line is open.

Yeah. Good morning. Really appreciate you guys fitting me in. Thanks. Um, just a question, uh, on light commercial and just business mix, right? Because the growth in light commercial has been so spectacular. It's a good margin business. And then in the face of resident clients and sort of steady growth in applied, as you look at North America, What does the business look like right now, sort of the mix between Resy, Light Commercial, and Applied? And how structurally sustainable is this mix going forward? Because clearly it's quite good for your margins.

Well, look, obviously Resy is a far bigger business than Light Commercial. And to your point, Andrew, Light Commercial has been, I know, far better than many thought that we're modeling it coming into the year. And we've been very pleased with the performance there. So, um, you know, resi is the biggest business followed by commercial followed by light commercial. We think with some of the D stocking that we'll see in four Q we're kind of, and the switch over to four 54 B and resi, we think there, uh, we know volumes down mid teen sales down kind of mid single digits for resi. We start to see, you know, recovery as we go and go into next year in that business. Um, light commercial is going to face some tough compares, but as I mentioned, a lot of those verticals remain very strong and light commercial. And they're also doing what the rest of the business is doing, is very much leaning into connected devices and the aftermarket opportunity. And frankly, it's a bit nascent in that space, and we think there's a lot of opportunity there. And then I think commercial, we still are dealing with very significant backlog in the commercial side. The controls business has done extremely well. Aftermarket's doing very well, double digits there, and we have further growth there. So we think that with the strong backlog, We think eventually lead times will kind of come back to normal for the North American commercial business, but they're still elevated, still strong backlog, so they're positioned for growth as we get into next year as well.

And just a follow-up question on commercial. Are you guys seeing the impact from megaprojects? Because my understanding is that these semiconductor fabs, EV factories, require a lot of air conditioning, HVAC, data centers. Can you just talk about what you're seeing about growth and visibility in these high-growth verticals on the commercial side. Thank you.

Yeah, Andrew, that's been very encouraging. You know, we've done very, very well on many of the megafactories, and that includes both data centers. It includes some of the factories associated with the CHIPS Act and some of the new construction activity there with all the Gen AI-type activities. So we have solutions not only that we're doing more creative solutions with the high temperature and very high temperature heat pumps we mentioned. We've introduced new offerings like our mag bearing design for the applied. We have a business that we bought a couple years back called Enlite that really complements our ALC controls business so we can provide sort of holistic controls to identify with specificity where's the heat getting generated in a data center and how we dissipate that heat most efficiently. It's effectively an integrated AI tool in and of itself. We'd love to see the continued construction with these mega projects, and we've gotten more than our fair share of new wins there.

All right, great. Congrats on a strong quarter. Thanks.

Thank you. This concludes the question and answer session. I'd like to turn the call back over to Dave for closing remarks.

Well, look, let me just thank all of you, our investors, for the continued confidence, and let me thank our team. You know, we have folks working tirelessly while we perform and continue to transform the business. So my hat's off and thanks to the team that's just not only working so hard, but working so well and together as a team. And with that, we'll conclude the call. And of course, Sam will be available for the rest of the day to everyone. Thank you all.

Thank you for your participation. This does conclude the program and you may now disconnect. Everyone have a great day.