Trane Technologies plc

Q3 2022 Earnings Conference Call

11/2/2022

spk10: Good morning. Welcome to the Trane Technologies third quarter 2022 earnings conference call. My name is Lisa, and I will be your operator for the call. The call will begin in a few moments with the speaker's remarks and the Q&A session. At this time, all participants are in a listen-only mode. Please limit yourself to one question and one follow-up. I will now turn the call over to Zach Nagel, Vice President of Investor Relations.
spk12: Thanks, Operator. Good morning, and thank you for joining us for Trane Technologies' third quarter 2022 earnings conference call. This call is being webcast on our website at tranetechnologies.com, where you'll find the accompanying presentation. We're also recording and archiving this call on our website. Please go to slide two. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our SEC filings for a description of some of the factors that may cause our actual results to differ materially from anticipated results. This presentation also includes non-GAAP measures, which are explained in the financial tables attached to our news release. Joining me on today's call are Dave Regneri, Chair and CEO, and Chris Kuhn, Executive Vice President and CFO. With that, I'll turn the call over to Dave. Dave?
spk15: Thanks, Zach, and everyone for joining us on today's call. Let's turn to slide number three. Before I dive into our quarterly results, I'd like to spend a few minutes on our purpose-driven strategy, which is the engine behind our differentiated financial performance and shareholder returns. Our strategy is aligned to powerful megatrends like climate change and the crucial need for climate action. Last week, the United Nations released its Emission Gap Report 2022, calling for urgent transformation to avoid climate disaster. The report cites critical actions needed, including efforts to scale zero-emission heating and cooling technologies and to decarbonize the food supply chain. That's where Trane Technologies has a unique position to make a difference. We have the technology today to transform tomorrow. We are proud to be leading our industry with aggressive, science-based sustainability commitments, actions and results. Together with our customers, we are dramatically reducing emissions and creating sustainable homes, buildings and cities. Our purpose-driven strategy, relentless innovation and strong customer focus enables us to deliver a superior growth profile through cycles. This in turn helps us drive strong margin and powerful free cash flow to deploy through our dynamic capital allocation strategy. The end result is strong value creation across the board for our team, our customers, our shareholders, and for the planet. Moving to slide number four, Q3 was another strong quarter for us across the board. Our innovation leadership continues to win customers at an unprecedented pace, and our bookings level remained extremely high, reflecting strong share gains in virtually every area of our businesses. Organic revenues were very strong, up nearly 20%, and our book to bill remained over 100%, with organic bookings up 8%. Absolute demand continues to be extremely robust. For perspective, Year to date organic bookings are 95% of our total revenues for 2021. And we still have the fourth quarter to go. Bookings continue to be particularly strong in commercial HVAC businesses globally. Our global commercial HVAC business is up more than 40% on a two year stack. Our America's commercial HVAC business is even stronger. up more than 50% on a two-year stack. Strong broad-based bookings growth over the past seven quarters have driven our backlog to unprecedented levels, with backlog of $6.4 billion at the end of the third quarter. We expect backlog to remain at elevated levels well into 2023. Strong execution of our business operating system has enabled us to stay ahead of persistent inflation, and deliver over 10 points of incremental price and positive price versus inflation again in the third quarter. Pricing execution is a core competency for us and increasingly important given higher costs to serve customers across the value chain. On our second quarter earnings call, we discussed two temporary plant closures that delayed 120 million in revenue from the second quarter into the second half of 2022. with the majority of the revenues expected to be recovered in the fourth quarter. I'm proud of the way our teams rose to the challenge to accelerate that recovery in the third quarter to meet or exceed our customers' needs. As a result, we successfully recovered 100 million of the 120 million in the third quarter, which is approximately 70 million ahead of our expectations. And we're on pace to deliver the additional 20 million in the fourth quarter. Our performance through the third quarter has been strong. Booking levels have remained robust. Backlog remains at unprecedented levels. Inflation has been persistent, but our pricing execution has more than kept pace. Supply chain remains tight, but are slowly improving. All in, we're confident in raising both our organic revenue and adjusted EPS guidance above the high end of our previous ranges. When you consider that our guidance includes an additional 7 cents of headwind from FX, we're effectively raising our operational guidance for the year by about 15 cents at the midpoint. The secular megatrends underpinning our strategy are only growing stronger. Execution of our high-performance business operating system and our unwavering focus on putting customers first remain at the core of everything we do. Our balance sheet, liquidity position, and ability to deliver strong free cash flow provides a robust financial foundation and good optionality for capital deployment. We are well positioned to not only navigate near-term macro challenges, but to thrive as conditions improve. Please turn to slide number five. As I discussed on the prior slide, both bookings and revenue growth were strong and broad-based in the quarter. America's commercial HVAC was again a standout, with organic bookings on a two-year stack up more than 50%. Continued strong bookings have driven our America's commercial HVAC backlog to new heights, up more than 70% year-over-year and more than 200% of historical norms. Commercial HVAC revenues were also strong, with low teams growth in both equipment and services. In residential HVAC, revenues were robust, up 16% in the quarter. Bookings were down 8%, consistent with our expectations, as bookings continue to normalize towards a GDP-plus profile that we see for our long-term outlook. Still, our book-to-bill was 92% in the quarter, and backlog remains at historically high levels. We just opened the first half of 2023 order book for our Transport Refrigeration Americas business in September and bookings were strong out of the gate, up high single digits for the quarter. Growth is consistent with our expectations as we've been working with customers on slotting throughout the year. Transport refrigeration revenues were very strong, up nearly 60%. Our team has done a terrific job of ramping up operations at the plant that was impacted by extreme weather in the second quarter and accelerating the recovery of delayed Q2 revenues into the third quarter. When we held our Q2 call, we expected the team to recover about $10 million of the $60 million in revenues in Q3, with the balance in Q4. The team delivered the entire $60 million in the quarter, effectively accelerating the recovery of $50 million in revenues into the third quarter and enabling us to meet or exceed our customers' expectations. If we exclude the shift in revenues from the fourth quarter into the third quarter, third quarter revenues were still extremely strong, up more than 40%. We're on pace for significant share gains in 2022, adding to strong share gains the team delivered in 2021. Turning to EMEA, we continue to see strong demand for our innovative products and services that help reduce energy intensity and greenhouse gas emissions for our customers. despite the challenging macro backdrop. EMEA commercial HVAC orders were up low teens and revenues were up in the mid-20s, reflecting strong demand across the portfolio, particularly for our thermal management systems, which are three to four times more efficient than conventional heating and cooling. EMEA transport refrigeration orders declined consistent with our expectations, mainly due to tough comps in the quarter. Additionally, We've been carefully managing our order book to mitigate inflationary impacts and therefore just opened our order book in September for the first half of 2023. Revenues were up high single digits, significantly outpacing end markets. Overall, backlog for the region remained strong, approximately 40% higher than historical norms. In Asia Pacific, commercial HVAC bookings growth continued to be strong, up low teens. The team has delivered organic bookings growth between low teens and low 20s in each of the past six quarters. Asia Pacific revenues were strong, up 28%. Similar to Transport Refrigeration Americas, our team has done a terrific job accelerating the recovery of delayed revenues due to a temporary plant closure from COVID-19 related lockdowns in China in the second quarter. When we held our Q2 call, we expected the team to recover about $20 million of the $60 million in delayed revenues in Q3, with the balance in Q4. The team rallied and delivered $40 million in the quarter, effectively accelerating the timing of recovery of $20 million in revenues into Q3. If we exclude the shift in revenues from the fourth quarter into the third quarter, third quarter revenues were still strong up mid-teens. Overall, backlog for the region remains strong, approximately 50% higher than historical norms. Now, I'd like to turn the call over to Chris. Chris?
spk16: Thanks, Dave. Please turn to slide number six. This slide does a nice job encompassing our overall performance in the quarter, which was strong across the board. Organic revenue growth was up 19%, adjusted EBITDA margins were up 50 basis points, and adjusted EPS was up 26%. We delivered robust enterprise growth in both equipment and services, up more than 20% and low teens, respectively. EBITDA and operating margin expansion was driven primarily by strong leverage on volume growth. Pricing remained strong, up more than 10% in the quarter, and price versus inflation was positive on a dollar basis. Productivity continues to be negatively impacted by supply chain challenges driving plant inefficiencies. as well as higher costs to serve customers. We also continue to make high levels of business reinvestment to support continued innovation and product leadership across our product portfolio. Organic leverage was strong at approximately 21%. Please turn to slide number seven. We discussed the key revenue dynamics for each of the businesses earlier in the presentation, so I'll focus my comments on margins. In addition to the items discussed below, Each of our segments also continued to make significant investments in our innovation pipeline to fortify our leading brands and drive market outgrowth. In our Americas segment, we delivered solid margin expansion, driven primarily by strong incrementals on robust volume growth. Price offset inflation on a dollar basis but remained a margin headwind. Margins were also negatively impacted by the supply chain challenges and higher costs to serve customers that I referenced earlier. In EMEA, strong volume growth with solid incrementals was more than offset by foreign exchange impacts and continued acute supply chain challenges, which continue to have an outsized impact on productivity in the region. Price versus inflation improved sequentially and was positive on a dollar basis but remained a margin headwind. In Asia Pacific, margins expanded over 300 basis points on robust volume growth with strong incrementals, more than offsetting FX headwinds. Now I'd like to turn the call back over to Dave. Dave?
spk15: Thanks, Chris. Please turn to slide number eight. As we've discussed throughout the call, underlying demand for innovative products and services has never been higher, with unprecedented levels of bookings and backlog across our businesses. Relentless innovation, strong brands with leading market positions, customer focus, and operational excellence are hallmarks of our market outgrowth over a long period of time. In the Americas, our commercial HVAC business is driving strong demand and share gains, as demonstrated by our order growth of approximately 50% on a two-year stack. And we're exiting the third quarter with another quarter of record backlog, up more than 70% year over year and more than 200% of historical norms. And markets remain strong, with a variety of economic indicators pointing to growth in 2022. Unemployment is low. and indicators like the architectural billing index remain favorable, with a reading of over 50 since February of 2021. Demand remains strong in data centers, education, healthcare, and high-tech industrial verticals, where we have strong customer relationships and market positions. Our commercial HVAC business is underpinned by long-term secular tailwinds of energy efficiency, decarbonization, and indoor environmental quality. We also see tailwinds from new and ongoing regulatory and policy-related drivers, such as Inflation Reduction Act and education stimulus. Our commercial HVAC business has a lot of runway, and we believe we have the premier franchise to capitalize on significant opportunities that lie ahead. Demand for our residential products remained healthy, with a book-to-bill of 92%, combined with 16% revenue growth in the third quarter. We expect bookings and revenue to normalize over time and for regulatory and policy-related tailwinds such as the upcoming SEER change and the Inflation Reduction Act to help buffer potential market declines. Longer term, we continue to see residential HVAC as a GDP-plus business, which makes up about 20% of our portfolio. Turning to America's transport refrigeration, ACT continues to project solid growth in 2022, followed by a relatively flat 2023, where the market is expected to remain at a high level. We have a diversified portfolio of solutions across a number of vertical markets, which provide opportunities and continued growth prospects through further market penetration and share gains. Longer term, we continue to see transport refrigeration as a GDP++ business for us. We'll talk more about the transport refrigeration outlook in our topics of interest section. Turning to EMEA Commercial HVAC, While we have muted expectations for overall market growth, given the volatile geopolitical backdrop, demand for our leading sustainability-focused solutions remains strong. We continue to see good opportunities for market outgrowth and share gains across the region, and we're seeing great traction and growth across our thermal management systems portfolio. Looking at EMEA transport refrigeration, The market is expected to be down roughly mid-single digits in 2022, primarily reflecting the removal of Russia from the market sizing. Looking out to 2023, we expect the market to be down modestly, reflecting economic uncertainty in the region. We're continuing to work closely with our customers as the market evolves. Turning to Asia, we continue to see strength in data center, electronics, pharmaceutical, and healthcare verticals. Outside of China, the picture is mixed. with varying dynamics country to country. Now, I'd like to turn the call back over to Chris. Chris?
spk16: Thanks, Dave. Please turn to slide number nine. As Dave discussed at the outset of the call, we are pleased with our execution through the first three quarters of the year, and we continue to see slow but steady improvement in our supply chain. Additionally, bookings and backlog continue at high levels, providing us with good visibility into future revenues. All in, We're confident in once again raising our full year revenue and EPS guidance for 2022. We are raising our full year organic revenue growth guidance to between 13 and 14%, up from our prior guidance of 12%, reflecting both stronger price and volume for the year. We're raising our adjusted EPS guidance range to $7.15 to $7.20, from a range of $7.05 to $7.15. which is an increase of about seven cents at the midpoint. As Dave mentioned previously, our updated guidance includes an additional seven cent headwind from FX for the year that we are absorbing in our guidance, which means our core guidance range is effectively higher by about 14 to 15 cents at the midpoint. Our full year organic leverage expectations are unchanged at mid-teens. While we continue to see our supply chain slowly improving, it remains challenging and continues to pressure productivity in our plants and drive higher costs to serve customers as we've discussed previously. As a result, we're expecting similar to modestly improved leverage in the fourth quarter versus the third quarter, or between 20% and 25%. We expect free cash flow to remain healthy and are targeting 100% of adjusted net income for the year. Dependent upon the timing of revenue and shipments as we close out the year, We could see some receivables carry over into 2023, which could modestly impact the timing of our cash conversion. Other elements of our guidance remain largely unchanged. One last item I wanted to highlight relates to our guidance cadence. As Dave discussed earlier, when we raised our guidance on our second quarter call, we envisioned recouping about $30 million of the $120 million in delayed revenues related to the second quarter plant closures in the third quarter and recouping the other $90 million in revenues in the fourth quarter. We're extremely pleased we were able to accelerate this recovery plan and recoup $100 million in revenues in the third quarter, $70 million ahead of our guidance expectations. The net effect is a modest shift in the timing of $70 million in revenues or approximately seven cents of adjusted EPS into the third quarter from the fourth quarter. with no impact of the full year. Please see page 17 of the presentation, which provides additional details related to guidance to assist with your models. Please go to slide number 10. We remain on track to deliver $300 million of run rate savings from business transformation by 2023. We continue to invest these cost savings in high ROI projects to further fuel innovation and other investments across the portfolio. It's important to note that our transformation savings program is a discrete program related to recovering three times the amount of stranded costs we expected to see as a result of the separation of our industrials business. Our business operating system is designed to drive continued strong productivity and cost savings over the long term. And we have a long track record of success over the past 10 plus years. Our relentless focus on executing our business operating system and driving productivity and cost savings continues long after the discrete transformation program has achieved its targets. Please go to slide number 11. We remain committed to our balanced capital allocation strategy, focused on consistently deploying excess cash to opportunities with the highest returns for shareholders. First, we continue to strengthen our core business through relentless business reinvestment. Second, We're committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve. Third, we expect to consistently deploy 100% of excess cash over time. Our balanced approach includes strategic M&A that further improves long-term shareholder returns and share repurchases as the stock trades below our calculated intrinsic value. Please turn to slide 12, and I'll provide an update on our capital deployment in 2022. In the third quarter, we deployed $406 million in cash, with $156 million to dividends and $250 million to share repurchases. Year-to-date through October, the company has deployed approximately $1.6 billion, with $900 million to share repurchases, $467 million to dividends, and approximately $250 million to M&A, including the acquisition of Alco Air Technology, which closed on Monday, October 31st. We continue to target the deployment of approximately $2.5 billion of capital in 2022. Our M&A pipeline remains active, and we have significant firepower for share repurchases with approximately $3.5 billion remaining under current share repurchase authorizations. Our strong free cash flow, liquidity, and balance sheet continue to give us excellent capital allocation optionality and dry powder moving forward. Now I'd like to turn the call back over to Dave. Dave?
spk15: Thanks, Chris. Please turn to slide number 14. Overall, global transport refrigeration markets are expected to remain healthy in 2022. Forecasts for 2022 are largely unchanged versus the last quarter, with strong growth in North America and a mid-single digit decline in EMEA, largely driven by the removal of Russia from the market sizing. For 2023, forecasts have softened a bit versus the prior quarter. ACT is now projecting roughly flat growth from 2022 to 2023, with the overall market remaining at a high level. In EMEA, while IHS has yet to publish an official outlook for 2023, we expect the market to be down modestly based on a softening European economic backdrop. After clear share gains in truck, trailer, and APU, and both the Americas and EMEA in 2021, we're expecting continued share gains in 2022. For 2023, we have strong and diversified portfolios in both North America and EMEA and see opportunities for growth and share gains across our portfolio. Please go to slide number 15. In summary, we are positioned to outperform consistently energy efficiency, decarbonization, and sustainability megatrends continue to intensify and create record levels of demand for our innovative products and services. We are uniquely positioned to deliver leading innovation that addresses these trends and accelerates the world's progress, supported by our business transformation and our engaging, uplifting culture. The strength of our business operating system, the power of our global team, and our broad-based market demand gives us confidence in raising our full-year revenue and EPS guide. We believe we have the right strategy, the best team, and a solid foundation in place to deliver strong performance in 2022 and differentiated long-term shareholder returns. And now, we'd be happy to take your questions. Operator?
spk10: Thank you. If you would like to ask a question on the phone lines today, please press star 1 on your telephone keypad. To remove yourself from the queue, you can press star 1 again. Once again, everyone, please limit yourself to one question and one follow-up. We'll take our first question from Andy Kaplowitz with Citigroup.
spk08: Good morning, guys. Nice quarter. Hey, Andy. How are you doing? Good. Dave, can you give us more color into the commercial HVAC bookings environment in the Americas? It looks like Your bookings actually accelerated a bit in Q3. Could you talk about the biggest drivers of that bookings growth at this point and the visibility of continued strong bookings? How much of the good growth is the impact from institutional customers maybe starting to reach day two spend in IAQ? Have you seen any customers begin to pull back on spend yet, and are you seeing any major differences between applied and unitary?
spk15: Yeah, well, we haven't seen any pullback, Andy. Good question, but we're seeing broad-based demand electronics, data centers, education, healthcare, high-tech industrial, think of electronics, EV plants, battery plants. So we're seeing some nice demand. I mean, our order rates were up around 20% in the Americas, and it's really across many verticals. So a lot of strength there.
spk08: Great. And then maybe a similar question on Resi. I know you don't want to give us exact forecasts for 23, but Booking's down high single digits in line with what you guys thought. But pricing is still very strong. Have you seen any weakness in replacement volume at this point? You kind of said that you didn't expect it to fall off a cliff. How's that going? What about inventory in the channel? And are you still measuring your resi backlog in months that gives you decent visibility, especially with SEER change in 23?
spk15: Yeah, our resume business had a very strong third quarter with strong mid-teens organic revenue growth. Book-to-bill in the quarter was 92%. Channel inventory in our independent wholesale distributor channel was a bit higher than normal, but nothing alarming. Sell-through in the independent channel was mid-teens, so it was strong. Order rates will be under pressure here in the short term, as we think about this backlog that we're still measuring in months as it starts to normalize. And Andy, if you remember in 2021, our order rates for our resi business on a full year basis were up around 30% and our revenue was up like 14%. So we built this really large backlog that we'll need to process through. And you really need to look at, when you think about residential, you really need to look at three different elements. One is, what's your order rate? Two is, what's your backlog? And then, obviously, the revenue. And those three will start to neutralize themselves over time. But longer term, we see our residential business as a GDP plus business. And they had a very strong third quarter for us.
spk16: Andy, I'll add on the enterprise backlog. We reported $6.4 billion. We still see that 90%. is non-residential. It's focused on our commercial businesses, including Thermo King. So I'll say the same here in the third quarter.
spk15: Andy, we do not see Resi falling off a cliff. There's going to be some positive tailwinds too next year. You know, you have the SEER change that will happen, which will drive some price. You also have IRA, which we're still working through. There's some elements there that still need to be defined, but that will be a tailwind. Hopefully that starts towards the beginning of the second quarter. So there is some positive too in residential.
spk08: Appreciate it, guys.
spk15: Okay. Thanks, Andy.
spk10: We'll take our next question from John Walsh with Credit Suisse.
spk11: Hey, good morning and congrats on the nice quarter. Thanks, John. Appreciate it. I'm going to take a stab at it. So you have incredibly strong backlog. You've opened up the order book at Thermo King. Services continues to grow nice just Anything you can give us in terms of maybe how you think the market develops into 23 or just how much more visibility you have today than you would normally have going into a year?
spk15: Yeah, I mean, I think with a backlog of $6.4 billion, it gives us a lot of visibility. If you think about a normal fiscal year, John, we typically go in with about 20% of our revenue in the backlog. Obviously, we're going to go into 2023 with a much larger number, which really is going to help us too with our forecasting capability with our suppliers. The supply base is still constrained. It's improving. The third quarter was certainly better than the second quarter. The fourth quarter will be better than the third quarter. But it is going to be constrained for a period of time. But having that visibility really helps us, helps our suppliers, helps us with our forecasting capability.
spk11: Great. And then maybe just on the margin, price costs still positive on absolute dollars. I think you said it's still a headwind to the margin. Just, you know, as you think about price flowing into next year, maybe also what you're seeing on inflation, just maybe give us some expectations for price cost and when it flips positive on a margin percent.
spk16: Yeah, John, you summarized it well. The third quarter price cost, positive on a dollar basis, still a margin headwind, but less of a margin headwind in Q3 than what we saw in Q2. So it is getting a little bit better. As we think about 2023, we'll certainly see some carryover price coming into next year. We're seeing those commodities start to come down off of their peaks. Certainly not back where we were two years ago in terms of commodity costs, but a little bit of deflation there. We see that impacting 2023 more so than 2022. But we also are looking at items like wage inflation and energy inflation as well. So we'll need to bundle all together and we'll provide a better look on 2023 in a few months when we report our Q4 earnings. But there should be some deflationary opportunities in there. We're going to have, as Dave mentioned, a very strong backlog entering into 2023.
spk02: and ultimately the goal here is to deliver top quartile results. Great. Thank you. I'll pass it along. Thanks, John.
spk10: We'll take our next question from Scott Davis with Milius Research.
spk04: Hey, good morning, guys. Hey, Scott. How are you doing? Good. Good. Thank you. Guys, if you think back to kind of prior housing recessions, we saw You know, a bit of a double mix shift, you know, a mix shift down to lower end units and a mix shift towards more repair versus replace. What, you know, given the SEER changes that are coming in in 23 and perhaps maybe change in how DORs have taken inventory and stuff, what do you, do you see a similar potential or muted impact? It sounds from your preferred remarks like perhaps a more muted impact, but maybe some color. on why it would be helpful.
spk15: Yeah, I think it will be a little bit more muted. I think that there's obviously the SEER change, which we are in the process, obviously, of shipping the new products as we speak. So that's going to add some price. It's also going to push up the higher end of the SEERS market. I also think that IRA will be a tailwind. Again, we're working through some of the details on that that still need to be defined, but that will certainly push
spk04: market more to the heat pump side of things and the higher sears on the heat pumps okay um and switching gears you know i see in kind of your releases press releases plus kind of trade magazines the the next generation of products and thermal king is where is that mark what i mean help us understand kind of you know the demand from the customer for next generation product in particular really where is that technology going is it going to a hybrid Um, or all battery where and when I suppose is another way to good question.
spk15: We don't have totally the crystal balls there, but I would tell you that it is moving to electrification. Okay. You're seeing it in the smaller vehicles now. Um, and we have a complete portfolio of products there that are able to capture that market on the long haul carriers. So think about the reefer units. That'll be a slower transition. but we're ready for it. We actually have products that are out now we're testing in the field with customers that are fully electric. It'll take an approach very similar probably to what you've seen with cars where you'll start with hybrid, and then it will move to an all-electric version.
spk04: Okay. Best of luck. Thank you, guys. Appreciate it. Thanks, Scott.
spk10: We'll take our next question from Julian Mitchell with Barclays.
spk07: Hi. Good morning. Good morning. I just wanted to start with the Thermo King outlook. So you've got that very helpful slide 14. Just when we're thinking about next year, you know, it looks like, as you said, the sort of third party market forecast and so forth of a sort of flat to down units in 2023. So I just wondered about, you know, how would you sort of, frame the scope for Thermo King or overall transport that train to do better than that? What's the outlook for that one-third of revenue, which is sort of marine, bus, rail, and aftermarket? How is pricing in transport for you versus the train enterprise? Any thoughts on share gain? potential perhaps after some undergrowth in North America this year? Any sort of color on that, please?
spk15: Yeah, I would say that our Thermo King business, I'll start in the Americas, it's performed very well for a number of quarters consecutively. Very strong quarter, obviously, in third quarter as we saw the revenue that we missed in Q2. The team was able to pick that up in Q3. Just a great effort there by that team. as far as share gains we're very happy with our share gains in our thermal king business outlook for 2023 we like the innovation that we've been able to you know drive in that business in really both regions both in mia and in the americas and it's really helping us with those share our share position so you know 2023 in the americas yeah act has got it relatively flat to 2022 But understand that's at a very, very high level. I mean, they're forecasting the trailer market to be, you know, the last number I saw was like 45,000, which is a very, very robust market. And in Europe, we haven't seen an official forecast from IHS. We're estimating that it's going to be down modestly. But don't assume that that means that our business will be down, okay? We have some great innovations there. and we continue to get traction with some of the innovations that we've had in our MIA business.
spk07: Dave, maybe just one follow-up on that. The pricing in transport, how do we think about that versus the train enterprise average of, I think, 10 points?
spk16: Julian, I'll jump in. We don't really dial it in necessarily by each SBU, but I would say it's certainly contributing to the enterprise performance The business operating system that's been deployed for many years, one aspect of that is pricing and getting in front of inflation. And the Thermo King team is really a part of that strength that we've shown over the last now seven quarters in this highly inflationary environment and staying ahead on price costs. So really proud of where our team's both in America's in Europe and in Asia have dealt there.
spk15: Joey, if I could just follow up on just a quick story here to talk a little bit about our culture here at Train Technologies. That team in the Americas overcame a massive obstacle that happened in the early May time period when a tornado hit our facility in Puerto Rico and really removed the roof from one of our major assembly operations there. And I can remember meeting with that leadership team, and it was early May. And the president of that business, she walked into the room and she looked at the team and she had three questions for the team. And she said, number one, are all our employees safe? And the answer was yes, because the storm hit on a Sunday afternoon and the plant was unoccupied. The second was, do any of our team members need help? And the answer was no, because as tornadoes are, they tend to be very targeted and it wasn't a large impact to the community. And the third question was, is how do we get this facility back up and running so we could take care of our customers? And here we are, you know, talking about this in the, you know, late third quarter, early fourth quarter, and we were able to recover all of the missed revenue that happened in the second quarter and the third quarter. That team performed exceptionally well and just it speaks volumes to the character of not only that team but to train technologies.
spk07: That's good to hear, Dave. Maybe just switching tack for a second, operating leverage, you know, Chris, you called out 20% to 25% of Q4. When we look at this sort of broadly the next 12 months, you know, do we assume that number lifts gradually as you get this kind of steady abatement of price, cost, and supply chain margin headwinds? There's no kind of step change, but it should clearly move higher from Q4.
spk16: Yeah, I would say, Julianne, The direction where commodities are going would suggest there should be certainly some improvement. We've done some great work staying ahead on price and keeping it ahead of inflation. So I think that is an opportunity going into next year is that price versus direct material cost inflation. We are looking at areas such as wage inflation and energy inflation as well that have to be factored in. So we'll provide more guidance on that in a few months. We're also going to be, right now we're in the middle of that planning process for next year. We're really spending a lot of time around our investments again and where can we accelerate some of those investments to really drive returns. So all of that's going to be baked in as we think about incrementals for next year. But, you know, a lot of moving components as always, but we'll give you guidance in a few months.
spk02: Great. Thank you. Thanks, Julian. Thank you.
spk10: We will take our next question from Joe Ritchie with Goldman Sachs.
spk02: Thanks. Good morning. Hey, Joe. How are you?
spk05: Doing great, Dave. Seems like you guys are doing well as well, but thanks for asking. Just going to maybe just starting off with EMEA, maybe just parse out a little bit what's happening here on the margins. You're clearly, I'm assuming, FX. price cost having an impact? It's been down now for four quarters in a row. I'm just wondering, at what point do we start to see an improvement in the margin profile for the EMEA business?
spk16: Yeah, Joe, think of that FX decline on a year-over-year basis. About half of that is coming from foreign currency. The other half of that is still these acute supply chain issues that You know, frankly, we saw in that region starting about a year ago with the significant demand. And, you know, we're still incurring higher costs to serve customers, which we know is the right thing to do in this market. But, you know, both those costs, the supply chain inefficiencies, which are still very real, and then foreign currency are really the drivers for margin. We do expect those margins to improve over time as these supply chain challenges improve. Dave's talked about this gradual recovery, and we've seen that occur in the third quarter with some stronger volumes than what we had forecasted. And we do see that gradually getting better as we move out over the next several quarters. But it's going to take some time.
spk15: Yeah, Joe, the other thing I would add is I'm very confident long-term with our outlook in Europe. That region continues to grow, share, and it is one of our leading regions with innovation. So just a really creative management team there that's been able to execute well and Long term, I feel good about Europe.
spk05: Yeah, I guess maybe part of my question, I should have asked it earlier, is like are you starting to see any impact from, you know, European energy costs? Like is that impacting the margin at all? Just any color around that would be helpful.
spk16: Yeah, I'd say maybe a little bit in the third quarter. I mean, certainly as we talk to our employees, they're feeling the impact of that in their own utility bills and the statements that they're getting at home. Yes, it is starting to creep in a little bit in the third quarter, a little bit into the fourth quarter, and certainly into next year, maybe a bigger dollar amount for us to kind of consider and think about from pricing perspective. I think what it's also doing is driving a fair amount of the order growth as well. As you think about products that are in the Thermo King space, hybrid electric products that have 30% fuel savings versus the product that was on the market two years ago. The electrification of heating and driving our thermal management systems on the commercial HVAC side, the reduced energy intensity, those are really contributing as well in this very challenging energy crisis in Europe.
spk05: Got it. That's helpful. And if I could just maybe sneak one more in just on Resi, can you parse out just how much of the growth this quarter was price versus volumes and whether there's been
spk15: any like you know discernible difference between what you're selling through your own network versus you know what you're selling through independent distribution yeah i think the simple answer there is everything was up mid-teens so that makes it easy to answer uh yeah i mean for the enterprise we had we had over 10 points of price uh and resi continues to be one of our you know uh leading businesses with price so it's north of 10. But we won't go any further than that for competitive reasons.
spk02: But it's a strong business, had a good strong third quarter.
spk05: All right, great. Thanks, guys.
spk02: Okay, thanks, Jeff. Thank you.
spk10: We'll take our next question from Gautam Khanna with Cowan.
spk13: Good morning. Nice quarter, guys. Thanks. Appreciate it, Gautam. Yeah, just to follow up on the last question on Rezzy, I was wondering, are you seeing any signs of double ordering, pushback, or maybe as lead times come in, you're getting cancellations or anything of that sort? I'm curious, you haven't given guidance for next year, but do you think resi profits can actually be up next year with volumes down some unquantified level? And if so, kind of why?
spk15: Yeah, I'll start. I'll let Chris talk about the profit next year, but we're not seeing any cancellations. Okay, that's not happening. If I look at the inventory in the channel, as I said earlier, it's a bit higher than we would normally see, but nothing alarming, and we haven't seen any cancellations. I do believe that we will see our order rates on a unit basis continue to come down because we have to process through this backlog that is You know, it's just we're still measuring it in months, and it's going to take several quarters before we're able to process that down.
spk16: Yeah, I would add on the on the margins, as we've said, the residential businesses really had some very strong price over the last seven quarters at the same time, stayed ahead of inflation. And as you go into our planning process, we look at all of our strategic business units and we think about top line growth, leverage growth, cash flow performance across the board. I think the team has executed quite well with investments they've made over several years in the value space. That's a market that continues to grow well for that SPU. And depending on how markets move in the U.S., that's an area that 10 years ago we didn't have very much of a presence in the value channel. That's an area we do have a presence in today. And on the replacement side versus... repair. We'll see where that plays out, but it's a business that has a great sense of purpose as well as brands.
spk15: And I've said this before, but we don't see the residential business falling off a cliff next year. And we don't see margin contraction or large revenue fall-offs.
spk02: Thank you, guys. Okay. Thank you, MQ.
spk10: We'll take our next question from Steve Tusa with J.P. Morgan.
spk15: Hi, good morning. Hey, Steve. How are you?
spk00: Good morning. Good. Is the mix of your resi business with furnaces, is that about in line with the industry? You know, call it like 30% or something like that?
spk15: Yeah, I don't. I know that. It's a good question, Steve. I don't have that in front of me. I would tell you that I know that our mix of heat pumps is stronger than the industry. So that would, and obviously you don't have a furnace with a heat pump, but I don't have the specifics on heat pumps when we're selling split systems.
spk00: Yeah. Okay. And then just on the commercial side, I think you guys put through a pretty dramatic price increase in the third quarter on light commercial. And we're continuing to hear about extended lead times there. Can you just talk about maybe if, you know, what kind of behavior you saw around that price increase or if I'm wrong about that? And then are you guys, you know, seeing longer than normal lead times on the light commercial side?
spk16: Yeah, Steve, I'll start with pricing. Just part of our business operating system is to evaluate the input costs and then ultimately making sure we're pricing based on value as well. I'd say across the majority of our businesses in 2022, we've seen actually three rounds of price increases, very similar to the three rounds we saw in 2021. So, yeah, I think the team is looking at significant demand, making sure we're pricing for it. A number of these products are being delivered, you know, three, six, nine months out. So we want to make sure we're protecting ourselves from an inflation perspective on the cost side.
spk15: Yeah, as far as lead times go, Steve, we have extended lead times across our portfolio, as does the broader industry, as do most industrials right now, as we're still working through the supply chain challenges that are improving. As far as on the unitary side, actually, we're doing pretty well there. So I don't see that. That's not an area that I would imagine that we're very competitive in the marketplace there.
spk00: What was your commercial unitary order up in the quarter? That's my last question. Thanks.
spk15: Orders, I'm sorry, in unitary?
spk00: Commercial unitary, yeah, commercial unitary equipment.
spk15: I don't know. I know our revenue was up in the 20s. I don't know what the order rate was. We'll get back to you on that on the after call.
spk00: Great. Okay. Thanks a lot. Appreciate it.
spk10: We'll take our next question from Nigel Coe with Wolf Research.
spk06: Yeah, thanks. Good morning. Thanks for the question. Just touching very quickly. Come on, Dave. Just quickly on the unitary versus applied mix. You know, obviously lots of questions about the macro. The applied large commercial feels like it's got a lot of secular tailwinds and it has. Would you say unitary still has a bit more stochasticity risk than applied? Just a quick question there. But really my question is really around the services. You know, low teens in the Americas and EMEA, really impressive. I think over time it's grown 78%. Is the delta between trend and now mainly price, or is this IEQ and other things that's driving that growth rate? And kind of like how do you think that trends in 23?
spk15: Yeah, I think if you look longer term at our service business, and let's look over a five-year period here on a global basis, our service business is up on a compound annual growth rate, you know, high single digits here. So that's a business that's very resilient, that's performed very well for us. In fact, in 2020, the pandemic year, we were flat to 2019, despite having, you know, lockdowns and having difficulty accessing some buildings. So service business is a great business. We have a great operating system around our service business. And, you know, today it represents, you know, close to a third of train technology. So we're very happy with our service business. On the unitary side, we had strong growth throughout our commercial HVAC business. So it was broad-based and unitary and inapplied. So really broad-based in many verticals across the globe.
spk01: Okay, that's great.
spk06: And my follow-on is really a quick one on supply chain. One of the companies this morning surprised on supply chain availability issues in the current quarter relative to last quarter. It feels like most companies are talking about supply chains slightly improving. I'm just wondering how you characterize the momentum in your, you know, kind of in the hard to get components.
spk15: Yeah, I'd say supply chain performed as expected during the third quarter. You know, we anticipate a gradual improvement through the rest of the year and for several quarters into 2023. Our team is doing just a great job of managing that. I think this large backlog gives us more visibility, as we talked about earlier, which, again, being able to tell our suppliers what we need is very important and being accurate with that, and our team's just done a fantastic job there. So supply chain's improving slowly, slower than any of us want, and we'll continue to see improvement in the fourth quarter here.
spk06: Great. Thanks, Ed.
spk10: We'll take our next question from Jeff Sprague with Vertical Research.
spk14: Hey, thanks. Good morning, everybody. Good morning, Jeff. How are you? Hey, I'm doing great. Thanks. Hey, just a couple loose ends. Hey, first, Chris, just back on Europe margins and FX, I typically think of FX being a profit headwind but not a margin headwind. Is there some particular transactional issue going on in Europe beyond just kind of translation effect of dollar strength?
spk16: Jeff, it's a good question. Not all the components raw material purchases in Europe are all denominated in euros. There's certainly components that come in from the US or from Asia. So there are some transactional headwinds here when you think about the declining euro against the dollar. So that's part of the driver. But I totally understand your question, but it is that dynamic of some of the components we buy in currency other than the euro.
spk14: And I was wondering also if you guys could kind of take a swag at measuring kind of the productivity headwinds you've absorbed here over the last, whether it's the year to date or since we got into this whole kind of tangled supply chain mess. And, you know, how significant have they been to margins and aggregate and just your thought process on being able to reverse some of that as we maybe perhaps get into the second half of 23?
spk15: Yeah, I think, you know, one of the knock-on effects of a supply chain that's inconsistent is productivity. So if you think about you're running a factory and you don't have the right components, you're stopping lines, you're partially building product, you're putting it out in the yard, you're bringing it back on the line when you get the components to retest the product because obviously we want to test everything before it gets shipped out to a customer. So it's been disruptive. It's improving, but it's going to improve slowly as the supply chain improves. As far as quantifying it, it's difficult to do right now. I would just tell you that it's going to be slowly improving and we'll continue to make progress. It's certainly a focus of our teams as to how do we get back to being able to have the productivity we've seen in the past. But the supply chain, the knock-on effect associated with it, it has had an impact in our operations for sure.
spk14: I'm sorry, just a related follow-up to that, Dave. So if If supply chain got better, you know, more quickly than expected, do you think you could actually accelerate backlog conversion or the customer at the job site still is not ready, you know, that there really isn't scope to dramatically accelerate backlog conversion?
spk15: Yeah, I think that we're obviously getting with extended lead times, okay, I think the first thing you're going to see is as the supply chain improves, you'll you'll see those lead times start to contract back to more of a normal level. But right now, we're obviously, especially on applied jobs, those are specific to a job site, and they're giving us enough lead way so we're able to hit their expectations. So it's very difficult to accelerate that on the applied side unless the job site suddenly gets pulled forward, which happens, but I wouldn't say it's, we're not seeing that as the norm right now.
spk14: Okay, great. Thank you.
spk15: Okay, thanks, James.
spk10: We'll take our next question from Dean Dre with RBC Capital.
spk03: Thank you. Good morning, everyone.
spk15: Hey, Dean.
spk03: Hey, I'm not sure how specific you can get here, but at the outset of the call, you talked about market share gains in virtually all businesses. If we think about that nine percentage points in volume growth, how much of that might be attributed to share gains? And again, it's harder at a total company level versus the business unit. But if any color there would be helpful.
spk15: Yeah, I mean, it is. I think when you start talking averages and you start getting share up to a company level, it's not meaningful. But I would tell you that if you look around the different regions, we like the growth rates we're seeing. We like the innovations we've been able to drive. And we certainly like the order rates that we're seeing. And, you know, you could see that with our order rates versus maybe some, some other companies, but, um, we're very happy with the performance. We're very happy with our product management teams, being able to really understand customers insights and being able to have innovations that, that exceed their expectations. So expect that to continue in the future. You know, one of the things that we pride ourselves in is the fact that we don't let up on innovation. We don't let up on the dollars that we invest in innovation. And you're going to continue to see that from trained technologies well into the future.
spk03: Appreciate that. And just as a follow-up on any update on Indoor Air Quality Healthy Buildings Initiative, you all had kind of drawn the line in the sand and said it would be a 200 basis point lift for 10 years or so. Where does that stand? Go ahead, Chris.
spk16: Yeah, we quantified it last year, Dean, as a two-point lift on revenues. And then as we moved through the year last year, we just found it was really hard to start bifurcating what was an indoor air quality order versus maybe a traditional equipment order or a service order. So it certainly helped contribute to the growth last year, but as we're seeing significant growth this year, it took the full year guide up. 13% to 14% organic growth on the full year. Indoor air quality is one of those contributors to customers looking at upgrading their equipment, getting energy savings right earlier, especially where we see energy prices right now. It certainly is a contributor in the remaining tailwind.
spk15: One of the areas, Dana, to just talk a little bit about is in the education vertical. And I know the funding there with ESSER, our education vertical in North America, order rates are up year-to-date over 40%, over 40%. So you could see the traction that we're having there.
spk02: That's real helpful. Thank you. Sure.
spk10: We'll take our next question from Joe O'Day with Wells Fargo.
spk09: Hi, good morning. Thanks for taking the question. Hey, Joe, how are you?
spk02: Good morning.
spk09: Doing well, thanks. I wanted to ask on COGS and just thinking about some of the cost dynamics moving forward. And if you could talk about sort of within the materials exposure, how much materials is of COGS, how much of that is RAS versus, you know, source components. And what do you think about those cost trends? Or should we see sort of a supply chain and lower RAS contribute to lower component costs as well? or strong demand doesn't translate to lower component costs, just to kind of understand some of those moving pieces.
spk16: Yeah, it's certainly all of the above in a mix. We're going to look, as we go into guidance for next year, trying to just give an update of the componentry of commodity costs versus other costs, because that has kind of changed over time. We've described between copper, aluminum, and steel, those being each about a third of total what I call tier one commodity costs, excluding state refrigerants. And certainly, as I said before, it provides a bit of a tailwind going into next year in terms of where we see those commodity costs going right now. Certainly with more volume, there generally is a bit more leverage we can try to get. But in this supply chain environment and the constraints, you know, we're ultimately just trying to manage that quarter to quarter and continue to see that getting better. So I guess I'd leave it at that kind of level as we kind of ultimately look to price for next year and ultimately try to get a price-cost positive spread for next year.
spk09: Got it. That's helpful. And then back to the price-cost margin dynamic, just based on the visibility that you have, when do you see that flipping such that you're positive on the margin side from a price-cost angle?
spk16: Yeah, I expect for the fourth quarter to remain price-cost positive on a dollar basis. I think it will still be margin decremental on a year-over-year basis. That price component, though, of the growth in the fourth quarter, that will be lower than the third quarter. We're just comping against stronger price realization from a year ago, certainly second half of 2021 much stronger than the first half. So I do expect top-line price to be less of a contributor in Q4, but we're on track to be price-cost positive for the full year, and ultimately for the full year, it'll be a bit of a margin headwind as well.
spk02: Okay. Thank you. Sure. Thanks.
spk10: And that concludes today's question-and-answer session. I would like to turn the call back over to Zach Nagel for closing remarks.
spk12: Great. I'd like to thank everyone for joining on today's call, and as always, we'll be around to take any questions that you might have in the coming days and weeks, and hopefully we'll see you on the road soon. Everyone have a great day. Bye.
spk10: And that concludes today's presentation. Thank you for your participation. You may now disconnect.
Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

Q3TT 2022

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