Trane Technologies Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 30, 2024

Key Takeaways

  • Q3 2024 results: Delivered 11% organic revenue growth, 120 bps adjusted EBITDA margin expansion and 21% adjusted EPS growth, led by strong bookings and backlog.
  • Raised full-year guidance to ~11% organic revenue growth (from 10%) and ~$11.10 adjusted EPS (up $0.30), expecting fourth consecutive year of ≥20% EPS growth.
  • Americas Commercial HVAC remains a standout, with Q3 revenues up nearly 20% and each quarter of 2024 tracking >50% growth on a three-year stack.
  • Asia Pacific faced headwinds, driven by weaker Chinese non-residential markets and tighter credit policies, though management anticipates improvement in Q4.
  • Year-to-date capital deployment of ~$2 billion (dividends, M&A and ~$1 billion in buybacks) leaves $1.5 billion share repurchase authorization, supporting balanced allocation.
AI Generated. May Contain Errors.
Earnings Conference Call
Trane Technologies Q3 2024
00:00 / 00:00

There are 13 speakers on the call.

Operator

Good morning. Welcome to the Trane Technologies Q3 2024 Earnings Conference Call. My name is Julianne and I will be your operator for the call. The call will begin in a few moments with the speaker remarks and the Q and A session. At this time, all participants are in a listen only mode.

Operator

After the speakers' remarks, we will have a question and answer session. I will now turn the call over to Stack Nagle, Vice President of Investor Relations.

Speaker 1

For joining us for Training Technologies' 3rd quarter 2024 earnings conference call. This call is being webcast on our website at trainingtechnologies.com, where you'll find the accompanying presentation. We're also recording and archiving this call on our website. Please go to Slide 2. 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.

Speaker 1

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

Speaker 2

on today's call are Dave Rugnieri, Chair and CEO and Chris Kyun, Executive Vice President and CFO. With that, I'll turn the call over to Dave. Dave? Thanks, Zach, and everyone for joining today's call. Please turn to slide number 3.

Speaker 2

I'd like to begin with a few minutes on our purpose driven strategy, which enables our differentiated financial results over time. Climate change is occurring much faster than anticipated, affecting people and communities around the world. As we saw here in North Carolina just a few weeks ago, Urgent and transformative action is needed to reduce emissions and limit global warming. That's where Trane Technologies comes in. Through our innovation, we are helping our customers reduce energy and emissions.

Speaker 2

When you consider that in a typical building, approximately 30% of the energy after the meter is wasted, it's a massive opportunity. And for our customers, it's green for green, good for the planet and good for the bottom line. With our relentless innovation, consistent execution and uplifting culture, we are positioned to deliver a leading growth profile and differentiated financial results over the long term and build a more sustainable future. Please turn to slide number 4. We delivered strong performance in the 3rd quarter, extending our track record of leading revenue and EPS growth among industrials.

Speaker 2

Our global team delivered 11% organic revenue growth, adjusted EBITDA margin expansion of 120 basis points and adjusted EPS growth of 21%. Enterprise organic bookings were very strong at $5,200,000,000 the 2nd highest quarter in the company's history, up 5% in the quarter and up 13% on a 2 year stack. To put this into perspective, bookings were only about $120,000,000 or 2% below our highest bookings quarter in Q2 of this year. Organic bookings in Americas Commercial HVAC this quarter were also the 2nd highest in company's history, up low single digits and up mid teens on a 2 year stack. Q3 bookings were only $100,000,000 below the highest bookings quarter in Q1 of 2024.

Speaker 2

Net absolute bookings remained very strong. Given the tremendous growth we've seen over the past 4 years and the variation in order timing, comps will likely continue to be somewhat lumpy. While absolute bookings are expected to remain very strong, backlog also remains very strong at $7,200,000,000 up from $6,900,000,000 at year end 2023, and we expect to exit 2024 with highly elevated backlog. We encourage investors to look at absolute bookings, revenues and backlog, along with growth rates in order to gain a clear picture of our strength. Robust performance continues to be led by our Americas commercial HVAC business, where revenue growth has been exceptionally strong and consistent.

Speaker 2

Revenues for each of the 1st 3 quarters of 2024 are up 50% plus on a 3 year stack, inclusive of both equipment and services. And we expect the 4th quarter revenue to be up 50% on a 3 year stack as well. We are building a strong track record of market outperformance, particularly as increasing project complexity plays to our unique strengths in innovation and direct sales and service. Case in point, organic bookings and revenue for our Applied Solutions in the Americas are both up well over 100% over the past 4 years. Our installed base is expanding rapidly, adding an estimated 8 to 10 multiple of higher margin services revenue over the life of the equipment.

Speaker 2

Our strong performance throughout 2024 has enabled us to accelerate incremental investments, while delivering full year leverage above our long term framework of 25% plus. We've stepped up the pace of investments in the second half of twenty twenty four, further strengthening our position for 2025 and beyond. Given our strong performance and positive outlook, we are raising our full year organic revenue and adjusted EPS guidance. Chris will cover our guidance update in more detail later in the presentation. Please go to slide number 5.

Speaker 2

Commercial HVAC has delivered exceptional bookings and revenues throughout the year, as I've highlighted on the prior slide, with broad based strength across vertical markets. Revenue was very strong, up nearly 20% in the quarter, with equipment and services up nearly 25% and mid teens, respectively. In residential, the team delivered very strong results, with bookings up high 20s and revenues up low teens. Turning to transport, the business performed as expected. Bookings were strong, up high 20s.

Speaker 2

Revenues were down high single digits consistent with our guide. In EMEA, commercial HVAC strength continues to be driven by demand for our innovation, with bookings up mid single digits in the quarter and up high teens on a 2 year stack. Revenue was also strong, up low teens. Our transport business performed in line with our expectations, with bookings up mid teens and revenues flat. Turning to Asia, results were mixed between China and the rest of Asia.

Speaker 2

Starting with the rest of Asia, bookings and revenues were solid, up low single digits and up mid single digits respectively. China had a challenging quarter, which I'll discuss in more detail on slide 8. Now, I'd like to turn the call over to Chris. Chris? Thanks, Dave.

Speaker 2

Please turn to slide number 6.

Speaker 3

This slide provides a snapshot of our performance in the 3rd quarter and highlights continued strong execution top to bottom. Organic revenues were up 11%, adjusted EBITDA margin was up 120 basis points and adjusted EPS was up 21%. At an enterprise level, we delivered strong organic revenue growth in both equipment and services, up double digits and low teens respectively. Our high performance flywheel continues to pay dividends with relentless investments in innovation, driving strong top line growth, margin expansion and EPS growth. Please turn to slide number 7.

Speaker 3

At the enterprise level, we delivered robust volume growth with strong incrementals, positive price realization and productivity that more than offset inflation and continued high levels of business reinvestment. In our Americas segment, we delivered about 12 points of volume and 3 points of price. Strong volume growth in our commercial HVAC and residential businesses was partially offset by muted performance in our transport business. Adjusted operating margin expansion of 130 basis points was driven by volume growth, productivity and price realization more than offsetting inflation and high levels of business reinvestment. In our EMEA segment, we delivered about 7 points of volume and one point of price with strong volume in our commercial HVAC business.

Speaker 3

Adjusted operating margin expansion of 140 basis points was driven by volume growth, productivity and price realization more than offsetting inflation and high levels of business reinvestment. In our Asia Pacific segment, volumes declined by approximately 22 points. The team was able to deleverage within gross margin rates. Now, I'd like to turn the call back over to Dave.

Speaker 2

Dave? Thanks, Chris. Please turn to slide number 8. Our outlook is largely unchanged as we move closer to the end of the year with Americas Commercial HVAC and Residential a bit stronger and Asia Pacific more muted. We've talked about the strength of our Americas commercial HVAC business at length, so I won't go into a lot more detail.

Speaker 2

We expect the strength to continue in the Q4 with 3 year stack revenue growth of approximately 50%, consistent with our performance each quarter this year. Our residential business delivered stronger than expected growth in the Q3, driven by the factors highlighted on the slide. We continue to expect a modest pre buy of 410A in 2024, primarily impacting Q1 of 2025. We've raised our full year 2024 revenue growth outlook to up high single digits, up from mid single digits prior. In our Americas transport business, ACT continues to forecast the 2024 transport markets to be down mid teens, and we expect to outperform.

Speaker 2

Looking to 2025, ACT has moderated their trailer growth expectations to up low single digits. This includes a weak first half and a stronger second half and we largely agree with that view. We've been investing heavily in our transport business. And as the markets recover, we expect to emerge well positioned to outperform. Overall, the changes to our outlook in the Americas segment are favorable, and we reflected this in our raised guidance for the year.

Speaker 2

Turning to EMEA. The business performed as expected and there's no change to our outlook. Asia represents about 8% of our overall revenue mix with about 50% in China and 50% in the rest of Asia. The rest of Asia performed in line with our expectations in the Q3 and we expect continued modest growth in Q4 as well. Our China commercial HVAC business came in below our expectations in the Q3, primarily related to two factors.

Speaker 2

First, the non residential markets in China deteriorated meaningfully since the June timeframe, and bookings and revenues were negatively impacted as a result. 2nd, we made the prudent decision to tighten our credit policies in China, primarily related to down payments and progress payments. Despite the significant revenue decline in China, the team maintained deleverage within gross margin rates. While China will remain a dynamic environment, we expect some improvements in the Q4 as our customers and sales teams navigate the market and policy changes. We have an outstanding team in China that has delivered leading results for many years, and I remain confident in our team's ability to outperform over the long term.

Speaker 2

Now, I'd like to turn

Speaker 3

the call back over to Chris. Chris? Thanks, Dave. Please turn to slide number 9. We continue to target top quartile performance on organic revenue and adjusted EPS growth for the full year and believe we're on track to achieve those objectives.

Speaker 3

Given our continued strong performance, positive outlook and exceptional backlog, we're raising our organic revenue guidance to approximately 11% from our prior guide of 10%. We're also raising our full year adjusted earnings per share guidance by $0.30 to approximately $11.10 up from $10.80 prior. We're well positioned to deliver our 4th consecutive year of adjusted earnings per share growth of 20% or greater. Between our strong year to date revenue performance and the addition of 2 small acquisitions that we made in the 3rd quarter, we expect M and A to contribute approximately 50 basis points to 100 basis points to revenue in 2024, which we expect to result at about 3 points of negative impact on reported versus organic leverage for the year. We also expect a more moderate negative impact from FX for the year at less than a point, effectively offsetting the positive revenue impact of M and A.

Speaker 3

Net organic and reported revenue guidance is the same at approximately 11%. We expect full year organic leverage of approximately 30%, up from our prior guidance of 25% plus. We continue to expect free cash flow conversion to adjusted net earnings of 100% or greater. Absolute free cash flow is expected to be higher, reflecting our higher adjusted earnings guidance. For the Q4, we expect organic revenue growth of approximately 7% and adjusted EPS of approximately $2.50 Embedded in this guidance is a step up in investments and higher incentive based compensation reflecting strong performance in 2024.

Speaker 3

Please see page 18 for additional details related to our guidance that may be helpful for modeling purposes. Please go to slide number 10. 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. 2nd, we're committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve.

Speaker 3

And 3rd, we expect to consistently deploy 100% of excess cash over time. Our balanced approach includes strategic M and A that further improves long term shareholder returns and share repurchases as the stock trades below our calculated intrinsic value. Please turn to slide number 11. Year to date through October, we've deployed or committed approximately $2,000,000,000 in cash with about $800,000,000 to dividends, dollars 230,000,000 to M and A and about $1,000,000,000 to share repurchases. We have $1,500,000,000 remaining under the current share repurchase authorization, providing us with strong optionality as our shares remain attractive, trading below our calculated intrinsic value.

Speaker 3

We continue to have an active M and A pipeline with potential value accretive opportunities to further improve long term shareholder returns. Our outlook for 2024 cash deployment remains unchanged at approximately $2,500,000,000 Our strong free cash flow, liquidity, balance sheet and significant share repurchase authorization gives us excellent capital allocation optionality moving forward.

Speaker 2

Now, I'd like to turn the call back over to Dave. Dave? Thanks, Chris. Please go to slide number 13. We discussed the transport markets in our outlook discussion on slide number 8, so I won't cover them again here.

Speaker 2

However, we've continued to provide this slide with additional details for your convenience. Please turn to slide number 14. We operate our transport business for the long term. And while we will continue to manage through a down cycle in 2024, this is a great business with a bright future. ACT projects a modest trailer market rebound in 2025, mid teens growth in 20262027 and continued strong markets in 20282029.

Speaker 2

We're directionally aligned with these projections. We have a diversified transport business globally and opportunities to grow across the portfolio With leading innovation, strong execution through our business operating system and a world class dealer network, we're well positioned to outperform in any market environment. Turning to slide number 15. We expect to provide 2025 guidance on our Q4 earnings call. However, given our strong bookings, backlog and growing pipeline of opportunities, visibility into 2025 has steadily increased.

Speaker 2

We thought it would be constructive to provide our early views on 2025 as another year of healthy growth. Our commercial HVAC businesses are executing well. Our world class direct sales and service teams are a clear competitive advantage, enabling us to quickly pivot across vertical markets to capture growth opportunities. We have the broadest and most innovative portfolio in the industry, and we're relentlessly reinvesting in our business for growth. As we look at market opportunities, we're in the early innings of a strong multi year CapEx cycle.

Speaker 2

We're also in early innings on the journey to decarbonize 100 of billions of square feet across the built environment. Increasing complexity of these project opportunities plays to our unique strengths, and we're seeing this in our bookings, backlog and pipeline of projects. Net, we see another strong year ahead for commercial HVAC in the Americas and in EMEA. In Asia and more specifically China, which is more than 90% commercial HVAC, the macro is more dynamic. However, with China at roughly 4% of our portfolio, we expect strength in the Americas and EMEA to more than offset a challenging backdrop for the region.

Speaker 2

Turning to residential, we've moved through a period of normalization in 2023 2024, and we believe we're returning to a GDP plus framework. While we expect a moderate amount of pre buy in 2024, we expect this to largely impact revenues in the Q1 of 2025. Pricing differentials from the A2L transition should also act as a tailwind as we move through 2025. Turning to our Americas Transport business, which is about 7% of our revenues, ACT is projecting modest growth, largely in the second half of twenty twenty five. Net 2025 will be a modest tailwind for the enterprise.

Speaker 2

We continue to lead with innovation, which yields healthy pricing opportunities and our business operating system is primed to stay ahead of inflationary pressures. Underpinning our enterprise growth is our resilient services business. Services comprise about a third of our enterprise revenues and has averaged high single digit growth over the past 7 years. We see opportunities for continued growth in services across our portfolio. In particular, we expect strong performance in our commercial HVAC businesses with our large and growing installed base.

Speaker 2

With increased focus on de carbonization, we're seeing increased demand for digital performance optimization and demand side management, where our energy services business shines. All in, we're excited about the opportunities for strong growth again in 2025. Please go to slide number 16. In summary, we are well positioned to deliver leading performance and differentiated shareholder returns in 2024 and beyond. We recently received the results of our annual employee engagement survey and engagement was at a record level and in the top quartile compared to external companies.

Speaker 2

I experience that engagement firsthand when I see our team members engage with customers around the world. That engaging culture combined with our leading innovation and proven business operating system continues to set us apart. I'm proud of our team's consistent track record and believe our brightest days are ahead. And now we'd be happy to take your questions. Operator?

Operator

Our first question will come from Scott Davis from Melius Research. Please go ahead. Your line is open.

Speaker 4

Hey, good morning, Dave and Chris and Tarek.

Speaker 2

Hi, Scott. How are you doing, Scott?

Speaker 5

Good morning.

Speaker 4

I'm great. The numbers are good. I'm just trying to figure out a little bit of perhaps you can help with some context around data center specifically just since it's so topical right now. Just anything you can give us, whether it's growth, orders, materiality to your algorithm.

Speaker 5

I'm just trying to get my arms around how

Speaker 4

important that is for you guys for the next year. To get my arms around how important that is for you guys for the next year.

Speaker 2

Sure. Good question, Scott. Look, Scott, we've been strong in data centers for decades now, okay? So this has always been a very strong vertical for us. And I think we were kind of early adopters in the data center.

Speaker 2

We had dedicated team that just focused on data centers, which has really allowed us to continue to remain very strong in that vertical. If you look at data centers, the growth project and that's projected, I mean, if you take the middle there and there's a lot of numbers out there, you're going to see the data center vertical is going to be growing at the mid teens for the foreseeable future. And you should expect that Trane Technologies will continue to be very, very strong in this vertical as we have been for a long time. So it's important that when you think of data centers, they're probably the most complex systems that we build, okay? We like working direct with the data center customers.

Speaker 2

We like thinking about it at a system level, okay? You'll hear a lot about different components within the system. We look at the entire system and really help the customer think through optionality that exist for their particular needs based on what they're going to be using that data center for. And it does depend on what they're going to be using it for. Chris, I don't know if you want to add.

Speaker 3

Yes. What I would add, Scott is year to date in our Americas commercial HVAC business, data centers have provided a lot of growth to bookings. But when you remove data centers from those bookings, the rest of the verticals in aggregate are also up very strong. So, we like the broad based focus of our direct sales force. Data centers is one strong vertical, but as we highlighted in our release, there's a number of verticals that have been strong for us this year, almost nearly all of them year to date showing strength.

Speaker 4

Okay. That's helpful. And I wish you'd size it for us, but I understand if you don't want to, that's totally fine. Just moving to China, guys, is that market mature enough at this point where we can start to see it perhaps moving to more retrofit and services and being a little bit more stable longer term? I understand the down 45%, projects can disappear pretty quickly over there.

Speaker 4

But it's been a couple of decades now that you guys have been pretty strong and have a pretty big installed base there. So is that something that you see that kind of becoming a more mature market going forward?

Speaker 2

Yes. I mean, we have a service business in China, as you're aware. It's not at the same level that you would see here in the Americas, but it's growing. Look, specifically in China, I know I've read a lot of the pre reports here. And let me just be very specific.

Speaker 2

Look, our business in China, I think we all understand what's happening in the markets in China, and we were obviously impacted by that. The second is that we thought it was very prudent for us to tighten our credit policies and specifically around down payments and progress payments. So for example, if a customer wants to give us an order and they don't give us a down payment with that, we will not accept the order. If we have a product that's complete and ready to ship to the customer and the customer doesn't provide the proper down payment or progress payments, we will not ship that product to the customer. So look, long term, we know this is the right decision to make.

Speaker 2

We have a great team in China. It's performed exceptionally well for a long period of time. And I have 100 percent confidence that we'll continue to outperform the market there. Our teams are just going to be working through this in the Q4 and these changes. And look, it's the right decision to make for that particular region at this particular time.

Speaker 4

Okay. Makes sense. I'll pass it on. Best of luck, guys.

Speaker 2

Thank you. Thanks, Scott. See you in December.

Operator

Our next question comes from Chris Snyder from Morgan Stanley. Please go ahead. Your line is open.

Speaker 6

Thank you. I wanted to ask on services, which continues to be really strong, up low teens again here in Q3. Can you just maybe talk a little bit about the mechanics of the service business? What is the lag between when you sell the equipment to when it starts generating service revenue? Anything you could talk about on service margins?

Speaker 6

And then it seems like a lot of the reinvestment the company is making is in that service side. So just what are you spending on to better position the company to capture more of that revenue?

Speaker 2

Sure. I'll start. I'll let Chris answer some of the margin questions. But look, we love our service business. It's a third of the company.

Speaker 2

And it's very, very resilient, okay. Over the last 7 years, its compound annual growth rate is high single digits. So it's a very, very competitive weapon that we have within Trane Technologies. And we continue to, as you've noted, invest heavily in it. Look, as far as the timing as to when product gets installed, specifically on the applied side to when service starts, it varies, okay, depending on what the warranty is on a particular product.

Speaker 2

A lot of customers will have extended warranties. That's why I say it varies. And obviously, that would vary around the world. But think of it year 2, year 3, it starts to ramp up. And by the way, even if it's under extended warranty, we're going to be doing PM work on these products in many cases.

Speaker 2

The applied systems are so much more sophisticated today than they were just 4 or 5 years ago. And the customers are really demanding that the OEMs do the service on these systems to make sure that they're always performing the way they're designed. And Chris, you and I spoke a lot about connected solutions in the past. And I would tell you that that's going to be so fundamental to how we continue to drive our service business in the future. I think you could certainly understand that our installed base is increasing.

Speaker 2

That's the that will continue to drive growth. But the connected solutions and making sure that the asset is always performing the way it was designed and consuming energy at that level is so important. Today and a little bit certainly into the future, an HVAC asset isn't performing not only if it's not cooling properly, not only if it's not heating properly, not only if it's not ventilating properly, but if it's using too much energy. And if you think about that, that's where the opportunities. And we have done hundreds of energy audits in buildings, and we know that I'll be conservative here and say that 30% of the energy after the meter is being wasted.

Speaker 2

However, if you are connected to an asset, you could always ensure that it's performing the way it was designed. And that's going to continue to be a significant tailwind for our service business well into the future. So, Chris, I don't know if you want to

Speaker 3

talk about margins? Yes. I'd add, with the applied growth over the past 4 years, Chris, over 100 percent. That obviously bodes well as we think about that installed base maturing and as Dave said, 2 to 3 years out, starts to build a little bit of a ramp on the services revenues. The services business, I'll call it higher margins than the average.

Speaker 3

So, we like that business for that reason as well. And, it's a perfect example of where we've accelerated investments over the last few years, but even more so into the second half of this year. Dave talked about digital connected solutions. That's absolutely one way we're making investments. But think about it as capacity as well.

Speaker 3

I'm not going to focus on factory or plant capacity. I'm going to focus on people. And when you think about sales and service, adding employees from covering verticals to adding service technicians to support our customers with that higher installed base, that's one area where we're really continuing to inflect up in investments. And then the tools to support the sales and service team. So, sales support tools, whether it be customer relationship tools, order intake tools, billing collections, you name it.

Speaker 3

It's all part of what Dave and I coming out of the Q2 said we're going to accelerate the speed of some of these investments. This gives us even further confidence on growth over the next couple of years. But it's such a strong business and we're going to keep investing in it.

Speaker 2

Yes. One other point, Chris, that I always tell people that some of our service technicians are our best sales associates. And if you think about it, our service techs are with our customers every day and they're building that trusted advisor relationship with our customers and they often see opportunities that the customer can make improvements in their own facility. So they do a fantastic job for us. But the service business is a strong part of Trane Technologies today and think of it being even stronger tomorrow.

Speaker 6

Really, really appreciate all of that. Maybe just following up on data center service specifically, if we kind of think about that 2 to 3 year lag, it would imply that a lot of the growth we've seen certainly in orders and even I guess revenue on the data center side over the last 12, 18 months hasn't really found its way into service yet. Can you just maybe talk about service and how is the process different in data center elsewhere? And I just ask because obviously these are customers that are very sophisticated, uptime is everything, energy efficiency is even more important there than it is elsewhere. So any just color on how the data center service model differs would be helpful.

Speaker 6

Thank you.

Speaker 2

As I said earlier, I think of it as the more sophisticated the product, the greater the appetite is for the OEM to do the service. And data centers tend to be some of the most sophisticated systems that we deploy. So we're very strong in the data centers there and service. And by the way, I know that the growth over the last several years has been fantastic in data centers. But remember, data centers have been around for a long time and we've been very strong in this vertical for since the beginning.

Speaker 2

So we have even though we've seen tremendous growth, we also have a big installed base in data centers that we're servicing today.

Speaker 3

Thank you. Sure, Chris.

Operator

Our next question comes from Julian Mitchell from Barclays. Please go ahead. Your line is open.

Speaker 7

Hi, good morning. Maybe just wanted to start with Slide 15, you give some very useful points on next year. Just when we're thinking about kind of any color you could give us as to how to think about organic operating leverage. This year has guided at 30% now. Trying to think about sort of that for next year.

Speaker 7

Anything you're calling out in terms of, say, mix? It looks like you get a mixed tailwind perhaps within resi from the A2L transition. There may be some high operating leverage as transport markets turn around more in the second half. I guess when we're sort of rolling all that together, should we expect kind of strong operating leverage in 2025, any reason not to?

Speaker 3

Hey, Julien, it's Chris. I'll start. We'll provide a bit more detail around 2025 in our earnings call for the Q4. But we really do like that long term algorithm of 25 percent or better operating leverage and making sure we have the ability to fund investments in the business. We would be targeting 2025 for top quartile financial performance.

Speaker 3

We're going to look at that in the top line. We're going to look at that in the bottom line and cash conversion as well. One thing so far this year, we've had excellent free cash flow conversion. The average over the last 4 years is, I think, 108%. And so we're going to be targeting top line, bottom line and really strong cash conversion going into 2025.

Speaker 3

So we would expect commercial HVAC to be remain strong. The backlog visibility gives us a lot of confidence around that. We just talked about services and the high single digit growth we've seen over the last 7 years gives us a lot of confidence that should continue. And I think about Americas Transport, it's probably not a headwind. It could be a modest tailwind going into next year just given the expectation of, refrigerated trailers in the Americas being up low single digits, more second half of the year than first half.

Speaker 3

So, we think we got some nice tailwinds going into next year, but on the leverage, we like the 25% or greater algorithm and keep those investments coming.

Speaker 7

Thanks very much, Chris. And then maybe my second question just around the U. S. Resi HVAC market, which I don't think has been touched on in the question so far. Maybe just help us understand that I think Dave you mentioned a slight increase to your revenue assumption for that business this year.

Speaker 7

Was that tied to sort of share gain or some behavior by distributors in general? Any color on that? And it sounds like you're pretty confident of decent revenue growth in 2025 again despite the pre buy. Just wondered if you could flesh that out please at all.

Speaker 2

Yes, sure. Well, Julien, first of all, nice job on CNBC the other day. I saw you did a fantastic job. So nice to see. Look, on resi, look, let's just go back.

Speaker 2

We started the year and we were thinking that resi was going to be plus or minus low single digits. And then at the end of the Q1, we kind of said, look, the EPA clarification around the refrigerant transition, that was a nice help. We thought that inventory had normalized in the channel, so that was a help. And then we had a very warm cooling season, right? So I think it was a very hot summer and that certainly drove growth as well.

Speaker 2

As far as share goes, I'm sure yes, we're saying we had nice gains, but I've heard everyone say they have nice gains. So I'm not sure where that will sort out, but we're very confident and we're happy with the share that we have in that space and the progress that, that team has been able to make. Look, our team is really executing at a high level in residential right now. We've made some investments there in our manufacturing that are really paying dividends. And I could not be more proud of what that team has been able to execute too.

Speaker 2

So we're very happy with what we're seeing in residential. As far as 2025 goes, look, I've been saying for a long time that I believe our resi business is a GDP plus business. And I think that that's the framework that we're working through that we'll get back to in 2025. The pre buy, look, I don't think there's going to be a significant pre buy. I've been saying that since January.

Speaker 2

There will be something. We'll clarify that as we get through the Q4. But look, resi business is operating on all cylinders right now, and we expect it to continue into the future.

Speaker 7

Great. Thank you.

Operator

Our next question comes from Andy Kaplowitz from Citi. Please go ahead. Your line is open.

Speaker 2

Hey, good morning, everyone. Hey, Andy. How are you doing? Good. How are you?

Speaker 8

Dave, look, I know you already talked about data

Speaker 5

centers a little bit, but interestingly in

Speaker 8

your presentation, you mentioned other verticals. Presentation, you mentioned other verticals. You've mentioned before education, health care, but you also mentioned office. Maybe you can elaborate on what you're seeing there? And then given where at the tail end of ESSER spending for K-twelve, what could that mean for education related HVAC spend in 2025?

Speaker 2

Yes. Well, Andy, look, first of all, thanks for noticing office on the page. We haven't talked about office in a long time. And although they say it may sound counterintuitive because you still have vacancy rates that are quite high. But we had a very strong quarter in office, actually year to date office is up from an order rate standpoint.

Speaker 2

And if you think about it, you go kind of a click lower, you could sit there and say, well, we're doing a really good job in Class A buildings. And we're also really helping our customers navigate through how they get tenants back into their space. And I know you had the opportunity to visit us in New York and you got to see it firsthand, right? Having this direct sales force with deep domain expertise as to what's happening in a particular city is critical, right? We know what the carrots are, what the sticks are, and more importantly, how to navigate that so that we could help the customer make the right decisions so they could get tenants back into their space.

Speaker 2

So, it's just I can't speak enough about our direct sales force. I can't speak enough about how they pivot to where the opportunities are and how it's not just about data centers that's growing. For us, it's really almost all of our verticals. I was doing a study. I had the team do a study and I was looking from year to date from order rates and I'll speak about commercial HVAC.

Speaker 2

We track 14 different verticals, 13 of them were positive by a lot and office was one of those. So it just shows you the broad based strength that we have and the ability of our teams to really navigate to where the opportunities are. So I could not be happier with seeing Office on the page and the team continues to execute at a high level there.

Speaker 8

Great. And let me just ask you about China in the context of, obviously, somewhat high decremental margins there, some of that is the choices you've made. Do you again, you've been in China for a long time, you moved to direct sales and everything was good once you did that. Do

Speaker 9

you

Speaker 8

see this as more structural issue or is it really just cyclical? And if it is, either way, can you take more cost out of that business? Or how should we think about that to offset higher decrementals?

Speaker 2

Yes. I mean, first of all, the team performed quite well even though the revenues were down. They were within gross margins on a deleverage standpoint, so that was good to see. Look, we're going to just work through this in China. We have a great team there and we have a great business and we've been over performing in China for a long time.

Speaker 2

We made a decision to change our credit policy, specifically around down payments and progress payments. And we long term, this will be the right decision. And I think people will see that in the future. But right now, our teams are working through this change. I have all the confidence in the world that they'll get back to outperforming here in the future.

Speaker 2

But right now, we're going to work through it. And but great team there that's executed for a long time at a high level, and I expect more of that in the future. Appreciate the color, guys. Okay. Thanks, and we'll see you in a couple of weeks.

Speaker 2

Yes. See you soon.

Operator

Our next question comes from Joe Ritchie from Goldman Sachs. Please go ahead. Your line is open.

Speaker 9

Hey, guys. Good morning.

Speaker 5

Hey Joe, how are you?

Speaker 9

Doing great, Dave. Thanks. Yes, look, we talked about office, we talked about data centers. Clearly, the commercial HVAC business is humming along. Can you maybe just kind of talk a little bit about some of the mega project activity, how that's coming through, whether it's semiconductor plants, there's been some delays on EV plants.

Speaker 9

Just any commentary around that would be helpful.

Speaker 2

Yes. Mega projects, my favorite term, I don't really like. But look, mega projects are happening in verticals that we've always been very strong in. And it's dynamic, as you could imagine, right? Yes, you've talked about a few projects that maybe are getting a little bit delayed.

Speaker 2

We have others that are pulled up. We have some, especially on the EV battery side, a couple of them actually have been canceled. But we also have new ones that are coming in. So it's dynamic, but we continue to win in the megaproject space, right? Again, verticals we've always been strong in, but a lot of these decisions are made on a global basis.

Speaker 2

So you have decision makers that live in different parts of the world. Again, a direct sales force that could help triage those decision makers is extremely important. And we've been very successful and I anticipate and I know we'll be very successful in the future as well.

Speaker 9

Got it. That's helpful. And look, I know you're not talking about a pre buy on the residential side of the business and yet the industry is seeing pretty significant growth in the back half of this year in resi and, if your competitors are talking about how much of the kind of R54B is going to go through their system next year with one saying 65% of their business, the other one saying 90% of their business. I'm just kind of curious as you kind of think about your resi business into next year, like how much of it do you think is going to be the 410A product, that you'll manufacture this year versus the R54B product that will be hitting the market next year? Any thoughts?

Speaker 2

Yes. I mean, if you think about inventory in the channel, think about 3 months of inventory is probably a good average to use. So by definition, you're going to be at 75. Now it won't probably be linear where it will be all in the back half. You'll have some of the $410,000,000 that will sell throughout the year.

Speaker 2

But look, we'll probably be in that 75%, 80% range in resi. In commercial, and by the way, no one wants to talk about commercial, but commercial also went through a refrigerant change on the unitary side. And that one will be obviously a lot higher. Think of that one in the 90 plus percent range.

Speaker 9

Helpful. Thank you very much.

Speaker 3

Okay. Thanks, Joe.

Operator

Our next question comes from Nigel Coe from Wolfe Research. Please go ahead. Your line is open.

Speaker 10

Thanks. Good morning, everyone. Thanks for the question. I know APAC and China are very small for you, so I will probably come back to this. But I guess the surprise is that it took so long because we've seen terrible markets in China now for some time.

Speaker 10

So you mentioned you've been outperforming, that makes sense. But obviously, the string broke this quarter. So it seems if you have to gauge how much of this is elective enforcing more stringent credit procedures versus a genuine deterioration in the markets. How would you sort of gauge that? And I'm guessing that this correction has to cycle through into 2025.

Speaker 10

There's no kind of spring back here. Just any thoughts there?

Speaker 2

Yes. I mean, I think the Q4 will be stronger than the Q3. I mean, just to I mean, Nigel, you kind of hit it. Look, China is 4% of our revenue, first of all. So it's a small portion of revenue, but it's important.

Speaker 2

And how much the downturn is market related versus our policy change? It's always hard to say that. I don't know, is it fifty-fifty? Maybe it's a little bit more weighted to policy change, at least in the short term, probably, just because we have to work through that. We have to educate our customers as to what the expectations are.

Speaker 2

So our teams are really good. Again, a direct sales force can have that direct conversation. They can understand the why and we'll work through it. We'll see how the Q4, as I said, will be a little bit stronger, we think, than the Q3. And that's what we have baked into our guide.

Speaker 10

Okay. Okay. That's great. And then a follow-up for Chris. Not asking for 25 guidance, but maybe just some of the moves and pieces.

Speaker 10

On corporates, running at 3.30 now, it was at as low as 2.50 back in 2022, 2021. So any sense on what would be a good run rate for corporates? And then it looks like Amort comes down in 2025. So I think some of the Trane acquisition, amort is starting to roll off. Is that correct?

Speaker 10

And then finally, just on interest, we got a refi coming up in November, I think, very small, but should we expect interest expense to go up a little bit next year?

Speaker 3

Hey, Nigel. Yes, corporate, I think $300,000,000 is probably a good longer term run rate number. I mean, there are times like this year where we have a little bit higher corporate expense and think of that as where we're driving some of the enterprise investments for the company. So those are decisions we'll make as we work throughout a year, always making sure that that pipeline of investments is getting funded. So but I think we're going into 2025, a squiggle of $300,000,000 is probably a good place start.

Speaker 3

We'll update you as we get together in a few months from now. On amortization, yes, there's going to be a little bit of a roll off on the train amortization. We'd have to look at that across the new M and A that we've done over the last few years and dial that all in. So, yes, we'll give you some more input on that over the next few months, see if there's any more M and A that comes through the balance of this year. And then on the interest side, yes, we I would say we had $237,000,000 of guided interest expense for this year.

Speaker 3

We took out some debt proactively earlier this year just to de risk a refinance that actually is going to come due here in a couple of days. We've held on to that cash actually this year from the bond offering we did in June. It's a net positive on net interest here. So we'll pay down that cash and pay down that bond, going into next year. But maybe that number for 2024 is not far off from what we have for 2025, but we'll see.

Speaker 3

We'll dial it in. The good thing is that we've generated a lot of cash this year, maybe earlier than normal. It's generated a little bit more interest income as well as we've earned it this year. But we have a pristine balance sheet, very strong leverage on the balance sheet, a lot of firepower to go deploy cash. And I would say maybe for next year, interest is probably in that ballpark is 2024.

Speaker 10

That's great. Thanks, Chris. Thanks, guys. You're welcome.

Operator

Our next question comes from Deane Dray from RBC Capital Markets. Please go ahead. Your line is open.

Speaker 9

Hi, good morning. This is Sahil Manocha on for Deane Dray. My question is on weakness in China, understanding it's a smaller part of the business, but have you taken any write downs of receivables or increased reserves? And how might the Chinese government stimulus actions play out? And are there any verticals in China doing particularly worse?

Speaker 2

Yes. Why don't I start?

Speaker 3

This is Chris. The first answer is no. We've not seen any material write downs or bad debt reserves. I think the key there is coming out of the Q2, working with our business team in China to make sure that they were deploying these tightened credit policies really at the end of the second quarter. And so, we've got orders that are waiting to be delivered and when the cash comes in, we'll deliver them.

Speaker 3

So at this point, no, we're not seeing that. We generally play in the non resi markets in China and largely commercial HVAC with a smaller transport business. And those are the markets that have been, as you may have seen here over the last several months, the non resi markets have just seen a bit of a downturn. So we've been outperforming for some time. At some point, it does catch up with you a little bit.

Speaker 3

But to Dave's prior comments, we're also making sure we're focused on the long term here. We don't want to create a short term problem that's a booking or a revenue that 3, 6, 9 months down the road, you wind up with a problem you have to deal with. We're making sure we've got quality orders, quality customers, quality receivables and then ultimately driving the cash.

Speaker 9

That's really helpful. And then one more on data centers. Could you provide an update on your liquid cooling investment in LiquidStack?

Speaker 2

Yes. We continue to work with liquid stack. We've been partners with them for extended period of time now. We're I think the activity is starting to pick up there. But there's some hurdles that we're still working through with them.

Speaker 2

And we'll keep you posted. But not really any kind of an update right now as far as orders are concerned.

Speaker 9

All right. Thank you very much.

Speaker 3

Sure.

Operator

Our next question comes from Andrew Obin from Bank of America. Please go ahead. Your line is open.

Speaker 5

Hi, guys. Good morning.

Speaker 3

Hey, Andrew. How are you?

Speaker 5

Hi. I am going to sort of belabor this China point a little bit more. My understanding was that for you, China was mostly industrial exposure. And I think the prior explanation for the fact that your performance in China was better was because you did not have exposure to these non residential office buildings. I just want to understand if that's the right way of thinking about it.

Speaker 5

And yes, right, because as I said, the commercial weakness was there. Your response was we're not really on this commercial developments. We're playing mostly on the industrial side, but did I just understand it wrong?

Speaker 2

No, it's about think about our business in China, think about 90% commercial HVAC, okay, mostly applied systems. So you're spot on there. Look, the downturn the markets are down, okay, that's pretty universal as to what's happening in China. But as I said earlier, Andrew, if a customer wasn't going to provide the down payment, okay, or the progress payment, even though the product was ready to be shipped, we held it, okay? We're not going to ship it until we get that progress payment.

Speaker 2

And you saw the acute fall off in the quarter because of that. But again, long term, this is a prudent decision that we're making. And the individual before for Dean was asking about, have we written off anything in bad debt? And the answer is no, and we don't intend to in the future.

Speaker 5

No, I understand. But the answer is that all along your China business was mostly commercial real estate, not industrial facilities, not factories, not data centers. It's 90% commercial real estate. Just want to get that point. Is that correct?

Speaker 2

No, that's false. No. We're actually the reverse. We don't really play in the commercial real estate space. Okay, these are applied systems.

Speaker 2

So think of them as semiconductor, think of them industrial applications.

Speaker 5

Yes, that's exactly what I was asking. Thank you. Yes, that was my understanding. Okay. Okay, fine.

Speaker 5

So it's really industrial weakness. It's weakness outside the real estate market that's getting you down.

Speaker 2

You got it.

Speaker 5

Okay. Thank you. No, that's exactly what it is. And maybe just A2L pricing, there's been a lot of data points. I think those of you that Daikin, right, because they use a different refrigerant, maybe it's not going to increase their prices as much.

Speaker 5

I think your peers are sort of saying high single digits around 10% maybe. What do you guys and I apologize if I missed it, but what do you guys fall in on this A2L pricing into 2025?

Speaker 3

Yes, Andrew. I mean think of the introduced pricing for the new refrigerant products really being up in the high single digit range. There is more cost associated with the products for many reasons, the refrigerant, the sensors, etcetera. Our target is to be margin neutral here as we think about pricing and cost for end customers. But think of it for us up in that high single digit range.

Speaker 3

As we guide next year, we'll dial in a little bit better based on visibility, the percentages that Dave outlined previously of how much will be 454B versus 4 10A. And then I know as you know, not all of the residential product we sell is subject to the new refrigerant like furnaces. So we'll kind of walk you through. We think that price contribution is for next year, but it will be a tailwind for next year.

Speaker 5

Terrific. And I really appreciate this clarification in China. Thanks a lot.

Speaker 2

Sure. No problem, Andrew. Thanks.

Operator

Our next question comes from Tommy Moll from Stephens. Please go ahead. Your line is open.

Speaker 11

Good morning and thank you for taking my questions.

Speaker 5

How are

Speaker 2

you doing, Tommy? Good morning.

Speaker 3

Doing fine. Thank you. We've talked

Speaker 11

a lot about China. So I wanted to circle back on one of the positive topics from today, which is the backlog you've called out for 2025, which was up sequentially by a pretty large amount. And I'm just curious as you look at the composition there, is there anything we can learn in terms of what verticals are particularly strong? Why customers may be ordering a little bit earlier in the cycle than in the past? Just anything we can glean.

Speaker 11

Obviously, you've talked about next year is a strong one for commercial HVAC. But maybe if we go one layer deeper there, what can we learn?

Speaker 2

Yes. I think, as I said earlier, if you think about our order rates, and I'll talk about commercial HVAC in the Americas, they're up close to 20% for the year. It's broad based. It's in basically all verticals. So and the other thing, Tommy, that I haven't talked about is that our pipeline, so this is before something actually becomes an order, is extremely strong, right?

Speaker 2

We have very sophisticated CRM systems. So we know what's being worked on. And it is extremely strong, which gives me lots of confidence, not only for the Q4, but into 2025 as to what we should be expecting in that business. So I'm very bullish on 2025. We'll dial that in as we get into our Q4 earnings.

Speaker 2

But look, our backlog is up $300,000,000 year to date. It's hard to say what's normal now, but it's if we looked at historical norms, it's over 2.5 times what's normal. We will go into next year with a very strong backlog and the activity, the market activity across all verticals is very, very strong right now.

Speaker 11

Which leads to my follow-up, Dave. Office got a little airtime earlier. And so if we just discuss these commercial trends ex data centers, which we've covered, and think about office and some of the other verticals that we don't talk about as much, am I hearing you correctly that it feels like the rest of that commercial business has actually gotten stronger in terms of the orders as 2024 has progressed?

Speaker 2

Certainly, Office has. I think all of our verticals have positive growth except for 1, have positive growth on a year over year basis, which is encouraging. But again, it kind of comes back to who we are as Trane Technologies, right? We are very broad based, right? Our portfolio of products and services is broad based.

Speaker 2

We have expertise in all verticals. And it's not like we become over indexed on any one. And I know that data centers are certainly very strong and it will be very strong in the future. We have a great team there that works on the data center. We also have great teams that work on other verticals and have that expertise.

Speaker 2

And by the way, if they see opportunities, they're going to pivot to that opportunity and really go after it and make sure that they can win with the customers. So very strong we're seeing right now. Backlog is very strong. Activity, this is before an order, is extremely strong and we're bullish.

Speaker 3

Thank you, Dave. I'll turn it back. Thanks, Tommy.

Operator

Our last question today will come from Noah Kaye from Oppenheimer. Please go ahead. Your line is open.

Speaker 12

Thanks. And I will keep it to one question. Dave, in the past, you've talked a little bit about a cascading impact of policies going from, say, ESSER to CHIPS and IRA. And I know there are a lot of fundamental drivers here around decarbonization and improved efficiency paybacks. But just at this point, as we look at 2025 and your comments around the pipeline of activity, to what extent are those policy impacts actually impacting the pipeline or the bookings you're seeing?

Speaker 12

Just help us level set what kind of impacts they're actually having on the business.

Speaker 2

I'm sure they have a tailwind, okay. But again, our solutions have great paybacks with or without those tailwinds. Obviously, the tailwinds make it more attractive, but we have great paybacks for existing whether we have a tailwind or not like ESSER funding. Certainly, some of them have been part of the back ESSER funding is a great example there, where it certainly is part of our backlog. We'll be filling orders all the way through probably about the next year that's in our backlog for schools.

Speaker 2

And a lot of that has to do, I know it sounds like a long time, but remember, in schools you tend to want to do the work when students aren't in the school. So it will be like the school season in the summer. But look, we'll see what happens with who the next party is in Washington, but we're optimistic that we'll continue to have attractive paybacks regardless of what the policies are, whether they're tailwinds or not, but we'll be successful well into the future.

Speaker 12

All right. Thanks, Dave. Appreciate it.

Speaker 2

Thanks, Noah.

Operator

We are out of time for questions. I would like to turn the call back over to Zach Nagel for closing remarks.

Speaker 1

I'd like to thank everyone for joining today's call. As always, we'll be available for questions at any time. We'll also be on the road quite a bit in the Q4, and we look forward to seeing many of you on the road. So have a great day. Thanks.

Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.

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