Trane Technologies Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
November 2, 2021

There are 12 speakers on the call.

Operator

Good morning. Welcome to the Trane Technologies Q3 2021 Earnings Conference Call. My name is Paula, and I will be your conference operator for the call. The call will begin in a few moments with the speakers' remarks and the Q and A session. In consideration of time, we do ask that you please limit to one question and one follow-up question.

Operator

I will now turn the call over to Zach Nagel, Vice President of Investor Relations. Please go ahead, sir.

Speaker 1

Thanks, operator. Good morning, and thank you for joining us for Trane Technologies' 3rd quarter 2021 earnings conference call. This call is being webcast on our website at turningtechnologies.com, you'll find the accompanying presentation. We are also recording and archiving this call on our website. Please go to Slide 2.

Speaker 1

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 Ordinary, CEO and Chris Kuhn, Executive Vice President and CFO. With that, I'll turn the call over to Dave?

Speaker 2

Thanks, Zach, and everyone for joining us on today's call. Let's turn to Slide number 3. As we do each quarter, I'd like to spend a few minutes upfront on our focused sustainability strategy. The engine that enables us to deliver differentiated shareholder returns over time. Long term sustainability megatrends continue to And our innovation leadership is transforming the climate industry as the world decarbonizes.

Speaker 2

Our aggressive goals and bold actions can dramatically reduce carbon emissions and accelerate the world's progress. This is more critical every day as the clock is ticking on climate change. That's why we are calling for businesses and governments to take Stronger action at COP26 and why we continue to set aggressive science based emission reduction targets to push our innovation further and faster. That innovation also extends to emerging trends as we see heightened focus on indoor air quality and strong momentum in aging infrastructure in our schools. We continue to make a difference consistently, relentlessly and over the long term.

Speaker 2

This unyielding approach drives market outgrowth over the long term, which in turn helps us drive strong margins and powerful free cash flow to deploy through our balanced capital allocation strategy. The end result is more value across the board for our customers, for our team, for our shareholders and for the planet. Moving to slide number 4. Our global team delivered solid execution in the 3rd quarter And we continue to target top quartile EPS growth for 2021. Bookings were once again exceptional in Q3, Building on strong growth in both Q1 and Q2 and bringing our year to date organic bookings growth to over 25% for the enterprise.

Speaker 2

Underlying demand for our innovative products and services have never been stronger and our Q3 ending backlog reflects the strength. In fact, Q3 ending backlog for the enterprise is up more than 70% or approximately $2,000,000,000 from year end 2020, With all three of our business segments at record levels, Americas and EMEA have backlog that are up over 90% 65% from year end 2020. We're well positioned to close out 2021 on a strong note and to enter 2022 with unprecedented levels of backlog as well. As we highlighted on our Q2 earnings call and in subsequent forums, Global supply chains, logistics systems and labor markets remain tight and inflation is persistent. Our global teams are focused on meeting the unique needs of our wide ranging customer base and helping them solve complex challenges on a daily basis As we navigated challenging yet positive demand and supply environment, temporary supply chain delays on key materials impacted Shifting the timing of approximately $150,000,000 or 4% of our revenue Out of the Q3 and into future periods, working closely with our key suppliers and with our customers, we anticipate that between 50 $1,075,000,000 or roughly 2% of the Q3 impact will shift into the 4th quarter, leaving our 2021 revenue guidance unchanged.

Speaker 2

We expect the remaining balance to shift into 2022. We also highlighted on our 2nd quarter earnings call That persistent inflation would require us to execute an incremental $150,000,000 in pricing actions in the second half of the year in order to neutralize the impact. Strong execution of our business operating system has enabled us to keep pace with the inflationary curve. In the Q3, we realized approximately $150,000,000 or 4.3 percent incremental price, offsetting approximately $150,000,000 of inflation. Leverage was negligible, as you would expect on flat volume, While adjusted operating income was modestly higher in the quarter, primarily reflecting nominal pull through on M and A and FX growth, consistent with our expectations and our guidance.

Speaker 2

We continue to execute the business transformation projects we discussed in detail at our Investor Day in December and are on track to deliver approximately $90,000,000 of incremental savings in 2021. These savings support leading innovation across our end markets relentless high levels of business reinvestment. They also enable us to stay on track to deliver incremental margins of approximately 30% organic for fiscal 2021 despite persistent inflation, tight logistics systems and supply chain challenges. We're also on track to deliver powerful free cash flow of equal to or greater than 100% of net earnings. This provides us with strong optionality to deploy significant cash to opportunities now and in the future, including M and A and share repurchases.

Speaker 2

Lastly, we never lose sight of our long term purpose driven strategy and the tremendous leadership role we can play in bending the curve on climate change. By changing the industry, we can change the world. Executing our purpose driven strategy is how we will continue to deliver top Tier financial performance for our shareholders. Please turn to Slide number 5. While we're still in the midst of our planning process for 2022 and anticipate providing guidance in conjunction with our Q4 earnings call, we thought it might be constructive to spend a few minutes discussing our initial thoughts on 20 2 and some of the key dynamics we believe will be in play.

Speaker 2

While this is not a comprehensive list, It will highlight some of the key reasons why we're so excited about what the future holds for Trane Technologies as well as some of the key challenges we see on the road ahead. First, we expect to have strong fundamentals entering the year. Exiting Q3, backlog in our Americas and EMEA segments are both at unprecedented levels, up over 90% and up over 65% versus December of 2020, respectively. Asia also has record backlog, up nearly 20%. If we very conservatively plot out bookings Through the balance of 2021, we anticipate entering 2022 with at least 70% more backlog in the Americas and EMEA Then we entered 2020.

Speaker 2

I've been in this business a long time and I've never entered any year with a stronger backlog position, which bodes well for us in 2022. Another fundamental strength entering 20 is the foundation of our business operating system. Strong execution of our business operating system has enabled us to stay ahead of the persistent inflation through 2021 and position us well to manage additional inflationary pressures and deliver strong price realization again in 2022. And we'll continue to drive transformation savings in 2022 that will support high levels of business reinvestment and continued innovation. These savings will also support healthy incremental margins and what we expect to be another year of tight conditions for supply chain, Labor Markets and Logistics Systems.

Speaker 2

Looking out to 2022, we also expect to see continued acceleration Of the strong secular sustainability megatrends that are so tightly aligned with our purpose driven business strategy. Decarbonization of the built environment is And momentum around indoor air quality upgrades, retrofits and new projects continues. Additionally, the global economy is expected to continue to recover in 2022 with solid underlying GDP and other economic indicators driving broader expansion in the nonresidential markets. Lastly, we're excited about the future of transport refrigeration markets All in, we're exceptionally well positioned for strong performance in 2022 and beyond. Please turn to Slide number 6.

Speaker 2

Customer demand for our innovative climate control products and services continues to grow. We delivered another quarter of robust organic bookings growth, up 20 With growth across all segments and business units. Customer demand has been high all year with organic bookings Up over 25% year to date, driving record backlog in each segment. Organic revenues were also up 4%, driven by continued strong price execution. Our Americas commercial HVAC business delivered robust bookings growth in the quarter With orders up over 30%.

Speaker 2

Strength was broad based with applied and unitary bookings both up more than 50% and service bookings up high teens. Demand for system focused indoor air quality solutions remained strong and contributed to our mid single digit revenue growth in commercial HVAC Americas. The residential HVAC markets continue to be and our residential team delivered low single digit bookings growth, building on nearly 40% growth in the Q3 of 2020. Revenues were flat in the quarter as demand outpaced supply and we entered the 4th quarter with record backlog, Up more than 150% year over year and up from prior record backlog at the end of the second quarter. With year to date organic bookings up over 80% and year to date organic revenue up over 30%, Our Americas transport refrigeration business is significantly outperforming the North America transport markets.

Speaker 2

During the Q3 with most of 2021 orders already in the backlog, we opened up our 2022 order book solely for the Q1 of 2020 2, which drove bookings growth of more than 20%. We are methodically managing our 2022 order book in order to mitigate inflationary risks. Organic revenues were also strong, up low to mid teens. 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. Our EMEA teams delivered 25 percent organic bookings growth in the quarter, with strong growth in both in transport refrigeration.

Speaker 2

Our Asia Pacific team delivered bookings growth of 11%. Revenue grew 1% in the quarter. Though we saw growth in China during the quarter, the impacts of the COVID-nineteen pandemic continue to be challenging in the region with low vaccination rates in some countries. Now I'd like to turn the call over to Chris. Chris?

Speaker 2

Thanks, Dave. Please turn to Slide number 7. Organic revenue growth in the quarter was driven by continued strong price execution, yielding 4.3% incremental price in the quarter. Price over material inflation was positive in the quarter and combined with mix, offset the net impact of productivity over other inflation and increased investment spending to support leading innovation. Organic volume and therefore pull through leverage was largely flat for the enterprise in the quarter.

Speaker 2

At a high level, positive leverage was primarily the result of mix and a modest flow through of M and A and FX, consistent with our guidance. Net adjusted EBITDA and operating margins Please turn to Slide number 8. We discuss the key revenue and margin dynamics for the enterprise on the prior page. The dynamics impacting revenue and margins were similar across each of our business segments as we've highlighted here, with strong price realization, Productivity, inflation and higher investments in innovation as consistent drivers. In EMEA, solid price realization was accompanied by segments delivered higher revenues on modest volume declines, impacting leverage.

Speaker 2

Asia Pacific also experienced price versus headwinds in the quarter, further impacting margins. We continue to expect Asia Pacific to deliver solid margin expansion for the full year and are pleased with our overall performance in the region. Now I'd like to turn the call back over to Dave. Dave? Thanks, Chris.

Speaker 2

Please turn to slide number 9. Commercial HVAC Americas has significantly outperformed the broader markets over a number of years It's compounded by the strength in the underlying market conditions power the business forward today, yielding bookings growth of over 30% in the quarter An exceptional backlog entering Q4. Booking strength was universal across nearly every vertical market and major product category. End markets continue to improve. Vaccination rates are improving and end market indicators are generally strong with ABI over 50 since February and a healthy GDP.

Speaker 2

Data centers and warehouse demand remain strong. Education and Healthcare end market demand is also growing. We're benefiting from increased demand across our K-twelve customers, with federal stimulus funds supporting both current and more importantly future growth. We see this as a multiyear tailwind for our business, Given our strong position in the education market and our direct sales force with deep relationships in this vertical. Our residential end markets remain strong.

Speaker 2

As I mentioned previously, we delivered low single digit bookings growth in the quarter, Compounding on nearly 40% growth in the prior year, and we are entering the 4th quarter with unprecedented backlog. I'm proud of our residential team that has continued to meet customer demand while ramping capacity after a February weather event in our Texas The team delivered historically high revenues in Q3 and is on track for capacity expansion in advance of next year's cooling season. Turning to Americas Transport, we're significantly outgrowing strong end markets in 2021. Turning to EMEA, economic conditions are improving across the region. We expect continued improvement for the remainder of the year with increased vaccination rates supporting the opening of an increased number and variety of venues.

Speaker 2

Transport markets have been strengthening throughout the year and we're on track to outperform end markets in 2021 as evidenced by our year to date performance. Turning to Asia, we expect growth in China in 2021 supported by increased vaccination rates And strength in data centers, electronics, pharmaceutical and healthcare. Outside of China, the picture is mixed With vaccination and economic recovery rates still low in some countries. Now I'd like to turn the call back over to Chris. Chris?

Speaker 2

Thanks, Dave. Please turn to Slide number 10. Given all the puts and takes we've discussed today, our guidance for 2021 is unchanged. Importantly, we continue to see our 2021 adjusted EPS growth guidance of more than 30% as top quartile among peers in the broader industrials. We discussed the shift in revenues from Q3 to Q4 in 2022 throughout the call.

Speaker 2

Our 4th quarter revenues are supported by record backlog And that backlog is firm. Supply chain, labor and logistics systems will continue to be challenging and are the limiting factor to potential upside, not demand or backlog. We also continue to expect free cash flow to remain strong at equal to or greater than 100% of adjusted net income. Please go to Slide 11. As we outlined during our investor event in December, We're on track to deliver $300,000,000 of run rate savings by 2023, including $90,000,000 in 2021.

Speaker 2

Importantly, we continue to invest these cost savings to further fuel innovation and other investments across the portfolio. This consistent investment strengthens our high performance flywheel, which has a reinforcing and compounding effect over time. Please go to Slide number 12. We remain committed to our balanced capital allocation strategy that is 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.

Speaker 2

2nd, we're committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve. 3rd, we expect to consistently deploy 100% of excess cash over time using a balanced approach that 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 13, and I'll provide an update on how we are deploying excess cash in 2021. Year to date, we have deployed $1,800,000,000 in cash, with approximately $1,000,000,000 to M and A and share repurchases, including $250,000,000 for the Farrar Scientific Life Sciences acquisition we closed in October. We have paid $422,000,000 in dividends and $425,000,000 to pay down debt.

Speaker 2

Our strong free cash flow, liquidity and balance sheet continue to give us excellent capital allocation optionality And dry powder moving forward. We are on track to deploy at least $2,500,000,000 in excess cash in 2021. Now I'd like to turn the call back over to Dave. Dave? Thanks, Chris.

Speaker 2

Please go to Slide number 15. I wanted to spend a couple of minutes providing an update on the transport refrigeration markets for 2021, as we've seen the forecast shift a fair amount since our Q2 earnings call. I think the primary takeaway this quarter is that ACT is projecting an in more gradual upturn in the North America transport refrigeration markets than initially projected. North America trailers is probably the Clearest example and one of the most watched by investors and analysts as a proxy for the overall transport refrigeration health. AG started out the year projecting an almost immediate snapback in the North America trailer production in 2021, up 39% off the lows of the pandemic in 2020.

Speaker 2

As trailer OEMs have had a challenging year producing enough trailers to meet Act has gradually pulled the forecast down and is now projecting a strong but more gradual improvement in 2021, up 18% and continued improvement in production rates in both 20222023, up another 18% 14%, respectively. If you look at the all in weighted average market forecast for North America Transport Refrigeration, 2021 is now expected to be up about 14% versus 24% projected in July. Year to date, our Thermal King Americas transport refrigeration business is up more than 30%, clearly outperforming the markets And we expect to outperform the markets for the full year as well. Looking at IHS and other key indicators for EMEA markets, the outlook has improved about 3 points With the weighted average market growth now expected to be about 12% for 2021. Year to date, our Thermo King EMEA business is up more than 20%, Clearly outperforming the markets and we expect outperformance for the full year 2021 as well.

Speaker 2

Please go to slide number 16. We added a second transport refrigeration slide to the deck this quarter to add more color around the North America trailer From both backward and forward looking perspectives, one of the things we've talked about over the past several quarters Is the North America trailer market has not been particularly volatile over the past several years and it's not projected to be particularly volatile over the act forecast horizon either. On the left side of the page, You can see the visual depiction of what we've been describing. We chart AG's reported actual trailer units built Going back to 2015 and AG's forecast for trailer builds through their forecast horizon of 2023. The 9 year average is in the mid-forty thousand unit range, with the pandemic in 2020 being the only significant outlier.

Speaker 2

We also see that good growth is projected in both 20222023. It's important to note that our global transport refrigeration Business is highly diversified. Trailer is an important part of the global mix at about 25% of the total. However, we're focused on strong execution across the transport refrigeration portfolio, which we believe will further help reduce Variability of this business over time. Please go to slide number 17.

Speaker 2

2021 is shaping up We're seeing unprecedented levels of demand for our products and services across the board, and our backlog has never been stronger. We're executing our business operating system well and staying ahead of persistent inflation with strong price realization, And we expect to deliver top quartile EPS growth for the full year. Energy efficiency and sustainability mega Trends are only growing stronger. We are uniquely positioned to deliver leading innovation that addresses these trends and accelerates the world's progress, supported by a business transformation and our engaging uplifting culture. We are proud to have been recognized by Forbes is one of the best employers for diversity and best employers for women and by Fortune as one of the best workplaces in manufacturing.

Speaker 2

It's our people that power our innovation and bring our purpose to life every day. We have many reasons to be excited about our prospects for strong performance as we look to 2022 and beyond. When combined with our exceptional ability to generate free cash flow and our balanced capital deployment, we are well positioned to continue to drive differentiated shareholder returns over the long term. And now, we'd be happy to take your questions. Operator?

Operator

Your first question comes from the line of Joe Ritchie of Goldman Sachs.

Speaker 3

Thanks. Good morning, everyone.

Speaker 2

Hey, Joe. How are you doing? Good morning.

Speaker 3

Yes, doing great. So maybe just the first Question on the supply chain, helpful to have kind of like that visibility on the revenues that pushed out from this quarter. I guess just any other color that you can provide as this Predominantly occurring in your North America trailer business, and then just confidence that you're going to be able shift these revenues and not see sustained supply chain issues in the next few quarters.

Speaker 2

Yes. Sure, Joe. Great question. Tight supply chain, really globally, we talked about it during our Q2 earnings call. It caused us to push about $150,000,000 of revenue out of the quarter.

Speaker 2

As we said, we think we'll get about $50,000,000 to $75,000,000 of that back in the Q4. Our team is doing a great job of managing the supply chain constraints. We chose not to include a slide in our deck Telling you the 50 things that we're doing to manage our suppliers or help our suppliers, but I could assure you that supply chain resiliency Has been part of our business operating system for a long time. And I can assure you that Trane Technologies employees around the globe Are working hand in hand with our suppliers, ensuring that we could take literally pages out of our And help them implement it. We think it's going to be choppy for a while in the supply chain, at least For the foreseeable future, it's a little bit I think I mentioned in the Q2 call, it's a little bit like when you were a kid, you played that game whack a mole, We fixed one problem and another problem pops up.

Speaker 2

But if you're looking for overarching kind of like where we're seeing constraints, I don't think we're I know we're not any different than what you probably already heard from the rest of the industrials that have reported. Electronics, Resins, semiconductors, wire harnesses, these are all areas that certainly at an overarching level we're And supply chain constraints. That said, just a couple of points I want to make. One is we're working very closely with our Customers, it's very important that in some cases, our customers are having supply chain constraints on the job sites, Which is causing them to push out jobs. So we're working with them to make sure that we could deliver product when they need it.

Speaker 2

If you look at our Thermal King business, we're really aligning with our customers there around build slots that they're getting from the trailer OEMs, tractor suppliers. So This hand in hand relationship with the customer, it's pretty dynamic right now. And then the last point I'd like to make Joe is that, I know we talked a lot about Supply chain constraints. We also have to be fair to our suppliers. I know many of them are probably listening to the call or will read the transcript.

Speaker 2

We are putting tremendous pressure on our suppliers with the amount of demand that we're seeing in the marketplace right now. If you look at our commercial HVAC business in the Americas, I mean, unitary and applied both are up over 50% incoming order rates in the So with that kind of you can imagine, we're pushing that right on to our suppliers and putting orders on them. So they're seeing some pretty big spikes that they're having to manage Sure. Your question on is there a particular business, it's pretty widespread. It's more acute maybe in our Thermal King business.

Speaker 2

We had a suppliers there that we've worked through, some of the issues with. So we're pretty confident that we'll be able to rebound there in the Q4. We're also seeing we're seeing across the globe, but the other business I would call out is probably our commercial HVAC business. Certainly, there, the resin impact and kind of the knock on effect that we've been

Speaker 3

Thanks, David. That was helpful. And then maybe my one quick follow-up. 1 of your suppliers Just did their conference call about an hour ago and they talked about the price cost formula being roughly $100,000,000 Positive for them in 2022. You did a good job of pricing this quarter.

Speaker 3

I'm just curious as you kind of think about 2022, should we be thinking about Yes, a positive price cost environment given what you're seeing in your cost curves today.

Speaker 2

Hey, Joe. It's Chris. I'll take the question. So we are in the middle of our 2022 planning. Going into 2022, though, we would expect some carryover price from the 3 price increases most of our businesses announced this year.

Speaker 2

We will start lapping price increases, though, really starting in the Q1 of next year. But I would tell you, as part of our business operating system, we enter every year coming up with a plan of how we're going to get about 20 to 30 basis points positive spread Price cost. So more to come in a couple of months as we release guidance for next year, but we're going to go in with the mentality that we're going to cover Price cost, but it's also a very inflationary environment, which is why we're really trying to size that for pricing increases if we need to going forward. Yes. The only thing I would add to that, Joe, is that price is never easy to get despite what people may think.

Speaker 2

But when you have an innovative portfolio of products, It becomes that much easier as you're selling additional value to our to your customer, being able to get pricing, it becomes a little bit easier.

Speaker 3

Great. Thank you, both.

Operator

Thanks. Your next question comes from Scott Davis of Melius Research.

Speaker 2

Good morning, guys. Hey, Scott. How are you doing? Good morning. Good.

Speaker 2

I want to talk about IAQ, if that's okay. And the 2 point tailwind that you noted in the slide is pretty material. 1, I want to just if you can give some color on the sustainability of that. How many years of project backlog do you probably have Where is that 2% stay 2%? Does it become 3% this year?

Speaker 2

And any kind of view around that? And then what does a systems focused solution really mean for practical purposes for us at least? Does that mean a Color around that too. Thanks. Sure.

Speaker 2

Yes, it's a good question. As far as the demand goes, we had said early on that we thought it'd be 1% to 2% Tailwind, we're seeing 2% this year. Pipeline is strong. What started To be strong in really just healthcare and education, we're now seeing it in office and other verticals. So that's the good news.

Speaker 2

And the other thing I would tell you that if you remember, we had an approach where we were doing indoor air quality audits where we would do a day one activity where we do the audit to make the environment is safe as possible today with existing assets and then we kind of give a roadmap as to how you would do day 2 activity. Those day 2 activities are really starting to come through for us, especially in the education with some stimulus funds flowing there. So that's a good news story. As far as we see indoor air quality as a megatrend that's not going to go away. It's top of mind.

Speaker 2

I mean, Trane Technologies has always Had a robust focus on indoor air quality. It was always big in the healthcare vertical. It's now top of mind in all verticals, We don't see this stopping. We see people constantly asking about indoor air quality. I would tell you that we're building it into our systems, Which is kind of your second point your second question there is, this is now integrated into a system And we're seeing nice traction there in all verticals.

Speaker 2

Yes. But I'll add Scott is because it is embedded in systems now, it is becoming harder and harder to kind Spike out the impact of indoor air quality separate from a systems order. I've offered Dave, we can hire a few more accounts to try to Those revenues in a little more detail, but I think the fact is it's really becoming just a long term tailwind for the company. Yes. Just to add to that, we're really seeing a lot of traction, especially with our dry hydrogen peroxide solutions.

Speaker 2

And this is predominantly in the education vertical as we're building this into the And the dry hydrogen peroxide solution, the unique innovation there is that these molecules last longer. So if you think about a school room where you have students that are moving around to different classrooms on different desks, these molecules actually settle on the desk, So they clean the air as well as the surface and we're getting a lot of traction around that. It's very interesting. I'll pass it on to my peers, but thank you and good luck. Thanks.

Speaker 2

Thanks.

Operator

Your next question comes from Jeff Sprague of Vertical Research.

Speaker 4

Hey, thank you. Good morning, everyone.

Speaker 2

Good morning, Jeff. Good morning. Hey, good morning.

Speaker 4

I just want to follow-up on backlog As it relates to price, and Dave, you mentioned open kind of measuring how you open up the order book to not get caught here. To what extent do you have the ability or are you in fact going back and repricing some of the backlog Or given the environment that we're in, perhaps you're changing commercial terms just to protect yourself better. If you take an order today and you're delivering 12 months from now, right? Who knows what we're dealing with on the inflation front. So just any color there on how you're managing that, protecting yourself and maybe adding some flexibility to commercial terms?

Speaker 2

Hey, Jeff. This is Chris. I'll start and then Dave can jump in. If I go business by business, we start with residential. Really, we have the ability this year to look at our backlog and reprice our backlog as we see higher inflation Impacting orders that will ship now a couple of months out where the backlog in residential used to be a couple of weeks.

Speaker 2

Now we see it continue to be a couple of months out. We actually have repriced the backlog already in 2021, but we've got that ability to reprice going forward should we see significantly more inflation. On the commercial HVAC side, when I think about long lead time and equipment, those contracts generally have price escalation clauses in them That allows us to reset pricing based on an index. So we have some protection there as well. And then on Thermo King, to Dave's remarks earlier, We've been really selective with opening up the order books for 2022.

Speaker 2

We wanted to get as much insight as we can get on the inflationary environment Through the Q3 of 2021, we've only had the Q1 of 2022 order book open. We've now recently opened up the 2022 order book for the balance of the year, and we did that intentionally to make sure we had the right interest in our book and increasing To reflect that in the backlog. So I think we've got resiliency there in the quarter in terms of price and being able to keep up inflation. Yes. The only thing I would add to that is, obviously, we've got pricing built in, we've got mechanisms in place.

Speaker 2

We also believe that our backlog is very firm. We're not seeing cancellations of our backlog and we don't anticipate any cancellations for backlog in the future.

Speaker 4

And then separately, just on resi, I don't think you mentioned resi in terms of Something you're positive on in terms of your 2022 outlook. Obviously, we've got this question that everyone's asking and isn't sure how to answer on how these Comps play out and that sort of thing. Dave, what is your high level view on how kind of the resi market behaves next year? And Certainly, you might have a different view on how you behave inside that, but any perspective would be appreciated. And I'll leave it there.

Speaker 4

Thank you.

Speaker 2

Okay. Thank you. Yes, Avi, we look at our resi business at a very high level as a GDP plus business. So if you could tell us what GDP is, You could tell us what consumer confidence is. We could dial in what our residential business and how it's going to perform.

Speaker 2

That said, obviously, we have detailed models that we go And it's really just to validate our high level approach. So GDP is projected to be positive next year And we do not see the resi business falling off a cliff in 2022. We see it a GDP plus business.

Speaker 4

Great. Thank you.

Operator

Your next question comes from Julien Rommel of Barclays.

Speaker 5

Hi, good morning. So just starting with price Just to understand the sort of jumping off point into next year, I saw you said that you have $150,000,000 of price in Q3, Similar sort of cost step up. Maybe just help us understand on those two numbers, what should we expect for Q4? And then what's the kind of Total year 2021 for price and cost, please.

Speaker 2

Julien, it's Chris. Thanks for the question. Yes. We were really pleased with the price realization in the 3rd quarter, 4.3% of price realization and Really equals the revenue growth we had in the Q3 as well as we were very flat on volumes. And for the quarter Q3, we saw slightly positive price cost.

Speaker 2

When I think back a few years ago when we had our last inflationary environment, we were Really trying to catch up on the price cost equation. I think it was about 6 quarters where the company was negative. Now we're able to Keep up with that at least through Q3 of this year and really that goes back to the business operating system we continue to enhance in the company. So, slightly positive price cost in Q3. For Q4, I'm expecting price realization to get a little bit stronger, but I'm also can see inflation getting stronger in the Q4 as well.

Speaker 2

So We're right now kind of expecting price cost to be flattish in the Q4, and then we'll see how this kind of plays out for 2022 where We're always targeting 20 to 30 basis points of price over cost for a given year, but I'm expecting that to be flattish in the 4th quarter. That's helpful. The only thing I would add to that is that the operating system, I don't want to Don't underestimate the amount of work we put into building our operating system to stay ahead of these inflationary curves. I mean, as Chris said, It was the last time we had this type of inflation took us several quarters to overcome it. And now we're in the quarter being able to offset it.

Speaker 2

We're very proud of what we've been able to do there.

Speaker 5

That's helpful. Thank you. And then maybe just Following up in terms of overall firm wide operating leverage, so it looks like I think in the Q4, you're looking for maybe sort of 20%, also operating leverage year on year. Just wanted to check that's roughly the right Ballpark, and do you think that's a good sort of entry point starting out next year, given you've still got pricecost Margin headwinds at least in the Q1 or 2.

Speaker 2

Yes, Julien, I think you're in the ballpark for Q4. We left the full year guide intentionally intact given we can see the push out of some revenues into the Q4, the $50,000,000 to 75,000,000 Really, from my perspective, our perspective, the backlog and the demand is very firm. It really comes down to supply chain. And that's why we got the squiggle $6.05 on the full year from an EPS adjusted EPS perspective. So could it be a little better?

Speaker 2

Could it be a little worse? I think we're right around that $6.05 based on how we see the supply chains today, but it's really going to be dependent on that. But yes, you're in the ballpark for Q4. We'll see how leverage kind of plays out for next year. I think we're certainly expecting an inflationary environment next year with pricing actions.

Speaker 2

We'll need to continue to moderate that, We'll have more insight on that as we get into January. Thank you.

Operator

Your next question comes from John Walsh of Credit Suisse.

Speaker 6

Maybe piggybacking off of, I think it was Jeff's question earlier. I think in your answer, it was mostly around the Wanted to hear a little bit about your ability to pass through inflation On your service contracts, because obviously labor availability and I think the wage inflation is something we're all Expecting into next year. So do you have those same kind of ability to pass through those inflationary pressures there?

Speaker 2

Good question. Yes, we do. Any kind of a long term contract, we have price escalations built into it. So that's taken into consideration we have our service agreements.

Speaker 6

Got you. And then Maybe coming at the backlog and orders question a little differently here, 20% order growth, it's not like you're comping a down 20%, you're comping a +7. So I mean, how do we think about just the orders rate and if you think you can actually build backlog next year Potentially, obviously, I understand you're not in the business of guiding orders, but it's definitely a question we're getting from investors here. So I would appreciate any color. Thank you.

Speaker 7

Yes. I mean, if you

Speaker 2

look at it, it's really phenomenal what's happening right now. I mean, We had 30% order growth in the Q1. We had 30% order growth in the 2nd quarter. And here we are in the 3rd quarter About 20% and in some of our businesses, I call out commercial HVAC, I mean, and equipment is up 50% there. So I don't anticipate that bookings will continue at the 30% growth rates, but I would tell you that we're seeing a lot of demand right now for our innovations in the And whether it be in the Thermal King business or in the commercial HVAC business, that's really driving a lot of this demand for us.

Speaker 2

And we also have these tailwinds behind us around sustainability and the decarbonization of the built environment That is only gaining momentum. So we like what we see here going into 2022. We're going to have record backlogs And we'll see what 2022 is from an incoming order rates. But right now, we really like the position we have going in.

Operator

Your next question comes from Andy Kaplowitz of Citigroup.

Speaker 8

Hey, good morning, guys.

Speaker 2

Hey, Andy. How are you doing?

Speaker 8

Good. How are you? So EMEA continues to be a significant outperformer versus your other regions. Maybe you can give us a little more color What's going on there? How big is your heat pump business already become?

Speaker 8

Are products such as heat pumps and the advance are just nicely accretive to margins that they're helping? And How sustainable is that 30% incremental you put up this quarter?

Speaker 2

Yes. I mean, innovation that you kind

Speaker 9

of hit on it, Andy, that's

Speaker 2

It's really driving us in EMEA and it's just such a great place to be. I mean, the Advancer product in our Thermal King business, it's exceeding our If you look at what we've been able to do with the electrification of heating in the HVAC business, again, it's we're getting Tremendous demand. Tremendous demand. So I don't want to get into specifics as to how big we are or large the market is there, but I would tell you that it is propelling our growth And we're excited about what the pipeline looks like in the future. But and Rest assured the innovations are continuing there as we continue to look to expand the what we call the operating maps of How our HVAC product works, we're going for higher temperatures on the heating side and lower temperatures on the cooling side, Which are only going to expand our market further.

Speaker 9

Great. I'll add, Andy.

Speaker 2

Sorry, on the incrementals, you had a question there. Look, we've set up Each of the segments to really have over the long term 25% plus incremental. So we think Europe is well situated for that over the

Speaker 8

Very helpful, guys. And then maybe you could give us a little more color into what you're seeing in Asia. You mentioned record backlog in the region. Did notice that transport revenue turned down a bit and the pandemic does remain a challenge in the area. So are you seeing overall China hold up well and how are you thinking about that region in 2022?

Speaker 2

Yes. I mean Asia Pacific is about 10% of trained technology, it's important region for Let's talk about in 2 different pieces. Let's talk about China first. Obviously, GDP is pretty well documented, has slowed a bit in the 3rd quarter at least versus Expectations, I think it was 4.9 and expectations were over 6. So it is slowing a bit in China.

Speaker 2

I would tell you though where it continues to grow, think about electronics, pharmaceutical, data centers, healthcare Are also verticals that we're very strong in. So we're seeing nice growth in China And we expect that to continue in the future. You get outside of China, it really becomes country specific. And unfortunately, we're still having some countries that are going into different phases of lockdowns based on where the pandemic is. But it's going to be a little bit mixed outside of China, at least into the Q4.

Speaker 8

Appreciate it, guys.

Speaker 2

Thanks. Thank

Operator

you. Your next question comes from Steve Tusa of JPMorgan.

Speaker 7

So where are you going to end on Price and cost for

Speaker 2

the year now with this neutral back half ish neutralish back half? Like what was the first half pricing cost? First half would have been positive, but on much smaller numbers, Steve, right, just given price has grown Considerably from Q1 now to Q3, expecting Q4 to be flattish price cost. On the full year, I think we're probably around the flattish range. Maybe it can be slightly positive.

Speaker 2

Our goal here is to keep Driving the innovation and then driving the pricing to reflect what we think the inflation is going to be. So really happy where we Our year to date on the price realization, like I said before, it's going to grow a bit in the Q4. At the same time, we're seeing inflation grow into the Q4, And we're really just trying to stay ahead of it. So I'm thinking flattish or slightly positive on the full year. Yes.

Speaker 2

I mean, Steve, we've already had 3 price increases in many of our businesses. And if we still see the inflation be persistent, another price increase would be part of our is operating system and we would execute on that.

Speaker 7

Right. I guess I'm just looking for the $150,000,000 and the $150,000,000 What was that in the first half?

Speaker 2

I don't know if we've actually probably given that number. It would have probably been less than the $150,000,000 would be my guess, but I'd have to go look at

Speaker 7

Okay. And then on commercial equipment, you said orders up 50%. Can you just Split those out between applied and then how did the light commercial kind of unitary business fare within that?

Speaker 2

Yes. I mean to be fair, Steve, it was more than 50% and both our unitary and applied We're both over 50%. So the light being part of that number was very strong as you would imagine. So we have seen unbelievable amounts of growth in our commercial HVAC equipment business. And it's actually and I said it earlier, but it's actually To be fair to our suppliers, we're putting that demand right on them.

Speaker 2

So it's causing them to have to spike forward as

Speaker 7

well. That's very positive. And then one more for you. What was sell through for your what do you think MVMT was for your resi business, The stuff that you can tell to the customer, I think you've given that before?

Speaker 2

Yes. On the IWD side, which again is about 50% of our business, Sell through was mid single digits, sell in was flat. So obviously, their inventory adjusted as you would expect in a shoulder season. The next the follow on question Steve would be what's inventory level look like in the IWD space. It's about what you would expect, maybe a bit lower than we would at this time of year, but it's nothing to call out.

Speaker 7

Great. Great color. Thanks a lot.

Speaker 2

Okay. Thank you, Steve. Steve, your earlier question is to follow-up on that for the first half kind of price for the enterprise is around 2.2%. So less than $150,000,000 we realized in Q3. We got a little less than that for the first half of the year.

Speaker 2

So that price has really ramped up From the first half to Q3, and we're expecting that to be stronger even in Q4. Yes. And cost? And cost? The $150,000,000 Yes, I would say in the first half was positive.

Speaker 2

Again, it was less than $150,000,000 but positive in the first half, Slightly positive in Q3, and we're expecting about flattish for Q4.

Speaker 7

Okay, thanks.

Speaker 2

You're welcome.

Operator

Your next question comes from Nigel Coe of Wolfe Research.

Speaker 9

Sorry, I

Speaker 2

I was going to say, let's go That's a

Speaker 10

3rd half price cost question, but let's not. But I do want to go back to the backlog, because obviously super hot, Plus70 in Americas. I'm just wondering is how does the aging of that backlog look? I mean, do you expect The majority of that to convert in 2022 outside of supply chain pressures. And I guess my real question is, I know you're not going to answer this specifically, We really haven't grown higher than 8%, 9% in climates over time organically.

Speaker 10

And I'm just curious, Could 2022 be above that bar? Just curious if that backlog converts?

Speaker 2

Yes. As we said earlier, We're still working through the 2022, but just talking about the backlog, I mean, you really need to as far as when it burns, you really need to go through it by business. So if you think about our commercial HVAC business with applied orders, that backlog When an order comes in, there could be a 6 to 9 month burn rate on those type orders before they actual ship. In the TK, a little bit different this year than I've seen in other years. We had a lot of customers place orders in the Q1 and kind of lay them in through the rest of the year.

Speaker 2

And the other complication with Teekay we're seeing right now is obviously we're working with our customers on their slots for trailers and tractors. So normally the burn rate in Teekay would be 2 to 3 months. That's been extended a little bit Just because of the constraints associated with the actual building of a trailer. On the resi space, I mean, our backlog turns. I mean, It's turning on a regular basis.

Speaker 2

And overall, I mean, we have a very large backlog. We have order demand that is Some of the best I've ever seen in my career. But understand, our backlog is not stale. It continues to churn And we're shipping out, we're just getting order rates that we haven't seen a very long time in this business that are continuing to build this backlog.

Speaker 10

Okay. I'll leave that backlog question there. On price cost, you did call out APAC as Challenging near term and I think we're all tuned into the fact that APAC over time has been a bit more challenging on price. So just curious, Are we seeing some deflation in APAC? And any concerns as we go into 2022 around that region?

Speaker 2

Yes. Nigel, I would say, yes, price cost right now is a little bit challenging in the near term. We're really on track So having very strong full year margin expansion in the region. If I go back even just 2 years, kind of a 2 year stack, We're up over 400 basis points in margin expansion in the region. If you go back to when we invested in our direct sales force, it's up over 500 basis points.

Speaker 2

So the region has had some great growth being very selective around orders as well. I would tell you that We'll continue to evaluate the pricing environment and make price increases where necessary. I'd be looking for that region like for the rest of the company To be getting price cost positive going into 2022, but near term, a little bit of challenges. It's also a little bit of a loss, small numbers For revenue or margin contraction in the quarter for Asia in Q3.

Speaker 10

Okay. Thanks. That's great color. Thanks.

Speaker 2

Thank you.

Operator

Your next question comes from Josh Pokrzywinski of Morgan Stanley.

Speaker 4

Hey, good morning, guys.

Speaker 2

Hey, Josh. How are you doing?

Speaker 4

Well, thanks. So just on this commercial equipment growth, I mean, Look, for what is historically kind of a replacement business and with a pretty massive installed base, like 50% sort of an eye popping number, Obviously supply chain and bottlenecks are kind of everywhere. Like is there sufficient labor, whether it's in your own house or kind of there in the independent world actually install this stuff in a reasonable timeframe or is that going to be sort of A gating factor on converting that backlog as well.

Speaker 2

Yes. I mean, as far as labor constraints in our own four walls, It's really we have seen some early in Q3. It subsided a bit as we move through the quarter. We're planning for it. It's just a matter of how your training mechanism and hiring of new people.

Speaker 2

So that's happening. On a job site basis, We have seen jobs push out to your point because of job site labor constraints. It's not anything that I would spike out and say it's super alarming, but it's certainly there. And it's not just in North America. It's really on global basis.

Speaker 4

Got it. And then on the Missed revenue that you're starting to make up in the 4th quarter. I mean, we've kind of heard similar metrics out of some other folks, but with the expectation that just We don't miss any more revenue in 4Q. Starting to make it up would imply that not only your maybe some of the supply chain issues stabilizing, but starting to improve. Like I don't want to put too many words in your mouth, but like would you characterize the last kind of 30 days or so as seeing some actual improvement rather than just stability?

Speaker 2

Yes. I mean, we had some acute supplier problems in our Thermal King business And we've been able to overcome those. So we have line of sight to what we're guiding to you right now. That said, supply chain is very volatile right now, okay? It is the whack a mole game.

Speaker 2

So we fix one problem and then another one comes up. But it's really about staying on top of where you are, working with your customers, working with your suppliers. And it's a lot about communication and I would tell you that our operating system allows us to be Working hand in hand with our suppliers to make sure they can meet the expectations that we're seeing, which again is extremely robust right now.

Operator

Your next question comes from Andrew Obin of Bank of America.

Speaker 9

Hi, guys. Good morning.

Speaker 2

Hey, Andrew. How are you? Good morning.

Speaker 9

I'm good. I'm good. Just a bit of a longer term question. You've highlighted Thanks for the institutional and I think after the first wave of stimulus came in, I think education was very much highlighted as an area, Air quality improvement, etcetera, which we're going to benefit the industry. My understanding is that there is a timeline on spending that financing you have to do it Over 3 years.

Speaker 9

Can you just tell us what you have seen so far? And how do you expect The spending to play out over this period of time in the institutional vertical and as I said specifically education? Thank you.

Speaker 2

Yes. We're seeing funds flow, which is a good thing. 2024 is the date we have to be spent. That may That's the date right now. That may get pushed out obviously.

Speaker 2

You got to think about any work you're going to do on a school you're going to do when students aren't there. So It tends to become a season to do school work, but funds are flowing, the elementary, secondary school relief, Emergency relief or ESSER as they have it, it's flowing from the states down to the local levels. And we're seeing really, really good traction where We did a Phase 1 indoor air quality audit. We gave our customer a roadmap for the future. They're now executing to many of those roadmaps with Upgrades in their facility.

Speaker 9

Got you. And just a longer term question on residential You sort of highlighted that it's a GDP plus business. But how should we think about 2021 Sitting into the overall sort of length of the cycle, right, do you think there was any pull forward? Or do you think just thinking out in next Several years, as I said, it just continues to be positive in 'twenty two, positive in 'twenty three and It just keeps going until consumer gets tired. Just maybe the broader shape, longer term shape of the resi cycles as you think about it, particularly after a strong 2021?

Speaker 9

Thanks

Speaker 2

Well, hopefully the consumer doesn't get tired, but I'm not sure the historical models on the cycles are have played out Certainly in the past. Again, we look at it as a GDP plus business. We have models that will go through replacement cycles And use of units, etcetera, and we have a lot of data on that. But at the end of the day, if you think about it as a GDP plus business, you think about consumer confidence, That's what drives that market. And we're very happy with the performance that we've had this year and GDP will be positive in 2022.

Operator

Your next question comes from Deane Dray of RBC Capital Markets.

Speaker 3

Thank you. Good morning, everyone.

Speaker 2

Hey, Deane. How are you?

Speaker 3

Doing very well. Thank you. Just Question about your CapEx plans and we're hearing from some companies who just are not able to get projects done, also a consequence Supply chain, labor constraints and so forth, but you as a customer, are you seeing any of that? And how is that factored into CapEx Planning for 2021 and 2022?

Speaker 2

Yes. We have several upgrades that we're doing. It's really continuous as we continue to upgrade our lines. We've seen some push out, but nothing that we can't manage.

Speaker 7

Okay.

Speaker 2

Yes. And I'd add that we're still tracking, again, that 1% to 2%, probably Close to the 2% this year spend on capital as a percent of revenue, but with enough advance notice and ordering within lead times, We've been able to try to mitigate some of that supply chain pressure.

Speaker 3

Got it. And then just a quick follow-up Question on the whole whack a mole phenomenon is, are you doing much in the way of partial assemblies At your manufacturing plants, you're waiting for a component. And so this would imply you've got You're actually spending on work in progress inventory and then when that product does come in, you ship them out. If it follows through to the subsequent quarter, that's actually a higher margin shipment since you've already expensed some of that. How does that Zach, we're into your planning right now, are you doing partial assemblies and so forth?

Speaker 2

The answer to partial assemblies is yes. We could have you come work for us And operations because that's obviously as we're waiting for some components. In some cases, you could do a partial sum and in some cases, you cannot. But as far as the revenue recognition or the cost, Chris, I don't know if you want to handle, but the answer is no. Yes.

Speaker 2

No, I think If we've got a partial assembly, we can't recognize the revenue. We're capturing all the costs associated with it. It stays in inventory until we can ultimately recognize the revenue. The following quarter, we're adding the components we need to on that parcel assembly to make it full, then that's when the full cost gets

Operator

Your final question comes from Steven Volkmann of Jefferies.

Speaker 11

Great. Thanks guys for squeezing me in. Most of my But maybe kind of a big picture question for you, Dave. I'm wondering sort of the old model that we had in this industry of trying to keep Inventories as lean as possible and so forth kind of worked well for a slower growth environment, but it feels like we're Transitioning into something better than that. So I wonder, do you need some more capacity?

Speaker 11

Does it make sense to layer in some more inventory on a sort of Structural basis to deal with a stronger growth environment?

Speaker 2

Yes. It is an excellent Good question. And I would say we pride ourselves in being a lean company. And maybe that's why we were out talking about supply chain choppiness In the Q2 ahead of many others because we saw it in our planning horizons. That said, I mean, we have capacity for sure, But the inventory investment is something that we're working with internally.

Speaker 2

And inventory, you don't think of it necessarily as finished Goods, maybe you would in the res business, but in our commercial business, it's really at the raw level where you're able to convert it more easily into And whip and then finish goods.

Speaker 11

Super, great. And then just anything else that you've thought about over the last few months as you've Taking on this role that might differentiate you a little bit from your predecessor?

Speaker 2

Yes. I mean, it's been I don't know, it's been 150 days. Feels like forever, but this is just such a great company, Trane Technologies. And we have and we're part of such a great industry. So I mean I couldn't be prouder to be the CEO of Trane Technologies.

Speaker 2

We're talking I'm talking next week at COP26, Talking about waiting for the next great invention to start decarbonizing the world. These inventions already exist today. So I'm excited to do that. And then the only thing I would add is, we just completed our employee engagement survey. And here we are, I don't know how many years it is, but top Decile performance for engagement.

Speaker 2

It is our culture that differentiates us and I'm not sure that's going to differentiate between me and Maya, but it is really our And how much pride we take into building a strong culture. So Trane Technologies is in a great place today and it's we're headed in an even better

Operator

This concludes the question and answer session for today's call. I will now turn the floor back over to Zach Nagel for any additional or closing remarks.

Speaker 1

Thanks, Paul. I'd like to thank everyone for joining today's call. As always, we'll be available in the coming days weeks to answer any questions that you may have. And

Operator

Ladies and gentlemen, thank you for your participation in today's call. This does conclude today's event. You may now disconnect.

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Earnings Conference Call
Trane Technologies Q3 2021
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