Trane Technologies Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 1, 2023

There are 15 speakers on the call.

Operator

Good morning, and welcome to the Trane Technologies Q3 2023 Earnings Conference Call. My name is Sheryl, and I will be your operator for 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. Call.

Operator

Call. I will now turn the call over to Zach Nagel, Vice President of Investor Relations.

Speaker 1

Thanks, operator. Call. Good morning, and thank you for joining us for Trane Technologies Third Quarter 2023 Earnings Conference Call. Call. This call is being webcast on our website at traintechnologies.com, where you'll find the accompanying presentation.

Speaker 1

Call. Please go to Slide 2. Call. 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 call. Please see our SEC filings for a description of some of the factors that may cause our actual results call to differ materially from anticipated results.

Speaker 1

This presentation also includes non GAAP measures, call, which are explained in the financial tables attached to our news release. Joining me on today's call are call. Dave Wignery, Chair and CEO and Chris Kuhn, Executive Vice President and CFO. Call. With that, I'll turn the call over to Dave.

Speaker 1

Dave?

Speaker 2

Thanks, Zach, and everyone for joining us on today's call. Call. I'd like to begin with a few comments on our purpose to boldly challenge what's possible for a sustainable world. Call. Our purpose is at the heart of our strategy, which is aligned to powerful megatrends like energy efficiency, decarbonization call and digital transformation.

Speaker 2

Coming off the hottest summer on record, we see policies company's aim at decarbonizing the built environment, continuing to expand. We see growing sustainability commitments for our customers, our suppliers and for our investors. Call. We see corporations not only setting goals, but taking action. Call.

Speaker 2

We are their partner of choice. And we have the technology to help bend the curve on climate change. And that's exactly what we're doing. Call. We are scaling today's technology and relentlessly innovating for tomorrow to meet our customers' needs to dramatically reduce emissions.

Speaker 2

Call. This enables us to consistently outgrow our end markets and deliver differentiated financial results. Call. The end result is long term value creation for our customers, our shareholders, our employees and for the planet. Call.

Speaker 2

Moving to slide number 4. Our global team performed extremely well in the 3rd quarter, call, setting us up for a strong 2023 and positioning us well for 2024. We delivered strong organic growth of 9% call and leveraged throughout the P and L, resulting in adjusted EPS growth of 23% and powerful free cash flow. Call. We continue to see very strong customer demand for our products and services, with the enterprise bookings call at an all time high of nearly $5,000,000,000 in the quarter.

Speaker 2

Bookings were exceptionally strong in our commercial HVAC businesses globally, call. With organic bookings growth of lowtomidteens in all segments, our Americas commercial HVAC business was once again a stand up call with organic bookings up mid teens in the quarter and up approximately 65% on a 3 year stack. Call. Enterprise backlog ended the quarter at $6,900,000,000 with the composition shifting increasingly towards commercial HVAC. Call.

Speaker 2

Year to date backlog in commercial HVAC is up approximately $800,000,000 call. Over the past 3 years, our commercial HVAC backlog has nearly tripled, up approximately 170%. Call. As residential and Thermal King have normalized, the backlog burn in these businesses has been completely off quarter. We are now fully offset by growth in commercial HVAC backlog, including a large percentage of long cycle applied systems.

Speaker 2

Call. We continue to drive strong demand and a healthy pipeline of projects in key growth verticals across our commercial HVAC businesses. Call. We're leveraging the power of our direct sales force, which brings specific expertise on how to customize solutions call and leverage policy, programs and incentives to optimize customers' paybacks, total cost of ownership and performance. Call.

Speaker 2

Our leading innovation and unique direct go to market strategy enables us to quickly pivot and win in the highest growth verticals call. We have a resilient and diverse portfolio, and our business operating And transport markets have softened, our overall business has delivered strong results and is on track to deliver high single digit organic revenue growth and company's earnings call. Our 3rd consecutive year of 20% or higher adjusted EPS growth. Call. We're on pace to deliver free cash flow equal to or greater than 100% of net earnings and continue to execute our balanced capital allocation strategy with high levels of business reinvestment, a strong and growing dividend, call.

Speaker 2

Our strong execution, robust bookings and revenue growth call. And exceptional backlog gives us confidence in raising our 2023 guidance and confidence in our ability to deliver strong performance in 2024 call as well. Please go to slide number 5. Demand for our innovative products and services call. This continues to be broad based across our segments, highlighting the strength of our global portfolio.

Speaker 2

Organic bookings were up 8%, call, led by our commercial HVAC businesses. In the Americas, commercial HVAC was very strong across the board. Call. We discussed booking strength on the prior slide, but revenues were exceptional as well, up in the low 20s percent range, call with equipment up approximately 30% and services up low teens. Our residential business continues to normalize as expected call with revenues up low single digit.

Speaker 2

Consistent with our prior comments, the nature of our transport refrigeration business is lumpy, call. And our performance in Q3 was in line with our expectations on both bookings and revenues. Revenues were a bit lower than our guidance of down 10%, call. Driven by the timing of customer deliveries between Q2 and Q3, but remained strong against a tough 60% prior year growth comp. Call.

Speaker 2

On a 2 year stack, revenues were up more than 40% in the quarter.

Speaker 3

Americas backlog

Speaker 4

conference call. Is approximately 3 times

Speaker 2

historical norms, with the largest component being commercial HVAC applied systems for 2024 and beyond. Conference call. Applied Systems are the most complex and innovative systems and the largest driver of our service business in commercial HVAC. Call. Our EMEA business was right on track with our expectations.

Speaker 2

Bookings were strong in both businesses, call. Commercial HVAC revenues were robust with mid single digit growth on tough prior year comps. Call. Teekay EMEA revenues were up versus a down market. Backlog remains strong, approximately 60% higher than historical norms call and predominantly commercial HVAC.

Speaker 2

Our Asia Pacific business performed well with strong bookings growth in China and the rest of Asia. Call. Asia revenues were slightly lower against a tough prior year comp of nearly 30% growth. Our outlook for the region continues to be positive. Call.

Speaker 2

Asia segment backlog continues to be robust call as we approach 2024, approximately 70% above historical norms and predominantly commercial HVAC. Now, call. I'd like to turn the call over to Chris. Chris?

Speaker 5

Thanks, Dave. Please turn to Slide number 6. Call. The scoreboard for the quarter highlights strong execution top to bottom. Organic revenues were up 9%, adjusted operating and EBITDA margins were up quarter.

Speaker 5

1 100 basis points respectively and adjusted EPS was up 23%. Call. At an enterprise level, we delivered strong organic revenue growth in both equipment and services, up high single digits and low teens respectively. Call. We continue to highlight our exceptional services growth because our services business continues to differentiate us in our industry.

Speaker 5

Call. It makes Trane Technologies more resilient with higher recurring revenues at higher margins over time and represents about 1 third of our enterprise revenues. Call. Over the past 6 years, including 2020, our services business delivered a revenue growth CAGR of up high single digits, call, and we're driving even stronger growth in 2023. Our high performance flywheel continues to deliver results call.

Speaker 5

With relentless investment in innovation, driving strong top line growth, margin expansion and EPS growth. Call. Please turn to slide number 7. As an enterprise, we delivered about 5 points of volume and about 4 points of price in the quarter. Call.

Speaker 5

Strong volume growth, positive price realization and productivity combined to more than offset inflation in the quarter. Call. The supply chain continues to stabilize, enabling improving productivity as we move throughout the year. Call. In the Americas segment, we delivered about 7 points of volume and 4 points of price, with a company's strong leverage and margin expansion call, led by our commercial HVAC business, more than offsetting volume declines in transport.

Speaker 5

The EMEA segment delivered very strong organic incrementals call and margin expansion, with organic revenues up low single digits in the quarter. The segment also delivered approximately 12 points of M and A growth in the quarter, call, which impacted reported leverage given year 1 integration costs. The Asia segment delivered strong margin expansion and organic leverage in the quarter call. For the enterprise, we earmarked an additional 30 plus basis points for incremental business reinvestment in 2023 call. This nearly doubles our average run rate of approximately 40 basis points annually call for a total of 70 plus basis points in 2023.

Speaker 5

We're extremely pleased we've been able to make these incremental investments in 2023, call. We see a tight linkage between investments and innovation and market outgrowth, and we're taking opportunities to go further and faster quarter in 2023. Now, I'd like to turn the call back over to Dave. Dave?

Speaker 2

Thanks, Chris. Please turn to slide number 8. Call. Overall, our positive outlook for our segments and our end markets is largely unchanged from the prior quarter. Call.

Speaker 2

And as we move into the Q4 with continued high levels of absolute demand, exceptional backlog and strong execution, call. We're gaining additional visibility into healthy growth in 2024. Across the enterprise, there are some key themes. Call. Strong demand for our sustainability focused solutions remains high.

Speaker 2

While we expect the law of large numbers to kick in at some point call. And for order growth to decline, absolute bookings are expected to remain robust, given our new baseline is at a very high level. Call. Across our businesses, we see the stacking effect of supportive policy and regulatory changes that play to our unique strengths as a leading climate innovator. Call.

Speaker 2

In addition to all the tailwinds at a national level in both the U. S. And Europe, we see activity at the state call. And our direct sales force is able to help customers leverage these programs. Call.

Speaker 2

In America's commercial HVAC, our business is extremely strong as we've outlined. We're winning with customers and developing innovative solutions in data centers, education and high-tech, just to name a few strong verticals. And we're driving tremendous growth in our applied business, call, which makes up the majority of our backlog. Applied Business is the most differentiated and complex, and it's where our competitive advantages shine. Call.

Speaker 2

It's long cycle with higher margin service opportunities representing a multiple of initial purchase price over the life of the system. Call. Additionally, this business helps to forge long term relationships with customers as they move from project to project over a multi year period. Call. We have the most comprehensive portfolio of products in the industry, which enables us to compete and win across all verticals, call.

Speaker 2

There's no change to our residential business outlook. Call. We expect residential to continue to normalize through the Q4 and for the normalization process to be largely complete in 2023. Call. Also, as expected, strength in commercial HVAC is more than offsetting the decline in residential in 2023.

Speaker 2

Call. Our transport refrigeration business was largely in line with our expectations in the Q3 and up more than 40% on a 2 year stack. Call. We expect to outperform the market for the year. ACT is projecting a dip in 2024 and a bounce back in 2025 call and continued growth afterwards.

Speaker 2

However, ACT's forecast has been volatile in recent months, and we are in the process the call. We'll update the market when we hold our year end earnings call. Call. In our EMEA segment, the 3rd quarter was also in line with our expectations for both businesses. Call.

Speaker 2

As we highlighted in our Q2 call, EMEA HVAC has very tough comps in both the 3rd and 4th quarters, call. Up high-20s and low-40s respectively and revenue growth is expected to be more moderate in the second half. Call. The 2 year stack for Q3 is up more than 30%. Our transport refrigeration outlook is unchanged.

Speaker 2

Call. Likewise, our Asia Pacific segment, our outlook for the full year is unchanged. Revenue in the second half is expected to be flattish, call, purely related to tough prior year comps, while bookings continue to be strong. Now, I'd like to turn the call back over to Chris. Chris?

Speaker 2

Call. Thanks, Dave. Please turn to slide number 9.

Speaker 5

Strong execution, record bookings and near record backlog puts us in an excellent position call as we move into the Q4. We're raising our full year revenue and EPS guidance for 2023. Call. Organic revenue growth is expected to be between 8% 9%, up from our prior guidance of up approximately 8%, call. Reflecting strong Q3 performance and a largely unchanged outlook for a robust Q4.

Speaker 5

We're raising our adjusted EPS guidance to approximately 9 call, up from a range of $8.80 to $8.90 mainly reflecting a flow through of our 3rd quarter outperformance versus our guidance call and continued strong leverage of 30% plus for the Q4. We're pleased with our free cash flow performance of approximately $1,300,000,000 year to date. Call. And on the full year, we continue to expect to deliver powerful free cash flow of equal to or greater than adjusted net earnings call for approximately $2,000,000,000 As we've highlighted before, we pay close attention to our investment peer group call and consistently target top quartile financial performance, including adjusted EPS growth and adjusted free cash flow conversion. Call.

Speaker 5

We believe our guidance places us in a strong position to deliver against that target in 2023. As we said in our last earnings call, call. We expect an increased M and A contribution in the second half versus the first half due to the timing of acquisitions. Call. We had approximately 3 points of M and A in the 3rd quarter and expect to have approximately 2 points of M and A in the 4th quarter call.

Speaker 5

As one acquisition passes, the 1 year mark is included in our base. There is no change to our full year guidance of approximately 2 points from M and A. Call. Please see Slide 19 of the presentation for additional details related to guidance to assist with your models. Call.

Speaker 5

Please go to slide number 10. We remain on track to deliver $300,000,000 of run rate savings from business transformation by 2023, call, including $60,000,000 which will be realized in 2023. We continue to invest in these cost savings and high ROI projects call to further fuel innovation and other investments across the portfolio. Our continuous improvement mindset is an integral part of our business operating system, call and it's designed to drive gross productivity each year to offset other inflation. While it's been extremely difficult to realize meaningful levels of productivity in recent years, call.

Speaker 5

Given the supply chain and other macro challenges, productivity is improving as supply chain challenges abate and is call contributing to our 30% plus organic leverage target in 2023. Please go to Slide number 11. Call. We remain committed to our balanced capital allocation strategy focused on consistently deploying excess cash to opportunities with the highest returns for shareholders. Call.

Speaker 5

First, we continue to strengthen our core business through relentless business reinvestment. 2nd, we're committed to maintaining a strong balance sheet conference call that provides us with continued optionality as our markets evolve. In 2023, we received upgrades to our credit ratings, which are now Baa1, call BBB plus reflective of our strong balance sheet and cash flow generation. 3rd, we expect to consistently deploy 100% of excess cash over time. Call.

Speaker 5

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. Call. Please turn to Slide number 12, and I'll provide an update on our capital deployment for 2023. Call. Year to date, as of the end of October, we've deployed $1,600,000,000 in cash with $513,000,000 to dividends, call.

Speaker 5

$535,000,000 to M and A $550,000,000 to share repurchases. We have significant dry powder call. With over $2,600,000,000 remaining under the current share repurchase authorization and our shares remain attractive, trading below our calculated intrinsic value. Call. Our M and A pipeline remains active, and we have deployed or committed approximately $900,000,000 year to date as of the end of October call to bolt on leading technology acquisitions and equity investments.

Speaker 5

Our latest acquisition, Nivolo, was announced in early October. Novolo will augment our Energy Services, Enterprise Management and Digital Capabilities and Commercial HVAC.

Speaker 4

Call. We expect the Novolo transaction to close in the Q4.

Speaker 5

All in, we're on track to deploy approximately $2,500,000,000 in cash in 2023. Call. Our strong free cash flow, liquidity and balance sheet continue to give us excellent capital allocation optionality moving forward. Call.

Speaker 2

Now, I'd like to turn the call back over to Dave. Dave? Thanks, Chris. Please turn to slide number 14. Call.

Speaker 2

Transport refrigeration market forecast for both North America and EMEA remain unchanged, and we expect to outperform each market in 2023. Call. Our performance through the Q3 is on track to meet these expectations. The slide shows key data points on the markets conference call and on Thermo King specifically to provide additional transparency and reference information. Call.

Speaker 2

Please go to Slide number 15. As discussed, ACT's projections for 2024 have been volatile, call, and we are focused on conducting a thorough analysis of the markets. In the interim, we've included ACT's most recent forecast for 2023 through Q4 earnings call. However, given increasing visibility, we believe it may be constructive to discuss key dynamics at play call that give us confidence we'll see healthy growth in 2024. Our commercial HVAC businesses, call, which make up roughly 65% of our total revenues, are executing well in healthy markets and the agility of our sales teams call.

Speaker 2

To quickly pivot focus to growing vertical markets is driving record bookings and backlog. Call. Our applied backlog is a standout and provides a long higher margin service tail that makes our business stronger and more resilient. Call. Secular megatrends continue to support growth and policy and regulatory stacking is amplifying these tailwinds, call with the majority of these programs still ahead of us.

Speaker 2

We expect to enter 2024 with our residential business largely through the normalization process and on path to our long term target of GDP plus growth. We continue to lead with innovation, call, which yields healthy pricing opportunities and our business operating system is primed to stay ahead of inflationary pressures. The call. The supply chain is vastly improved and pockets of remaining challenges continue to abate. Call.

Speaker 2

Our culture is lean based and we're excited about the productivity we can unlock as we move into 2024. Call. We've also been heavily investing in productivity enhancing projects such as factory automation, which we expect to unlock further value. Call. ACT is forecasting a dip in North America trailer production in 2024, a snapback in 2025 and growth thereafter.

Speaker 2

Call. While we're in the process of further assessing their forecast, our North America transport refrigeration business is approximately 10% of our total revenues. Call. We expect to execute well, manage the business tightly, outperform the end markets, and if necessary, call. Lastly, while we don't talk about our service business a lot, call.

Speaker 2

We're quietly putting up double digit growth in 2023, on top of a 6 year compound annual growth rate of call. Our service business is strong, resilient and poised for growth, call. And we continue to build out our energy services and digital capabilities and offerings, which represents a big current call and even larger future opportunity. Please go to slide number 17. Call.

Speaker 2

In summary, we are well positioned to drive significant value over time. We are proud to have been named 1 of Fortune's Best Workplaces Company for Women and 1 of the World's Best Companies by Time Magazine. Our culture and people fuel our innovation call and help us to fulfill our purpose every day. This steadfast focus on purpose, our leading innovation, call. Our proven business operating system enables us to execute our strategy and stay nimble across our resilient portfolio.

Speaker 2

Call. This in turn enables us to consistently deliver a leading revenue and earnings growth profile and powerful free cash flow. Call. With our strong performance, elevated backlog and continued high levels of customer demand, we are confident in once again raising our full year revenue and EPS guidance and reaffirming our free cash flow conversion target. Call.

Speaker 2

We have the team, the strategy and the track record to deliver strong performance in 2023 call and differentiated shareholder returns over the long term. And now, we'd be happy to take your questions. Operator?

Operator

Call. Thank you. Your first question is from Scott Davis of Melius Research. Please go ahead. Your line is open.

Speaker 6

Hey, good morning, Dave and Chris and Zach.

Speaker 4

Call. Good morning, Scott.

Speaker 6

I'm kind of getting sick of congratulating you on good quarters, but this is one of the better ones. Call. You're making Lehi proud, Dave. All good. Call.

Speaker 6

Guys, when you think about the backlog that you have in the demand environment in commercial, is this the type of environment where you can really Be selective on projects and kind of cherry pick the stuff that has really the margin price margin structure that you want? Call. Are you still or is that not kind of how it works and you're just out there bidding on a wider array of stuff, but just bidding at a higher price. I'm just trying to get a sense of that interplay between project selectivity and really just the supply demand imbalance that's out there right now. Call.

Speaker 2

Yes. Scott, it's a good question. We have strong core business right now and we spend a lot on innovation call. And we price our innovation to ensure that we get proper returns. So I would say it's leading more with innovation and we're company.

Speaker 2

Constantly looking for how we can improve our portfolio, how we can improve the efficiency of our products, how our products can use next generation low GWP refrigerant, that's all inclusive in our business operating system when it comes to innovation. And that's what's really leading the Our markets right now. And I would also tell you that having this and I know I've told you this before, but this direct sales force And being able to educate them on new innovations real time and having them take those messages to the influencers on jobs It's very, very important when you go to close, especially some of these large applied jobs.

Speaker 6

Yes. Call. That's helpful color. I have to ask this question and you have a competitor who had a ransomware issue in the quarter. Did that help you guys call.

Speaker 6

As it related to bidding on things and such or was that a non event?

Speaker 2

Call. It was a non event. So, I hope everything is okay there, but it was a non event.

Speaker 6

Okay. I'll pass it on. Thank you again.

Speaker 2

Okay. Thanks, Scott.

Operator

Call. Your next question is from Julian Mitchell of Barclays Capital. Please go ahead. Your line is open.

Speaker 7

Hi, good morning. Call. I think, Dave, you emphasized a couple of times the strength in applied bookings and the difference versus like commercial because of the service element. So maybe just a follow-up on that point would be around sort of what's the rough split call today of say the revenues in your commercial HVAC business between Applied and Light Commercial. And just wondered When you're looking at the revenue outlook next 12 months, do you anticipate much of a difference in revenue trends Of applied versus light commercial, maybe because of stimulus impacts or the scale of the respective the backlogs, any sort of perspective around that please?

Speaker 2

Yes. Julien, we don't look at just light. We look at units here in call. So it would be light and large. And historically, it's been about fifty-fifty in our equipment business.

Speaker 2

But obviously in the Q3, we had Very, very strong demand in our applied business. So think of data centers, high-tech, Education were very strong. We had solid performance in other verticals too like healthcare, life science, government, industrial. Call. And then there were some weaker verticals as well.

Speaker 2

Think of traditional office, warehousing and retail. And those weaker verticals where you tend to see more unitary than applied systems.

Speaker 7

Call. That's very helpful. Thank you. And then just my follow-up, it's more of a Sort of silly short term one, but only 1 quarter left in the year. Your sales guide, I think your Q4 sort of construct on guidance is the same as it was back in July and you just kind of flowed through the Q3 beat call.

Speaker 7

Your full year guide, but if I wanted to look at the Q4 for what that's worth, the revenue guide implies Nearly, I think, sort of 8%, 9% sequential sales decline from Q3, which seems a bit heavier than normal. Call. Is that just kind of noise around backing out from the year or is there anything specific maybe in transport or something like that that's weighing on Q4?

Speaker 5

Call. Hey, Julien, it's Chris. I'll start off. The Q4 implied guide is kind of around mid single digits organic revenue growth call. And it is a little bit of a step down versus Q3, but if we put a few reasons behind it, one is, when I think about the toughest comp of the year.

Speaker 5

Our commercial HVAC businesses, this is really the toughest comp across the board going into the Q4 on a year over year basis. Call. 2nd would be the contribution from price. We would expect to be a bit lower in the Q4 than the Q3. We commented price delivered around 4 points of growth in Q3.

Speaker 5

You probably dialed that into about 2 ish points of growth in Q4. Call. So there's about 2 points right there sequentially. And then maybe just to round out another response here, really be around residential as it continues to call. We did a little better in the Q3 on revenues.

Speaker 5

Our constructive view around residential for the full year hasn't changed With revenues down around mid single digits. So, we're very focused on making sure inventory in the channel is positioned well for the start of 2024. Call. So we would expect that normalization to continue really into the Q4. So hopefully that gives you a little bit call.

Speaker 5

I have some view here on how we think about Q3 to Q4, but let's not forget maybe the first point, the commercial HVAC on tough comps. We had 40% growth in EMEA last year, 30% growth in Asia last year, really toughest comp of the quarter. Call.

Speaker 7

That makes sense. Thank you.

Speaker 2

Welcome. Thanks, Julian.

Operator

Your next question is from Andy Kaplowitz of Citigroup. Please go ahead. Your line is

Speaker 8

open. Good morning, everyone, impressive quarter.

Speaker 2

Hey, thanks, Andy. Thank you.

Speaker 8

Call. Dave, with the understanding that orders can be lumpy, it appears that you actually had a positive inflection in orders in Americas commercial HVAC in the quarter despite In terms of higher U. S. Rates, so did you see larger mega projects start to hit a little more frequently in the quarter? I know you mentioned strength in data centers.

Speaker 8

Did you see like Some of your bigger verticals actually heat up a bit as the quarter went on. And would you say that, that gives you more of a probability of ending backlog At the end of this year, closer to $7,000,000,000 $6,000,000,000 as I know you're guiding.

Speaker 2

Yes. I mean, we're still tracking a lot of quote mega projects and we're defining a mega project again as a project where the total revenue would be over total size of it is over $1,000,000,000 We're still tracking a lot of those in our pipeline. So yes, we had a little bit of activity in the Q3, but we just had some really nice growth. And as I said earlier, data centers, Education continues to be very strong and then we had like what I would call solid performance over a lot of different verticals, Healthcare, Life Science, Government, Industrial. Those are all very solid performance in the quarter.

Speaker 2

So call. I think a lot of the mega projects are yet to come, which is still good news. And I think I've told you on our Q2 call, our ability to Track these projects and to triage them on a global basis because some of these big mega projects, you have decision makers that are in different parts of the world. Call. And you have you could have the owner in Korea, you could have the engineer in Seattle, Washington and the project is in Texas and we're able to Triage that and work with the customer and show the value that we can provide.

Speaker 2

So we're super excited about a lot of the mega projects that are still in the pipeline. Call.

Speaker 8

Thanks for that. And then Chris, could you give more color into the organic leverage you've been delivering? Organic leverage in the mid-thirty percent range is obviously good result for Trane. We know you're guiding 30% for Q4 and 25% plus long term, but maybe you could talk about whether you have an extended period of productivity projects Along with good price versus cost that could help your margin performance well in the 24, given I think it was more difficult to engage these projects during the pandemic.

Speaker 5

Call. Yes, Andy, it's a great question. And I would say we go into every year looking at incrementals in the 25% or better category, right, and we'll dial that in as we get a little closer to 2024. But we continue to see this dovetail of the contributions from gross price call. Normalizing with the gross productivity getting better as we work through the quarter this year the quarters this year.

Speaker 5

Call. The supply chain has continued to improve. With that, the volume growth has continued to grow each and every quarter. We Delivered around 5 points of volume growth here in the Q3. And with that, the inefficiencies, as you said, it was hard to get that productivity the last couple of years, the The inefficiencies have gotten less.

Speaker 5

So, there's a lot of room to go here. We're starting to see some of the benefits of that in 2023, but this will be a continued opportunity for us as we go into 2024 really and beyond. We're really getting back to the DNA of the company, right, the ability for us to drive the lean culture and look at cost takeout and ultimately lean through with automation in our factories. These are all investments we're making this year call. And we're able to pivot the workforce to focus on that versus the supply chain challenges over the last few years.

Speaker 2

Yes, Andy, I had the opportunity to visit several of our locations during the quarter. And it was just such a great feeling to feel the flow that's happening in the operations today versus where we were a year ago, where we were looking at the yard full of product that had to go back on the line to be reworked. So that's all helping with the productivity. So We're really starting to hit our stride here in our operations, which is a great job by the team because they've had some tough times there working through supply chain, but I'm glad to say that they're operating extremely well right now.

Speaker 8

Appreciate all the color guys.

Speaker 2

Thanks, Andy.

Operator

Call. Your next question is from Gautam Khanna of TD Cowen. Please go ahead. Your line is open.

Speaker 4

Call. Hey, good morning and great quarter.

Speaker 2

Thanks, Gautam. Appreciate it.

Speaker 4

Just wanted to get your sense on you mentioned Port Refrigeration, you opened the order books in October. Any early read on how demand looks call. And how far out you're booking into 2024 right now?

Speaker 2

Yes. I mean, like I said, we did open the order book in October. Call. As expected, Gautam, I mean, the Thermal King business has performed very well for us over a number of years. Call.

Speaker 2

And with our current guide, we're forecasting that we're going to outperform the markets again in 2023. So it's a great business. We have a lot of innovation that we're Pumping through that business right now as we electrify our portfolio of products. Great team and it's call. I'm pretty excited about where we are with Thermal King.

Speaker 2

I know that ACT is forecasting a bit of a dip in 2024, validating that there's Some things that don't align up with our internal forecast, but we'll validate that in the short term and update everyone as we report out our Q4 earnings. Call.

Speaker 4

Okay. Can you comment on how far out you guys are actually booking into 2024 at this point?

Speaker 2

Call. It's always within a 12 month period. So these orders don't get booked way out. But in fact, in the prior years, we were only opening up the book for 6 month incremental increments. So just because we wanted to make sure we have pricing right when we were in a higher inflation market.

Speaker 5

Yes. I think for Americas, it may call. Through middle of 'twenty four Gotham and I think for Europe it may be open for a bit longer than that. But to Dave's point, the order book would really only be for 2024 at this point.

Speaker 4

Call. Thanks. And just one quick follow-up on resi. Any evidence of people Deferring replacement and instead repairing units, are you seeing any uptick in those products?

Speaker 2

Yes, I was with the resi team recently. We're not seeing that, call. No. So I think the short answer is no. We haven't seen that yet.

Speaker 4

Thank you, guys. Appreciate it. Thank you.

Operator

Call. Your next question is from Chris Snyder of UBS. Please go ahead. Your line is open.

Speaker 9

Thank you. Call. I wanted to ask on commercial HVAC. Orders this quarter clearly bifurcated from the broader industry. The company has always prided itself on driving innovation.

Speaker 9

So I guess my question is, with the world moving to emissions targets Just higher electricity prices globally. Are you seeing customers more so appreciate the innovation and efficiency that you are providing to them. And do you think that could result in a higher rate of share gains moving forward? Thank you.

Speaker 2

Call. Hey, Chris. Hope all is well with you. Great question. Look, we always lead with innovation.

Speaker 2

I think our customers always appreciate Higher Efficient Products, Greener Products, Using Low GWP Refrigerant. So we pride ourselves on that. Call. Look, we do a lot of innovation around verticals and I don't talk a lot about that But if you think of data centers, we had a very strong quarter in data centers. A lot of that has to do with the innovation that we're providing working with the customer.

Speaker 2

So these are unique solutions for them and then they scale it through all the data centers the building. So we'll continue to do that in the future. We'll continue to sell our energy efficiency to our customers call. And we'll continue to make sure that we have connected solutions so that our service business can continue to expand in the future.

Speaker 4

Call. Thank you. I appreciate that.

Speaker 9

And then maybe following up, Dave, you mentioned in the prepared remarks that orders need to go down at some point call. Due to the law of large numbers.

Speaker 4

So I guess the question is,

Speaker 9

would we need a step change negative in the macro To see that because it feels like the lead time compression headwinds are kind of largely in the rearview at this point. Commercial is healthy, Resi seems to be turning and you mentioned before the mega projects really haven't ordered yet. It's mostly still in the pipeline. So, I mean, what do you need to see in a macro standpoint

Speaker 5

call. Yes, Chris, it's Chris. I'll start. This is why we want to make sure it's important that investors look at growth rates as well as backlog position and just absolute bookings levels, right? I think the trends around decarbonization and as you mentioned just before customers putting on emissions targets, we see these as long term Tailwinds.

Speaker 5

Growth around data centers appears to be a multiyear tailwind as we think about the need for data and for saving data and to process data. So, we see this as some longer term tailwinds. Call.

Speaker 2

When we think about the beginning of

Speaker 5

the year, we guided ending backlog down to around $6,000,000,000 and that would have implied bookings down around 5%, 6%. But even on a down 5% or 6%, that would have been still very elevated levels in terms of absolute bookings. And we continue to see that strength here through the Q3. So I would say that the trends we don't necessarily see as abating. Could we find some quarters where the backlog will start to normalize or bookings growth will be negative?

Speaker 5

I guess we could. Call. But I would just encourage people to look at absolute bookings levels because when you look at 2 year stacks, 3 year stacks around bookings growth, they're significant. You think about commercial HVAC in the Americas, a 3 year booking stack of over 65%. 65%.

Speaker 5

So the The fact is if we went down 5 points in a given period, you still have to subtract that from 65% points of growth. So Maybe a bit of a long answer to your question, but where we're confident we've got a long term tailwind here. Call. Appreciate that. Thank you.

Speaker 5

Thanks, Chris.

Operator

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

Speaker 10

Hey guys. Good morning. Nice quarter.

Speaker 2

Thanks Joe. Appreciate it. Call. So

Speaker 10

yesterday, Eaton resized the mega project funnel, up 25%, Yes, now tracking almost close to like $900,000,000,000 And they suggested that about 20% of the projects have I'm curious like I know that you guys have your own funnel and you guys are also Tracking projects over $1,000,000,000 but does that all kind of jive with what you're seeing in your pipeline broadly or any other color around that would be helpful?

Speaker 2

Call. Yes, I haven't read Eaton's report, so I can't comment specifically. I would just tell you that We have a lot of projects in the pipeline right now that we're tracking. I think it's always you always have to be a little bit careful when you track one company versus another company is When orders are procured by different companies could vary. So, Eaton maybe a bit before us, but call.

Speaker 2

I guess the good news is, is we still see a lot out there. It sounds like Eaton does as well. And we're very, very confident with Many of the solutions that we have that we're talking with customers about and we feel that on many of these projects we're in a unique position.

Speaker 6

Call. Yes. Maybe following up

Speaker 10

on that, Dave, have you had any concerns? I know you're not seeing really a new order book today, but Are there any concerns out there on project financing or things pushing to the right just given the rate environment that we're in?

Speaker 5

Call. Joe, it's Chris. No, we're not. I think while certainly interest rates have gone in a negative direction on paybacks, I would tell you that the change in paybacks is minor when we think about the energy efficient systems that we're able to quote customers. Call.

Speaker 5

A payback may have gone from 2, 2.5 years to 3 ish years now with interest rates. So, the fact is there's still very strong paybacks

Speaker 10

call. Got it. That makes sense. And I guess maybe one last one quickly for you, Chris. I know that we're kind of not ready to bless any 2024 numbers at this But as you kind of think through both pricing and mix for next year, just any thoughts, initial thoughts on how that should kind of play out Across the Americas business.

Speaker 5

Yes, we'll dial in a little bit further, Joe, as we get a couple of months from now. But call. We do target from a price inflation measure, let's say, a spread of 20 basis points or 30 basis points in a normal year. We'll dial that in call. As we get closer to next year, today's earlier point, we're making sure we're pricing for innovation and also long term customer relationships.

Speaker 5

So, call. I'm confident that we'll have a good set of numbers there. We're going to target positive on a dollar basis And margin basis on price versus inflation. And we've been able to demonstrate that for the last 3 years. So I have a lot of confidence our teams will be able to do that going forward.

Speaker 5

Call. Great. Thank you.

Speaker 4

Thanks, Joe. Thank you.

Operator

Your next question is from Steve Tusa of JPMorgan. Please go ahead. Your line is

Speaker 6

open. Hey guys, good morning.

Speaker 2

Hey, good morning Steve. How are you?

Speaker 11

Yes, I'll let go of those orders, pretty strong call. For sure. What were there's been a lot of strength in light commercial. How strong was your light commercial business?

Speaker 2

Call. Our revenue was up in the Americas was up over 20 Equipment was up over 30%. Applied was stronger than unitary.

Speaker 11

Applied was stronger than unitary?

Speaker 2

Call. Yes, yes, yes. Both were strong, but Applied was stronger than Unitil. I mean, you could look at the verticals that really had the strength in it, Steve, data centers, high-tech, Those tend to be more applied systems and even the verticals that were solid like healthcare, life science, call. Again, those tend to be the more intricate projects where you need to really a design system, which is our applied systems.

Speaker 2

So call. We're pretty happy with the performance that we saw in the Q3. And again, not to reiterate, but please imply, I know you know this, but This is where you get the long service tail. And so this is going to continue to fuel our service business in the future. Call.

Speaker 11

Yes. Can you just give us maybe a little I know you kind of you haven't done this before, but like you've mentioned These four verticals, in every slide presentation for like the last several years, obviously, you guys are doing a great job there. Can you just give us given it's so important now, I mean, commercial HVAC, 65% of your revenue base. Can you just give us some sort of color on how much those 4 verticals represent now? I mean is that like 50% of your portfolio, like just roughly how much those growthy verticals represent?

Speaker 5

Call. They're strong Steve is what I would answer. We track about 14 verticals in the Americas and call. Certainly office and warehousing would be areas retail that would be a little bit weaker today. I know the office vertical has a number of things kind of buried in it today.

Speaker 5

We're We've been lobbying to try to break that out just given demand on warehouse and data centers, but I won't dial it in specifically, but we like our positioning here. And what I think is, again, most important with the direct sales force is their ability that if a vertical is slower like office, the ability to pivot into another vertical Is really

Speaker 4

a testament to that.

Speaker 2

That's exactly where I was going to go, Chris. I mean these verticals, we track 14, you could even get 18 If you sub do a little subdividing there. But there's oftentimes when one vertical is stronger than another vertical for an extended period of time. I'll use warehousing as an example. 2 years ago, 3 years ago, warehousing was extremely strong.

Speaker 2

We pivot our sales force to focus on warehousing. We develop programs for them and they go Sure, Sharon, in those particular verticals. Right now, the strength in data centers, I don't see that going away in the near term. Call. Hi Tech.

Speaker 2

We have all the mega projects that are really in front of us. And education, education has been strong. Obviously, ESSER funding is helping that. I think ESSER funding is probably in the 5th or 6th inning, but we've been extremely strong in education for an extended period of time.

Speaker 11

Call. One last one for you. Your peers have talked about this refrigerant change in resi driving some pretty nice price mix 10% to 15% or something like that over the next couple of years, perhaps a bit more back end loaded into 2025%, given the change comes then. Can you just give us your latest and greatest lens on price and mix from that transition and What potentially you could see in 2024 and 2025 on that front for resi?

Speaker 2

Yes. The short answer is we're dialing it in. But I mean if you think about the whole refrigerant Change, right. We've been leading with refrigerant change, really the industry. I think we've been at it since about 2013 with next generation refrigerants.

Speaker 2

Call. So we're more than ready for this transition away from 410 to in our case 454B. Call. Our designs are complete. Our manufacturing is ready to go.

Speaker 2

We're going to start up production here in early Q2. Call. So all systems goes there. There are some definitions, Steve, that we're still working with the EPA to make sure our interpretation is correct. Call.

Speaker 2

And then really our focus is going to shift to the channel to make sure we have a clean phase in phase out of inventory. Call. We will be manufacturing both 410 product and 454 product in 2024 And probably even into 2025, at least our interpretation right now what we're seeing with the EPA. As far as price, we're still dialing that in. The The 454 product is going to be more expensive.

Speaker 2

Obviously, it's a slightly flammable refrigerant, so you're going to have to put different sensing equipment Around the year. So we'll get more data on that in the coming weeks here and we'll update everyone on our Q4 call.

Speaker 6

Call. Great. Thanks a lot.

Speaker 2

Okay. Thanks, Steve.

Operator

Your next question is from Jeff Sprague of Vertical Research Partners. Please go ahead. Your line is open.

Speaker 3

Call. Hey, thank you. Good morning, everyone.

Speaker 5

Hey, Jeff. How are you?

Speaker 3

Hey, I'm doing great. Not as good as you guys, but doing well. Thank you. Call. I wonder if we could just dig a little bit more into just customer behavior and backlogs.

Speaker 3

As big as

Speaker 4

the backlogs are versus history, right?

Speaker 3

If I think about 90 Right. If I think about 90% of $6,000,000,000 maybe it's $6,000,000,000 plus, right? But call it my math, roughly half of your 2024 commercial revenues are in backlog. Call. That's a good healthy number, but given the size and scope of some of these projects, maybe it goes back a little bit to one of the earlier questions.

Speaker 3

I'm not sure why backlog would really Go down much from here. Do you actually see customers call. Just kind of changing their order patterns or there's kind of something else that would suggest that backlogs really do need Kind of go back down towards where they were historically?

Speaker 5

Jeff, I'll start. I mean, I think the lead times are still a bit extended call. So I think as the lead times come in a bit, you may see where the backlog contracts a bit over time. It is elevated today. You're right, 90% of the backlog would relate to our global commercial HVAC business.

Speaker 5

And when you think about our commercial businesses, including Thermo King, it's over 95%. So, It gives us a lot of visibility into what we think 2024 would be with some healthy growth. But let's see how the The policy stacking effects that continue to positively affect us, and the order rates, Mega projects, as Dave said, are ahead of us here in terms of bookings and apply these are long cycle kind of projects. Call. Let's see how this plays out.

Speaker 5

We think it could be elevated for longer, but it will start to normalize at some point. Yes.

Speaker 2

I think the only thing I would add to that Jeff is, call. Yes. I'll go back to data centers again and kind of our strategy was just to work with the data center engineers and develop solutions that Our optimal for them. Once we do that, they do tend to lock in for an extended period of time with you. Call.

Speaker 2

So they'll provide orders beyond your lead times just to ensure that they have slots available and we don't disappoint by missing a shipment.

Speaker 3

Call. And can you gauge in any way what percent of this forward project pipeline call. Is tied to various stimulus programs, be they IRA, ships, other things and what's coming down through the state promulgations.

Speaker 5

Jeff, I would say from an IRA perspective, that's really all in I don't think that's necessarily in the backlog today, but from an ESSER funding for several years now, we've had projects and call. Making sure that over the summer months when schools are open, we're ready to service and upgrade equipment. So So I think that's certainly been the backlog for a while. Data Centers continues to elevate, and we see it as a long term tail. But Chips

Speaker 2

and Science Act, we don't have that dialed in, but that would be one where I guess you could specifically say this is driving this demand. But In the data center, there's no that's more about just a pure demand for data centers right now.

Speaker 5

Call. Right. Thanks for the color guys. Appreciate it.

Speaker 4

Thanks.

Operator

Your next question is from Nigel Coe of Wolfe Research. Please go ahead. Your line is

Speaker 12

open. Thanks. Good morning everyone. Thanks for the question. So going back to the commercial HVAC growth in 3Q, which was obviously spectacular, but especially in the Americas, the pickup Q over Q It was quite something.

Speaker 12

So you called out obviously the strength in the verticals. Was there any kind of supply chain So loosening or kind of flush there that maybe drove that. I understand the demand is very strong. And then within that education, I think there's some concerns out With the stimulus funding kind of reaching a peak perhaps that maybe education falls off in 2024. So any visibility on education would be helpful.

Speaker 2

Yes. I'll start with the latter. The education, we haven't seen it cool off yet. We still have a lot in our pipeline call. There's still a lot of money to be spent out there.

Speaker 2

As I said, I think if we had a if we were playing baseball, I'd say we're in the 6th inning. There's still some funding to come there. We've been strong there for an extended period of time. The other question was?

Speaker 12

Yes. Just Obviously, supply chain constraints have been a factor

Speaker 3

in the Applied business. Yes.

Speaker 2

The supply chain, it's I wouldn't say it's normal, but it's pretty close to normal. We always have some noise that you're going to see in the supply chain, but our teams have done just Great job there. So I wouldn't say it was I would not say our Q3 performance was because supply chain suddenly got better because it's been better for some.

Speaker 13

Call. Okay.

Speaker 12

And then just on the comment

Speaker 2

executing very well on the front end of our business. We're executing very well on the operations side of our business call. And you really see it in our results.

Speaker 12

Okay. Thanks, Faith. Just another crack at the pricing question. Chris, you mentioned 23 basis points spread versus inflation is what you target. It does feel like some of your competitors are taking a much more aggressive policy towards pricing.

Speaker 12

So I'm just curious on 2 aspects. Number 1, the potential to really be a bit more aggressive on price I'd be going to 24. And then secondly, as this commercial HVAC backlog starts to convert, call. Is there sort of embedded pricing in that backlog that's going to emerge over the next 12 months?

Speaker 5

Yes. I'll start with your second question, Nigel. As We think about the backlog that runs out a year, year and a half. We're making sure that we've got the right cost escalators built in, and it could be the reference to an external index or it could be where we've put cost inflators into the project to ultimately make sure we're pricing effectively. So call.

Speaker 5

I think we've got that embedded in the backlog right now on a best view, and the teams have done an outstanding job with this over the last call. 3 plus years in the inflationary environment to stay ahead on inflation. Yes, look, I think pricing will remain call. A way for us to continue to drive with our innovative products, making sure we're pricing effectively. It's going to be healthy.

Speaker 5

I just want to get 3 more months ahead of us here before we dial it in for 2024. But I am confident that as we think about the cost environment and the innovation of our products. We're going to make sure we're pricing effectively. And again, making sure we've got long term customer relationships here, call. As Dave described, with the Applied business, we want to make sure that the services business continues to grow with that, which it can and it will.

Speaker 5

Call. And that, of course, brings with itself healthy margins. So we're well positioned for next year. Just give us a little more time to dial that in.

Speaker 12

Call. Great. Thanks guys.

Speaker 2

Thanks, Michael.

Operator

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

Speaker 14

Thank you. Good morning, everyone.

Speaker 2

Hey, Dean. How are you?

Speaker 14

Doing real well. Thank you. Maybe you Circle back on China, you had good bookings. I was impressed that even though you had lighter margins lighter revenues and margins were much stronger. So, how did China play out for you?

Speaker 2

I'm very happy with our performance in Asia Specific overall. So, thanks for the question. You think about I'll start with orders, right? I mean, orders were up in the low teens, up 12%, Okay. For the region and China had high single digits and the rest of Asia had mid teens.

Speaker 2

Call. So very strong performance on order rate. On revenue, we were flattish down a bit. But remember last year we had 30% growth in Asia Pacific. So it's really just a comp issue.

Speaker 2

The team there is performing very well. I was very, very happy with the incoming order rates in that region and the pipeline is strong as well.

Speaker 14

Great. And just as a follow-up to that September customer experience event in New York. Can you give us a sense of the on the applied business both the backlog and the funnel? Call. How much is our customers opting for this thermal management feature?

Speaker 14

Are we still since you like using the baseball analogy, is it Are we in the early innings of adoption? Where does that stand?

Speaker 2

Yes. Thermal storage, yes. I mean, we have Adoption that's continuous there. We've been selling thermal storage systems for quite some time. I do think that call.

Speaker 2

One of the elements of IRA that could accelerate that is that would be included there. And we're still dialing in what that exact rebate would be, and how it will be applied, but that could be significant and really drive that. And just so everyone's aware, Our thermal storage systems are great ways for energy efficiency, but they're also great ways to help balance the grid. Call. And if you have a need in a peak period to shut off power or limit Power.

Speaker 2

This is a great way to do it because you burn ice versus running your compressors on your chillers. So we're excited about the technology. We've had it for a while And IRA could be a catalyst to even have it grow faster.

Speaker 7

Thank you.

Speaker 2

All right. Thanks, Dean.

Operator

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

Speaker 13

Hey, guys. Good morning.

Speaker 2

Call. Hi, Andrew. How are you?

Speaker 13

I'm good. I'm good. So question on gross margins, I guess. Look at my model, I think gross Margins are hitting all time highs. And I know you guys don't look at other companies, but we do.

Speaker 13

And I'm just Wondering how much price cost, the spread between price cost is a benefit. And I guess the bigger question is, call. Have we rebased gross margins because clearly you guys have done a lot of work on cost cutting, Right. It seems that you have an aggressive stance on maintaining the spread, but also how much of it is Timing, right, it's just the peak between the balance between price and cost. So if you could just talk about, are we And the new normal was gross margins or should we expect the gross margins normalize somewhat going forward?

Speaker 13

Thank you.

Speaker 5

Call. Andrew, I'll start. As I think about the Q3, we really were able to execute across all parts of the P and L call. To drive leverage and gross margin expansion, so the price execution versus inflation, as I said earlier, was positive on a margin dollar basis. There are areas though of inflation, especially in Tier 2 around wage and energy inflation the quarter, so we like those incrementals.

Speaker 5

And we've continued to invest in the business as well, right? We're still targeting for the full year around 70 basis points of incremental investment above a 40 basis point normal. So all parts of the P and L are really working, but I would tell you the productivity Opportunity for us as price comes back to a bit more of a normalized level, that is really the opportunity for Going forward to really continue to drive 25% or better incrementals. And we really like our mix in service.

Speaker 13

Call. So, service is what's driving high gross margins as well?

Speaker 5

It's a contributor, right? Contributor.

Speaker 2

It's a system of things that doesn't, but we really like Next we have with our service business.

Speaker 13

Great. And just a follow-up question on Nuvolo. Call. Right. I think JCI also bought a Workplace Management Software Company.

Speaker 13

Call. Can you just talk about what excites you about this vertical and maybe also remind us how big a software call. As a business for you at this point? Thank you.

Speaker 2

Yes. Novolo is a cloud based connected workplace and enterprise asset management company And it's leveraging the ServiceNow platform. Look, we look at this as a way to augment our current digital capabilities. Just to remind everyone, we have over 36,000 connected buildings. We have well over 1,000,000 connected assets.

Speaker 2

So we think this is a great company, Great leadership, great technology and we're excited to get this closed and have it be part of the Trane Technology portfolio and it's going to Really help us grow our digital business at a nice clip.

Speaker 13

And how big is the digital business now?

Speaker 2

Call. I won't be specific on that. I would say that this acquisition is less than 1% of the enterprise revenue.

Speaker 13

Call. Okay. Thanks a lot.

Speaker 2

Okay. Thanks, Andrew.

Operator

We have completed the allotted time for questions. I will now turn the call over to Zach Nagel for closing remarks.

Speaker 1

Thanks, operator. I'd like to thank everyone for joining on today's call. As always, we'll be available in the coming days weeks call. Thanks for taking my questions. Thanks for taking my questions.

Speaker 1

Thanks for taking my questions.

Speaker 4

Call.

Operator

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

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Earnings Conference Call
Trane Technologies Q3 2023
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