Q3 2020 Lennox International Inc Earnings Call
Ladies and gentlemen, thank you for standing by welcome to the Lennox International third quarter Conference call at the request of your host all lines are currently in a listen only mode. There will be a question and answer.
Your session at the end of the presentation you may enter the queue to ask a question by pressing one and zero on your phone crushing one in zero again exits the queue. As a reminder, this call is being recorded I would now like to turn the conference over to Steve Harrison Vice President of Investor Relations. Please go ahead.
Good morning, Thank you for joining us for this review of Lennox International's plenty of performance for the third quarter 2020.
I'm here today, with chairman and CEO, Todd Bluedoor and CFO, Joe Reitmeier, Todd will review key points for the quarter and the outlook Joe will take you through the company's financial performance and guidance to give everyone time to ask questions. During the Q1 night. Please limit yourself to a couple of questions or follow ups and re queue for any additional questions.
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In the earnings release, we issued this morning, we have included the necessary reconciliation of the non-GAAP financial measures that will be discussed to GAAP measures.
All comparisons mentioned today are against the prior year period.
You can find a direct link to the webcast of today's conference call on our website at Www Dot Lennox International Dot com.
The webcast will be archived on the site and available for replay.
I would like to remind everyone that that in the course of this call to give you a better understanding of our operations, we will be making certain forward looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from such statements.
Information concerning these risks and uncertainties see Lennox International's publicly available filings with the FCC.
The company disclaims any intention or obligation to update or revise any forward looking statements, whether as a result of new information future events or otherwise.
Before I turn the call over to Todd I would like to announce the date of our annual investment community meeting the event.
The event will be held the morning of Wednesday December 16.
The format will be virtual this year. Please.
Please mark your calendars invitations and more details will follow.
Now, let me turn the call over to chairman and CEO Todd Bluedorn. Thanks, Steve Good morning, everyone and thank you for joining US let me start with a quick overview on the third quarter that continues to be impacted by co that 19 pandemic and then discuss our updated 2020 outlook for the year, we're raising guidance for revenue earnings and free cash flow driven.
By the continued strength in our residential business overall.
Overall for the company in the third quarter revenue was up 2% to $1.06 billion, a third quarter record.
GAAP operating income was up 7% to a third quarter record $167 million.
EPS from continuing operations was up 16% to a new high for any quarter $3 or 42 cents.
Total adjusted segment profit for the third.
Third quarter record of 177 million up 1% from the prior quarter that include 16 million on insurance benefit from an off.
From an operational perspective, excluding the insurance benefit total adjusted segment profit was up 11%.
Total adjusted segment margin for the third quarter were 16.7% compared to 17% in the prior year quarter from an operational perspective, excluding the insurance benefit in the third quarter.
Last year total adjusted segment margin was up 130 basis points.
Adjusted EPS from continuing operations was up 6% to $3 to 53 cents a third quarter record.
Our residential segment in the third quarter revenue was up 13% to new high for any quarter of $722 million revenue from replacement business was up low double digits revenue from the from new construction was up mid teens rather.
Residential segment profits set a new record skewed to set new third quarter record of $153 million up 21% segment margin expanded 140 basis points to a third quarter record of 21.2 on an operational basis, excluding the insurance benefit in the prior year quarter.
And profit rose, 38% and segment margin expanded 390 basis points.
Our residential business benefited from continued strong market conditions and favorable hot weather in July and on EPS could see.
Consumers continue to replace units more than repair with equipment growth rate running multiple was ahead of the parts growth rate. So.
September turned significantly cooler, which has continued to which has continued to date October as contractors look toward winner and furnace season strengthen the residential market continues and the team is executing well as it continues to take advantage of market opportunities and gain share.
Turning to our commercial facing businesses. They continue to be more heavily impacted from the pandemic than residential as expected.
In the commercial business segment revenue and profit were down 18%.
Segment margin expanded 10 basis points to 18.7%.
National account equipment revenue was down nearly 30% in regional local revenue was down mid teens breaking down revenue. Another way replacement was down high teens and new construction was down high high Twentys.
On the service side Lennox National accounts service revenue was down low double digits.
RF revenue was down low double digits.
Well overall commercial equipment revenue was down 20% in the third quarter, we continue to see signs a relative improvement in the business with commercial equipment backlog currently down mid teens year over year and order rates, reflecting gradual improvement as well.
Our commercial team continues to win new business and position for future growth commercial won 11, new national account customers in the third quarter, bringing the year to date totaled 26.
In addition, our commercial group has launched an initiative called building better air that is focused on improving indoor air quality commercial spaces. This initiative combines our innovative product line and industry, leading building services to provide comprehensive I accuse solutions to commercial customers were helping business and building owners.
With respect to systems recommend the comprehensive indoor air quality solution tailored to the building.
And identify maintenance plan to ensure ongoing indoor air quality effectiveness.
Turning to our refrigeration business segment revenue was down 14% at constant currency north.
North America was down high teens, and Europe was down high single digits segment profit was down 34% and segment margin contract, a 350 basis points to 10.4%.
For duration profitability was impacted by negative mix with Europe down less than the us in the quarter as well as factory inefficiencies due to cope with 19.
As in the commercial business, we are seeing signs in refrigeration, a relative year over year improvement from the third quarter with backlog up and order rates, reflecting strong improvement.
A quick update on EPS unit cost savings this year.
Early this year, we enacted a $115 million Sta shavings program.
Due to the improved performance of our end markets and our strong operational performance, we restored compensation volume related SGN a costs. Several examples of what I'm talking about are we instituting pay from the temporary salary reduction increased sales commissions and paying performance based compensation.
We're now planning for $65 million of SG Nay savings this year with 45% coming from discretionary spending.
40% from head count reduction and the remaining 15% from paying incentives that return in 2021.
To wrap up with our updated guidance on 2020, we are raising revenue adjusted EPS and free cash flow revenue is now expected to be down 5% to 9% for the full year adjusted EPS from continuing operations is now expected to be $9.05 to $9 is 65 cents.
Free cash flow is expected to be approximately $425 million, we continue to face highly uncertain economic conditions in the fourth quarter and remain cautious on the potential impact from the pandemic heading into the winter season, but Lennox has a seasoned team experienced in managing through downturns well continue.
To invest in advance the company for the future. We look forward to closing 2020 strong with momentum in 2021 now over to Joe. Thank you Todd and good morning, everyone I'll provide some additional comments and financial details business segments for the quarter, starting with residential heating and cooling.
In the third quarter revenue from residential heating and cooling was a record $722 million up 13% volume was up 11% and price and mix combined was up 2% and foreign exchange was neutral to revenue.
Essential profit was a third quarter record $153 million up 21% as reported over the prior quarter that included $16 million of insurance benefit.
Segment margin was a third quarter record, 21.2%, which was up 140 basis points as reported over the prior quarter with the insurance benefit.
Segment profit was primarily impacted by higher volume favorable price lower material and other product costs higher factory productivity and lower distribution and freight costs partial offsets included the year over year difference in insurance benefit higher selling and incentive expenses and tariffs.
Turning to our commercial heating and cooling business commercial revenue was $208 million down 18% volume was down 16% price and mix combined was down 2% and price flat and mix down.
Foreign exchange was neutral to revenue.
Commercial segment profit was $39 million down 18% so.
Net margin ticked up 10 basis points to 18.7%.
Segment profit was primarily impacted by lower volume driven by the COVID-19 pandemic and unfavorable mix.
Partial offsets included lower material costs higher factory productivity lower distribution costs and lower EPS Sheena expense.
In refrigeration third quarter revenue was $125 million down 12% volume was down 16% price and mix combined was up 2% and foreign exchange had a favorable 2% impact on revenue.
Refrigeration segment profit was $13 million down 34% segment margin was 10.4% down 350 basis points.
Segment profit was primarily impacted by lower volumes and lower factory efficiencies due to the COVID-19 pandemic and unfavorable mix partial offsets included favorable price lower material costs, lower SDMA expense and favorable foreign exchange.
Regarding special items in the third quarter. The company had net after tax charges totaling $4.4 million that included a $3.6 million loss from natural disasters net of insurance recoveries related to an August 2020 high wind damage at the company's manufacturing facility in Iowa.
$2.2 million for personal protective equipment and facility deep cleaning expenses incurred due to the COVID-19 pandemic.
Net charge of $1.4 million for various other items and a benefit of $2.8 billion for excess tax benefits from share based compensation.
Corporate expenses were $28 million in the third quarter compared to $18 million in the prior quarter as the company's financial results in the third quarter trigger incentive compensation true ups.
For performance year to date.
Overall, SDMA was $152 million up 6% from the prior quarter and for the first nine months SGN a is down 7%.
In the third quarter, the company generate $440 million of cash from operations compared to $236 million in the prior quarter.
Capital expenditures were $12 million compared to approximately $25 million in the prior quarter and free cash flow was $428 million in the quarter compared to $211 million in the prior quarter.
The company paid approximately $30 million in dividends in the quarter totaled.
Total debt was $1.01 billion at the end of the third quarter and we ended the quarter with a debt to EBITDA ratio of 1.8.
Cash cash equivalents and short term investments were $59 million at the end of September.
Now before I turn it over to Q1 day, our view, our current market assumptions and guidance guidance points for 2020.
For the industry overall, we now expect North American residential HVAC shipments to be roughly flat this year.
We now expect both commercial unitary shipments and refrigeration shipments to be down approximately 20% for the industry. This year.
Looking at the company's performance year to date and outlook for the fourth quarter. We are raising our 2020 revenue guidance from a decline of 10% to 15% to decline of 5% to 9% for the year.
We are raising our guidance for GAAP EPS from continuing operations from a range of $7.31 to $8, an 11 cents to a new range of $8 to 35 cents to $8.95 for the year.
We are raising our guidance for adjusted EPS from continuing operations from a range of $7.90 to $8.70 to a new range of $9.05 to $9.65 for the year.
Looking at the various puts and takes in our financial guidance for 2020.
Now that we are updating commodities are now expected to be a $25 million benefit for the year compared to prior guidance of a $20 million benefit.
We now expect the $25 billion benefit from sourcing and engineering led cost reductions compared to prior guidance of a $20 million benefit.
Residential mix is expected to be a headwind of approximately $10 million for the full year as new construction has outperformed replacement business year to date.
Early our earlier expectations were for new construction to slow and mix to be flat.
We now expect corporate expenses of approximately $90 million compared to prior guidance of $75 million, primarily due to higher compensation expense related to the company's performance.
We now expect interest in pension expense of approximately $35 million compared to prior guidance of $40 million.
We now expect an effective tax rate for the full year on an adjusted basis up 19% to 20% compared to the prior range of 21% to 22% due to the timing of certain tax benefits. This year and for 2021, we expect the effective trap tax rate to be back in the 21% to 22% range.
Capital expenditures are now expected to be $100 million for this year from prior guidance of $120 million on the timing of some spending between 2020 and 2021.
And our guidance for free cash flow is now approximately $425 million from the prior guidance of $340 million for the year.
For our guidance points that are remaining the same price is still expected to be a 25 million dollar benefit for the year.
Residential factory productivity is still expected to be a 10 million dollar headwind.
We still expect tariffs to be neutral and we continue to expect freight to be a $10 million benefit.
The weighted average diluted share count for the full year is still expected to be between 38 to 39 million shares and our stock repurchase plan to remain on hold after repurchasing $100 million of stock in the first quarter for the $400 million that was planned going into the year now with that let's go to Hewitt.
And ladies and gentlemen, if you wish to ask a question. Please press. One then zero on your telephone keypad you may withdraw your question at any time by repeating the one zero command.
If you're using a speakerphone please pick up the handset before pressing the numbers. Once again, we have a question you may press one than zero at this time.
And first go to line of Julian Mitchell with Barclays. Please go ahead.
Hi, good morning.
Hey, maybe just a first question on the top line.
The guidance at the midpoint and even the high end implies.
Sort of step down in Q4.
Sequentially, that's much worse than normal is that.
Just because of the.
Uncertainty in the environment.
Or is there anything sort of specific that you're calling out and maybe related to that.
Just wondered on your latest assessments of the health of the resin market entering next year I heard you say this year, you're looking at a flattish market now.
Thoughts on sort of fundamentals into next year.
On the first point.
It's a combination both the uncertainty in the fourth quarter.
But also we have such a strong third quarter, if you're looking at it sequentially year over year munis record third quarter for us our residential revenue was up 13% driven by hot weather. So that helped and so I think thats part of it in terms of looking into 2021.
On on markets.
We continue to remain bullish on the residential markets Theres lots of moving pieces, but we call we're calling for the market to be flat. This year and I think thats, an important perspective remember I understand I understand that some folks are wondering did demand get pulled in to something from 2021 get pulled into the strong third quarter.
Two points I'd make one is overall year, the market's going to be flat year over year.
In the middle of a pandemic second is just the behavior of the residential homeowner.
Even when there is not a pandemic no one wants anyone into their house to replace the unit unless they have to there's a catastrophic failure. They replaced the unit and especially in a pandemic no one wants people coming into their houses and spending two or three days replacement units. So these are being placed when they break.
And they're not being pair like they were during the financial crisis, but there has to be approximate cost for them coming in and Thats not pull forward demand no one's sort of saying let's.
Lets replace it now rather than next summer the replacing it now when it breaks in the hands of choice. So we remain confident as Weve talked before that we think theres. Another couple of years of this mid single digit growth and for it to be flat in the middle of the pandemic shows the resiliency of this market and so we remain confident in the resi market for 2021.
Thank you and then my second question just on the margin outlook.
Perhaps clarify.
Exactly how much of that 65 million.
In the savings could reverse all come back into the PML.
Next year.
And what are you thinking for sort of residential operating leverage as you look out now that the revenue line has returned to growth again.
I think the way.
The way I think about it is.
Our new guide on the EPS, you take up 65 million.
And.
And then when you look at that $65 million only 15% of it now is paying incentives for so much came back into the peak. This year. So the 15% this pan paying incentives that will bounce back next year. So thats whatever the math is seven $7.5 million.
The balance of the 45% that's discretion to 40% Thats headcount we control those.
It depends on how the market is performing and investments that we want to make in the business.
But our sort of goal, having 30% incremental margins is plus or minus what our target will be for next year.
So probably previously our guide was 115 million with a lot more tied to paying incentives I think that risk is now off the table for next year in terms of it bouncing back on us in a meaningful way.
Great. Thank you.
Yes.
Our next question is from Ryan Merkel with William Blair. Please go ahead.
Hey, good morning, guys.
First off can you just dive hey, good morning can you just dive into some of the commercial end market performance to give us a little more detail.
I think we caught in a somewhat out on the call we've seen.
National accounts down more than our local and regional business and that's what we would have expected.
Just the way the market behaves that the the planned replacement gets deferred as people sort through things.
And so our planned replacement was down.
Mid twentys versus a year ago, but in Q2 was down over 40%. So the trend line on planned replacement is going the right direction and when we looked at our order and backlog to plan placements.
As as many companies are getting more comfortable in the current environment and some of our large customers are people like home depot, Lowe's specified pretty well are getting more comfortable spending.
Perceived replacement was down.
10% ish in the quarter after being down 35% second quarter. So again heading the right direction and then.
In the new construction is the one that goes the other way because you construction things that weren't flights.
We continue to be built but that new business starts to go down and we saw that down.
Near 30% in third quarter after only being down mid teens in second quarter, and then as we mentioned on the call. The order excuse me the backlog is down mid mid.
Mid teens.
And so the backlogs heading the right direction.
But when we think about the full year, we still think the market's going to be down 20%.
The one silver lining and all of that is the comp gets a lot easier next year. So when we think about 2021 so.
So at least the way the world looks now we would expect that the commercial market commercial unitary market would be up after such a hard hit 2020, and when you look back on history on the commercial unitary market, whether it's the 911 downturn.
Financial crisis downturn goes down hard comes back quickly.
Okay. That's helpful. And then secondly, you mentioned commercial Q initiatives can you just talk about how big that business is today and then what is your outlook for the coming quarters.
Yes, I mean, we tend not to quote.
By the market and again I think you heard in a way I talked about it.
We think about it as a facilitator to when the equipment business and in our build better air initiatives led.
Leveraging off our in store capabilities and indoor air quality in our relationships with with the building owner.
And we're an industry leader in indoor air quality in both residential commercial markets.
As we've talked about indoor air quality is air purification like builders, who UBI lights ventilation in circulation and humidity control.
Residential care equipment is the best in the industry as noted by consumer reports.
And then we talked about building better error in our advantages and our opportunities there.
Great. Thanks, Scott.
Our next question from the line of Jeff Hammond with Keybanc capital markets. Please go ahead.
Hey, good morning, guys.
Yes, I just want to point out we ask your question with so many things changing in 2020 I first great comfort.
The Pittsburg Cleveland remains consistent over a decade.
I knew that was coming okay. Okay.
Okay.
Can you just talk about your distribution base business versus direct sales in the quarter and then just talk about how you think inventories are in your channel and and at independent and maybe speak to how.
The channel is thinking about.
Furnace distribution build versus maybe how they they manage to the cooling side.
The performance of the businesses were relatively consistent.
They were both up plus or minus 13%. So there wasn't.
One that outperformed the other and ready to note and I thought you raised valid questions around the HR numbers versus the Harding numbers, one being sell out when do you sell in and we take great comfort that our atlantic's business performed very similar to our allied business I.E. the sell through.
Who are the sell out of Atlantic's business directly to dealers was up the 13, 14% whatever the exact number was that.
That and so thats a good sign for our Lenox business. Our Allied business also did well I think the direct question answer to your question is inventories are low right now, which is normal coming out of such a hot summer.
And then what happens is.
Theres a recency biased have short memories are harder you want to phrase of dealers and so they had trouble getting cooling product in the summer, which many did because our competitors had trouble delivering.
Then they want to make sure that they're bars are full furnaces and so we see that right now as people are loading up on cards.
Okay and then.
And then just on refrigeration I think you said backlog was up maybe whats differentiated in the order trend there and then I think you've mentioned covert disruption there what's what's unique about.
The the facilities there.
Versus versus the other businesses.
The we got it both in our European business in an art shift in Georgia business. If you look at Tipton, Georgia plant amount.
In one of the hardest hit areas for.
Totally in the country and so that had some impact on our businesses and so absenteeism and that actually having had the factory shutdown for a bit on both locations impacted our productivity. When you look at the backlog of commercial as you know we're more exposed to retail.
There than we are refrigeration and thats been a softer spot and then also in refrigeration.
Cold storage is one of our largest verticals and thats been relatively strong given that people are building out the cold chain to support different consumer buying habits buying food at home.
Also maybe a bit to prepare for the for the vaccine and so we've seen strength in cold storage and that's helped us.
Okay. Thanks for the color. Thanks.
Thanks.
And next go to the line of Joe Ritchie with Goldman Sachs. Please go ahead.
Hi, Thanks, good morning, everyone.
Okay.
Hey, Todd maybe just just commenting a little bit on the red the H. Sachs Mutt monthly trend.
So you guys had told US what July was up I'm, just curious how the rest of the quarter wed and then as you are switching over to furnace I'm just curious whether you think there any any.
Any issues that may occur just given how strong.
H. back as Ben just from a manufacturing perspective, I'm, just wondering if theres any kind of like pig in the Python type problem as you try to deliver on turning to sales.
The trend line during the months.
July and August were up mid teens as I talked about on on the second quarter earnings call leased on July and then and then September was up significantly.
But up more low double digits high single digits, as we sort of got away from hot summer selling season.
We're positioned as well or better than anyone in the industry to meet those cooling demand in front us demand. So we think we're in good shape I think some of our competitors may have issues and again I think it gets.
Thanks, Alex.
Gets more pronounced as just if you have independent distributors trying to get large orders from you all at once and maybe our competitors are seeing some of that but we think we're in good position as well or better as well or better than anyone in the industry to meet the upcoming furnaces.
Okay great.
My just my one follow on if you think about 2021 and I know, it's probably a little too early but I'm just trying to think about how to think about the price cost dynamics and read the thought copper is up a lot but you.
But you mentioned getting good price mix this quarter on that on the resi HVAC side any any comment on just the dynamics heading into 2021 just given.
Just given given the increase we've seen in commodity costs.
Yes, I'll broaden the question just sort of talk little bit about 2021 more broadly I.
So lots of moving pieces, there's always uncertainty.
And in October when you're thinking about the following year, but maybe as much now as ever and.
Talk a little bit about the end markets earlier I'd repeat that we.
We walk out or almost 2020.
With a clear understanding of the resiliency of the residential market and again its demand thats being caused by the home failing and we model that we think there is another couple of years of that so we think mid single digits.
Next year for residential and new construction remains strong.
For commercial and refrigeration as I talked earlier more uncertainty there, but after being down 25, 20%. This year, we'd expect some rebound in 2021 directly to your to your question is we do expect some commodity headwind for next year, but I would also just mentioned we've always historically said.
Commodities that matter most to us for steel copper aluminum in that order.
With all the work we've done on moving to aluminum and our heat exchangers across our business. It's now steel aluminum and copper that's most important to us and so while copper steel matters. It matters significantly less than it did four or five years ago in aluminum I think has behaved more more more nicely if you will.
President for that with that terminology, but has behaved better.
And so we expect some commodity headwind, we expect some freight had headwind at the current point in time, although that still has to be shaken out and then as we talked about we expect a little bit of compensation bounce back given the.
Takeout or reduction this year, but as.
But as always we're going to be announcing a price increase.
Here shortly and we expect to get price next year, just like we do every year, we're going to benefit from sourcing and engineering cost reductions, we talked about raising that number from 20 to 25 million this year.
Thats order of magnitude that we've done for the last decade, 20 to 30 million depending on year factory productivity after not really having much if any factory productivity. This year because of all the disruptions because of co that we'll be back on track there and then as always our target of half a point of market share. So I know.
I haven't quantified a lot of those but.
But it is to send the signals that that we think to set up for next year will be not dissimilar to the set up.
Prior years, where we have market share gain price to offset commodities and continued productivity and material costs and factory productivity.
Thanks appreciate the color.
Our next question is from one John Walsh with Credit Suisse. Please go ahead.
Hi, good morning.
Right.
Hey, maybe just.
Finer question on that commodity discussion, we just had there.
You Chuck commodities and the Sourcings combined up 10 million relative to where we were in Q3, just how much of that falls through in Q4 versus how much has been realized kind of.
The year to date.
I'm not sure to be honest with you John maybe if we can sort of guide I think the commodities.
I think people are scrambling diligently to sort of find I think the commodities tent.
Tamper down as we go through the year, where the material cost reduction starts continues to increase as we go through the year. So if I had to guess I would say.
Commodities are around 20 22 million year to date.
And then MCR I think the range is just confidence that that will continue to execute for the balance of the year.
Great. Thank you for that and then just I guess maybe.
You talked a little bit about 2021, just kind of to two questions on my mind. I mean, you just talked about in your normal kind of market share gains, but as I understand it you know what are your competitors right had the factory disruption and so they might have not been able to fulfill orders and that arguably comes back online.
Line next year, so does that make it harder to get that kind of normal market share gain that blend expenses been getting.
And then maybe just on this.
Replacement pull forward question I guess.
I guess it depends on how you how you think we look from a work from home benefit next year, but wouldn't because we were sheltering we'd see more breakage. This summer that needed replacement arguably that pulls from 21 to 22 or is that just not the right way to think about it would be just like.
To get your perspective there.
I'll answer the second question first.
Not a huge on I've heard others talk about that I don't think that at work site and what I mean by that is.
I don't think people set their thermostat to 85, when they go to work and when they come home. They said 68 that I think the majority of people don't even sensor thermostats on a time or just sort of remains constant over time, and then I think people raise it maybe to 70 880, when they're gone and then 75.
And when they get back so I don't in terms of usage that doesn't drive a spike up where units all of a sudden have huge acceleration of uses break and so I just step back and say the markets flat year over year in 2020 that doesn't show pull forward to me.
It's flat and a hot summer. So the market is flat hot summer that doesn't show pull forward to me such as people were hesitant to spend money unless they had to but when the unit breaks they replace the unit rather than repair that I don't think theres.
I don't think it was pull forward because people were at home.
Remind me what the first question was just on the.
Just on the ability to kind of get your normal market share gains.
Yes.
Yep.
One give me first.
Personal privilege to just sort of observe that when we lost it because its tornado everyone assumed we'd never get it back and now that we've taken it from others. There's an assumption that maybe we won't build hang onto it.
I think a couple of things I think have been on the other end of it we were cognizant that constrain supply environment.
Supply the dealers, who we thought we had the best chance of keeping business too. So we weren't selling arms to anybody we were selling arms or units of those dealers that we felt we had we were already sort of in the conversations with and converting over knows the ones. We sold it. So so we made were not hang on all that we'd get but we're going to hang on to a lot of it.
Whole lot of it and then were also on the attack to gain more share. So I remain confident that we will be we are gaining significant share. This year I'm confident we'll be.
Great. Thank you that's really helpful color.
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And next from the line of Deepa Raghavan with Wells Fargo Securities. Please go ahead.
Hi, good morning, all.
The pad can you provide your thoughts on when.
When you think you can resume share buybacks looks.
Looks like you're starting to loosen up on some of the variable costs and getting comfortable given your strong cash outlook. So what would be normal for us to assume buybacks were done in 2021.
Yes.
I'll be more direct put it in your model, we were not going to started up here in the fourth quarter.
Given some of the uncertainty, but when we give the December guide.
For 2021, we'll be back to a more normal stock repurchase program for 2020.
Great. Thanks.
Can you how do we think about normal volume driven leverage in 2021, I mean, you have you're going to have all these.
Costs in there now rollbacks more seems like more headwinds.
I don't know price gets that much more incrementally better so should I think about your walliams driven leverage to be slightly below trend or should should all those dynamics not impact just given that you probably should be able to price where the market got elsewhere.
Our our variable gross margins around 40%, so what volume drops through it sort of a normal 40% either direction.
Obviously in a year, where we're spending ESG and doing other things done that the Incrementals goes.
Goes down and so that that's how we end up at the 30 incremental that were making investments in the business building out distribution.
Driving productivity, but sort of normal volume leverage is about 40%.
Got it thank you very much.
And next we'll go to Adam Khanna with Cowen. Please go ahead.
Hey, Thanks, good morning, and great results supporting on.
Had a couple of questions first I was wondering if you could maybe frame the magnitude of the pricing opportunity for Randy you mentioned you're going to.
Announcing price increases just should 21 be better better net realization here then.
Than than normal anyway, any framework for that.
Yes, I mean, I'm going with hope what will announce will be what we always announced publicly.
Four to six foot through the final number is going to be so.
So so so we'll announce price, but yes, I do I do think there's.
When we expect the market to be up after having been constrained year before that sort of leads you to believe you can get price in the marketplace as we spoke about when we're when we're.
Having challenges meeting demand as we did in its whole industry in 2020 wasn't really the right time to raise price dynamically to middle season, but we go into next year, we'll be looking to raise prices and.
For a couple of reasons, one we talked about commodities co.
Cove. It has added cost to our cost structure, we talked a little bit about what happened in our refrigeration margins because quite frankly, it's impacting the entire business.
Both on EPS teenage side, everything we have to do to manage suppliers and advantage.
Business assets he has done in our factories.
We think rates going to be upset so those are all reasons on why we're going to need to pass price on I think are in fact, I know our competitors using force.
Thanks that makes sense and also could you just expound upon.
Hey, you opportunity.
Level of engagement with customers.
Does it drive like a much bigger retrofit cycle anything like that.
Yes, I mean I.
I may be.
I don't know what the right phrase is may be more clear island Ani Q I don't think its billions and billions and billions of dollars of opportunity, we see unitary where we play in.
In residential I think you know if you're selling a 5000 dollar.
Residential unit here you are indoor air quality component is four or 500 Bucks on commercial it's maybe less of a percentage. So I don't think it drives the overall ticket I think.
I think what happens is you.
Have to have knowledge and expertise in it for those customers who want it.
And you want to steer customers, who want to go in and handle their questions and so commercial customers that feel bedding. It build better air sit down with them talk about what we have and we have everything.
And then put it in place and then use our NSR National account service to measure and monitor the compliance.
In.
Our residential business as does our pure air EPS.
Which which has both passive filters in active use lights.
That allows us to clean air and then also.
Digitized as part of our controller, you can measure and monitor what's going on.
So I think it's being an expert in the area that allows you to win the jobs and convert dealers and that's what we're focused on.
Thank you very much guys.
Thanks.
And next we go to Nicole Deblase with Deutsche Bank. Please go ahead.
Yeah. Thanks, Good morning, guys good morning.
We covered a lot of ground here, but I guess.
On the free cash flow guidance, it doesn't really embed a whole lot of free cash flow in the fourth quarter I am getting to something a little bit more than 30 million. So just outside and I'm guessing that working capital what's kind of the biggest swing factor. There. So any thoughts that you have about what we should expect for Q.
That's the answer I know the sequence of the quarter for different this year by the way, they're going to be different next year.
Talk about that in December, but we're typically at this point in time.
Driving down production levels, and burning off inventory, but given the hot summer selling season, and given that we expected to markets to be down while we saw summer selling season was a burn off of inventory.
Burn off of receivables.
She payables and what we see in Q4 is it on a year over year basis, we inflation of inventory and working capital and so Thats why you see we typically have the big cash quarter fourth quarter. This year, we had the big cash quarter third quarter.
Okay totally makes sense got it and then.
Just one more on refrigeration. So I think you characterized you quantified a bit of what's going on with order and backlog within commercial could you just provide some detail around what you're seeing in refrigeration Todd.
Yes, our backlog is up year over year, right now, where we stand in the order rates on 369 week basis are all up in refrigeration to the trend lines are good I think it's both in our North America business, there's distribution business, where we sell to about half of its distribution business we saw.
The large refrigeration wholesalers and that has bounced back from being down significantly in the second quarter.
And then the other business is project business look cool storage that in that as I mentioned earlier has been relatively strong.
Our Europe business.
Has has has been strong, but we're a little obviously little were concerned about coated lockdowns in France, and Spain, and what the trend line is there but.
But again on that.
Last three or four months up business in Europe.
The order rates are also trending right George.
What have you actually seen any slowdown in Europe or is that just reading the headlines and being concerned about what could materialize.
We're starting to see things slip.
Got it okay. Thanks, I'll pass it on.
And.
And we'll go to Nigel Coe with Wolfe Research. Please go ahead.
Oh, Thanks, good morning, everyone.
Okay residential margins essentially.
Exceptionally strong.
The the probably in showing the benefit.
Benefits.
I'm just curious do you have can you do you think you think volumes remain sort of high single digit low double digits. Since the full queue. Maybe 21, you can maintain above 40% EBITDA margins and then within your commentary on on on on the margins I think you mentioned sourcing multi is actually now more of a bench.
Than you expected so last quarter is that mainly volume related.
And then I'm just surprised that freight is turning into a more of a headwind can you just maybe just address what you're seeing.
Segmentation.
Freight remains tailwind this year part of that.
We were aggressive on we're managing freight like we've made over the last year or two we've invested in freight management like we did in MCR fit.
10 years ago. So we have a pretty sophisticated team. We now have the tools to measure it and so I think part of it's just productivity on our side, regardless of what's happening with the overall rate and we expect to be a tailwind this year and a bit of a headwind next year in terms of residential.
Margins I think you sort of see it peak out in the current environment, where we had volume.
We have done aggressive EPS unit cost reduction and we haven't invested in stores because.
The tornado I think on an ongoing basis since residentials, 60% of our business, we talked about 30% Incrementals I think thats plus or minus we should think about residential I don't think it remains 40, because we were investing in us DNA, we're investing stores will start back up in 2021. So we'll we'll have the.
Less than headwind, if you will that PTC engine on an ongoing basis.
And then was there another question Denison.
Oh, I see I see kind of that when this I just wanted to touch back on the buyback comments, you mentioned 21 will be CEO, a more normal year on buybacks.
I think you told the B ticket on which would be sort of the run rate is there any catch up probably in the 20-F, hoping on buyback. So we are we back to that 5400.
I think the way to think about it is you can run the model and your own right is we don't want debt to EBITDA to go above two that's sort of our pay point.
And so we will invest in the business with Capex will do acquisitions, but we don't.
What's left will pay in dividends and share buyback and so I think you model that I think we started to pick what we do I don't think this year will be to six or $700 million.
Thats a direct question, but there may be are we do work, but it's all going to come down to that formula.
Okay excellent. Thanks.
Thanks.
Our final question will be from the line of Steve Tusa with JP Morgan. Please go ahead.
Hey, How's it going.
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On tax rate, what what's kind of the.
What's kind of the go forward are you guys is this kind of 19 to 20, the right number and have you.
Have you guys kind of evaluated.
Does that kind of revert if there's a I know any like politics, if that theres, a blue waiver abide when did that revert to a certain level maybe.
Maybe not back to where it was but.
What's kind of the long term view on the tax rate and.
Right.
As Joe mentioned in his script we.
21, we think tax rate's going to be 20 to 21. So it goes back to more normal rate as we got to this year. We had some discrete items. This year that allowed us to take it down for 20 to 21 is what we are seeing next year and beyond.
Who knows.
Okay react whatever is done then we'll adjust accordingly.
Just going back to this kind of read the cycle discussion. So are you, saying this year was okay.
Kind of ended up being a normal year. Despite the pandemic. So there wasn't really a you know a push or a pull in and out of this year and I know you guys had had that housing.
Housing.
Okay.
Chart out there.
At work, what kind of a couple of years into that chart. So are we still thinking that that's the swing factor in this cycle I mean, you know how.
Housing peaked in INO 516 year useful life I mean is that still the way to think about it that 21 from an echo boom perspective is.
Kind of a peak year or is there something that happened this year that kind of changes that profile.
I think I'd answer 2020 this year is.
We had a warm summer.
And and we also had a pandemic.
And I think broadly they offset each other we have flat. So I think if we didnt have an endemic to market within a four.
And I think if we hadn't had a hot summer the market would have been down.
I think so we think the right call knows this new look to try numbers I'm doing this from memory, but through August it's down about 3%. We think on a year to date basis, that's going to be closer to flat in all shapes out right.
Right.
So so so thats our call in terms of the market going forward I think we've been pretty consistent I know, we disagree and and so I know that.
But weve when we model it look at it we still think we have another couple of years and single digit growth everything else speak more and if it's a hot summer maybe better cold summer will do worse.
Is that is that is that echo boom, you know analysis still in play or is there something else driving it.
No it's done but.
Okay, and then one last one just heartbreaking I don't think that I don't think the pandemic pulled anything forward.
For sort of saying Theres. Another couple of years Photocall pulled their share I say no way because it's flat market in a hot summer business right right.
Right, absolutely and then just one last one on free cash flow.
You know you bounced around a bit here in the last couple of years, what what is kind of the normalized conversion rate for you guys and again just to reaffirm that's on a GAAP basis. When you talk about conversion right. It is and.
I read your note set.
Set 90% I think if you look at a longer horizon is closer to 100%.
Thats, our number 1% initiate we're having strong cash flow and Thats, obviously, because one we performed EBIT loss, but obviously the flavor working capital to generate cash that we did.
So in the years were inflated working capital we have more headwind in years.
In years for building, Mexico, we have headwind tornadoes, so lots of moving pieces, but over a longer perspective, it's a business that will generate on a percent of net income yeah. I think I think our note was talking about adjusted <unk> to be clear so that that would be more close to 100%. If it's on a GAAP basis. So just just to be clear on that one.
Alright, Thanks, a lot guys I appreciate it.
Thanks, everyone to wrap up the residential market remains strong entering the fourth quarter and commercial and refrigeration markets continue to improve the 11 team is executing well and taking advantage of market opportunities share gains. We look forward to closing 2020 strong with momentum is 2021.
And thanks, everyone for joining us today.
Ladies and gentlemen that does conclude your conference. Thank you for your participation you may now disconnect.
Yes.
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