Q3 2021 Trane Technologies PLC Earnings Call
Good morning, welcome to the Trane Technologies Q3, 2021 earnings Conference call. My name is smaller and that will be your conference operator for the call.
Paul will begin in a few moments with the speaker's remarks, and the Q&A session.
At this time all participants are in a listen only mode.
I'll ask a question during the Q&A. Please press Star then the number one on your telephone keypad.
If you would like to remove yourself from the queue simply press star one again.
In consideration of time, we do ask that you. Please limit to one question and one follow up question.
I will now turn the call over to Zac Nagle, Vice President of Investor Relations. Please go ahead Sir.
Thanks, operator.
Good morning, and thank you for joining us for Trane technologies third quarter 2021 earnings Conference call. This call is being webcast on our website at true technology Dot com, where you'll find the accompanying presentation.
We are also recording and archiving this call on our website.
Please go to slide two.
Statements made in today's call that are not historical facts are considered forward looking statements and are made pursuant to the safe Harbor provisions of Federal Securities Law.
Please see our SEC filings for a description of some of the factors that may cause our actual results could differ materially from anticipated results.
The presentation also includes non-GAAP measures, which are explained in the financial tables attached to our news release.
Joining me on today's call are <unk> CEO.
And Chris Kuehn, Executive Vice President and CFO.
With that I'll turn the call over to Dave Dave.
Thanks, Zach and everyone for joining us on today's call.
Let's turn to slide number three.
As we do each quarter I'd like to spend a few minutes upfront on our focus sustainability strategy.
Engine that enables us to deliver differentiated shareholder returns overtime.
Long term sustainability Mega trends continued to intensify and our innovation leadership is transforming the climate industry as the world Decarbonize.
Our aggressive goals and bold actions can dramatically reduce carbon emissions and accelerate the world's progress.
This is more critical every day as the clock is ticking on climate change.
That's why we are calling for businesses and governments to take stronger action at Cop 26.
And why we continue to set aggressive science space emission reduction targets to push our innovation further and faster.
That innovation also extends to emerging trends as we see heightened focused on indoor air quality and strong momentum in aging infrastructure in our schools.
We continue to make a difference consistently relentlessly and over the long term. This unyielding approach drives market outgrowth over the long term.
Which in turn helps us drive strong margins and powerful free cash flow to deploy through our balanced capital allocation strategy.
End result is more value across the board for our customers for our team for our shareholders and for the planet moving to slide number four.
Our global team delivered solid execution in the third quarter.
And we continue to target top quartile EPS growth for 2021 bookings were once again exceptional in Q3.
Building on strong growth in both Q1, and Q2 and bringing our year to date organic bookings growth to over 25% for the enterprise.
Underlying demand for our innovative products and services have never been stronger and our Q3 ending backlog reflects the strength.
In fact Q3 ending backlog for the enterprise was up more than 70% or approximately $2 billion from year end 2020, with all three of our business segments at record levels.
Americas and EMEA have backlogs are up over 90% and 65% respectively from year end 2020.
We are well positioned to close out 2021 on a strong note.
And to enter 2022 with unprecedented levels of backlog as well.
As we highlighted on our second quarter earnings call and in subsequent forums global supply chains logistics systems, and labor markets remain tight and inflation is persistent.
Our global teams are focused on meeting the unique needs of a wide ranging customer base and helping them solve complex challenges on a daily basis as we navigated challenging.
Yet positive demand and supply environment.
Temporary supply chain delays on key materials impacted portions of our product portfolio.
Shifting the timing of approximately $150 million or 4% of our revenue out of the third quarter and into future periods.
Working closely with our key suppliers and with our customers, we anticipate that between 50 million and $75 million or roughly 2% of the Q3 impact will shift into the fourth quarter, leaving.
Leaving our 2021 revenue guidance unchanged.
We expect the remaining balance to shift into 2022.
We also highlighted on our second quarter earnings call that persistent inflation would require us to execute an incremental $150 million and pricing actions in the second half of the year in order to neutralize the impact.
Strong execution of our business operating system has enabled us to keep pace with the inflationary curve.
In the third quarter, we realized approximately $150 million or four 3% incremental price.
Offsetting approximately $150 million of inflation.
Leverage was negligible as you would expect on flat volume, while adjusted operating income was modestly higher in the quarter, primarily reflecting nominal pull through on M&A and FX growth consistent with our expectations and our guidance.
We continue to execute the business transformation projects, we discussed in detail at our Investor Day in December and are on track to deliver approximately $90 million of incremental savings in 2021.
These savings support leading innovation across our end markets through relentless high levels of business reinvestment.
They also enable us to stay on track to deliver incremental margins of approximately 30% organic for fiscal 2021 <unk>.
Despite persistent inflation type logistics systems and supply chain challenges.
We're also on track to deliver powerful free cash flow of equal to or greater than 100% of net earnings.
This provides us with strong optionality to deploy significant cash to opportunities now and in the future, including M&A and share repurchases Lastly, we never lose sight of our long term purpose driven strategy and the tremendous leadership role we can play in bending the curve on climate change.
By changing the industry, we can change the world.
Executing our purpose driven strategy is how we will continue to deliver top tier financial performance for our shareholders.
Please turn to slide number five.
While we're still in the midst of our planning process for 2022, and anticipate providing guidance in conjunction with our fourth quarter earnings call. We thought it might be constructed to spend a few minutes discussing our initial thoughts on 2022 and some of the key dynamics. We believe we will be in play.
While this is not a comprehensive list it will highlight some of the key reasons why we're so excited about what the future holds for Trane technologies as.
As well as some of the key challenges we see on the road ahead.
First we expect to have strong fundamentals entering the year.
Exiting Q3 backlog in our Americas and EMEA segments are both at unprecedented levels.
Up over 90% and up over 65% versus December of 2020, respectively.
Asia also has record backlog up nearly 20%.
If we very conservatively plot out bookings through the balance of 2021, we anticipate entering 2022 with at least 70% more backlog in the Americas and EMEA than we entered 2020.
I've been in this business, a long time and I've never entered any year with a stronger backlog position.
Which bodes well for us in 2022.
Another fundamental strength entering 2022 is the foundation of our business operating system.
<unk> execution of our business operating system has enabled us to stay ahead of the persistent inflation through 2021 and position us well to manage additional inflationary pressures and deliver strong price realization again in 2022.
And we will continue to drive transformation savings in 2022 that will support high levels of business reinvestment and continued innovation.
These savings will also support healthy incremental margins and what we expect to be another year of tight conditions for supply chain labor markets and logistics systems.
Looking out to 2022, we also expect to see continued acceleration of the strong secular sustainability megatrends that are so tightly aligned with our purpose driven business strategy.
Carbonization of the built environment is accelerating.
Education stimulus dollars are being put to good use upgrading our aging infrastructure and momentum around indoor air quality upgrades retrofits and new projects continues.
Additionally, the global economy is expected to continue to recover in 2022 with solid underlying GDP and other economic indicators driving broader expansion in the nonresidential markets.
Lastly, we're excited about the future of transport refrigeration markets, where act and IHS are plotting a steady growth path forward in both 2022 and 2023.
All in we're exceptionally well positioned for strong performance in 2022 and beyond please.
Please turn to slide number six.
Customer demand for our innovative climate control products and services continues to grow.
We delivered another quarter of robust organic bookings growth up 20% with growth across all segments and business units customer.
Customer demand has been high all year with organic bookings up over 25% year to date driving a record backlog in each segment.
<unk> revenues were also up 4% driven by continued strong price execution.
Our Americas commercial HVAC business delivered robust bookings growth in the quarter with orders up over 30%.
Strength was broad based with applied and unitary bookings, both up more than 50% and service bookings up high teens.
<unk> for system focused indoor air quality solutions remained strong and contributed to our mid single digit revenue growth in commercial HVAC Americas.
The residential HVAC markets continued to be strong and our residential team delivered low single digit bookings growth building on nearly 40% growth in the third quarter of 2020.
Revenues were flat in the quarter as demand outpaced supplied and we entered the fourth quarter with record backlog up more than 150% year over year and up from prior record backlog at the end of the second quarter.
With year to date organic bookings up over 80% and year to date organic revenue up over 30%, our Americas transport refrigeration business is significantly outperforming the North America transport markets.
During the third quarter with most of 2021 orders already in the backlog, we opened up our 2022 order books solely for the first quarter of 2022.
Each drove bookings growth of more than 20%.
We are methodically managing our 2022 order book in order to mitigate inflationary risks organic revenues were also strong up low to mid teens.
Turning to EMEA, we continue to see strong demand for our innovative products and services that help reduce energy intensity and greenhouse gas emissions for our customers.
Our EMEA team delivered 25% organic bookings growth in the quarter.
With strong growth in both commercial HVAC and transport refrigeration.
Revenues were also strong up 8% led by high teens organic revenue growth in transport refrigeration.
Our Asia Pacific team delivered bookings growth of 11%.
Revenue grew 1% in the quarter, though we saw growth in China during the quarter the impacts of the COVID-19 pandemic continues to be challenging in the region with low vaccination rates in some countries.
Now I'd like to turn the call over to Chris Chris.
Thanks, Dave Please turn to slide number seven.
Organic revenue growth in the quarter was driven by continued strong price execution.
Four 3% incremental price in the quarter.
Price over material inflation was positive in the quarter and combined with mix offset the net impact of productivity over other inflation and increased investment spending to support leading innovation.
Organic volume and therefore pull through leverage was largely flat for the enterprise in the quarter.
At a high level positive leverage was primarily the result of mix and a modest flow through of M&A and FX consistent with our guidance.
Net adjusted EBITDA, and operating margins declined by 70% and 60 basis points respectively.
Adjusted EPS grew 5% driven primarily by higher adjusted operating income.
Please turn to slide number eight.
We discussed the key revenue and margin dynamics for the enterprise on the prior page.
The dynamics impacting revenue and margins were similar across each of our business segments. As we've highlighted here with strong price realization productivity inflation and higher investments in innovation as consistent drivers and.
EMEA saw.
Solid price realization was accompanied by strong volume growth delivering good leverage and margin expansion in the quarter.
Both the Americas, and Asia Pacific segments delivered higher revenues on modest volume declines impacting leverage.
Asia Pacific also experienced price versus cost headwinds in the quarter further impacting margins.
We continue to expect Asia Pacific to deliver solid margin expansion for the full year and are pleased with our overall performance in the region.
Now I'd like to turn the call back over to Dave.
<unk>.
Thanks, Chris Please turn to slide number nine commercial HVAC Americas has significantly outperformed the broader markets over a number of years through strong focus agility and execution combined with relentless innovation for our customers.
These defining characteristics compounded by the strength in the underlying market conditions power of the business forward today, yielding bookings growth of over 30% in the quarter and exceptional backlog entering Q4.
Bookings strength was universal across nearly every vertical market and major product category.
End markets continue to improve vaccination rates are improving and end market indicators are generally strong with Abi over 50 since February and a healthy GDP.
Data centers and warehouse demand remained strong education and health care end market demand is also growing.
We're benefiting from increased demand across our K through 12 customers with federal stimulus funds supporting both current and more importantly, future growth we.
We see this as a multiyear tailwind for our business given our strong position in the education market and our direct sales force with deep relationships in this vertical.
Our residential end markets remained strong as I mentioned previously we delivered low single digit bookings growth in the quarter compounding on nearly 40% growth in the prior year and we are entering the fourth quarter with unprecedented backlog.
I'm proud of our residential team that has continued to meet customer demand while ramping capacity. After our February weather event in our Texas facility.
The team delivered historically high revenues in Q3 and is on track for capacity expansion in advance of next year's cooling season.
Turning to Americas transport, we're significantly outgrowing strong end markets in 2021.
Market forecasts are projecting strong growth in 2022, and 2023 as well.
Talk more about the transport outlook in our topics of interest section.
Turning to EMEA economic conditions are improving across the region. We expect continued improvement for the remainder of the year with increase vaccination rates supporting the opening of an increased number and variety of venues.
Transport markets have been strengthening throughout the year and we're on track to outperform end markets in 2021, as evidenced by our year to date performance.
Turning to Asia, we expect growth in China in 2021 supported by increase vaccination rates and strength in data centers electronics pharmaceutical and health care.
Outside of China. The picture is mixed with vaccination and economic recovery rates still low in some countries.
Now I'd like to turn the call back over to Chris Chris.
Thanks, Dave Please turn to slide number 10.
Given all the puts and takes through discussed today, our guidance for 2021 is unchanged.
Accordingly, we continue to see our 2021, adjusted EPS growth guidance of more than 30% as top quartile among peers in the broader industrials.
We discussed the shift in revenues from Q3 to Q4 and 2020 to throughout the call.
Fourth quarter revenues are supported by record backlog and that backlog is firm.
Supply chain labor and logistics systems will continue to be challenging and are the limiting factor to potential upside not demand or backlog.
We also continue to expect free cash flow to remain strong at equal to or greater than 100% of adjusted net income.
Please go to slide number 11.
As we outlined during our Investor event in December we're on track to deliver $300 million of run rate savings by 2023.
Including $90 million in 2021.
Importantly, we continue to invest in these cost savings to further fuel innovation and other investments across the portfolio. This consistent investment strengthens our high performance flywheel, which has a reinforcing and compounding effect over time.
Please go to slide number 12, we.
We remain committed to our balanced capital allocation strategy that is focused on consistently deploying excess cash to opportunities with the highest returns for shareholders.
First we continue to strengthen our core business through relentless business reinvestment.
Second we're committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve.
Third we expect to consistently deploy 100% of excess cash over time using a balanced approach that includes strategic M&A that further improves long term shareholder returns.
And share repurchases as the stock trades below our calculated intrinsic value.
Please turn to slide 13, and I'll provide an update on how we are deploying excess cash in 2021.
Year to date, we have deployed $1 8 billion in cash with approximately $1 billion to M&A and share repurchases, including $250 million for the Ferrari Scientific life Sciences acquisition, we closed in October.
We have paid $422 million in dividends and $425 million to pay down debt.
Our strong free cash flow liquidity and balance sheet continue to give us excellent capital allocation optionality.
And dry powder moving forward.
We're on track to deploy at least $2 $5 billion in excess cash in 2021.
Now I'd like to turn the call back over to Dave Dave.
Thanks, Chris Please go to slide number 15.
I wanted to spend a couple minutes, providing an update on the transport refrigeration markets for 2021, as we've seen the forecast ship a fair amount since our second quarter earnings call.
I think the primary takeaway this quarter is that act is projecting an extended and more gradual upturn in the North America transport refrigeration markets than initially projected North America trailers is probably the clearest example, and one of the most watched by investors and analysts as a proxy for the overall transport refrigeration health.
<unk> started out the year projecting an almost immediate snapback in the North America trailer production in 2021 up 39% of the lows of the pandemic in 2020.
As trailer Oems have had a challenging year producing enough trailers to meet the forecast.
Act has gradually pulled the forecast down and is now projecting a strong but more gradual improvement in 2021 up 18% and continued improvement in production rates in both 2022 and 2023.
Up another 18% and 14% respectively.
If you look at the all in weighted average market forecast for North America Transport Refrigeration 2021 is now expected to be up about 14% versus 24% projected in July.
Year to date, our thermo King America's transport refrigeration business is up more than 30%.
<unk> outperforming the markets and we expect to outperform the markets for the full year as well.
Looking at IHS and other key indicators for EMEA markets. The outlook has improved about three points with the weighted average market growth now expected to be about 12% for 2021.
Year to date, our thermo King EMEA business is up more than 20% clear.
Clearly outperforming the markets and we expect outperformance for the full year of 2021 as well.
Please go to slide number 16.
We added a second transport refrigeration slide to the deck this quarter to add more color around the North America trailer market.
From both backward and forward looking perspectives.
One of the things we've talked about over the past several quarters as the North America trailer market has not been particularly volatile over the past several years and it is not projected to be particularly volatile over the forecast horizon either.
On the left side of the page you can see the visual depiction of what we've been describing.
We chart acts reported actual trailer units built going back to 2015.
<unk> forecast for trailer builds through their forecast horizon of 2023.
The nine year average is in the mid 40000 unit range with the pandemic in 2020 being the only significant outlier.
We also see that good growth is projected in both 2022 and 2023. It is important to note that our global transport refrigeration business is highly diversified trailer is an important part of the global mix at about 25% of the total.
However, we're focused on strong execution across the transport refrigeration portfolio, which we believe will further help reduce variability of this business over time.
Please go to slide number 17.
2021 is shaping up to be a strong year for us overall, despite a number of macro challenges that we expect to continue over the near term.
We're seeing unprecedented levels of demand for our products and services across the board and our backlog has never been stronger.
We're executing our business operating system, well and staying ahead of persistent inflation with strong price realization and we expect to deliver top quartile EPS growth for the full year.
Energy efficiency and sustainability Megatrends are only growing stronger.
We're uniquely positioned to deliver leading innovation that addresses these trends and accelerates the world's progress supported by our business transformation and are engaging uplifting culture.
We are proud to have been recognized by Forbes as one of the best employers for diversity and best employers for women.
And by Fortune as one of the best workplaces in manufacturing.
It's our people that power, our innovation and bring our purpose to life every day.
We have many reasons to be excited about our prospects for a strong performance as we look to 2022 and beyond.
When combined with our exceptional ability to generate free cash flow.
At our balanced capital deployment, we are well positioned to continue to drive differentiated shareholder returns over the long term.
And now.
We'd be happy to take your questions operator.
At this time I would like to remind everyone in order to ask a question. Please press star.
Number one on your telephone keypad and again, if you would like to turn Nathan yourself from the queue simply press Star one again.
Now as a reminder, in consideration of time, we do ask that you. Please limit to one question and one follow up question.
Your first question comes from the line of John Ritchie of Goldman Sachs.
Thanks, Good morning, everyone.
Hey, Joe how are you doing good morning.
Yes doing great. So.
Maybe just the first question on the supply chain.
Helpful to have kind of like that visibility on the revenue that pushed out from this quarter I guess just any other color you can provide as a predominantly occurring in your North America trailer business.
And then just just confident that youre going to be able to ship these revenues and not be sustained.
<unk> initiated in the next few quarters.
Yeah sure John Great question.
Tight supply chain.
Really globally, we talked about it during our second quarter earnings call.
It caused us to push about $150 million of revenue out of the quarter as we said.
We think we'll get about $50 to 75 of that back in the fourth quarter.
Our team is doing a great job of managing the supply chain constraints. We chose not to include a slide in our deck.
Telling you the 50 things that we're doing to manage our suppliers or help our suppliers, but I could assure you that supply chain resiliency has been part of our business operating system for a long time and I can assure you that trane technologies employees around the globe are working hand in hand with our supplier.
<unk>.
Ensuring that.
We could take literally pages out of our operating system to help them implement it.
We think it is going to be choppy for a while and the supply chain at least for the foreseeable future. It's a little bit I think I mentioned in the second quarter call. It is a little bit like when your kids, who played that game of whack, a mole, where we fix one problem in another problem Pops up but if you looked at for overarching kind of.
Like where are we seeing constraints I don't think I know, we're not any different than what you've probably already heard from the rest of the industrials that have reported electronics resin semi conductors wire harnesses.
These are all areas that.
Certainly on an overarching level, we're seeing supply chain constraints.
That said just a couple of points I want to make one is we're working very closely with our customers.
It's very important that in some cases, our customers are having supply chain constraints on the job sites, which is causing them to push out jobs. So we're working with them to make sure that we can deliver product when they need it. If you look at our thermo King business, we're really aligning with our customers there around build slots that there.
From the trailer Oems tracker supplier. So this hand in hand relationship with the customer it's pretty dynamic right now and then the last point I'd like to thank Joe is that I.
I know we've talked a lot about supply chain constraints. We also have to be fair to our suppliers I know many of them are probably listening to the call over or read the transcript.
Putting tremendous pressure on our suppliers with the amount of demand that we're seeing in the marketplace right now.
You look at our commercial HVAC business in the Americas.
Unitary and applied both are up over 50% incoming order rates in the third quarter. So it was that kind of thing you can imagine, we're pushing that right onto our suppliers improving orders on them.
So theyre seeing some pretty big spikes that they're having to manage through your question on is there a particular business it's pretty widespread.
No it's more acute maybe in our thermo King business, we had a couple of suppliers there that we've worked through.
Some of the issues with so we're pretty confident that we'll be able to rebound there in the fourth quarter. We're also seeing we're seeing across the globe, but the other business I would call out is probably our commercial HVAC business certainly there the resin impact and kind of a knock on effect that we've been seeing now for several quarters.
Thanks, David that was helpful. And then maybe my one quick follow up one of your suppliers.
On their conference call about an hour ago.
And they talked about the price formula being roughly $100 million positive for them in 2022.
You did a good job with pricing this quarter.
Just curious as you kind of think about 2020 to be thinking about.
Positive price cost environment, given what youre seeing in your cost base today.
Hey, Joe It's Chris I'll take that question. So we are in the middle of our 2022 planning going into 2022, though we would expect some carryover price from the three price increases most of our businesses announced this year, we will start lapping price increases, though really starting in the first quarter of next year.
Would tell you as part of our business operating system.
Answer every year coming up with a plan of how we're going to get about 20% to 30 basis points positive spread price cost so more to come in a couple of months as we released guidance for next year, but we're going to go in with the mentality that we're going to cover price cost, but it's also a very inflationary environment, which is why we're really trying to size that for.
Pricing increases if we need to going forward.
Only thing I would add to that Joe is that price is never easy to get despite what people may think.
When you have an innovative portfolio of products it becomes that much easier as youre selling additional value to our to your customer.
Being able to get pricing it becomes a little bit easier.
Great. Thank you both.
Thanks.
Okay.
Davis with Melius research.
Good morning, guys.
Hey, Scott how are you doing good morning.
Good.
I wanted to talk about IAA acute that's okay too.
Two point tailwind that you.
Noted in the slide is pretty material.
One I want to just give some color on the sustainability of that how many years of project backlog.
Probably half.
Where is that 2% say, 2% as it become three this year and any kind of view around that and then well.
What does a systems focused solution really mean for practical.
Purposes for us at least does that mean.
Our service contract with monitoring I mean.
Maybe just a little color around that too.
Sure Yes, it's good question as far as demand goes we had said early on that we thought it would be 1% to 2% tailwind we're seeing 2%. This year pipeline is strong.
What started out to be strong and really just health care and education, We're now seeing an office and other verticals. So that's the good news on the other thing I would tell you that if you remember we had an approach where we were doing indoor air quality audits, where we would do a day one activity, where we do the audits to make the environment is.
Safe as possible today with existing assets and then we kind of give a roadmap as to how you would do day two activity. Those day two activities are really starting to come through for us, especially in the education with some stimulus funds flowing there. So thats a good news story as far as we see indoor air quality as a megatrend.
Thats not going to go away, it's top of mind I mean, Trane technologies has always had a robust focused on indoor air quality was really big in the healthcare vertical it's now top of mind in all verticals, but we don't we don't see this stopping we see people constantly asking about indoor air quality I would tell you that we are.
We're building it into our systems, which is kind of your second point. Your second question there is.
This is now integrated into our system and we're seeing nice traction there in all verticals with I'll add Scott is because it is embedded in systems now it is becoming harder and harder to kind of spike out the impact of indoor air quality separate from our systems order.
<unk> offered Dave we can hire a few more accounts to try to track those revenues and that level of detail, but I think the fact is it's it's really becoming with the long term tailwind for the company.
Yes.
We're really seeing a lot of traction, especially with our dry hydrogen peroxide solutions and this is predominantly in the education brewery and glass were building this into the systems and the dry hydrogen peroxide solutions are unique.
Innovation there is that this these molecules last longer. So if you think about our school room, where you have students centers are moving around to different classrooms on different desks. These molecules actually settle on the desk. So they clean the air as well as the surface and we're getting a lot of traction around that.
That's very interesting I'll pass it on to my peers, but thank you and good luck.
Thanks. Thanks.
Your next question comes from Brian Martin Kobe.
Hey, Thank you good morning, everyone.
Good morning, Jeff.
Hey, Good morning, just one quick follow up on the backlog.
As it relates to price and Dave you mentioned open.
Measuring how you open up the order book to not get caught here.
Hum.
To what extent.
Do you have the ability or are you in fact.
Going back and repricing some of the backlog or.
Given the environment that we're in perhaps your change in commercial terms just to protect yourself better.
If you take an order of the day and are delivering at 12 months from now who knows what we're dealing with on the inflation front. So just any color there on how you're managing that protecting yourself that maybe adding some flexibility to commercial terms.
Hey, Joe This is Chris I'll start and then Dave can jump in if I go business by business. When we started the residential.
Really we have an ability to adhere to look at our backlog and reprice, our backlog as we see higher inflation in.
Impacting orders that will ship.
Now a couple of months out where the backlog in residential used to be a couple of weeks now we see it continue to be a couple of months out we actually have repriced the backlog already in 2021, but we got that ability to reprice going forward should we see significantly more inflation on.
On the commercial HVAC side, when I think about long lead time equipment.
Those contracts generally have price escalation clauses in them, but allows us to reset pricing based on an index. So we have some protection there as well.
And then on Thermo King to Dave's remarks earlier, we've been really selective with opening up the order books for 2022.
Wanted to get as much insight as we can get on the inflationary environment.
Through the third quarter of 2021, we've only had the first quarter of 2022 order book.
We've now recently opened up in 2022 order book for the balance of the year and we did that intentionally to make sure we had the right.
Be safe.
Back to the backlog I think darrin.
In terms of pricing being able to keep up with inflation.
I would add to that is obviously, we've got price built then got mechanisms in place.
Awesome.
And one of the very firm, Okay, we're not seeing cancellations of our backlog.
And we don't anticipate any cancellations for back in the future.
And then separately just on the Ramsey I don't think you've mentioned rosy in terms of something you are positive on in terms of your 2022 outlook. Obviously, we've got this question that everyone is asking.
Wasn't sure how to answer on how these comps play out and that sort of thing.
What is your high level view on how.
The rest of the market behaves next year and certainly you might have a different view on how you behave on the sidewalk, but any perspective would be appreciated and I'll leave it there. Thank you.
Yes, I think we.
Look at our resi business at a very high level as a GDP plus business. So if you could tell us what GDP as you could tell us where consumer confidence is we could dial in what our residential business and how it is going to perform.
That said, obviously, we have detailed models that we go through and it's really just to validate our high level approach. So GDP is projected to be positive next year, and we do not see the resi business falling off a cliff in 2022, we see the GDP plus business.
Great. Thank you.
Your next question will come from.
Julien with Barclay.
Hi, good morning.
So get.
Starting with price cost just to understand the sort of jumping off point into next year.
I thought you said that you have $150 million of price in Q3, similar sort of cost step up.
Maybe just help us understand those two numbers what should we expect for Q4 and then what's the kind of total year 2021.
Price and cost please.
Hey, Julien it's Chris Thanks for the question, Yes, we were really pleased with the price realization in the third quarter four.
Four 3% of price realization really equals the revenue growth we had in the third quarter as well as we were very flat on volumes.
For the quarter Q3, we saw slightly positive price cost.
When I think back a few years ago. When we had our last inflationary environment. We were really trying to catch up on the price cost equation I think it was about six quarters, where the company was negative now we're able to keep up with that at least through Q3 of this year and really that goes back to the business operating system. We continue to enhance the company so slightly positive.
Price cost in Q3 for Q4, I'm expecting price realization to get a little bit stronger, but I'm also can see inflation getting stronger in the fourth quarter as well. So we're board right now kind of expecting price cost to be flattish in the fourth quarter and then we'll see how that plays out for 2022, where we're always targeting 20 to 30 basis points.
Price over cost for a given year, but I'm expecting that to be flattish in the fourth quarter.
John the only thing I'd say.
Yes.
The only thing I would add to that is that the operating system I don't want to.
Don't underestimate the amount of work we put into building our operating system to stay is to stay ahead of these inflationary curves I mean as Chris said.
It was the last time, we had this type of inflation took several quarters to overcome it.
And now were in the quarter.
Being able to offset it so we're very proud of what we've been able to do that.
That's helpful. Thank you and then.
Maybe just following up in terms of overall firm wide operating leverage.
So it looks like I think in the fourth quarter, you're looking for maybe sort of 20% or so operating leverage year on year.
Wanted to check that's roughly the right.
Ballpark do you think thats, a good sort of entry point starting out next year.
Given you've still got price cost margin headwinds at least in the first quarter or two.
Julien I think youre in the ballpark for Q4.
We left the full year guide.
Intentionally intact given that we can see the push out of some revenues into the fourth quarter that $50 million to $75 million.
Really for my perspective, our perspective, the backlog and the demand is very firm it really comes down to supply chain and Thats why we got the squiggles 605 on the full year from an EPS adjusted EPS perspective.
So could it be a little better could it be a little worse I think we're right around that $6 five.
Based on how we see the supply chain today, but it's really going to dependent on that but yeah youre in the ballpark for fourth quarter we.
We will see a lever kind of plays out for next year I think we're certainly expecting an inflationary environment next year with with pricing actions will need to continue to moderate that but we'll have more insight on that as we get into January.
Great. Thank you.
Thank you.
Your next question comes from John Walsh of Credit Suisse.
Hi, good morning.
Good morning, Jeff.
Maybe piggybacking off of I think it was Jeff's question earlier, I think and your answer was mostly around the equipment.
Wanted to hear a little bit about your ability to pass through inflation on your service contracts because.
Because obviously labor availability and I think wage inflation is something we're all expecting and into next year. So do you have those same kind of ability to pass through those inflationary pressures there.
You bet.
Good question, Yes, we do.
Another long term contract prices.
Foundations built into it so the medicine that is taken into consideration when we have our service agreements.
Got you and then maybe coming at the backlog in orders question, a little differently here.
20% order growth, it's not like you're Comping down 20, you're comping up plus seven so I mean, how do we think about just the orders rate and if you think you can actually build backlog next year potentially obviously I understand youre not in the.
<unk> of guiding orders, but it's definitely a question we're getting from investors here.
So I would appreciate any color. Thank you yes.
If you look at it it's really phenomenal whats happening right now I mean, we.
Had 30% order growth in the first quarter, we had 30% order growth in the second quarter and here. We are in the third quarter talking about 20% and in some of our businesses.
All of our commercial HVAC and equipment is up 50%. There. So I don't anticipate that bookings will continue at the 30% growth rates, but I would tell you that we're seeing a lot of demand right now for our innovations in the marketplace and whether it would be in the thermo king business or in the commercial HVAC business Thats really drive.
A lot of this demand for us and we also have these tailwind behind us around sustainability and the de carbonization of the built environment that is only gaining momentum. So we like we like what we see here going into 2022, we're going to have record backlogs.
And we'll see what 2022 is from an incoming order rates, but right now we really like the position we have going in.
Great. Thank you I'll pass it along.
Thanks.
Your next question comes from <unk>.
Andy Kaplowitz with Citigroup.
Hey, good morning, guys.
Hey, Andy how are you doing good how are you.
EMEA continues to be a significant outperformer versus your other regions. Maybe you can give us a little more color into what's going on there how big is your heat pump business already become our products such as heat pumps and the advantage is nicely accretive to margins that are helping and how sustainable is that 30% incrementally you put up this quarter.
Yes.
<unk>, you kind of hit on and Andy that's what's really driving us in EMEA.
It's just such a great place to be I mean, the advance our product and our thermo King business, it's exceeding our expectations. If you look at what we've been able to do with the electrification of heating in the HVAC business again.
Again tremendous demand tremendous demand so I don't want to get into specifics as to how big we are of our large the market is there, but I would tell you that it is propelling our growth and we're excited about what the pipeline looks like in the future.
And rest assured the innovations are continuing there as we continue to look to expand the what we call the operating maps of how our how our HVAC product works were going for higher temperatures on the heating side and lower temperatures on the cooling side, which are only going to expand our market further.
Great.
Ed Andy sorry on Incrementals, you had a question there.
Set up each of the segments to really have over the long term, 25% plus incrementals. So.
We think.
Europe is well situated for that over the long run to deliver.
Very helpful guys, and then maybe you could give us a little more color into what Youre seeing in Asia, you mentioned record backlog in the region did noticed transfer revenue turned down a dead end.
And it does remain a challenge in the air. So are you seeing overall, China hold up well and how you're thinking about that region in 2002.
Yes, I mean Asia Pacific is about 10% of Trane technologies important region for us.
Let's talk about two different pieces to talk about China first obviously GDP, it's pretty well documented has slowed a bit in the third quarter at least versus expectations. I think it was $4 nine and expectations were over six so it is slowing a bit in China I would tell you, though where it continues to grow.
Think about electronics pharmaceutical data centers healthcare are also verticals that we're very strong in.
So we're seeing nice growth in China, and we expect that to continue in the future you get outside of China. It really becomes country specific and unfortunately, we still having some countries that are going into different phases of lockdowns based on where the pandemic is but.
It's going to be a little bit it's going to be a little bit mixed outside of China.
At least into the fourth quarter.
Appreciate it guys.
Thanks, Thank you.
Your next question.
Steve Tusa of Jpmorgan.
Hey, guys good morning.
Hey, Steve how are you good morning.
So where are you going to end on on price and cost for the year now with this neutral back half ish neutral ish back half like what was the first half.
<unk> cost.
First half would have been positive, but a much smaller numbers, Steve right just given prices grown.
Considerably from Q1 now to Q3, we're expecting Q4 to be flattish price cost the full year I think we're probably around the flattish range, maybe it can be slightly positive.
Our goal here is to keep driving the innovation and then driving the pricing.
Reflect what we think the inflation is going to be so really happy where we are year to date on the price realization.
Like I said before it's going to grow a bit in the fourth quarter at the same time, we're seeing inflation grow into the fourth quarter.
And we're really just trying to stay ahead of it so I'm being a flattish to slightly positive on a full year, yes, I think David you've already had three places we've already had three price increases in many of our businesses.
If we still see the inflation be persistent another price increase will be part of our business operating system, when we would execute on that.
Alright, I guess I'm, just looking for the 150 and the 150 what was that in the first half.
I don't know if we've actually probably given that number it would have been would have probably been less than the $1 50 would be my guess, but I'd have to go look at that.
Alright, Thanks, and then on commercial.
Equipment, you said orders up 50% can you just.
Split those out between applied and then.
How did the light commercial unitary business there within that.
Yes.
So the first it was more than 50% in both our unitary and applied where both over 50%.
So the light being part of.
That number was very strong as you would imagine so we have seen unbelievable amounts of growth in our commercial HVAC equipment business and.
It's actually and I said it earlier, but it's actually.
It would be fair to our suppliers, we're putting that demand right on them, so it's causing them to have to despite forward as well.
That's very positive and then one more for you what was sell through for your what do you think movement was for your resi business the stuff that you know.
To the customer I think you've given that before.
On the <unk> side, which again is about 50% of our business sell through was mid single digits sell in was flat. So obviously their inventory adjusted as you would expect in a shoulder season.
The next follow on question Leslie would be what's inventory level look like in the in the <unk> space.
It's about what you would expect maybe a bit lower than then we would not at this time of year, but it's nothing nothing to call out.
Great Great color. Thanks, a lot.
Thank you Steve to your earlier question is to follow up on that for the first half kind of price for the enterprise is around two 2% so less than $150 million. We realized in Q3, we got a little less than that for the first half of the year. So that price has really ramped up.
From the first half to Q3 and were expecting it to be stronger EBIT in Q4.
And cost.
And cost the one positive.
Yes, I would say in the first half was positive again, it was less than 150, but positive in the first half slightly positive in Q3 and were expecting about flattish for Q4.
Okay. Thanks.
Youre welcome.
Your next question comes from Nigel Coe of Wolfe Research.
Nigel your line here in Idaho.
Sorry.
I was on mute and I had a really funny joke, which I won't repeat but.
Yeah.
Nigel.
I'm going to say, let's go back to that price cost question, but let's milk.
I do want to go back to the backlog.
Because obviously super hubs.
Plus empty in Americas I'm, just wondering is how does the aging of that backlog look I mean do you expect.
The majority of that to convert in 2022 outside of the supply chain pressures and I guess my real question is on I know you're not going to answer this is explicitly but we.
We really haven't grown higher than eight 9% in climate over time organically and I'm just curious.
2020 to be above that.
Just curious at that backlog.
Yes.
As we said earlier, we're still working through the 2022, but just talking about the backlog I mean, you really need to as far as when it Burns you really need to go through it by business. So if you think about.
Our commercial HVAC business was applied orders that backlog when an order comes in there could be a six to nine month burn rate on those type orders.
For the actual shift in the TK, it's a little bit different this year than ive seen in other years, we had a lot of customers place orders in the first quarter and kind of lay them in through the rest of the year and the other complication with TK. We're seeing right. Now is obviously, we're working with our customers on their their slots for trailers and track.
<unk>.
Normally the burn rate in Teekay would be two.
Two to three months, that's been extended a little bit.
Because of the constraints associated with the actual building of a trailer on the resi space I mean, our backlog turns I mean, it's.
It's turning on a regular basis and overall I mean, we have a very large backlog. We have order demand that is some of the best ive ever seen in my career, but understand our backlog is not scale. It continues to churn and we're shipping out we're just getting order rates that.
We haven't seen a very long time in this business that are continuing to build this backlog.
Okay, I'll leave that backlog question on price cost.
You did call out APAC as challenging near term and I think we're all tuned into the fact that APAC or a time as being a bit more challenging on price. So just curious.
<unk> seen some deflation.
In APAC.
And any any concerns as we go into 2022 around that region.
Yes, Nigel I would say price cost right now is a little bit challenging in the near term, we're really on track to having very strong full year margin expansion in the region. If I go back even just two years kind of a two year stack.
We're up over 400 basis points in margin expansion in the region to go back to when we invested in our direct sales force, it's up over 500 basis points.
The region has had some great growth being very selective around orders as well.
I would tell you that we will continue to evaluate the pricing environment and make.
This increases where necessary.
Be looking for that region like for the rest of the company to beginning price cost positive going into 2022, but near term limit of challenges. It's also a little bit of loss small numbers for.
No revenue or margin contraction in the quarter for Asia in Q3.
Okay. Thanks, that's great color. Thanks.
Thank you.
Question comes from Josh Hunker Lindsey of Morgan Stanley.
Hey, good morning, guys.
Hey, Josh how you're doing it.
Well thanks.
Just on this commercial equipment growth I mean.
Look for what is historically kind of a replacement business and what I'm pretty massive installed base by 50% sort of an eye popping number.
Obviously supply chain bottlenecks are kind of everywhere like is there sufficient labor whether it's in your own house or kind of out there in the independent world actually install this stuff in a reasonable timeframe or or is that going to be sort of.
Our gating factor on converting that backlog as well.
Yes.
And as far as labor constraints on our own four walls, it's really we have seen some.
Early in Q3.
Subsided a bit as we move through the quarter.
Planning for it it's just a matter of how you're training mechanism in hiring of new people. So that's happening on a job site basis, we have seen jobs push out to your point because of.
Job site labor constraints.
It's not anything that I would spike out and say, it's super alarming, but it is certainly there and it's not just in North America, it's really on a global basis.
Got it and then R&D.
Mis revenue that you're starting to make up in the fourth quarter. I mean, we've kind of heard similar metrics out of some other folks, but with the expectation that we don't Miss any more revenue in <unk> starting to make it up would imply that.
Not only you are maybe some of the supply chain issue stabilizing but starting to improve.
Don't want to put too many words in your mouth, but like would you characterize the lap.
30 days or so is seeing some actual improvement rather than just stability.
Yes.
We had some acute supplier problems in our thermo King business and.
And we've been able to overcome those so.
We have line of sight.
So what we're guiding to right now that said supply chain is very volatile right now okay. It is the whack a mole game. So we fix one problem and then the other one it comes up but it's really about staying on top of where you are working with your customers working with your suppliers.
And.
It's a lot about communication and I would tell you that our operating system allows us to be.
Working hand in hand, with our suppliers to make sure. They can meet the expectations that we're seeing which again is extremely robust right now.
Hey, Thanks, Good luck.
Those malls.
[laughter].
Your next question comes from Andrew <unk> with Bank of America.
Hi, guys good morning.
Hey, Andrew how long a morning, I'm glad I'm good just.
Just.
Bit of a longer term question.
You highlighted strength on institutional and I think after the first wave of stimulus came in I think education was very much highlighted as an area.
Air quality improvement et cetera, which we're going to benefit the industry. My understanding is that there is a timeline on spending that financing you have to do it over three years can.
Can you just tell us what you have seen so far.
How do you expect the spending to play out over this period of time.
If novartis climb as ice has specific education. Thank you.
Yeah, we're seeing we're seeing funds flow, which is a good thing that 'twenty 'twenty four is the date where else we spend does that may.
That's the date right now that May get pushed out obviously, you got to think about what any work youre going to do on a school youre going to do when students aren't there. So it tends to become a quote season to do score but funds are flowing the elementary secondary school relief emergency relief for Essar as they have and it's flowing from the states down to the local levels.
And we're seeing really really good traction, where we did a phase one indoor air quality audit, we gave our customer a roadmap for the future. They are now executing to many of those roadmaps with upgrades in their facility.
Gotcha and I am just a longer term question on <unk>.
Residential is while you sort of highlighted that it's a GDP plus business.
But how should we think about.
'twenty one fitting in to the overall sort of length of the cycle do you think there was any pull forward or do you think just thinking out in the next several years.
Thanks.
Continues to be positive in 'twenty two positive I'm 23, Im just keeps going until consumer fired just maybe the broader shape longer term shape of the ready cycles. As you think about it to take off to a strong 21, thanks a lot.
Hopefully the consumer doesn't get tired, but.
I'm not sure of the historical models on the cycles are.
Have played out in the certainly in the in the past again, we look at it as a GDP plus business.
We have models that that will go through replacement cycles and use of units et cetera.
A lot of data on the right, but at the end of the day. If you think about it as a GDP plus business you think about consumer confidence that's what drives that market.
We're very happy with the performance that we've had this year.
GDP will be positive in 2022.
Great answer I appreciate it thanks a lot.
Your next question comes from Deane Dray of RBC capital market.
Thank you and good morning, everyone.
Hey, Dan how are you doing very well thank you.
Question about your Capex plans and we're hearing from some companies who just are not able to get projects done also a consequence of supply chain labor constraints and so forth.
You as a customer is are you seeing any of that.
How is that factored into the Capex planning for 'twenty, one 'twenty two.
Yes, we have several upgrades that we're doing and it's really continuous as we continue to upgrade our lines.
We've seen some push outs, but nothing that we can't manage.
Okay.
Add that where we are.
Still tracking again that 1% to 2% probably closer to 2% this year spend on capital as a percent of revenue but.
With enough advance notice and ordering within lead times, we've been able to try to mitigate some of that supply chain pressure.
Got it and then just a quick follow up question on the whole whack a mole phenomenon is are you doing much in the way of parcel assemblies at your manufacturing plants, you are waiting for a component.
And so this would imply you've got.
You are actually spending a work in progress inventory and then when that product does come then you ship them out if it follows through to us.
The subsequent quarter, that's actually a higher margin hit Matt since you are already expense some of that how does how does that <unk>.
We are into your planning right now are you doing parcel assemblies and so forth.
The answers are partial assemblies is yes, we can have you come work for us in operations because thats, obviously as we're waiting for some components in some cases, you could do a partial some of in some cases you cannot.
But as far as the revenue recognition of the cost Chris on what you want to handle the answer is no but yes.
If we've got a partial assembly, we can't recognize the revenue recapturing all the costs associated with it it stays in inventory until we can ultimately recognize the revenue.
Following quarter, we're adding the components, we need to on that parcel assembly to make it for then thats when the full cost get against expense.
Okay. That's real helpful. Thank you.
Youre welcome.
Your final question comes from Stephen Volkmann of Jeffries.
Great. Thanks, guys for squeezing me in most of my questions have been answered, but maybe kind of a big picture question for you, Dave I'm wondering sort.
The old model that we had in this industry of trying to keep inventories as lean as possible and.
So far it's kind of worked wells for a slower growth environment, but it feels like we're sort of transitioning into something better than that so I wonder do you need some more capacity does it make sense to layer in some more inventory on a sort of a structural basis to deal with a stronger growth environment.
Yes.
An excellent question and obviously, we pride ourselves in being a lean company and maybe maybe that's why we were all talking about supply chain Choppiness in the second quarter ahead of many others because we saw it in our.
And our planning Horizons that said I mean, we have capacity for sure.
But the inventory investment is something that we're working with internally and in inventory don't think of it necessarily as finished goods, maybe you would in the res business, but in our commercial business, it's really at the raw level, where youre able to converted.
More easily into the width and finished goods.
Super Great and then just anything else that you've thought about over the last few months are you taking on this role that might differentiate you a little bit from your predecessor.
Yeah.
I don't know its been 150 days it feels like forever, but this is just such a great company Trane technologies and.
And we have.
We're part of such a great industry.
No I mean, I couldnt be prouder to be the CEO of Trane technologies.
We're talking I'm talking next week at Cop 26 talking about.
For the next rate intention to start Decarbonising. The world sees in banking is already exists today. So I'm excited to do that and then the only thing I would add is we just completed our employee engagement survey and here. We are I don't even know how many years. It is the top decile performance for engagement is our culture.
Differentiates us.
I'm not sure that's going to differentiate between me and Mike, but it is really our culture and how much pride we taken to building a strong culture. So trane technologies is in is in a great place today and it's we're headed into an even better place in the future, but thanks for the thanks for the question.
Great I appreciate all the best.
Thank you.
Yes.
<unk> and answer session for today's call I will now turn the floor back to advocated zac nagle for any additional or closing remark.
Thanks, Paul I'd like to thank everyone for joining today's call and as always we'll be available in the coming days or weeks to answer any questions that you may have and hopefully we will see you in person on the road in the not too distant future.
Have a great day thanks.
Ladies and gentlemen, thank you for your participation in today's call. This does conclude todays event you may now disconnect.
Okay.
Okay.
Okay.
Yes.
Thanks.
Hum.