Q3 2023 Lennox International Inc Earnings Call

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Welcome to the Lennox third quarter 2023 earnings call. All lines are currently in listen only mode and there will be a question and answer session. At the end of the presentation. You may enter the queue to ask a question by pressing star one on your telephone touch pad two.

The Q press Star two.

As a reminder, this call is being recorded I would now like to turn the conference over to Chelsea portion from the Lennox Investor Relations team Chelsey. Please go ahead.

Thank you Gary Good morning, everyone. We have had an exciting quarter and we are looking forward to discussing the details with all of you. This morning with me today as CEO of local Mascara, CFO, Joe Reitmeier, and VP of Finance Michael Peter.

Mike will take you through some quarter highlights as well as some preliminary perspective on the year ahead.

Joe will go into depth on the company's quarterly financial results as well as our revised guidance for fiscal 2023.

At the end of the call, we will move to our Q&A session.

Turning to slide two a reminder, that during today's call, we will be making certain forward looking statements, which are subject to numerous risks and uncertainties are outlined on this page. We may also refer to certain non-GAAP financial measures that management considers to be relevant indicator of underlying business performance. Please refer to our SEC filings available.

On our Investor Relations website for additional details, including a reconciliation of all GAAP to non-GAAP measures.

The earnings release, today's presentation and the webcast archive link for today's call are available on our Investor Relations website at Investor Dollar next dot com.

You can also find our press releases for a CFO transition and a yes acquisition on the Investor Relations website.

Now please turn to slide three I'll turn the call over to our CEO Mascara.

Thank you Chelsea and good morning, everyone.

I'm proud to report that this has been another record quarter for Linux with results that truly speak to our commitment towards delivering growth acceleration and resilient margin expansion.

The record revenue profit and earnings that we are sharing today.

Let the transformative impact of our self help initiatives put in place last year.

These results were made possible by the hard work of Lennox is 13000 employees as well as the unwavering loyalty.

And customers.

I deeply appreciate the tireless effort, everyone, who played a part in delivering these exceptional results.

I also extend my appreciation to our dealers and customers for interestingly enough to provide top tier innovative products and solutions.

No let me transition into an overview of this quarter's highlights.

Let us just core revenue grew 10% and.

Adjusted segment margin expanded 334 basis points to 19, 3%, resulting in an adjusted earnings per share increasing 30% to $5.37.

All of our operating cash flow of 230 million was up 83% year over year.

Additionally earlier this morning, we announced Joe Reitmeier his decision to retire and the appointment of Michael Quenzer as our new CFO.

We are excited for both Joe and Michael as we complete this plan transition.

Additionally, we also announced the strategic acquisition of architectural engineering services or E. S. This morning.

The acquisition is consistent with our bolt on acquisition strategy and is a clear strategic fit that will accelerate growth.

Unlock operational synergies and enhance our service offerings to create incremental shareholder value.

Now please turn to slide four for more details on our CFO transition.

Announced earlier this morning, Joe Reitmeier has decided to retire and I like to express my sincere gratitude for his remarkable 18, new your tenure Atlanta.

Under his leadership the company achieved many significant milestones, including seven of earnings per share growth and 12 X increase in market cap.

Beyond his financial stewardship juul has cultivated a tad.

Clint It dynamic finance organization here Atlanta.

With that strong foundation and robust succession plan, we expect a smooth transition as Michael Queens or takes on the role of Chief Financial Officer.

Effective January 1st 'twenty 'twenty four.

Michael joined let up in 2004 and has been a key contributor to Linux its strong financial performance.

He has a proven track record.

Driving operational excellence, developing talent and creating shareholder value.

Michaels experience as the segment's CFO during the commercial to turn around and most recently as VP finance and Investor Relations equips him with a solid foundation for his new role.

I'm very happy for Joe as he looks forward to his well earned retirement and I am excited to work with Michael in his new capacity.

Please join me in congratulating, both Joe and Michael.

Now please turn to slide five for an overview of the E S acquisition.

We are pleased to welcome <unk>.

Customers and employees to deal in our family.

This strategic bolt on acquisition is in line with our overall capital deployment strategy and provide clear benefits to our customers employees and shareholders.

As you May know.

And then also with existing National account service team is focused on preventative maintenance and energy monitoring services.

The new acquisition is <unk>.

Centered on turnkey installation accessories, as well as the refrigerant reclaim and recycling.

The combined portfolio will allow us to serve our customers more holistically, ensuring that all their needs are met by let us.

Additionally, it didn't hadn't say as our cross selling opportunities as we can now offer a broader range of services and solutions to our client base.

This.

<unk> strengthened our relationship with our customers and positions us for a comprehensive lifecycle provider.

This strike winter light commercial service industry.

He is also provides new services to facilitate product life style, and decommissioning, including refrigerant reclamation and material recycling.

For example.

Commercial customer can purchase rooftop equipment from Linux utilize E S installation services.

Use thus far maintenance and monitoring.

And leveraging our reclaim and recycling services at the edge.

And if it could be life.

By offering these services, we'd not only aligned with the evolving environmental needs and regulations, but also create a new revenue stream for our business.

Ensuring that we remain at the forefront of sustainable innovations.

Another compelling aspect of this acquisition is the vertical integration in two parts and accessories.

Particularly in corporate actors.

My manufacturing corporate actors in house, we will be able to generate cost efficiencies.

Increased profitability.

And build a stronger competitive edge in the marketplace.

Ultimately.

This strategic bolt on acquisition addresses several critical execution needs in our growth strategy.

It didn't add installation capabilities, we're industry, leading preventative maintenance services.

Provides new services, such as refrigerant reclaim it.

Recycling.

Support product lifecycle, these commissioning and increases the sales of parts and accessories.

Now, let me hand, the call over to Joel who will take us through the details of our Q3 financial performance.

Thank you Luke and good morning, everyone. Please turn to slide six.

That's a little bit mentioned earlier, the company posted strong revenue and earnings growth.

Core revenue, which excludes our European operations was a record $1.3 billion up 10%, where pricing mythics drove significant year over year improvement.

Adjusted adjusted segment profit increased $62 million is $97 million of price and mix benefits were partially offset by inflationary impacts on SG&A and distribution costs.

Total adjusted segment margin was 19, 3% up 334 basis points versus prior year.

For the quarter corporate expenses were $27 million, an increase of $11 million as a result of higher incentive compensation and wage inflation.

In the third quarter.

For the third quarter <unk> achieved record levels of revenue segment profit and adjusted earnings per share adjusted earnings per share grew by 3% to $5.37.

Our third quarter tax rate of 25 point systems, 6% and diluted shares outstanding were $35 7 million compared to $35 5 million in the prior year quarter.

Turning to our residential results on slide seven.

The chart shows revenue growth of 7% to a record $896 million in the third quarter. The segment benefited from new minimum efficiency standards.

Richard maybe ex of higher efficiency products. We also noticed the positive impact from strategic price increase in June.

Although unit sales volumes for the segment declined by 2%.

Our direct to contractor sales volume increased mid single digits, reflecting healthy end markets and.

Ongoing market share gains.

Unit sales falling EMS through independent distribution channels declined mid teens, primarily due to continued industry destocking, which decelerated during the quarter.

Residential segment profit increased 18% to $181 million and segment margin improved by 183 basis points to 22% driven primarily by price and mix and partially offset with lower volume higher incentive compensation and inflationary effects on wages and distributions.

Turning to slide eight and our commercial business that continues to deliver strong results.

Revenue was $406 million in the quarter up 15%.

Combined price and mix were up 13% and volume was up 2% <unk>.

Commercial segment profit was $97 million or up 86% and segment margin expanded 912 basis points to 24%.

These results were driven by price and mix for a total of 40 set forth for the total of our $47 million increase in profit for the quarter.

Increased factory productivity is offset inflation and we have made significant progress on our new factory construction, which will support growth and productivity.

Moving on to cash flow performance and our net debt to EBIT EBITDA starting on slide nine.

Operating cash flow for the quarter was $313 million.

$171 million in the prior year quarter.

Capital expenditures were $40 million for the quarter, an increase of $20 million compared to prior year.

Our capital deployment priorities remain consistent supporting organic growth investments like our new commercial manufacturing facility in Mexico.

[noise] driving industry, leading innovation and.

And exploring potential bolt on acquisitions like E S.

In the quarter the company paid approximately $78 million in dividends.

That was approximately $125 billion at the end of the quarter and our net debt to EBITDA ratio was one seven times.

Cash cash equivalents and short term investments were 141 6 million at the end of the quarter.

Construction on the new commercial factories also coming along nicely with first production anticipated mid 'twenty 'twenty four we.

We do anticipate some P&L inefficiencies and temporary working capital build as the factory ramps up.

By the second half of 2025, however, we expect the factory will be fully ramped and we will begin realizing productivity gains.

Now turning to slide 10, I'll review, our revised 2023 full year guidance.

As a result of our strong execution on driving growth and expanding margins, we are increasing our full year outlook.

We estimate core revenue to be.

Up approximately 5% for the year and earnings per share of $17 25 per share to $17 70, 775 cents per share.

We are also increasing our free cash flow target to a range of 350 million to $400 million.

Our guidance for capital expenditures is unchanged from our prior guide at $250 million and this includes our investment in the new salt to your factory and refrigerant transition related investments.

Pricing cost benefit are now expected to be 325 billions of dollars.

Material costs are expected to be flat for 2023.

We revised our corporate expense estimate to be $100 million attributable to higher incentive compensation expenses.

We will remain diligent on managing SG&A expense. So it's quite also making necessary investments in the business for growth promote the development of our innovative products and solutions and improve overall productivity.

And finally, we still expect our weighted average diluted share count for the full year to be approximately 35 5 million shares with that let's turn to slide 11, and I'll hand, it back over to Luke.

Thanks, Joe.

In addition to delivering impressive results.

We're making significant progress towards streamlining our portfolio.

Last year, we announced a plan to divest.

That was the plan to divest our European operations.

Mining with lanoxin strategic concentration on the North American market, where we are well positioned to accelerate growth and expand resilient margins.

In the third quarter.

Read each exclusive agreements for the sale of our European commercial H E R businesses as well as our European process cooling businesses.

Based on these agreements, we recorded a $63 million noncash impairment this quarter.

We expect both transactions to be completed before the end of the year.

We also made strides in simplifying our already strong balance sheet.

In September we.

Issued $500 million of senior unsecured five year loans.

Which will replace the $350 million note maturing in November of this year.

In order to retire all secured debt, we increased our revolving credit facility and introduce a commercial paper program.

With these changes we have lowered our financing costs and created additional liquidity.

Now please turn to slide 12, where I will provide an initial assessment of 'twenty 'twenty four business conditions.

What do you 24 will be another transformative year for Linux as we ramp up the new commercial factory transition to low DWP refrigerant and continue our transformation plan.

Our strategic management and execution discipline will allow us to navigate ongoing macroeconomic and regulatory uncertainties.

On the left hand side of this slide we have laid out.

Several deal wins and headwinds that are likely to impact industry demands.

We anticipate channel Destocking to end in 2023, which will lead to favorable volume trends in 'twenty 'twenty four as China returns to its usual ordering patterns.

Additionally, the I R a T.

<unk> credits and other local incentives aimed at promoting energy efficiency upgrades.

Encourage consumers to replace versus the bad as well as the boost.

Sales of higher efficiency products.

Also our supply chain continue to heal and lead times normalized.

And the demand for commercial products will drive growth.

We continue to monitor demand changes related to the impending epogen regulatory transition in 2025.

It is likely to be demand disruptions as distributors are going to adjust inventory levels to mitigate supply chain risks.

And possible price advantage and prepare to meet regulatory deadlines.

In terms of headwinds.

Most significant source of uncertainty stems from macroeconomic factors.

These include 'twenty 'twenty four is an election year.

Tuitions and consumer confidence influenced by geopolitical concerns.

And the impact of elevated interest rates on residential and new homes and large commercial construction projects.

On the right hand side of the slide we have identified several profit drivers.

We believe that end market demand and normal amortization of channel inventory will drive improved volume with consistent incremental profits.

We also expect the ongoing benefits of the strategic pricing initiatives.

They still have pricing opportunity driven by the increase in the cost of food and represent.

Towards the end of 'twenty 'twenty, four we will start experiencing additional price and mix benefits driven by the higher cost of $4 54, b units that required new sensors control boards and more advanced heat exchangers to maintain energy efficiency ratings.

We forecast they still manufacturing productivity due to higher absorption and fuel supply chain constraints.

Operator: Welcome to the Lennox Third Quarter 2023 earnings call. All lines are currently in listen-only mode, and there will be a question and answer session at the end of the presentation. You may enter the queue to ask a question by pressing star and one on your telephone touchpad. To exit the queue, press star and two. As a reminder, this call is being recorded.

These drivers will be partially offset by ongoing inflation.

The amp up cost for the new commercial factory installed to you and costs associated with the refrigerant transitions.

Regarding cash flow, we anticipate cash conversion to be impacted by a temporary increase in working capital.

Chelsey Pulcheon: I would now like to turn the conference over to Chelsey Pulcheon from the Lennox Investor Relations Team. Chelsey, please go ahead. Thank you, Gary.

As well as capital investment to complete the new commercial factory and to meet 2025 refrigerant transition requirements.

Ultimately our outlook or 'twenty 'twenty four is cautiously optimistic.

Chelsey Pulcheon: Good morning, everyone. We have had an exciting quarter, and we are looking forward to discussing the details with all of you this morning. With me today is CEO, Alok Maskara, CFO, Joe Reitmeier, and VP of Finance, Michael Quenzer. Alok will take you through some quarter highlights, as well as some preliminary perspectives on the year ahead. Joe will go into depth on the company's quarterly financial results, as well as our revised guidance for fiscal 2023.

Our strategy remains focused on consistent execution.

<unk> top line growth and expanding our margins.

We plan to provide our 2024 financial guidance when we report our fourth quarter earnings call.

Early next year.

With that please turn to slide 13.

Chelsey Pulcheon: At the end of the call, we will move to our Q&A session. Turning to slide two, a reminder that during today's call, we will be making certain forward-looking statements with our subject to numerous risks and uncertainties as outlined on this page. We may also refer to certain non-gap financial matters, that management considers to be relevant indicators of underlying business performance. Please refer to our SEC filings available on our Investor Relations website for additional details, including a reconciliation of all gap-to-non-gap measures.

Allow me to summarize some of the factors.

That.

Lead me to believe the Nox is poised to continue delivering great resource.

First.

We are making the necessary investments to enhance our go to market effectiveness to meet the attractive long term industrial demand.

Second.

Our unique direct to dealer model.

It has to deliver sustainable and resilient how high margins by leveraging both our manufacturing and distribution network to optimize profitability.

Chelsey Pulcheon: The earnings release, today's presentation, and the webcast archives link for today's call are available on our Investor Relations website at investor.linux.com. You can also find the press releases for our CFO transition and AES acquisition. Thank you, Chelsea.

Third we.

We deliver consistent execution through utilization of our balanced scorecard based operating system.

Our supply chain and lean digital processes.

Our capital deployment remains disciplined as we prioritize organic growth investments.

Alok Maskara: Good morning, everyone. I am proud to report that this has been another record quarter for Linux with results that truly speak to our commitment towards delivering growth acceleration and resilient margin expansion. The record revenue, profit, and earnings that we are sharing today reflect the transformative impact of our self-help initiatives put in place last year. These results were made possible by the hard work of Linux's 13,000 employees, as well as the unwavering loyalty of our dealers and customers. I deeply appreciate the tireless efforts of everyone who played a part in delivering these exceptional results. I also extend my appreciation to our dealers and customers for trusting Linux to provide top-tier innovative products and solutions.

Trends acquisitions and share repo purchases.

The fourth pillar is our advanced technology portfolio.

That allows us to address mega trends and provide innovative solutions to our customers.

Finally, we live by our core values and embody our guiding principles.

Strengthen our high performance culture.

Our pay for performance incentive structure also ensures close alignment of talent and stakeholder interest.

I would like to conclude.

By expressing my appreciation to all of our employees and customers.

I also want to thank Joe Reitmeier for his dedication over the years and congratulate Michael Quenzer on his new role as CFO.

Finally, I would like to welcome all.

Alok Maskara: Now, let me transition into an overview of this quarter's highlights. Linux's core revenue grew 10%, and our adjusted segment margin expanded 334 basis points to 19.3%, resulting in our adjusted earnings per share, increasing 30% to $5.37. Excellence. Our operating cash flow of 313 million was up 83% year over year.

The 200, and a T E S employees to the Knox family.

I am excited about what the future holds for Linux.

Our best days are still ahead of us.

Thank you, Joe Michael and I would be happy to take your questions now carry now let's go to Q&A.

Thank you.

At this time, if he would like to ask a question. Please press the star and one on your Touchtone keypad, you may remove yourself from the queue at any time by pressing star two.

Alok Maskara: Additionally, earlier this morning, we announced Joe Wright-Meier's Decision to Retire and the appointment of Michael Quenzer as a new CEO. We are excited for both Joe and Michael as we complete this planned transition.

Once again that is star one to ask a question.

And we'll take our first question from the line of Jeff Sprague with vertical research partners.

Alok Maskara: Additionally, we also announced the strategic acquisition of architectural engineering services or AES this morning. The acquisition is consistent with our bolt-on acquisition strategy and is a clear strategic fit that will accelerate growth, unlock operational synergies and enhance our service offerings to create incremental shareholder value.

Go ahead.

Thank you good morning, everyone, Joe we're going to Miss you I think it was you mean law broadened from Akron. So you know we're gonna be down to two now.

Yeah. Thanks I appreciate it.

Alright, Thanks for all the hall, yeah. Thanks for all the help over the years Uh Huh.

Thanks for the early are you in the 'twenty 'twenty four I wonder if we could just drill a little bit more into the the transition itself and just thinking about the you know that the timing of all this.

Alok Maskara: Now please turn to slide 4 for more details on a CFO transition. Announce earlier this morning, Joe Wright-Meier has decided to retire and I like to express my sincere gratitude for his remarkable 18-year tenure at Lennox. Under his leadership, the company achieves many significant milestones including 7X earnings per share growth and 12X increase in market cap. Beyond his financial stewardship, Joe has cultivated a talented, dynamic finance organization here at Lennox. With that strong foundation and robust sufficient plan, we expect a smooth transition as Michael Quenzer takes on the role of Chief Key Contributor to Lenox's strong financial performance.

Alok Maskara: He has a proven track record of driving operational excellence, developing talent and creating shareholder value. Michael's experience as a segment CFO during the commercial turnaround and most recently as VP finance and investor relations equips him with a solid foundation for his new role. I am very happy for Joe as he looks forward to his well-earned retirement and I am excited to work with Michael in his new capacity.

Should we expect say you know kind of cost burdens early in the year that are then kind of recaptured.

And higher selling prices later in the year, just kind of thinking about the progression of this through your P&L as you prepare and then ultimately sell on the other side.

Hey, Jeff This is Michael Yeah, I'll speak specifically to the commercial factory, what you'll see in the first half of next year is that we'll ramp that factory up specifically on the head count and some of the the training needed to start the production kind of late in the Q2, so you'll see some costs in the first half with no production output and then in the second half, we'll start to get some production output but.

That also still won't be at full efficiency, it'll take a bit of time before we get the efficiency, but the the second half will at least start to get some more production out and let it start to get back into the.

The inventory levels that we need to get into emergency replacement. So most first half of the year is going to be kind of the cost and efficiency getting better in the second half.

And Jeff the same would be true on the refrigerant transition. So I think youre right to assume that the first half there would be cost burdens.

Converting lines ordering more spare parts and then second half is where we start getting the price mix benefits.

Most of the price mix benefits for their fridge and transition is likely to be in 2025.

Starting some of that towards the tail end of next year.

Alok Maskara: Please join me in congratulating both Joe and Michael.

Thank you for that and maybe just as a as a follow on comment here I'm just thinking about the commercial margins. Obviously, just a very positive story here in 2023.

Alok Maskara: Now please turn to slide 5 for an overview of the AES acquisition. We are pleased to welcome AES customers and employees to the Lenox family. This strategic bolt-on acquisition is in line with our overall capital deployment strategy and provides clear benefits to our customers, employees and shareholders. As you may know, Lenox's existing national account service team is focused on preventative maintenance and energy monitoring services. Our new acquisition is centered on turnkey insulation accessories as well as the refrigerant reclaim and recycling. The combined portfolio will allow us to serve our customers more holistically, ensuring that all their needs are met by Lenox.

Three it looks like you know you are still expecting kind of a significant step down in Q4, obviously, there's some seasonality, but maybe just give us.

Some color on what you'd expect in Q4, and commercial price cost mix and how that bridges to margin expectation there.

Naturally our Q4 has a little less volume than it seasonally it drops down a little bit, but as we look to our backlog the margin and the backlogs are still it's supports margins that we saw in Q3, so pricing still remains a hold their world as well as the mix dynamic is positive. So we see that continuing into next year I mean after.

Several years of being behind on the price cost dynamic we've kind of gotten back to where we think we have normal margins now it's about maintaining those margins going forward as we start to see cost for refrigerants and some of the new 454 B.

Alok Maskara: Awards. Additionally, it enhances across filling opportunities as we can now offer a broader range of services and solutions to our client base. This will strengthen our relationship with our customers and positions us for a comprehensive life cycle provider in this fragmented light commercial service industry. AES also provides new services to facilitate product life style and commissioning, including refrigerant reclamation and material recycling. For example, a commercial customer can purchase rooftop equipment from Lennox, utilize AES insulation services, use us for maintenance and monitoring and leverage our reclaim and recycling services at the end of a good life.

<unk> stations that we need to do.

Alright, thank Jeff on the guide perspective, I mean, I just want to remind that.

We are still heavily volume constrained and they could even in Q3, if we had more capacity we would have sold more.

So I was wondering in mind that like in a world made good progress in the factory.

Still.

They kept paying back a more sometime but supply chain with oxygen output.

Wanted to make sure that we didn't get too far ahead of ourselves as we were giving guidance for the rest of the year.

Understood. Thanks.

And we'll take our next question from the line of <unk> Patel with Jefferies. Please go ahead.

Thank you just wanted to also thank Joe for his time and patience with us.

Alok Maskara: By offering the services, we not only align with the evolving environmental needs and regulations, but also create a new revenue stream for our business ensuring that we remain at the forefront of sustainable innovations. Another compelling aspect of this acquisition is the vertical integration into parts and accessories specifically in corporate actors. By manufacturing corporate actors in house, we will be able to generate cost efficiencies, increase profitability and build a stronger competitive edge in the marketplace.

Over the years and Michael I look forward to your continued insights into new roles congratulation.

Just one thing I wanted to kind of hit on what was on the acquisition side.

Any sort of thoughts on you know a seasonality of that business. If there is something it doesn't match up with where commercial is currently and then we talked about it being accretive to earnings just wanted to also get a sense for how that margin profile kind of works is it will it be at the similar levels that we're seeing here in commercial currently or is there maybe a little bit of a dilution to that in the near term.

Yeah.

Sure. Thanks, Thiago, let me start on that so first of all very excited about the acquisition.

Alok Maskara: Ultimately, this strategic bolt on acquisition addresses several critical execution needs in our growth strategy. It adds installation capabilities to our industry leading preventative maintenance services, provides new services such as refrigerant reclaim and material recycling to support product life cycle, decommissioning, and increases the sales of parts and accessories.

Very consistent with our stated goal of how we look at bolt on areas such as service parts and accessories. So super excited on what that brings in terms of seasonality I mean, given that it's installation and service says it's going to be very similar to the rest of the <unk> business. So I wouldn't expect anything materially differ.

And compared to the rest of the business there.

The same comment also who is on the margin the margin on par would be same as the rest of it I know neither accretive not dilutive to us.

Joe Reitmeier: Now, let me hand the call over to Joe who will take us through the details of our QC financial performance. Thank you, Luke.

Joe Reitmeier: Good morning, everyone. Please turn to slide six. As I mentioned earlier, the company posted strong revenue and earnings growth. Our core revenue, which excludes our European operations, was a record $1.3 billion dollars, up 10 percent, where price and mix drove significant European improvement. Adjusted partially offset by inflationary impacts on SG&A and distribution costs. Total adjusted segment margin was 19.3 percent, up 334 basis points versus prior year. And for the quarter, corporate expenses were $27 million dollars, and increased of $11 million dollars as a result of higher incentive compensation and wage inflation.

We embark on 2024, so great fit for us it kind of from a revenue perspective and margin perspective would be similar dynamics to the rest of Linux business. I mean, the fact is it like I'm gonna glove fit for us on how well this business fits with our existing portfolio.

And then I guess on the commercial side, we talked about all of the idea of being able to sell more if we had more volume.

<unk> currently, but just digging a little bit deeper into the actual end markets themselves are you seeing any sort of softness or weakness in any of the various markets you serve as their specific area that maybe moderating just given the current macro environment. That's out there anything that you can help us win with an understanding that a little bit better.

You know, where we have seen some softer as is all like large office complexes and others. The good news is our exposure to that market is very small our primary exposure as you know isn't flat single storey buildings like retail restaurants schools.

Joe Reitmeier: In the third quarter, but for the third quarter, achieved record levels of revenue, segment profit, and adjusted earnings per share. Adjusted earnings per share grew by 35 percent to $5.37. Our third quarter tax rate of 25.66 percent and diluted shares outstanding worth 35.7 million compared to 35.5 million in the prior year quarter.

News and all of them have been doing very well. So we haven't seen any significant change no. We do see it get a.

Joe Reitmeier: Turning to our residential results on slide 7, the chart shows revenue growth of 7 percent to a record $896 million in third quarter. The segment benefited from new minimum efficiency standards and a richer mix of higher efficiency products. We also noticed a positive impact from the strategic price increase in June. Although unit sales volumes for the segment declined by 2 percent, our direct-to-contractor sales volume increased mid-single digits, reflecting healthy end markets and ongoing market share gains.

Backlog, which.

Which is not that big for us going back to more normal levels as lead times are going back to more normal levels.

Core demand perspective, we're not noticing any noticeable different sense, except into small pocket, where we don't have much exposure there.

Large office buildings and office complexes.

Thanks, I appreciate the time.

And we'll take our next question from the line of Nigel Coe with Wolfe Research. Please go ahead.

Thanks, Good morning, guys nice quarter.

Joe Reitmeier: Unit sales volumes through independent distribution channels declined mid-teens, primarily due to continued industry destocking, which decelerated during the quarter. Residential segment profit increased 18 percent to $181 million, and segment margin improved by 183 basis points to 20.2 percent, driven primarily by price and mix, and partially offset with lower volume, higher incentive compensation, and inflationary effects on wages and distribution.

So the net material inflation now I think it looks flat. So I think prior you were looking for I think commodity cost $35 million of deflation offset by components inflation of Ah I think 90, if I'm not mistaken how does it.

About flat between the components and the commodities how does that look as it is it mainly steel price deflation coming through on the commodities I was just curious how that how that market looks.

Yeah, what we've seen is the commodities God about favorable we saw steel year to date favorable one for the rest of the year. We think commodities are going be pretty flat. So we don't see a lot of benefit in the commodities.

Joe Reitmeier: Turning to slide 8 and our commercial business that continued to deliver strong results. Revenue was $406 million in the quarter up 15 percent. Combined price and mix were up 13 percent, and volume was up 2 percent. Commercial segment profit was $97 million, or up a 6 percent, and segment margin expanded 912 basis points to 24 percent. These results were driven by price and mix for a total of $47 million increase in profit for the quarter. Increase factory productivity has offset inflation, and we have made significant progress in our new factory construction, which will support growth and productivity.

Fourth quarter, you'll see continued headwinds a little bit on some of the material cost in Q4, but it's not as significant as we previously thought under our last guidance, that's really where the big change is that a little bit less expecting inflation on some of the non commodity material, but for now the commodities have been relatively flat across steel copper and aluminum.

And then if we think carry that through into 'twenty, four and obviously with the hedges you got some visibility there how does that look in maybe the first half of the year.

Yeah.

Yeah, we will see a little bit of benefit on the drift.

Drift into next year in the first half for the aluminum aluminum we spend more on that the copper and steel.

Joe Reitmeier: Moving on to cash flow performance and our net debt to EBITDA starting on slide 9. Operating cash flow for the quarter was $313 million, compared to $171 million in the prior quarter. Capital expenditures were $40 million for the quarter and increase of $20 million compared to prior year. Our capital deployment priorities remained consistent, supporting organic growth in this investments like our new commercial manufacturing facility in Mexico, driving industry leading innovation, and exploring potential bullfighting acquisitions like AES.

That's more fluctuation on the current pricing so we'll see where steel goes but we think it will be pretty muted next year on commodities.

And then just a quick 130 P M.

With me on the refinancing because I think I'll look you mentioned lower fencing costs with the refi I think it was $500 million at 5%, replacing 353%. So I was just wondering how the mathematics with them.

Sure I'll take that I mean, I think if you look at the overall financing cost I mean, clearly interest rates are out of our control, but many of our secured credit lines and if you looked at what the actual financing costs were higher but from a pure interest rate perspective, you're right. I mean, the new bonds are at a higher rate than the bonds that are expiring, but as you look at the whole package together.

Joe Reitmeier: In the quarter, the company paid approximately $78 million in dividends. Total debt was approximately $1.5 billion at the end of the quarter, and our net debt to EBITDA ratio was 1.7 times. Cash, cash equivalents, and short-term investments were $141.6 million at the end of the quarter. Construction on the new commercial factory is also coming along nicely with first production anticipated mid-2024. We do anticipate some P&L inefficiencies and temporary working capital as the factory ramps up. By the second half of 2025, however, we expect the factory will be fully ramped and we will begin realizing productivity gains.

On what we're paying for secured financing versus the benefits of commercial paper.

Good items in our control would now be at a lower cost or is it otherwise.

Okay, I don't think it know that and Joe Congratulations Michael Gratulation 70 per berth.

Thanks.

And the next question comes from the line of Noah Kaye with Oppenheimer. Please go ahead.

Thank you and I'll add my congratulations to the mix as well wishing them both a lots of luck.

It appears there are sounding like are they may expect a richer mix.

The low G. W. P. A products next year, just based off of the installation requirements under the EPA rules that recently came out or are you thinking similarly.

Joe Reitmeier: Now turning to slide 10, I'll review our revised 2023 Folier guidance. As a result of our strong execution on driving growth and expanding margins, we are increasing our Folier Outlook. Inc. We estimate core revenue to be up approximately 5% for the year and earnings per share of $17.25 per share to $17.75 per share. We are also increasing our free cash flow target to a range of $350 million to $400 million. Our guidance for capital expenditures is unchanged from our prior guide at $250 million.

Could there actually be stronger frontloaded pre buy of 410 E.

Just your thoughts on how the rules impact those considerations furniture.

Sure I mean, the rules are still a bit of an influx as you know he came up with some final guidelines recently, we are still waiting for some clarifications from D. O E and other pieces would there be mixed benefits for the new references absolutely is it going to be early next year.

No we think it's likely going to be more towards second half of next year as the transition stopped taking forward, but what we know for sure is given our preparation, which we think we are at or ahead of all the stores in terms of preparation given our direct to dealer model.

Joe Reitmeier: And this includes our investment in the new Saltillo factory, and refrigerant transition related investments. Pricing cost-benefit are now expected to be $325 million, and net material costs are expected to be flat for 2023. We revised our corporate expense estimate to be $100 million, attributable to higher incentive compensation expenses. We will remain diligent on managing SDNA expenses while also making necessary investments in the business or growth, promote the development of our innovative products and solutions, and improve overall productivity. And finally, we still expect our weighted average diluted share count for the full year to be approximately $35.5 million shares.

Given that our indoor units are compatible with our outdoor unit as we go through the transition. We think we are favorably positioned as we go into the transition year, but we will give you more details when we announce Q4 results and there'll be greater clarity on the different regulations and rules that will impact their transition.

Ready for the change and we feel we're going to do better than others.

But the mix impact is still to be TBD likely to be more in the second half versus first half.

Okay. Thanks, a lot and I'm pleasantly surprised to hear that the margins on the E. S acquisition, our comparable you know two.

Joe Reitmeier: With that, let's turn to slide 11, and I'll hand it back with a tool log. Thanks, Joe.

Alok Maskara: In addition to delivering impressive results, we are also making significant progress towards streamlining our portfolio. Last year, we announced the plan to divest our European operations, aligning with Linux's strategic concentration on the North American market, where we are well positioned to accelerate growth and expand resilient margins. In the third quarter, we reached exclusive agreements for the sale of our European commercial HVACR businesses, as well as our European process cooling businesses. Based on these agreements, we recorded a $63 million non-cash impairment this quarter. We expect both transactions to be completed before the end of the year.

Two two the commercial or to the Lenox average just given that that's a what appears to be largely an install business can you talk a little bit about that and what accounts for sort of the quality implications in that business and what was really appealing about the business that made it a target for you.

Yeah.

Yeah, so the financial profile.

Profile as I said, it's similar to the rest of Lenox, which is good.

What was attractive to us to be able to provide a comprehensive holistic range of services to our customers because earlier, we did not provide installation services.

Did not provide represented reclaim and recycling and we did not manufacture our own corporate doctors.

So it was really a very very good fit with the gaps in our portfolio.

We like the team we like the customer base.

Alok Maskara: We also made strides in simplifying our already strong balance sheet. In September, we issued $500 million or senior unsecured five-year notes, which will replace the $350 million note maturing in November of this year. In order to retire all secured debt, we increased our revolving credit facility and introduced a commercial paper program. With these changes, we have lowered our financing cost and created additional liquidity.

You can imagine we did significant due diligence, including using external services for financial due diligence and.

And we are super excited about taking the business forward.

Getting a greater share of our customers' spend giving them. Good assurance all the way from cradle to grave for the product to be able to service them out.

So wilden.

Financials are small we're just super excited about the strategic fit.

And where this business is going to go including the synergy that we can.

Alok Maskara: Now, please turn to slide 12, where I will provide an initial assessment of 2024 business conditions. 2024 will be another transformative year for Linux, as we ramp up the new commercial factory, transition to low GWP refrigerant and continue our transformation plan. Our strategic management and execution discipline will allow us to navigate ongoing macroeconomic and regulatory uncertainties. On the left hand side of this slide, we have laid out... Several deal wins and head wins that are likely to impact industry demand.

Eight out of this business.

Okay I appreciate that thank you.

And our next question comes from the line of Joe Ritchie with Goldman Sachs. Please go ahead.

Hey, guys. Good morning, and my congratulations to Michael as well and then thank you Joe for all the time and wish you the best in retirement.

Okay.

Hi.

So so maybe my first question can we just focus on resin volumes for the quarter nice to see that.

Decelerating trend this quarter.

Curious can you maybe just kind of parse that out what did you see specifically in your independent distribution channel versus selling direct.

Alok Maskara: We anticipate channel destocking to end in 2023, which will lead to favorable volume trends in 2024 as channel returns to its usual ordering patterns. Additionally, the IRA tax credits and other local incentives aimed at promoting energy efficient upgrades will encourage consumers to replace versus repair as well as the boost the sales of higher efficiency products. Also, as supply chains continue to heal and lead times normalize, pent up demand for commercial products will drive growth.

Yeah. So the independent district distribution, we saw volumes down kind of mid teens, and we saw that improve as the quarter went on specifically in our coils business that was one of the first businesses that started destocking, we're starting to see that improve so that's a good sign.

The Destocking is ending on the on the coil side. So he was kind of mid teens on the independent district distribution.

Got it and and Michael It what kind of like the expectation then for four Q on the independent distribution side.

But overall were gone into kind of a flat volume for <unk> for Q4, we think it'll be down a little bit theres still some furnace inventory in the channel that needs to destock, it's more of a seasonal product in Q4, so you'll see that for a bit but then the direct side should be up.

Alok Maskara: We continue to monitor demand changes related to the impending refrigerant regulatory transition in 2025. There is likely to be demand disruptions as distributors are going to adjust inventory levels to mitigate supply chain risks, gain possible price advantage and prepare to meet regulatory deadlines.

Offsetting that.

Okay Cool and then and then I guess, just thinking about 2024 and yep.

Yeah. Appreciate the comments you've already made on commercial margins in the plan.

Yep Yep potentially productivity inefficiencies as you kind of ramp the plant at the same time like you haven't seen a lot of you know productivity benefits coming through commercially yet get the margin. There you know than had been really really good. So I'm just curious like how do you kind of how do we level set like what what the margin profile for the commercial.

Alok Maskara: In terms of head wins, the most significant source of uncertainty stems from macroeconomic factors. These include 2024 as an election year, fluctuations in consumer confidence influenced by geopolitical concerns and the impact of elevated interest rates on residential new homes and large commercial construction projects.

And it should.

It should be or could be in 2024.

Sure let me take on that so you know as we look at the commercial business. We are very pleased with the progress and as a reminder, we are sort of ahead of where we had communicated unexpected and we have delivered over 100 million in EBIT improvement even before Q3.

Alok Maskara: On the right hand side of the slide, we have identified several profit drivers. We believe that end market demand and normalization of channel inventory will drive improved volume with consistent incremental profits. We also expect the ongoing benefits of the strategic pricing initiatives and additional pricing opportunities driven by the increase in the cost of phone and refrigerant. Towards the end of 2024, we will start our experiencing additional price and mixed benefits driven by the higher cost of 454B units that require new sensors, control modes and more advanced heat exchangers to maintain energy efficiency ratings.

If you go back and look at strategically what we did there we rationalize a significant portion of our product you can call that mix benefit you can call that productivity benefit it really doesn't matter, but yes, I mean, we our factories are running much better getting a greater output and giving us more of the products that we can get margins.

Doug.

So and what it does is it sets us up really nicely for 'twenty for <unk>.

Even though we are going to have a one time cost for factory start up and we'll be building that kind of extra labor extra cost before we start production, we think going into 2024.

Alok Maskara: We forecast additional manufacturing productivity due to higher absorption and fuel supply chain constraints. These drivers will be partially offset by ongoing inflation, ramp up costs for the new commercial factory in Saltio and costs associated with the refrigerant transitions. Regarding cash flow, we anticipate cash conversion to be impacted by a temporary increase in working capital as well as capital investment to complete the new commercial factory and to meet the 2025 refrigerant transition requirements. Ultimately, our outlook on 2024 is cautiously optimistic. Our strategy remains focused on consistent execution, driving top-line growth and expanding our Elections.

Not gonna be degrading margins in commercial throughout the year. So I think we are set up for long term success second factory. It gets us more volume at similar margins and we are excited about the future commercial and I wouldn't read too much into whether we got productivity and not because on those walks you can put makes sense any different ways. We're just putting a lot.

Those benefits have been to mix.

Okay. That's that's great clarification, thanks, guys.

And we'll take our next question from the line of Ryan Merkel with William Blair. Please go ahead.

Hey, everyone nice quarter I'm, a little could you just comment on demand trends exiting <unk> and into for Q sounds like the allied business is improving but anything else you'd add.

Hey, Ryan. Thanks, So it's been very similar we said even when we gave 23 guidance that we would expect destocking to essentially ending twenty-three. Besides some furnaces and that's exactly what we are seeing is a destocking is dealing down some furnaces as Michael mentioned earlier are still in there.

Alok Maskara: We plan to provide our 2024 financial guidance when we report our fourth quarter earnings only next year.

Alok Maskara: With that, please turn to slide 13. Allow me to summarize some of the factors that lead me to believe, Lennox is poised to continue delivering great results. First, we are making the necessary investment to enhance our goal to market effectiveness to meet the attractive long-term industry demand. Second, our unique direct to dealer model enables us to deliver sustainable and resilient higher margins by leveraging both our manufacturing and distribution network to optimize profitability.

And we haven't noticed anything.

Different compared to the end of Q3 versus the beginning of Q4.

That holds true for both direct and indirect channel. Thank you know consumer seems to be holding pretty well on the R&D side on the commercial side you know there's lots of sophisticated dialogue around how we transition next year and what we do with capacity when it comes back on.

But again no significant changes in demand over the past few weeks as we finish Q3 and moved into Q4 everything is very very consistent with how we thought about it and what we have communicated in the past.

Alok Maskara: Third, we deliver consistent execution to utilization of our balanced co-card-based operating system, dual-source supply chain, and lean digital processes. Our capital deployment remains disciplined as we prioritize organic growth investments, dividends, acquisitions, and share repurchases. The food pillar is an advanced technology portfolio that allows us to address mega trends and provide innovative solutions to our customers. Finally, we live by our coal values and embody our guiding principles to strengthen our high performance culture. Our pay-for-performance incentive structure also ensures close alignment of talent and stakeholder interest. I would like to conclude by expressing my appreciation to all of our employees and customers.

Got it okay. That's great to hear and then a question on commercial for 'twenty. Four you mentioned pent up demand I'm. Just curious you know how much visibility do you have do you have backlog through the first part the first half of 'twenty for just any commentary on sort of your confidence in that part of the <unk>.

Yeah.

You know I mean, we are not in the long lead backlog type business. So I mean within a quarter, we typically book and ship.

We ended the quarter, we might have six to eight weeks of backlog on the books. So no from a booked order perspective.

Don't carry over beyond a quarter or so.

But from conversations with our customers and quotation activity and starting to schedule.

Changeovers, we feel good about 'twenty 'twenty four because remember there's a pent up demand.

The average age of units on rooftops when you look at large customers, whether its lowes Walmart others is much higher than what it should be which means they are paying more for bass than they should and our new unit may have a much quicker payback compared to in the previous times.

Alok Maskara: I also want to thank Joe Wright-Meier for his dedication over the years and congratulate Michael Kwenzer on his new role as CFO. Finally, I would like to welcome all the 280 AES employees to the Lenox family. I am excited about what the future holds for Lenox as our best days are still ahead of us. Thank you.

So those conversations I'll make us feel confident but we'll get more into this and we can announce Q4 results in early 2024.

Got it thanks and best of luck Joe I appreciate it. Thank you. Thank you.

Operator: Joe, Michael and I will be happy to take your questions now. Kerry, let's go to Q&A. Thank you. At this time, if you would like to ask a question, please press the star and one on your touch-tone keypad. You may remove yourself from the queue at any time by pressing star two. Once again, that is star one to ask a question.

And our next question comes from the line of Jeff Hammond.

With Keybanc. Please go ahead.

Hey, good morning, guys.

Hey, Jeff Good morning.

Congrats Joe I'm wondering if you're getting your retirement home in Cleveland.

Well believe it or not yes, and we'll see around store figure out at some point. So good we'll go up here.

Jeff Sprague: And we'll take our first questions from the line of Jeff Sprig with Vertical Research Partners. Please go ahead. Thank you. Good morning, everyone. Joe, we're going to miss you. I think it was you, me, and LeBron from Akron. We're going to be down to two now, but thank you. Thank you. Thanks for all the help. Thanks for all the help over the years. Hey, I look, thanks for the early view into 2024. I wonder if we could just drill a little bit more into the transition itself. And just thinking about the timing of all this.

Just you know look I wanted to I wanted to go back to pricing you made some comments at a at a conference you know kind of 15% price I think carrier was out with similar to how much just maybe walk through your confidence in being able to kind of realize those and then it seems like year. One is maybe more around refrigerant inflation, which we're not seeing yet.

Just any feedback on kind of where refrigerant prices go from here.

Yeah. So I think first of all we are pleased that they've got all the numbers, we gave us similar to what appears on giving them. The mine just a reminder to others, who may be less familiar because those numbers were over two years right. We said starting 2023.

Michael Quenzer: Davis, should we expect, say, you know, kind of cost burdens early in the year that are then kind of recaptured in higher selling prices later in the year, just kind of thinking about the progression of this, you know, through your P and L as you prepare and then ultimately sell on the other side.

Hey, Megan.

They can acquire 25, we think there's a pricing opportunity.

In that range over two years first year, yes, there is ephedrine now the spot pricing. Unfortunately, it goes up and down a little bit but keep in mind that the production corridor has not been introduced yet that gets them to a reduction starting 2024. So we still expect represent price to go up.

Michael Quenzer: Jeff, this is Michael, yeah, I'll speak specifically to the commercial factory, what you'll see in the first half of next year is that we'll ramp that factory up specifically on the headcount in some of the training needed to start the production kind of late in the Q2. So you'll see some costs in the first half with no production output. And then in the second half will start to get some production output, but that also still won't be at full efficiency.

And all indications based on conversations with suppliers is that it well so far.

It would force everybody to do price increases, including us. So we are monitoring that closely and no change in our outlook yet.

Michael Quenzer: It'll take a bit of time before we get the efficiency. But the second half will at least start to get some more production out and let us start to get back into the inventory levels that we need to get into emergency replacement.

In addition, as we go further into the year and we think of the new rep for entire fish and see the cost of sensors that outlook has not changed either.

So while you can never be certain and we'll get more into this in early.

Michael Quenzer: So most first half of the year is going to be kind of like cost and efficiency getting better in the second half. And Jeff, the same would be true on the refrigerant transition. So I think you're right to assume that the first half there would be cost burdens as we start converting lines ordering more spare parts. And then second half is where we start getting the price mixed benefits. Most of the price mixed benefits for refrigerant transition is likely to be in 2025, but we're starting some of that towards the tail end of next year.

Early 2020 for Jeff I can our viewpoint on that has not changed.

Okay, Great and then just.

The mix on <unk> continues to be impressive I'm. Just wondering how much is just sheer strike share change versus consumers mixing up or you know I know supply chain was an issue on the higher end stuff and then just on you know share gain.

Obviously, some noise with destocking and everything but it seems like you know some share pickup in and in the residential business, maybe where where do you see that coming from.

Michael Quenzer: Thank you for that. And maybe just as a as a follow on comment here, just thinking about the commercial margins, obviously just a very positive story here in in 2020. Three looks like, you know, you are still expecting kind of a significant step down in Q4. Obviously there's some seasonality, but maybe just give us some color on what you'd expect in Q4 and commercial price cost mix and how the bridges to a margin expectation there.

Sure on the mix just as a reminder, last year, we talked a lot about mix being negative. So remember that makes it would be negative for the past two years.

Lot of it was semiconductor driven as we didn't have the chips.

For the high end products, which uses a lot more chance. So that has to be voted itself. We are selling a lot more of the premium products I think it's part of pricing excellence. The team is doing a really good job driving the right mix as we go into larger accounts and running the appropriate promotions that would promote.

Michael Quenzer: Yeah, naturally our Q4 has a little less volume and it's seasonally it drops down a little bit, but as we look to our backlog, the margin and the backlogs still supports margin that we saw in Q3. So pricing still remains to hold there well as well as the mixed dynamic is positive. So we see that continued in the next year. I mean, after several years of being behind on the price cost dynamic, we've kind of gotten back to where we think we have normal margins.

Mix the incentive structure helps us out because a lot of the government incentives and rebates commodity at high deficiency products not alone or what.

Then of course, there's the.

Change, which we called out.

I think that number has not changed but I think the upside and the mix is more from all the other factors, mostly on selling higher end premium products.

Michael Quenzer: Now it's about maintaining those margins going forward as we start to see costs for refrigerant in some of the new 450 for the cost decisions that we need to do. Right, I think Jeff on the guide perspective, I mean, I just want to remind that like, you know, we are still heavily volume constrained and like you know, even in Q3, if we had more capacity, we would have sold more. So it's going to remind that like, you know, we made good progress in the factory.

And then and then just you know kind of around share gain.

You know on share gain I like to look at it over a 12 months period, I mean, right now because of Destocking, our direct businesses clearly shows very good share gains. We think some of it's artificial and will go away as destocking ends.

Michael Quenzer: There are still people like you are paying back a mold some time with supply chain with auction output. We want to make sure that we didn't get too far ahead of ourselves as we were giving guidance for the rest of the year.

We have confidence some of it is real and will stick around as.

unknown: Understood.

The dust cleared between stocking and Destocking, but it's too early to call victory or too early to take a victory lap here you know, we like to see all the numbers subtle and by Mexico.

unknown: Thanks.

Chirag Patel: And we'll take our next question from the line of Cherag Patel with Jeffries. Please go ahead. Thank you. I just wanted to also thank God Joe for his time and patience with us over the years and Michael, look forward to your continued insights in the new road. So congratulations. Just one thing I wanted to kind of hit on what was on the acquisition side. Any sort of thought on, you know, seasonality of that business, if there is something that doesn't match up with work commercial is currently.

We feel very good based on conversations based on number of dealers, who are coming back to us.

Based on our new dealer pipeline and based on just the feedback and customer satisfaction store that we are getting cut.

Customer satisfaction at depth.

I look at N. P. S scores, we are back to regular slashed better than regular which is always a leading indicator into share. So we could feel good where we are but I'd like to give it a few more months and dust to settle before we kind of I don't claim that could be a win.

Chirag Patel: And then we talked about being a creative to earnings just wanted to also get a sense for how that margin profile kind of works. It will be at the similar levels that we're seeing here in commercial currently or is there maybe a little bit of a delusion to that in the near term. Sure, thanks, Chirag.

Okay great.

Yeah.

Once again, if he would like to ask a question that is star one on your Touchtone keypad and we'll take our next question from the line of Joe O'dea with Wells Fargo. Please go ahead.

Chirag Patel: Let me start on that. So, first of all, very excited about the acquisition. Very consistent with our stated goal of how we look at bolt-on and areas such as service, parts and accessories. So, super excited on what that brings. In terms of seasonality, I mean given that it's installation and service says it's going to be very similar to the rest of the Lennox business. I won't expect anything materially different compared to the rest of the business.

Hi, good morning.

I guess wanted to start on just 2024 and your comments around volume growth and consistent Incrementals and just touch on the volume growth side of that a little bit and in particular on the resi side and just the dynamic that you consider as kind of a set up for 2024.

Maybe some kind of comp benefits a little bit of absence of destock.

Chirag Patel: The same comment also holds on the margin. The margin on power would be same as the rest of Lennox, neither a creative nor delutive to us as we embark on 2024. So, great fit for us. It's kind of from a revenue perspective and margin perspective would be similar dynamics to the rest of Lennox business. I mean, the fit is like hand in a glove fit for us on how well this business fits with our existing portfolio.

But then are there other factors, you're considering kind of how how youre thinking about that volume algorithm.

Yes that was an amendment that you did touch on the absence of the destock, that's obviously going to revert next year. So we will see that pick up on the indirect side of our business and then outside of that we still expect the economy to continue to grow.

Single digits, GDP and with that we see the replacement market continue to do it to expand we will get some volume there potentially some share gains as well in residential.

Alok Maskara: And then, I guess, on the commercial side, we talked about all of the idea of being able to sell more if we had more volume capacity currently. But just digging a little bit deeper into the actual end market themselves. Are you seeing any sort of softness or weakness in any of the various markets you serve as a specific area that may be moderating just given the current macro environment that's out there.

And then as we talked about we still see good visibility into next year on the commercial after many years of being down in the industry going to continue to see that grow as we talk with national accounts. They have big Plaid replacement programs going for several years to come and we see that.

All in tailwind next year.

And then on the fourth quarter implied margin step down you touched on commercial it sounds like nothing more than typical seasonality.

Alok Maskara: Anything that you can help us with in understanding that all the better. You know, where we have seen some softness is on like large office complexes and others. The good news is our exposure to that market is very small. Our primary exposure, as you know, is in flat single story building like retail, restaurants, schools and all of them have been doing very well. So we haven't seen any significant change. Now, we do see, you know, backlog, which is not like, you know, big for us going back to more normal levels and lead times are going back to more normal levels from a core demand perspective. We know noticing any noticeable differences except in the small pocket where we don't have much exposure that's large office buildings and office complexes. Thanks, I appreciate it fine.

Could you also touch on resi because it looks like what's implied is a larger than normal.

Sequential step down.

Is there anything within rescue that's adding any kind of abnormal pressure versus typical seasonality.

Yes.

Now, we'll have a little bit of headwinds from absorption as you saw in Q3, we started to ramp down our inventory levels. We had some absorption headwind to Q3, we'll see some more of that into Q4 as we get the inventory levels to where we want to be maximize our cash flow. This year and then next year, we'll start to grow inventories again, as we transitioned to the new refrigerant product you get there.

But if it back next year.

Okay, and so when we think about the third quarter fourth quarter.

This margin move.

A bigger and bigger impact on resin and while we haven't seen on commercial is that reasonable.

Nigel Coe: And we'll take our next question from the line of Nigel Coe with Wolf Research. Please go ahead. Thanks, good morning guys.

Yes.

Okay great.

Great. Thank you and congrats both Joe and Michael.

Joe Reitmeier: Nice quarter. So the net material in the patient now I think looks flat. So I think prior you were looking for I think commodity costs $35 million of the patient off debt by component inflation of I think 90 if I'm not mistaken. How does, if we break our slap between the components from the commodities, how does that look as it is? It mainly steel by the patient coming through on the commodities.

Alright.

Our next question comes from the line of Brett Linzey with Mizuho. Please go ahead.

Hey, good morning, and congrats to Joe and Michael.

I wanted to come back to.

Price and understandably, there's a lot of moving pieces on the regulatory in terms of price mix at everything and resume but thinking more broadly to commercial I guess that your lead times and your ability to serve.

Joe Reitmeier: I would just curious how that how that bucket looks. Yeah, what we've seen is the commodities got about favorable. We saw steel a year-to-date favorable. For the rest of the year, we think commodities are going to be pretty flat. We don't see a lot of benefit in the commodities in the fourth quarter. You'll see a continued headwinds a little bit on some of the material costs in key floor, but it's not as significant as we previously thought under our last guys.

Does improve here does it give you an inherent price entitlement.

And you know how should we think about that as we flip the calendar here.

There's a little.

I don't know if it gives us additional pricing document that we have today. So we have done better at getting key account pricing that had been stuck with contracts in the past we have done better at driving mix appropriately so getting out of lower margin products and focusing our capacity on the higher margin.

Joe Reitmeier: That's really where the big change is that a little bit less expected inflation on some of the non commodity material, but for now, commodity is at the relatively flat across steel copper. Aluminum. And then if we then carry that through into 24, obviously with the hedges, you've got some visibility there. How is that looking maybe the first half of the year? Yeah, we'll see a little bit of benefit on the hedges as they drift into next year and the first half for the Aluminum Aluminum, we've been more on that the copper and then still, that's more fluctuation on the current pricing. So we'll see where steel goes, but we think it'll be pretty muted next year on commodities.

<unk> business, where we have a thinking about appropriate advantages in terms of both price and performance.

As we roll into 2024 that go beyond the 14 need pricing impact that we talked about earlier and towards the tail end of the year.

The new 454 units I don't think Theres anything incremental beyond those two have you already talked about and getting into there and a lot of it.

Alok Maskara: And then just a quick one, if you'd be there with me on the refunds, because I think Alok, you mentioned lower fencing costs with the refi. I think it was $100 million at 5% replacing 350% at 3%. So just just wondering how the mathematics were then. Pure I'll take that. I mean, I think if you look at as an overall financing cost, I mean clearly interest rates are out of our control, but many of our secured credit lines and if we looked at what the actual financing cost were higher, but for a pure interest rate perspective, you're right.

Catch up on National account commercial was done this year and I wouldn't expect on a catch up next year.

Okay got it that's helpful. And then just a follow up on commercial and was hoping you might be able to provide a little bit of context on the individual vertical performance within that business. I think you noted last quarter. There was a gradual improvement within emergency replacement as you regain your footing there, but did that continue into Q3 and then.

Alok Maskara: I mean, the new bonds are at a higher interest rate than the bonds that are expiring, but I did took a whole package together on what we were paying for secure financing versus the benefits of commercial paper. You know, items in our control would now be in a lower cost versus otherwise. Okay, I'll take it in a bit.

Any you know any color on the individual.

Articles there.

Same trend as Q2, and some things like schools are always seasonal so you would see that tailing off in Q3 compared to Q2 as most of those placements happen in summer, but beyond that no specific trend and we continue to make.

Nigel Coe: And Joe, congratulations, Michael, congratulations. I'll leave it there. Thanks.

Noah Kaye: And the next question comes from the line of Noah K with Oppenheimer. Please go ahead. Thank you.

Inroads I would call it into emergency replacement and they will continue to maintain our key account volume.

And beyond normal seasonality nothing specific to point out.

Noah Kaye: And I'll add my congratulations to Mix as well, wishing you both lots of luck. You know, peers are sounding like they may expect a richer mix, the low GWTP products next year, just based off of the installation requirements under the EPA rules that recently came out. But are you thinking similarly? Could there actually be a stronger front-loaded pre-buy of 410A? Just your thoughts on how the rules impact in both considerations for next year?

Yeah.

Okay got it I appreciate the answer.

And our next question comes from the line of Deane Dray with RBC capital markets. Please go ahead.

Thank you good morning, everyone.

Good morning.

Hey, maybe we can circle back on the Reg G. Destocking. This quarter you said it was decelerated. So seems to mostly have played out or has there been any surprises from your perspective.

Noah Kaye: Sure. I mean, the rules are still a bit of a flux as you know. EPA came out with some final guidelines recently. We are still waiting for some clarifications from DOE and other pieces. Would there be a mix benefits for the new reference? Absolutely. Is it going to be early next year? We don't know. We think it's likely going to be more towards the 2nd half of next year as the transition starts taking forward.

No not really big surprises I mean, sometimes when we look at the overall industry numbers month to month.

There are some months, where we thought it was well we need better some months away worse, but net net not that many surprises dean because I think what we're all it's turning out very much exactly as we thought it would be in.

In terms of when it would act now.

I think there's different dynamics between independent distributors and large organized distributors and.

Keep in mind is our focus and our exposure is largely to independent distributors.

Large organized district.

But as it's played out very similar to what we target.

Great and I appreciate the early look on some of the 'twenty 'twenty four dynamics was hoping you could expand on the free cash flow implications.

Noah Kaye: And there will be greater clarity on the different regulations and rules that will impact the transition. We are ready for the change, and we feel we're going to do better than others. For the mix impact, it's still to be DVD likely to be more in the 2nd half of next year.

Just yeah could you size, what that temporary working capital bill might be and when might that get worked down.

We're still false formalizing all the plants, but it might be maybe a 1% of sales, it's mostly related to the commercial business as we ramp up that factory were going to need additional raw materials might have a little bit of pre build on the commercials, but so with the fort and equipment since the manufacturing day cutoff as well as it did at the end of the year for all of that package.

Alok Maskara: Okay, thanks a lot. And I'm pleasantly surprised to hear that the margins on the AES acquisition are comparable, you know, to the commercial or to the Linux average, which is given that that would appear to be largely an install business. Can you talk a little bit about that and what accounts for sort of the quality implications in that business, and what was really appealing about the business that made it to target for you?

So that's really where most of that growth is going to be and then in addition to that we'll have some higher or elevated capital expenditures going into next year as we finish up the factory and finish up the transition of <unk>.

Alok Maskara: Yes, the financial profile, as you said, is similar to Rest of Lennox, which is good. You know, what was attractive to us was to be able to provide a comprehensive holistic range of services to our customers, because earlier we did not provide installation services, we did not provide refrigerant reclaim and recycling, and we did not manufacture old carbon-apters. So it was really a very, very good fit with the gaps in our portfolio.

The commercial fact and finish up the investments we need to make to transition our factories to the 454 b product. So capex will be elevated maybe kind of $150 million.

All of that for next year as well.

And then you ask them about burning off that working capital that will take place over a 2025.

Great. Thank you and congrats to Joe and Michael.

Thank you.

And our next question comes from the line of Gautam Khanna with TD Cowen. Please go ahead.

Alok Maskara: You know, we like the team, we like the customer base, as you can imagine, we did significant due diligence, including using external services for financial due diligence, and we are super excited about taking the business forward, getting a greater share of our customer spend, giving them good assurance all the way from cradle to grave for the product. To be able to serve as well, so while then, you know, financials are small, we are just super excited about the strategic fit, and where this business is going to go, including the synergies that we can gain out of this business.

Please check your mute button I'm not able to hear you.

Okay.

Tom are you.

But I think I got them I think got a move down into Qs maybe go to steep next go to the next question. Okay. One moment. Please.

unknown: Okay, appreciate that.

Steve Tusa with Jpmorgan. Please go ahead.

Oh, Hey, guys. Thanks for taking the question.

Hi, good morning, Steve.

unknown: Thank you.

Ah congrats.

Joe Ritchie: And our next question comes from the line of Joe Richie with Goldman Sachs, please go ahead.

To both of you for sure Joe was a pleasure working with you I'm always a tremendous.

Tremendous straight shooter. So I appreciate the the work over the years.

Joe Ritchie: Hey guys, good morning, and my congratulations to Michael as well, and then thank you, Joe, for all the time and wish you the best from retirement. So, so maybe my first question, can we just focus on REZI volumes for the quarter nights to see the the accelerating trend this quarter curious, can you maybe just kind of parse that out, what do you see specifically in your independent distribution channel versus, you know, selling direct.

Thanks.

Joe.

Yeah.

So just on the commercial side I mean, I know you guys are all putting up some really good numbers carrier up you know, 30% again, this quarter or something like that.

You say orders are solid like what is the book, but the lead times are like you know 50 weeks at some point, which is almost even like a fake lead time to an extent what is the book to Bill what was the book to Bill this quarter.

Joe Ritchie: Yep, so the independent district distribution we saw volumes down kind of bid teens and we saw that improve as the kind of quarter went on specifically in our coils business that was one of the first businesses that started destocking, we're starting to see that and pretty much that's a good sign that the stocking is ending on the coil side so it was kind of mid teams on the independent district distribution. Got it and Michael, what's kind of like the expectation then for 4Q on the independent distribution said.

For that business as the backlog normalizes.

S T for us as.

As we look at our business, we have very little or does that carry over beyond the quarter, but I mean are there like booked order. So book to Bill ratio was extremely close to one which is what it has been most of the time, except during really bad crisis highs.

Lead times for at least for US are no longer 50 weeks, where lead times are now trending just around the quarter within a quarter and getting much much closer to normal.

Joe Ritchie: But overall, we're gotten to kind of a flat volume for Q4 would think it'll be down a little bit, there's built some furnace inventory in the channel that needs to destock it's more of a seasonal product and Q4 so you'll see that for a bit, but then the direct side should be offsetting that. Okay, cool and then and then I guess just thinking about 2024 and you appreciate the comments you've already made on commercial margins and the plants.

Right, so you're saying that even when those lead times kind of stretched out there was really no.

Theres really no backlog built does it I mean does that is that what you're saying I don't I'm, just having trouble reconciling that cause everybody else built a lot of backlog obviously.

So we did so if you'll go back to last year right about the same time, we had talked about our backlog and we had said that it's unusual for us to carry so much backlog given the nature of the business at this point 12 years. After that we're saying that we still have backlog, but it's more than a normal level, it's no longer an elevated backlog.

Joe Ritchie: And you know, you have potentially productivity and efficiencies as you kind of ramp the plant. At the same time like you haven't seen a lot of, you know, productivity benefits coming through commercially yet get the margins are, you know, then kind of been really, really good so I'm just curious like. How do you kind of how do we level that like what what the margin profile for the commercial business, you know, should be or could be in 2024.

Our book to Bill So essentially shipping as much as we are booking at any given time, so that's close to right.

Okay got it and then just on the on the pricing side you guys had talked about you know that kind of mid season price adjustment for some of the resi customers. Your pricing was kind of consistent through Q2 Q can you maybe just talk about how that how that played through I know that maybe a little bit of a tougher comp versus last year, but.

Joe Ritchie: Sure, let me take on that so, you know, as we look at the commercial business, we're very pleased with the progress another reminder we thought of ahead of where we. If you go back and look at strategically what we did there, we rationalized a significant portion of our product. You can call that mixed benefit. You can call that productivity benefit. It really doesn't matter. But yes, I mean, we are factories are running much better, getting a greater output and giving us more of the products that we get margins on.

Maybe just some color on that how that played through.

Yeah, I think what you saw in Q2 is that we still had some benefit of lapping some prices in Q2 and by Q3, we fully lapped all of that benefit, but we picked up the incremental strategic pricing in Q3.

So that's where we'll start to see that our normalized for the rest of the year, though but yeah. We did see a good pricing that the strategic price initiative, we launched in Q and Jim.

Okay and then one last question on pricing for next year I know you said the you know the double digit over a two year period.

Joe Ritchie: So then what it does is sets us up really nicely for 24. Even though we are going to have one time cost for factories, we start up and we'll be bidding extra labor, extra cost before we start production. We think going into 2024, we are not going to be degrading margins and commercial throughout the year. I think we have set up for long term success. Second factory gets us more volume at similar margins.

I'm not sure if that meant you know like mid singles in 'twenty, four and mid singles in 'twenty five maybe just a little bit more clarity on how you see that breaking out between 'twenty four and 'twenty five.

Steve that's still a bit TBD.

But can only in October as we go into a price increases we would have greater clarity and a couple of months because there.

Joe Ritchie: And we are excited about the future of commercial. And I wouldn't read too much into whether we got productivity or not because on those walks, you can put mix as any different ways. We just put a lot of those benefits simply into mix. Okay, that's great clarification.

Joe Ritchie: Thanks, guys.

Lots of moving pieces, including crossover epogen sensors, where the.

You know overall situation is in defense manufacturing cost as well.

We haven't even made.

But you know any measurable quantity of the new product so we'd be able to give you a much more refined view of that when we announce Q4 results early next year.

Ryan Merkel: And we'll take our next question from the line of Ryan Merkel with William Blair. Please go ahead. Hey, everyone, nice quarter, a look.

Right I know Investor day, right obviously.

In December.

Ryan Merkel: Could you just comment on demand trends exiting 3Q and into 4Q sounds like the allied business is improving, but anything else you'd add? Hey, Ryan, thanks. No, it's been very similar. We said, even when we give 23 guidance that we would expect de-stalking to essentially end in 23 beside some furnaces. And that's exactly what we are seeing is, you know, de-stalking is stealing down some furnaces as Michael mentioned earlier, I still in there.

That's right no Investor day.

Okay. Thanks, a lot guys. Good luck.

Once again, if you would like to ask a question. Please press the star and one on your Touchtone keypad.

We'll take our next question from the line of Julian Mitchell with Barclays. Please go ahead.

Thanks, very much and congratulations to Joe and to Michael maybe just a first question.

Commercial margins are not particularly original topic, but if we think about what you said Michael earlier on this call. What I think it's that you know there's sort of a firm wide operating margin looks like it's down maybe to 300 basis points sequentially in Q4.

Ryan Merkel: And we haven't noticed anything different compared to the end of Q3 versus the beginning of Q4. That holds true for both direct and indirect channel, like you know consumer seems to be holding pretty well on the right side on the commercial side, you know, there's lots of sophisticated dialogue around how we transition next year and what we do with capacity when it comes back on. But again, no significant changes in demand over the past few weeks as we finished Q3 and moved into Q4. Everything is very, very consistent with how we thought about it and what we have communicated in the past. Got it. Okay, that's great to hear.

And commercial is down sort of lesson that in resi down a little bit more.

So we have that sort of jumping off point to the commercial margin of 22% or something for the and for the year a little bit more than that when we look at next year.

The sort of puts and takes of all your color are we assuming kind of fairly normal commercial operating leverage do you have the sort of the balance of the tailwind from volume and price.

Alok Maskara: And then a question on commercial for 24, you mentioned 10 of demand. I'm just curious, you know, how much visibility do you have? Do you have backlog through, you know, the first part, the first half of 24 to any commentary on for your confidence in that part of the business? You know, I mean, we are not in the long lead backlog time business. So within a quarter, we typically book and ship.

Mix and then the headwind from the new plant ramp up is that maybe just confirm that that thought process for Q4 and next year is roughly correct.

Hey, Julien I'll start and then Michael will continue but I just want to start by reminding that we don't really get segment margin targets by quarter end.

Alok Maskara: When we end a quarter, we might have six to eight weeks of backlog on the books. So no, from a book order perspective, we don't carry over beyond a quarter or so. But from conversations with our customers and quotation activity and starting to schedule, changeovers, we feel good about 2024 because remember, there's a pent up demand. The average age of units on rooftops when you look at large customers, whether it's laws, Walmart, others, is much higher than what it should be, which means they're paying more for repairs than they should.

Part of it was just too small for that in terms of there's always puts and takes because I think when we give guide we look at the company overall.

Alok Maskara: And a new unit may have a much quick payback compared to in the previous time. So those conversations all make us feel confident, but we'll get more into this when we can announce Q4 results in early 2024.

Having said that I hand over to Michael who can get into the details of margin expectations and pluses and minuses both for Q4 and for next year. So maybe what I'll just talk about next year first I think that's mostly a focus at this point. So what we'll see next year is that the margins that are in our P&L. Currently will retain next year will want to price to maintain those as cost.

And specifically on the components and in some of the <unk> refrigerants and maintain those margins and then on top of that we see volume growths will get 30 plus percent incrementals as we get some additional volume out of that second factory in end markets are solid so you'll see that help lift up some of the operating margins offsetting that there will be some of it.

Once that we have in the factory the new factories, we wrap this up that's kind of our early thinking right now, but overall structurally the margins you see in 2023, we think will repeat next year.

Ryan Merkel: Got it, thanks, and best of luck, Joe, appreciate it, thank you, thank you.

Jeff Hammond: And our next question comes from the line of Jeff Hammond with Keybank, please go ahead. Hey, good morning, guys. Great job. Congrats, Joe. I'm wondering if you're getting your retirement home in Cleveland. Believe it or not, yes. And we'll see you around the stop and grab a boy. Good, good. We'll go, beer.

That's very helpful. Thank you and just my quick follow up is I know, we're up on time, the price mix tailwind to ebay contour quantified it for this year.

Just sort of fourth quarter, and we think it's about 50 million or so tailwind is that roughly the order of magnitude and then do we assume that that's sort of a good.

Alok Maskara: Just, you know, Alok, I want to go back to pricing. You made some comments at a conference, you know, kind of 15% price. I think Kerry was out with similar comments. Just maybe walk through your confidence and being able to kind of realize those. And then it seems like year one is maybe more around refrigerant inflation, which we're not seeing yet. Just any feedback on kind of where refrigerant prices go from here.

Run rates into early next year.

Well, that's the guide that we have right now, we'll see where the final results come in it yet you need to remember that commercial last year, we had a lot of price increases that we started to get in Q4, So you're lapping some pretty big comps and of course, which is why it drops off a little bit in Q4, but yeah. We should retain that and then you'll get a carryover price benefit next year for the residential.

Alok Maskara: Yeah, so I think, first of all, we are pleased that the numbers we gave are similar to what the peers are giving. And we remind just a reminder to others who may be less familiar because those numbers were over two years. Right. We said starting 2023, aiming in 2025. We think there's a pricing opportunity in that range over two years. First year, yes, there is a refrigerant. Now the spot pricing on 410A goes up and down a little bit.

Strategic pricing that we did in June so that would be on top of any price increases we announced that effective January one that will come out in the next month or so.

Great. Thank you.

Yes.

We'll take our last question from the line of Tom corner with TD Cowen. Please go ahead.

Hey, Good morning, I Hope you can hear me can you hear me guys.

Yes, we can hear you think you got terrific alright, well first congratulations Joe and Michael I appreciate that all of your help over the years Joe.

Alok Maskara: But keep in mind that the production quota has not been reduced yet. That gets into reduction, starting 2024. So we still expect refrigerant price to go up. And all indications based on conversations with suppliers is that it well. So that will force everybody to do price increases, including us. So we are monitoring that closely and no change in our outlook yet. In addition, as we go further into the year and we think of the new rep for this entire efficiency, the cost of sensors, that outlook has not changed either. So while you can never be certain and we'll get more into this in early 2024, Jeff, I can all view point on that has not changed.

Wish you well thank you.

A lot of questions have been asked and answered, but I was curious.

Some companies have remarked that there has been evidence of trading down if you will repair over replacement and.

In North American Resi HVAC have you seen any evidence of that.

Sales in the third quarter.

Well Gautam I'll take that you know it's unclear now our exposure to repair is much lower than some of the other players in the industry as you know.

So we have read the transcripts and we have gone through the same earnings and that does cause.

Cause us some concern, but when I look at our own results and what we're hearing from our owned dealers. We don't see that so I mean I've read the same thing and makes us a little cautious as we look at.

Alok Maskara: Okay, great. And then just the mix on Rezi continues to be impressive. I'm just wondering how much is just straight-seer change versus consumers mixing up. Or I know supply chain was an issue on the higher end stuff. And then just on, you know, share gain. I mean, it's obviously some noise with destocking and everything, but it seems like, you know, some share pickup and in the residential business. Maybe where do you see that coming from?

They can guide going forward and making sure we continue to train our dealers.

To inform the consumer and make a very informed sale.

At the end of the day.

Right. So refrigerant keeps going up with it's not 'twenty, two or four penny as cost of repair keeps going up and the fact that the new units come with full warranty and are thinking of or better in terms of efficiency.

Alok Maskara: On the mix, Jeff, as a reminder, like, you know, last year we talked a lot about mixing negative. So remember, a mix has been negative for the past two years. A lot of it was semiconductor driven as we didn't have the chips for the high end products, which uses a lot more chips. So that has reverted itself. You know, we are selling a lot more of the premium products. I think it's part of pricing excellence that team is doing a really good job driving the right mix as we go into larger accounts and running the appropriate promotion.

Or do they do the right thing and educating the consumers around it.

So what we have read the same things.

We have not heard back I've seen that from a channel on our dealer base yet but.

But we are going to keep a close eye on that phone got them.

Okay.

And you know just to reconcile the comment.

You made the Steve on book to Bill and then earlier on productivity and.

Within the commercial business it sounds like.

Alok Maskara: Alliance, that would promote higher mix. The incentive structure helps as well because a lot of the government incentives and rebates come only at higher efficiency products, not at a lower level. And then, of course, there's the pure serious change, which we called out early. I think that number has not changed, but I think the upside in the mix more from all the other factors, mostly on selling higher and premium products. [inaudible] it's just, you know, it's just, you know because it looks like what's implied is a larger than normal sequential step-down.

I'm just curious at what level of backlog or are you kind of operating off of this at this point because it sounds like how do you have capacity to do more you would have shipped more.

Yes, I'm just I'm curious like how much out of the next quarter or two is actually visible to you in terms of demand.

So I think we and maybe the tone backlog is used differently by different company.

And when we think of backlog it's for US orders that are used in the system right confirmed and then there's pipeline pipeline, we could be having discussions with the customer and getting the commitment about shipments in 2025.

Those are not confirmed.

System.

So our pipeline visibility is much higher and we can see that like you know through next 12 to 18 months, but there is a conversion drop out in there. So we can be 100% sure.

What would be 100% shows our backlog would typically be booked and shipped within the same quarter.

Enduring supply chain disruption it became more than one quarter and now we are back to sort of within the quarterly range and.

And we don't want to get into the situation, where we start publishing backlog numbers, because it's really not that relevant to our business.

It is all within the quarter. So that's the comment on the backlog that I, specifically mentioned and I'll just add to that it'll be even less important its boot barn in March surplus that is really fast backlog activity.

Yeah.

Yeah, and just maybe last one for me on that productivity journey at the commercial facility.

In Arkansas like how far along are you in that journey are you.

Kind of where you expect to be and I'm just curious like how much headroom is actually left in terms of throughput.

The supply chain has gotten better and the like.

How much upside do we still have.

Yeah.

There is upside remaining and I think some of that has to be captured after the second factories online I mean right now we are still running at a.

Quoted earlier, sometimes it's bandaid in tweaks I'm going to be a pretty new management are great leaders, we have car Saar that labor issues. So there's a lot of good things going on there.

But from a lean operations perspective and to be able to run our factories.

Consistent outboard very low defect rates very little rework, we have significant room for improving.

Productivity net factory a lot of that.

It's happening, but a lot more will happen as we get a second factory online and.

And not run the factory up I'll start off and all that.

He has been on what we think it's capable of so some of that will happen only after the second market comes online.

And we'll keep working through that.

Great well, thank you very much guys.

Thank you.

Thank you for joining us today since there are no further questions. This will conclude Lennox. This third quarter conference call. You may disconnect your lines at this time.

Hum.

Yeah.

Alok Maskara: Is there anything within residue that's adding any kind of abnormal pressure or statistical seasonality? We'll have a little bit of headwinds from absorption. Did you saw in Q3, we started to ramp down our inventory levels. We had some absorption headwind and Q3. We'll see some more of that in the Q4s. We get the inventory level to where we want to be. And Maximiser Cash will this year. The next year, we'll start to grow in the tours again as we transition to the new refrigerant product and get the absorption benefit back next year. Okay, and so when we think about the third quarter, fourth quarter, this margin move, a bigger impact on resident and what we would see on commercials that are reasonable. Yes.

Yeah.

Yeah.

Okay.

Yeah.

Yeah.

Jeff Hammond: Okay, great. Thank you and congrats both Joe and Michael.

Okay.

[music].

unknown: Great.

Brett Lindsay: Our next question comes from the line of Brett Lindsay with Muvuo.

Brett Lindsay: Please go ahead. Good morning and congrats to Joe and Michael. I wanted to come back to price and understandably there's a lot of moving pieces on the regulatory in terms of price mix and everything and resi. But thinking more broadly to commercial, I guess as your lead time and your ability to serve does improve here. Does it give you an inherent price entitlement and how should we think about that as we flip the counter here?

Hum.

[music].

Okay.

[music].

Brett Lindsay: You know, this is a look, I don't know if it gives us any additional price entitlement that we have today. So we have done better at getting key account pricing that had been stuck with contracts in the past. We have done better at driving mix appropriately, so getting out of lower margin products and focusing on capacity on the higher margin. Business where we have a kind of appropriate advantages in terms of both price and performance.

Brett Lindsay: As we roll into 2024, we can be on the fourth day and a pricing impact that we talked about earlier and towards the tail end of the year, the new 454 units. I don't think there's anything incremental beyond those two that we already talked about and getting into there. You know, a lot of the catch up on national account and commercial was done this year, and I wouldn't expect another catch up next year. Okay, got it. That's helpful.

Brett Lindsay: And then just to follow up on commercial was hoping you might be able to provide a little bit of context on the individual vertical performance within that business. I think you noted last quarter, there is a gradual improvement within emergency replacement as you, you know, rigging your footing there. But did that continue into Q3 and then any, you know, any color in the individual verticals there? Same trend as Q2. You know, I mean, some things like schools are always seasonal, so you will see that failing off in Q3 compared to Q2.

Brett Lindsay: As most of those statements happen in summer, but beyond that, no specific trend and continue to make, you know, in roads, I would call it into emergency replacement, but you know, continue to maintain our key account volume. And beyond normal seasonality, nothing else specific to point out. Okay, got it. I appreciate the answer.

Dean Dray: And our next question comes from the line of Dean Dray with RBC Capital Markets.

Dean Dray: Please go ahead. Thank you.

Dean Dray: Good morning, everyone. Good morning. Hey, maybe we can circle back on the Reggie D stocking this quarter, you said it was decelerated. So it seems to mostly have played out. Would there been any surprises from your perspective? You know, not really big surprises. I mean, sometimes when we look at the overall industry numbers, months to month, I think there are some months where we thought it was really better, some months away worse, but net net, not that many surprises, Dean, because I think overall it's turning out very much exactly as we thought it would be in terms of when it would end.

Dean Dray: Now, you know, I think there's different dynamics between independent distributors and large organized distributors. And just keep in mind is our focus and our exposure is largely to independent distributors versus large organized distributors. For us, it's played out very similar to what we thought it would.

Joe Reitmeier: Great. And I appreciate the early look on some of the 2024 dynamics was hoping you could expand on the free cash flow implications. Just you know, can you size what that temporary working capital bill might be and when might that get work down? We're still formalizing all the plans, but it might be maybe a one for some of sales. It's mostly related to the commercial businesses. We wrap up the factor we're going to need additional raw materials.

Joe Reitmeier: Might have a little bit of pre-build on the commercial side with the Ford and the equipment since the manufacturing day cutoff is at the end of the year for all of that package. So that's really where most of that growth is going to be. And then in addition to that, we'll have some higher or elevated capital expenditures going into next year as we finish up the factory and finish up the transition of the commercial factor and finish up the investments we need to make to transition our factories to the 454B product. So the capital bill elevated maybe kind of 150 million on that for next year as well. And then you ask about going off that working capital. That will take place over 2025.

Joe Reitmeier: Great. Thank you and congrats to Joe and Michael. Thank you.

Gautam Khanna: And our next question comes from the line of Gatam Kana with TD Cowan. Please go ahead. Please check your mute button. I'm not able to hear you. Gatam, is your mute button undone? I think Gatam moved down and the cues and maybe go to steep next.

unknown: Go to the next question. Okay, one moment please. Deep two, so with JP Morgan, please go ahead. Hey guys, thanks for taking the question. Hi, good morning, Steve. Congrats to both of you. For sure, Joe was a pleasure working with you. Always a tremendous great tutor. So I appreciate the work over the years. Thanks. So just on the commercial side, I mean, I know you guys are all putting up some really good numbers, carrier up, you know, 30% again this quarter or something like that.

unknown: You say orders are solid, like what is the, but the lead times are like, you know, 50 weeks at some point, which is almost even like a fake lead time to extend. What is the book to bill? What was the book to bill this quarter for that business as the backlog normalizes? It's the for us as we look at our business, we have very little orders that carry over beyond a quarter.

unknown: And when I'm in order, like booktaulder, some book to build ratio was extremely close to one, which is what it has been most of the time, except during really bad crisis. And the lead times for at least for us are no longer 50 weeks. No, lead times are now trending just around the quarter within a quarter and getting much, much closer to normal. Right. So you're saying that even when those lead times kind of stretched out, there was really no, there's really no backlog bill.

unknown: I mean, is that, is that what you're saying? I'm just having trouble reconfiling that because everybody else built a lot of backlog, obviously. So we did so if you'll go back to last year, right about the same time, we talked about our backlog and we had said that is unusual for us to carry so much backlog given the nature of the business. At this point, 12 years after that, we're saying that we still have backlog, but it's more in a normal level.

unknown: It's no longer an elevated backlog, but our book to bill. So we have essentially shipping as much as we are booking at any given time, so that's close to right. Okay, got it. And then just on the pricing side, you guys have talked about that kind of mid-seize and price adjustment for some of the Rezzy customers. Your pricing was kind of consistent, 3Q to 2Q. Can you maybe just talk about how that played through?

unknown: I know that maybe a little bit of a tougher comp versus last year, but maybe just some color on that, how that played through. Yeah, I think what you saw on Q2 is that we still had some benefit of lapping some prices in Q2, and by Q3, we've fully lapped all that benefit, but we picked up the incremental strategic pricing in Q3. So that's where we'll start to see that the normal ones for the rest of the year, but yeah, we did see a good pricing on the strategic pricing initiative we launched in June.

unknown: Okay, and then one last question on pricing for next year. I know you said the, you know, the double digit over a two-year period. I'm not sure if that meant, you know, like mid-singles and 24 and mid-singles and 25. Maybe just a little bit more clarity on how you see that breaking out between 24 and 25. In a state that's still a bit TBD, but you know, we're in October, as we go into price increases, we were a greater clarity in a couple of months because a lot of moving pieces, including cost of refrigerant sensors, where the, you know, overall situation is in different manufacturing costs as well, because we haven't even made, you know, any measurable quality of the new product.

unknown: So we'll be able to give you much more defined view of that when we announce Q4 results only next year. Right, and no investor day, right? Obviously, in December. That's right, no investor day. Okay, thanks a lot, guys. Good luck.

Operator: Once again, if you would like to ask a question, please press the star and one on your touchstone keypad.

Julian Mitchell: We'll take our next question from the line of Julian Mitchell with Bart, please. Please go ahead. Thanks very much and congratulations to Joe and to Michael. Maybe just a first question, commercial margins are not a particularly original topic, but if we think about what you said more like earlier on this call, I think it's that, you know, the sort of firm wide operating margin looks like it's down, maybe two, three hundred basis points, sequentially in Q4, and commercial is down sort of less than that and resi down a little bit more.

Julian Mitchell: So we have that sort of jumping off point of, you know, commercial margin of, you know, sort of 22% or something for the year, a little bit more than that. When we look at next year, the sort of puts and takes of all your color, we assume kind of fairly normal commercial operating leverage.

Alok Maskara: You have the sort of the balance of the tailwind from volume and price mix and then the headwind from the new plant ramp up is that maybe just confirm that that thought process for Q4 next year's roughly correct. Julian, I'll start and then Michael will continue, but I just want to start by reminding that we don't really get segment margin targets by quarter. And in part of it, we just do small for that in terms of there's always puts and takes, I think when we give guide, we look at the company overall. And having said that, I'll go to Michael who can get to the details of margins expectations and pluses and minuses both for Q4 and for next year.

Michael Quenzer: So maybe what I'll just talk about next year first, I think that's mostly our focus at this point is. So what we'll see next year is that the margins that are in our panel currently will retain next year will want to price to maintain those as costs come in specifically on the components and and some of the 410 a refrigerants to maintain those margins. And then on top of that, we see volume growth.

Michael Quenzer: We'll get 30 plus percent incrementals as we get some additional volume out of that second factory net markets or ourselves. So you'll see that help lift up some of the operating margins offsetting that there will be some of the ones that we have in the factory, the new factories we ramp those up. That's kind of our early thinking right now, but overall structure of the margins you see in 2023. We think we'll repeat next year. That's very helpful. Thank you.

Julian Mitchell: And just my quick follow-up is in a word up on time. The price makes tailwinds a bit, you know, you've quantified it for this year. Just sort of fourth quarter, everything hits about 50 million or so tailwind. Is that roughly the order of magnitude? And then do we assume that that's sort of a good run rate into the next year? But that's the guy that we have right now. We'll see where the final results come in.

Julian Mitchell: If you need to remember that commercial last year, we had a lot of price increases that we started getting Q4 series. We'll happen to pretty big comms in commercial, which is why it's off a little bit in Q4. But yeah, we should retain that. And then you'll get a carry over price benefit next year for the residential strategic pricing that we did in June. So let it be on top of any price increase. We announced effective January one that will come out in the next month or so. Great. Thank you.

Gautam Khanna: We'll take our last question from the line of Gautam Khanna with TD Cowland. Please go ahead. Hey, good morning. I hope you can hear me. Can you hear me, guys? Yes, we can hear you. Thank you, go. Oh terrific. All right.

Gautam Khanna: Well, first congratulations, Joe and Michael. I appreciate that. All your help over the years. Joe and wish you well. Thank you. A lot of questions have been asked and answered. But, you know, of course, some companies have remarked that there's been evidence of trading down, if you will, repair over replacement in North American Rezzi HVAC. Have you seen any evidence of that in your sales and the third quarter? Got on my take that, you know, it's unclear.

Gautam Khanna: Now, our expulsion to repair is much lower than some of the other players in the industry as you know. So, you know, we have read the same transcripts and we have gone through the same earnings and that does cause us some concern. But when I look at our own results and what we're hearing from our own dealers, we don't see that. So, I mean, I've read the same thing. It makes us a little cautious as we look at the guide going forward and making sure we continue to train our dealers to inform the consumer and make a very informed sale.

Gautam Khanna: But the end of the day, as price of refrigerant keeps going up, whether it's not 22 or 4.10. As cost of repair keeps going up and the fact that the new units come with full warranty and are like, you know, better in terms of efficiency. You know, our dealers do the right thing to educating the consumers around it. So, but we have read the same things. We have not heard that or seen that from our channel or our dealer base yet. But we're going to keep a close eye on that from bottom. Okay.

Alok Maskara: And, you know, just to reconcile a comment, I think you made the Steve on book to Bill and then earlier on productivity and within the commercial business. It sounds like I'm just curious what level of backlog are you going to operate enough at this point because it sounds like as you had capacity to do more, you would have shipped more. Yeah, just I'm curious like how much the next quarter or two is actually visible to you in terms of demand.

Alok Maskara: You know, so I think we, and maybe the term backlog is used differently by different company. I mean, when we think of backlog, it's for us orders that are peos in the system, right? Confirm. And then there's pipeline pipeline. We could be having discussions with the customer and getting their commitment about shipments in 2025, but those are not confirmed PO in our system. So our pipeline visibility is much higher and we can see that they can go through next 12 to 18 months, but there's a conversion dropout in there so we can be 100% sure.

Alok Maskara: But we are 100% sure is a backlog and typically we book and ship within the same quarter and during supply into disruption, it became more than one quarter and now we are back to far off, you know, within the quarterly range. And we don't want to get into the situation where we start publishing backlog numbers because it's really not that relevant to our business. It is all within the quarter. So that's the comment on the backlog that I specifically mentioned. And I'll just add that it will be the less important as we move more in emergency or less, and that is really fast backlog act.

Michael Quenzer: Tiffany? Yeah, just maybe a lesson for me on that productivity journey at the commercial facility in Arkansas. Like how far along are you in that journey? Are you kind of where you expect to be? And I'm just curious, like how much headroom is actually left in terms of throughput and as the supply chain's gotten better and the like, you know, how much upside do we still have? There is upside remaining. And I think some of that has to be captured after the second factories online.

Michael Quenzer: I mean, right now we are still running it as I called it earlier. Sometimes it's bandaid and twigs. I mean, we have put in new management, create leaders. We have got solved our labor issues, but there's a lot of good things going on there. But from a lean operations perspective, and to be able to run a factory with you know, consistent outboard, very low defec rates, very little rework. We have significant room for improving productivity in that factory.

Michael Quenzer: A lot of that is happening, but a lot more will happen as we get the second factory online and not run the factory above sort of, you know, where it's capacity has been or what we think is capable of. So some of that will happen only after the second factory comes online, second will keep working through that. Great.

Operator: Well, thank you very much, guys. Thank you for joining us today. Since there are no further questions, this will conclude Lennox's third quarter conference call. You may disconnect your lines at this time.