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. I would now like to turn the conference over to Chelsea Polshin from the Lennox Investor Relations Team. Chelsea, please go ahead. Thank you, Chelsea. 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 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, as outlined on this page. We may also refer to certain non-GAAP financial measures 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 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 dot lennox dot com. You can also find the press releases for our CFO transition and AES acquisition on the investor relations website. Now, please turn to slide three as I turn the call over to our CEO, Alok Maskara. Thank you, Chelsea. Good morning, everyone. I am proud to report that this has been another record quarter for Lennox, 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 Lennox'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 entrusting Lennox to provide top-tier innovative products and solutions. Now, let me transition into an overview of this quarter's highlights. Lennox'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. Our operating cash flow of $313 million was up 83% year-over-year. Additionally, earlier this morning, we announced Joe Reitmeier's 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 planned transition. 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. 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'd like to express my sincere gratitude for his remarkable 18-year tenure at Lennox. Under his leadership, the company achieved 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 succession plan, we expect a smooth transition as Michael Quenzer takes on the role of chief financial officer, effective January 1, 2024. Michael joined Lennox in 2004 and has been a key contributor to Lennox's strong financial performance. 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. Please join me in congratulating both Joe and Michael. Now, please turn to slide five for an overview of the AES acquisition. We are pleased to welcome AES customers and employees to the Lennox 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, Lennox's existing national account service team is focused on preventative maintenance and energy monitoring services. Our new acquisition is centered on turnkey installation, accessories, as well as refrigerant reclaim and recycling. The combined portfolio will allow us to serve our customers more holistically, ensuring that all their needs are met by Lennox. Additionally, it enhances our cross-selling 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 lifestyle decommissioning, including refrigerant reclamation and material recycling. For example, a commercial customer can purchase rooftop equipment from Lennox, utilize AES installation services, use us for maintenance and monitoring, and leverage our reclaim and recycling services at the end of equipment life. By offering these 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 curb adapters. By manufacturing curb adapters in-house, we will be able to generate cost efficiencies, increase 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 adds installation capabilities to our industry-leading preventative maintenance services, provides new services such as refrigerant reclaim and material recycling to support product lifecycle decommissioning, and increases the sales of parts and accessories. Now, let me hand the call over to Joe, who will take us through the details of our Q3 financial performance. Thank you, Alok, and good morning, everyone. Please turn to slide six. As Alok mentioned earlier, the company posted strong revenue and earnings growth. Our core revenue, which excludes our European operations, was a record $1.3 billion, up 10%, where price and mix drove significant year-over-year improvement. Adjusted segment profit increased $62 million, as $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. And 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, or the third quarter, achieved record levels of revenue, segment profit and adjusted earnings per share. Adjusted earnings per share grew by 30% to $5.37. Our third quarter tax rate of 25.6% 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 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%, our direct-to-contractor sales volume increased mid-single digits, reflecting healthy end markets and ongoing market share gains. 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% to $181 million, and segment margin improved by 183 basis points to 20.2%, driven primarily by price and mix, and partially offset with lower volume, higher incentive compensation, and inflationary effects on wages and distribution. 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%. 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 a $47 million increase in profit for the quarter. Increased factory productivity has 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, compared to $171 million in the prior 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 in this investments, like our new commercial manufacturing facility in Mexico, driving industry-leading innovation and exploring potential bolt-on acquisitions like AES. 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 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 $17.75 per share. We are also increasing our free cash flow target to a range of $350 million-$400 million. Our guidance for capital expenditures is unchanged from our prior guide at $250 million, and this includes our investment in the new Saltillo factory and refrigerant transition-related investments. Price and 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 manning, managing SG&A expenses, while also making necessary investments in the business to support growth, promote the development of our innovative products and solutions, and improve overall productivity. 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 Alok. Thanks, Joe. 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 Lennox'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. We also made strides in simplifying our already strong balance sheet. In September, we issued $500 million of senior unsecured 5-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 introduced a commercial paper program. With these changes, we have lowered our financing cost and created additional liquidity. Now, please turn to slide 12, where I will provide an initial assessment of 2024 business conditions. 2024 will be another transformative year for Lennox 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 tailwinds and headwinds that are likely to impact industry demand. 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 to 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. We continue to monitor demand changes related to the impending refrigerant regulatory transition in 2025. There's 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. In terms of headwinds, 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. 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 R-410A refrigerant. Towards the end of 2024, we will start experiencing additional price and mixed benefits, driven by the higher cost of R-454B units that require new sensors, control boards, and more advanced heat exchangers to maintain energy efficiency ratings. We forecast additional manufacturing productivity due to higher absorption and fewer supply chain constraints. These drivers will be partially offset by ongoing inflation, ramp-up costs for the new commercial factory in Saltillo, 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 margins. We plan to provide our 2024 financial guidance when we report our fourth quarter earnings early next year. 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 investments to enhance our go-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. Third, we deliver consistent execution through utilization of our balanced scorecard-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 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 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. 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 the 280 AES employees to the Lennox family. I am excited about what the future holds for Lennox, as our best days are still ahead of us. Thank you. Joe, Michael, and I will be happy to take your questions now. Carrie, 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. We'll take our first question from the line of Jeff Sprague with Vertical Research Partners. Please go ahead. Thank you. Good morning, everyone. Joe, we're gonna miss you. I think it was you, me, and LeBron from Akron, so you know, we're gonna be down to two now. But- Yeah, I appreciate you. Thank you. Thanks for all the help. Yeah, thanks for all the help over the years. Hey, look, thanks for the early view into 2024. I wonder if we could just drill a little bit more into the transition itself. Just thinking about the, you know, the timing of all this, 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 PNL 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 headcount and 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, 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 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. Most first half of the year is gonna be kind of that, that cost and efficiency getting better in the second half. 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 mix benefits. Most of the price mix benefits for refrigerant transition is likely to be in 2025, but we'll start seeing some of that towards the tail end of next year. Thank you for that. And maybe just as a follow-on comment here, just thinking about the commercial margins, obviously, just a very positive story here in 2023. 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 a, you know, some color on what you'd expect in Q4 and commercial price cost mix and how that bridges to a margin expectation there. Yeah, naturally, our Q4 has a little less volume in it seasonally. It drops down a little bit, but as we look to our backlog, the margin in the backlogs still supports the margins that we saw in Q3. So pricing still remains to hold there well, as well as the mix dynamic is positive. So we see that continuing 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. Now it's about maintaining those margins going forward as we start to see costs for refrigerant and some of the new 454B cost additions that we need to do. Great. I think, Jeff, on the guidance perspective, I mean, I just wanna 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 I just wanna remind that, like, you know, while we made good progress in the factory, there are still. Feel like you're playing whack-a-mole sometimes with supply chain, with production output. We 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. We'll take our next question from the line of Chirag Patel with Jefferies. Please go ahead. Thank you. Just wanted to also thank Joe for his time and patience with us over the years. And Michael, look forward to your continued insights in the new role. Congratulations. Just one thing I wanted to kind of hit on was on the acquisition side. Any sort of thoughts on, you know, seasonality of that business, if there is something, if it doesn't match up with where commercial is currently? And then we talked about being accretive to earnings. Just wanted to also get a sense for how that margin profile kind of works. Will it be at the similar level that we're seeing here in commercial currently, or is there maybe a little bit of a dilution to that in the near term? Sure. Thanks, Chirag. 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 services, it's gonna be very similar to the rest of the Lennox business. So I wouldn't expect anything materially different compared to the rest of the business. The same comment also holds on the margin. The margin on par would be same as the rest of Lennox, neither accretive nor dilutive to us as 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 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. And then, I guess, on the commercial side, we talked about 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 markets themselves, are you seeing any sort of softness or weakness in any of the various markets you serve? Is there a specific area that may be moderating, just given the current macro environment that's out there? Anything that you can help us with in understanding that a little bit 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 buildings 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 as lead times are going back to more normal levels. But from a core demand perspective, we're not 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 the time. We'll take our next question from the line of Nigel Coe with Wolfe Research. Please go ahead. Thanks. Good morning, guys. Nice quarter. So the net material inflation now, I think, looks flat. So I think, prior, you were looking for, I think, commodity costs, $35 million of deflation, offset by component inflation of, I think $90 million, if I'm not mistaken. How does—if, if we break out that gap between the components and the commodities, how does that look? Is it mainly steel price deflation coming through on the commodities? I'm just curious how that bucket looks. Yeah, what we've seen is the commodities guide about favorable. We saw steel year to date favorable. And for the rest of the year, we think commodities are gonna be pretty flat, so we don't see a lot of benefit in the commodities in the fourth quarter. You'll see it continue to headwinds a little bit on some of the material costs in Q4, but it's not as significant as we previously thought under our last guide. So that's really where the big change is, is that a little bit less expected 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 then carry that through into 2024, obviously, with the hedges, you've got some visibility there. How does that look in 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, in the first half for the aluminum. Aluminum, we spend more on that than copper. And then steel, 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. And then just a quick one, but if you bear with me on the refinancing, 'cause I think, Alok, you mentioned lower financing costs with the refi. I think it was $500 million at 5%, replacing $350 million at 3%. So just wondering how the mathematics work there. Sure, I'll take that. I mean, I think if you look at it 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 costs were higher. But from a pure interest rate perspective, you're right. I mean, the new bonds are at a higher interest rate than the bonds that are expiring. But as you look at the whole package together on what we are paying for secured financing versus the benefits of commercial paper, you know, items in our control would now be at a lower cost versus otherwise. Okay, I'll take it into that. And, Joe, congratulations. Michael, congratulations. So I'll leave it there. Thanks. Thanks. 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 you both lots of luck. You know, peers are sounding like they may expect a richer mix of the low GWP products next year, just based off of the installation requirements under the EPA rules that recently came out. Are you thinking similarly? Could there actually be a stronger front-loaded pre-buy of R-410A? Just your thoughts on how the rules impact you know those considerations for next year. Sure. I mean, the rules are still a bit in 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 mixed benefits for the new refrigerants? Absolutely. Is it gonna be early next year? We don't know. We think it's likely gonna be more towards second half of next year as the transition starts ticking forward. But what we know for sure is given our preparation, which we think we are at or ahead of others in terms of preparations, given our direct-to-dealer model, and given that our indoor units are compatible with our outdoor units 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 the transition. We are ready for the change, and we feel we're gonna 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, Alok. I'm pleasantly surprised to hear that the margins on the AES acquisition are comparable, you know, to the commercial or to the Lennox average, just given that that's what appears to be largely an installed 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, so the financial profile, as you said, is similar to the 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 our own curb adapters. So it was really a very, very good fit with the gaps in our portfolio. 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 service well. While the, like, you know, financials are small, we are just super excited about the strategic fit and where this business is gonna go, including the synergies that we can gain out of this business. Okay, appreciate that. Thank you. 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. Thank you. So maybe my first question, can we just focus on resi volumes for the quarter? Nice to see the decelerating trend this quarter. Curious, can you maybe just kind of parse that out? What'd you see specifically in your independent distribution channel versus, you know, selling direct? Yep. So the independent district distribution, we saw volumes down kind of mid-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 improve, so that's a good sign that the destocking is ending on the coil side. So you'll see kind of mid-teens on the independent district distribution. Got it. And Michael, what's kind of like the expectation then for Q4 on the independent distribution side? Overall, we're guiding to kind of a flat volume for Q4. We think it'll be down a little bit. There's 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, offsetting that. Okay, cool. And then I guess just thinking about 2024, we appreciate the comments you've already made on commercial margins and the plants, 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, yet the margins are, you know, have been really, really good. So I'm just curious, like, how do you kind of, how do we level set, like, what the margin profile for the commercial business, you know, should be or could be in 2024? Sure. Let me take on that. So, you know, as we look at the commercial business, we're very pleased with the progress. And as a reminder, we are sort of ahead of where we had communicated and expected, and we have delivered over $100 million in EBIT improvement even before Q3. 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, our factories are running much better, getting us greater output and giving us more of the products that we can get margins on. So then what it does is, sets us up really nicely for 2024. Even though we are gonna have a one-time cost for factory startup, and we'll be putting, like, you know, extra labor, extra costs before we start production, we think going into 2024, you know, we are not gonna be degrading margins in commercial throughout the year. So I think we are set up for long-term success. Second factory gets us more volume at similar margins, 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. Thanks, guys. We'll take our next question from the line of Ryan Merkel with William Blair. Please go ahead. Hey, everyone. Nice quarter. Alok, 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. So, you know, it's been very similar. We said, even when we gave 2023 guidance, that we would expect destocking to essentially end in 2023 besides some furnaces, and that's exactly what we are seeing is, you know, destocking is scaling down. Some furnaces, as Michael mentioned earlier, are still in there. 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 resi 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 online. 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 then a question on commercial for 2024. You mentioned pent-up demand. I'm just curious, you know, how much visibility do you have? Do you have backlog through, you know, the first part or the first half of 2024? Just any commentary on sort of your confidence in that part of the business. You know, I mean, we are not in the long lead backlog type business, so, I mean, within a quarter, we'll typically book and ship. When we end a quarter, we might have 6-8 weeks of backlog on the books. So no, from a booked 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 Lowe's, Walmart, others, is much higher than what it should be, which means they're paying more for repairs than they should, and a new unit may have a much quick payback compared to in the previous times. Those conversations all make us feel confident, but we'll get more into this when we announce Q4 results in early 2024. Got it. Thanks, and best of luck, Joe. Appreciate it. Thank you. Thank you. Our next question comes from the line of Jeff Hammond with KeyBanc. Please go ahead. Hey, good morning, guys. Hey, Jeff. Morning. 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 stomping ground at some point, so. Good. Good. We'll grab a beer. Just, you know, Alok, I wanna, I wanna go back to price, and you made some comments at a conference, you know, kind of 15% price. I think Carrier was out with similar comments. 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, like, you know, the numbers we gave are similar to what the peers are giving. Just a reminder to others who may be less familiar, because those numbers were over two years, right? We said starting 2023, ending in, like, you know, 2025, we think there's a, like, you know, pricing opportunity in that range over two years. First year, yes, there is a refrigerant. Now, the spot pricing on R-410A goes up and down a little bit, 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 will. 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 refrigerant, higher 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, like, early 2024, Jeff, like, in our viewpoint on that has not changed. Okay, great. Just, you know, the mix on resi continues to be impressive. I'm just wondering how much is just SEER, straight SEER change versus, you know, 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. I mean, it's obviously some noise with destocking and everything, but it seems like, you know, some share pickup in the residential business maybe. Where do you see that coming from? Sure. On the mix, Jeff, as a reminder, like, you know, last year we talked a lot about our mix being negative. So remember, our 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. Like, you know, we are selling a lot more of the premium products. I think as 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 a 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 the lower one. And then, of course, there's the pure SEER change, which we called out early. So I think that number has not changed. But I think the upside in the mix is more from all the other factors, mostly on selling higher-end premium products. And then just, you know, kind of around share gain? You know, on share gain, I like to look at it over as a 12-month period. I mean, right now, because of destocking, our direct business clearly shows very good share gains. We think some of it's artificial and will go away as destocking ends. We are confident some of it's real and will stick around as, like, in the dust clears 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 settle in by next year. But 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 scores that we are getting. You know, our customer satisfaction had dipped, but as I look at NPS scores, we are back to regular, 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 just to settle before we kind of, you know, claim that to be a win. Okay, great. Once again, if you would like to ask a question, that is star one on your touch tone keypad. We'll take our next question from the line of Joe O'Dea with Wells Fargo. Please go ahead. Hi, good morning. I just 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 the setup for 2024. Maybe some kind of comp benefits with a little bit of absence of destock, but then other factors you're considering, kind of how you're thinking about that volume algorithm. Yeah, that was the main one that you just touched on, the absence of the destock. That's obviously gonna 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, you know, the economy to continue to grow at a low single digits GDP. With that, we see the replacement market continue to expand. We'll get some volume there, potentially some share gains as well in residential. 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. We're gonna continue to see that grow. As we talk with national accounts, they have big planned replacement programs going for, you know, several years to come, and we see that as a volume 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. Can you also touch on resi? Because it looks like what's implied is a larger than normal sequential step down. Is there anything within resi that's adding any kind of abnormal pressure versus typical seasonality? Yeah, 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 in Q3. We'll see some more of that into Q4 as we get the inventory levels to where we want to be and maximize our cash flow this year. Then next year, we'll start to grow inventories 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, kind of this margin move, a bigger impact on resi than what we would see on commercial, is that reasonable? Yes. Okay. Great. Thank you, and congrats, both Joe and Michael. Great. Thank you. Our next question comes from the line of Brett Linzey with Mizuho. Please go ahead. Hey, good morning, and congrats to Joe and Michael. Wanted to come back to, yeah, to price. And, you know, understandably, there's a lot of moving pieces on the regulatory in terms of price mix and everything in resi. But thinking more, you know, broadly to commercial, I guess, as your lead times and your ability to serve, you know, does improve here, does it give you an inherent price entitlement? And, you know, how should we think about that as we, you know, flip the calendar here? You know, this is look, I don't know if it gives us any additional price entitlement that we have today. So, like, you know, 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 business, where we have a, you know, appropriate advantages in terms of both price and performance. As we roll into 2024, like, you know, beyond the 410A 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 in 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. And then just to follow up on commercial, I 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, you know, regained your footing there. But did that continue into Q3? And then any, you know, any color on the individual verticals there? Same trend as Q2. You know, I mean, some things like schools are always seasonal, so you will see that tailing off in Q3 compared to Q2, as most of those placements happen in summer. But beyond that, no specific trends. We continue to make, you know, inroads, I would call it, into emergency replacement, like, 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 insight. 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. Morning. Hey, maybe we can circle back on the resi destocking this quarter. You said it was, it 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 month-to-month, I think there are some months where we thought it was, wow, way better, some months are way 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. Now, you know, I think there's different dynamics between independent distributors and large organized distributors. And just keep in mind that our focus and our exposure is largely to independent distributors versus large organized distributor. For us, it's played out very similar to what we thought it would. 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 build might be and when might that get worked down? We're still formalizing all the plans, but it might be maybe a 1% of sales. It's mostly related to the commercial business. As we ramp up that factory, we're gonna need additional raw materials. Might have a little bit of pre-build on the commercial side, with the R-410A equipment, since the manufacturing day cut-off is kind of at the end of the year for all of that package system. That's really where most of that growth is gonna be. 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 factory, finish up the investments we need to make to transition our factories to the R-454B product. So CapEx will be elevated, maybe kind of $150 million on that for next year as well. And then you ask about burning off that working cap. Well, that'll take place over 2025. Great. Thank you, and congrats to Joe and Michael. Thank you. Our next question comes from the line of Gautam Khanna with TD Cowen. Please go ahead. Please check your mute button. I'm not able to hear you. Gautam, are you-- is your mute button on done? I think Gautam, I think Gautam moved down in the queue, so maybe go to Steve next, go to the next question. Okay, one moment, please. Steve Tusa 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, it was a pleasure working with you. Always a tremendous straight shooter, so I appreciate the work over the years. Thanks. Thank you, Joel. 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, 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 for that business as the backlog normalizes? Hey, Steve, for us, as we look at our business, we have very little orders that carry over beyond a quarter, and when I mean order, like, booked order. So our book to bill ratio was extremely close to one, which is what it has been most of the time, except during really bad crises. And the lead times for, at least for us, are no longer 50 weeks. You know, lead times are now trending just around a 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 was really no backlog built? I mean, is that, is that what you're saying? No- 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 is unusual for us to carry so much backlog, given the nature of the business. At this point, twelve years after that, we are saying that we still have backlog, but it's more in the normal level. It's no longer an elevated backlog, but our book to bill, so we are 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 have talked about, you know, that kind of mid-season price adjustment for some of the resi customers. Your pricing, you know, was kind of consistent, 3Q to 2Q. Can you maybe just talk about how that, how that played through? I know that may be a little bit of a tougher comp versus last year, but, maybe just some, 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 that benefit, but we picked up the incremental strategic pricing in Q3. So that's where we'll start to see that normalize for the rest of the year, though. But yeah, we did see a good pricing on the strategic pricing initiative we launched in June. 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 in 2024 and mid-singles in 2025. Maybe just a little bit more clarity on how you see that breaking out between 2024 and 2025. You know, Steve, that's still a bit TBD. Like, you know, we're in October, as we go into price increases, we want a greater clarity in a couple of months because there are lots of moving pieces, including cost of refrigerants, sensors, where the, like, you know, overall situation is in different manufacturing costs as well. 'Cause we haven't even made, like, you know, any measurable quantity of the new product. So we'll be able to give you a much more refined view of that when we announce Q4 results early next year. Right. No investor day, right? Obviously, in December. 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 touch tone 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 a particularly original topic, but if we think about what you said, Michael, earlier on this call, I think it's that, you know, the sort of firm-wide operating margin looks like it's down maybe 200-300 basis points sequentially in Q4, and commercial is down sort of less than that, and resi down a little bit more. So we have that sort of jumping off point of a, 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, are we assuming kind of fairly normal commercial operating leverage? You have the sort of the balance of the tailwind from volume and price, mix, and, 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, Julian, I'll start, and then Michael will continue. But I just want to start by reminding that, you know, we don't really get segment margin targets by quarter. I mean, part of it, we're just too small for that in terms of there's always puts and takes. So I think when we give guide, we look at the company overall. And having said that, I'll go to Michael, who can get into the details of margins, expectations, and pluses and minuses, both for Q4 and for next year. So maybe what I'll just talk about next year first, so I think that's mostly your focus at this point is. So what we'll see next year is that the margins that are in our P&L currently will retain next year. We'll want to price to maintain those as costs come in, specifically on components and some of the R-410A refrigerants to maintain those margins. And then on top of that, we see volume growth. So we'll get, you know, 30%+ incrementals as we get some additional volume out of that second factory, and end markets are sold. So you'll see that help lift up some of the operating margins. Offsetting that, though, will be some of the headwinds that we have in the factory, the new factory, as 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 will repeat next year. That's very helpful. Thank you. And just my quick follow-up, as I know we're up on time. The price mix tailwind to EBIT, you know, you've quantified it for this year. Just sort of fourth quarter, are we thinking it's about $50 million or so tailwind? Is that roughly the order of magnitude? And then do we assume that that's a sort of a good run rate into early next year? Well, that, that's the guide that we have right now. We'll see where the final results come in. Yet you need to remember that commercial, last year, we had a lot of price increases that we started to get in Q4. So this year will have some pretty big comps in commercial, which is why it drifts 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 strategic pricing that we did in June. So that'll be on top of any price increases we announce, you know, effective January one, that will come out in the next month or so. Great. Thank you. Yep. We'll, we'll take our last question from the line of Gautam Khanna 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. Thank you, Gautam. Oh, terrific. All right. 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, I was curious. Some companies have remarked that there's been evidence of trading down, if you will, repair over replacement in North American resi HVAC. Have you seen any evidence of that in your sales in the third quarter? 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, 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, like, you know, 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, as price of refrigerant keeps going up, whether it's R-22 or R-410A, 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 of 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 gonna keep a close eye out on that for Gautam. Okay. You know, just to reconcile a comment I think you made to Steve on book to bill and then earlier on productivity and within the commercial business. It sounds like I, I'm just curious, at what level of backlog are you kind of operating off of at this point? Because it sounds like had you had capacity to do more, you would have shipped more. Yeah, just I'm curious, like how much of the next quarter or two is actually visible to you in terms of demand? You know, so I think we and maybe the term backlog is used differently by different companies. I mean, when we think of backlog, it's for us, orders that are POs in the system, right? Confirmed. 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, like, you know, through next 12-18 months. But there's a conversion dropout in there, so we can't be 100% sure. What we're 100% sure is our backlog, and typically, we book and ship within the same quarter. And during supply chain disruption, it became more than one quarter, and now we are back to sort of, you know, within the quarterly range. And we don't wanna 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. I'll just add to that, it'll be even less important as we move more into merge surplus, and that is really fast backlog activity. Yeah, just maybe a 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 and as the supply chain's gotten better and the like, and how much upside do we- You know- Do we still have? There is upside remaining, and I think some of that has to be captured after the second factory is online. I mean, right now we are still running it, as I called it earlier, sometimes with Band-Aid and twigs. I mean, we have put in new management, great leaders. We have got solved our 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 a factory with, you know, consistent output, very low defect rates, very little rework, we have significant room for improving productivity in that factory. A lot of that is happening, but a lot more will happen as we get a second factory online and not run the factory above, sort of, you know, where its capacity has been or what we think it's capable of. Some of that will happen only after the second factory comes online. Second, we'll, like, you know, 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's third quarter conference call. You may disconnect your lines at this time.