Lennox International Inc. (LII) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International 2020 Investment Community Meeting. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the conference over to Todd Bluedorn, Chairman and Chief Executive Officer. Please go ahead.

Good morning, everyone. It's good to be here with you today and share with you our thoughts on LII, even if it is virtual. Joining me today on the call are Joe Reitmeier, our Chief Financial Officer; and Steve Harrison, our VP of Investor Relations. Given the weather in New York today, I don't -- I would not have looked forward to fighting our way from midtown to LaGuardia, so maybe it's good that we're here. Secondly, with what we always do, a forward-looking statement. Just continue with the presentation. Three things I'd -- we'd like to do today: One is I'm going to lead off and do a quick business overview and get into some details of the initiatives within the segments. Joe is then going to follow me with a review of 2020 guidance and then give you the 2021 overview. And then finally, we'll open it up for Q&A at the end. The operator gave a quick overview of how to post the questions. I might encourage you to wait until we get a little further into the presentation and see if I don't preempt some of your questions. And I think 10 months into the pandemic, everyone understands how you post it. And then at the end, Steve will curate the questions. So let's go ahead and get started on the material. Those of you who are familiar with our story have seen this chart over the last decade or so. It's consistent, and it's a strategy that works. We're capitalizing on growth markets, the resiliency of the North America residential market really seen this year even in the face of a pandemic, and then a market bounce back in both our North America commercial and our Refrigeration business in 2021. Well positioned for margin expansion. Material cost reduction, another year planned for material cost reduction next year. Factory productivity of $20 million to include a new factory, our third factory in Saltillo that we've already broken ground on and will be completed next year. And then continue leveraging technology to drive leverage in our SG&A spend. Third is winning in the marketplace with investments in product and distribution. We're excited to be reinstituting our store growth strategy in 2021. We're going to be opening 30 new stores. Also a great year for new products. We're going to be launching a 28 SEER residential product line as well as our new Model L commercial rooftop, which will be the highest energy-efficient unit in the marketplace. And then driving shareholder value with disciplined use of free cash flow. We'll go back to growing dividends with earnings in 2021. And then after a hiatus because of the pandemic on the share buyback, we'll start the share buyback up, and Joe will get into some of the detail. But it's $400 million that we're indicating that we're going to do in 2021. Let's talk a little bit about the business. Again, a consistent chart, takes a look at the revenue on the left and segment profit on the right; residential in red, commercial in green, Refrigeration segment in blue. We're now, given the pullback in the commercial and refrigeration end markets and the growth -- continued growth in residential, we're now about 2/3 residential. And the balance of our business is commercial and Refrigeration. Our business mix. Again, we're primarily a North America business with almost 95% of our revenue. We're about 3/4 of our business, replacement, which obviously we like. And then, as I said earlier, about 2/3 of our business is residential. This is our standard chart that shows revenue and EBIT ROS on the left and free cash flow on the right. For 2019, we're also calling out a pre-tornado ROS number to allow for a better comparison to 2020 and 2018. Joe will be discussing the updated guidance for 2020 in a bit more detail later. But you can see on this page, it's a core EPS of $9.55 to $9.75; and our revenue the guidance, of a decline of revenue of 4% to 6%. You can also see our 2021 guide on this page. It's core EPS of $10.55 to $11.15. Well, you can see a revenue number of $3.8 billion on this page. Later, Joe will walk through the revenue guide of 4% to 6%. If you do all the math on the midpoint of these numbers, it will be revenue up 6%, return on sales of 90 basis points and an incremental drop through of 30%, in line with our traditional drop through performance. On the right-hand side of the chart, you see free cash flow. An outside performance in 2020, about 135% of net income, reflecting our focus on cash in a tough operating environment, combined with the natural reduction of working capital in down markets. In 2021, our free cash flow is forecasted to be $325 million, approximately 80% of net income, lower percent than normal for a couple of reasons. One is 50% of CapEx is tied to our -- about half of that $50 million is tied to our new Saltillo facility. And then about half of it is finishing the Marshalltown construction post tornado that got disrupted in 2020 because of the derecho. So about $50 million of that CapEx spend is more than normal. And as you might remember, the $25 million or so that we're spending on Marshalltown, we're using insurance proceeds to spend. And then the second major reason, along with that $50 million of additional CapEx, is we'll be reinflating working capital as we have revenue growth as an enterprise in 2021. Over a 2- year period, so between '20 and '21, about a little under 110% free cash flow as a percent of net income, and over a 6-year period, almost exactly 100%, which is our target. Material cost reduction, a major initiative across LII, as we talked about internally forever and ever amen. And as we spoke about multiple years, a couple of major prongs of our initiative: One is continued leveraging of low-cost supply base. Approximately half of our components are sourced outside U.S. and Canada. And extending the global supply chain and qualifying the best global suppliers are important to us. The tariffs were approximate cause, but we've continued to move out of China into Southeast Asia, India and Mexico. And we think this will continue to be the case. And even if the new administration revisits tariffs, we're going to continue to move from China to other low-cost sources. Second prong of our material cost reduction continues to be designing cost out of our products, a significant key enabler for us. We make continued investments in our capabilities to do that. And on the right-hand side of the page, you see some of the examples of designing costs out of things like variable speed drive technology and optimizing our combustion chamber designs. Joe will talk about it more when he gives the 2021 guide, but we're targeting $25 million of savings in 2021. Again, this is outside of commodities, which we'll talk -- Joe will talk about. But we expect commodities to be a $30 million headwind. And we expect our progress in material cost reduction to continue in future years. We continue to make significant investments in digital across our entire enterprise, and we leverage it across LII. Three broad areas that we focus on: e-commerce, controls and factory productivity. We continue to make investments in 2020, and we will in 2021. These investments continue to drive market share gains, supporting our dealer, contractor customer and margin expansion. And again, I will go into more detail a little bit later in the presentation. Factory productivity initiatives. 2021, we are targeting $20 million incremental EBIT from factory productivity initiatives across LII. Three buckets of focus area: One is Mexico expansion. As I mentioned earlier, we have started building a third factory on our Saltillo campus, approximately 325,000 square feet. We will be moving indoor coil production from our Grenada, Mississippi factory and also moving some sheet metal fabrication in-house. In 2020, while over 50% of our units were produced in Mexico, only approximately 40% of the residential production hours were in Mexico. When we're done with this, what we're calling building 3, we will be up to 50% of production hours in Mexico. This project is worth approximately $0.20 of EPS spread over 2021 and 2022. Automation. We continue to make automation investments in both fabrication and the assembly portion of our factories to drive down conversion costs. Information flow. Again, we continue to make significant investments to allow our team to see the information that they need to make the -- to manage the factories. All these are important factory productivity initiatives that will pay dividends in 2021 and beyond. As I mentioned earlier, 2021 is going to be a nice year for us for product innovation. First is residential. We call our top-of-the-line system, the Ultimate Comfort System. In 2021, we are making it even ultimate-r, if that's a phrase. In the second half of 2020, we launched our new SLP99 furnace, a 99 AFUE, that's a measure of efficiency, furnace, the most efficient in the industry as well as being a quiet unit -- quietest unit in the marketplace. In early 2021, we will launch our new top-of-the-line 28 SEER, 28-SEER air conditioner with variable capacity inverter compression, our new SL28XCV -- you can write that down, if you like. It will be our most energy-efficient and precise air conditioner in the market. In our commercial business, we will launch a new premium rooftop line up in late Q1 of 2021. The Lennox Model L rooftop line will redefine the premium segment with industry-leading efficiency, variable speed technology and a completely redesigned control system. All Model L rooftop feature the all-new Lennox core control system and service app that goes with it. The innovative unit controller drives advanced variable speed technology to maximize energy savings and space comfort. Premium diagnostic features reduce installation, service and maintenance expenses to provide the lowest total cost of ownership in the industry. The Model L will also have advanced IAQ package that will allow building owners to purify air, ventilate and control humidity better than any product in the marketplace. Also leading into IAQ. Just like our competitors who've spoken quite a bit about it, we have an industry-leading IAQ offering. Our Pure Air S is a residential filtration system with a filter that removes from the air over 99% of the virus that causes COVID-19 based on independent third-party testing. We also have a full line of residential IAQ products, include UV lights, humidity control and outdoor air ventilation. We did a little under $100 million in residential IAQ revenue, with only about approximately 25% of our new systems, new replacement systems, having an attachment rate of our IAQ product lines. So we see this as a continued growth opportunity. In October, Lennox Commercial introduced the Building Better Air initiative, which helps facilities evaluate the state of their HVAC systems by using IAQ surveying and create solutions tailored to the needs of the building. We have a full product lineup of high-efficiency filters, UV lights, bipolar ionization, energy recovery and dedicated outdoor units and humidity control. We work with our unitary commercial customers to meet their IAQ needs. Another area that I haven't traditionally talked about, and quite frankly, our competitors talk about it more than we do, is our position in ESG. And we think we're an industry leader. Over the last decade, we've made significant progress in our environmental sustainability initiatives. As you can see on the chart, a 69% reduction in greenhouse gases and a 32% reduction in energy usage, both adjusted for revenues, so volume adjusted. While at the same time, producing the most energy-efficient product line in the industry. As you can also see in the chart, we have made great strides in our diversity representation and our safety recordable and lost workday frequency rates. We take great pride in our focus in these areas. We spend a lot of time discussing it and communicating in it -- results internally but quite frankly, haven't done as -- done quite as good a job as our competitors at communicating our achievements to investors. We're changing that. We released yesterday online our new ESG report on lennoxinternational.com. I'd ask you to check it out. And again, we're going to be more aggressive on communicating all the good work that we have done and continue to do in this area. Let me now go through the segments. Let me lead off with residential. On the left-hand side of the chart, you see our revenue and ROS. Over the last 4 years, our revenue has grown at a 4% CAGR. That includes a major tornado, a pandemic and the derecho. Our 2021 ROS is up 50 basis points when compared to the 2019 pre-tornado of 17.6%. Our mix of business in 2020 is approximately 80% replacement, 20% new construction. Lennox makes up 80% of our equipment sales, selling directly to dealer contractors. While Allied makes up the balance, selling exclusively through independent distribution. This is a pretty important chart. So I'm going to spend a little bit of time on it. On the left-hand side shows industry information on year-over-year change in units. We are forecasting the overall market to be up mid-single digits in 2020. It's hard, quite frankly, to call exactly what the number is going to be because of the difference between AHRI industry numbers, which measures the sales from OEMs to include sales to independent distributors; and HARDI numbers, which measures sales from distributors to dealers. For example, for the months of September and October, AHRI data show the industry up 45%. So September, October, AHRI, up 45%, which is sales from OEMs. And so our larger competitors had sales to independent distributors. While HARDI data shows the industry up approximately 8% in September and October net sales from distribution to dealer, and that's more in line with our model. This difference is obviously driven by the loading of independent distributor with products to both reload what was sold in 2020, but also distributors stocking their warehouses for 2021 given supply uncertainties. We don't sell toilet paper, but the same phenomenon that's taking place in homes across the country is taking place with independent distribution as their concern about the impacts of pandemic to the supply chain in independent distribution is pulling in volume from 2021 into 2020. Since we are primarily directly to dealer, we don't have that pull-forward effect from loading up independent distribution. There's been lots of discussion on this point, so let me reiterate. Given our direct-to-dealer model, we haven't pulled forward demand from 2021 into 2020. You can't say that necessarily for those who have independent distribution models, but that's true for Lennox. For 2021, we are calling for the market to be up mid-single digits. We expect to see continued growth in both new construction, where we're still seeing the last few years of the echo of the housing boom play out in the replacement market. 2021, with our new product launches, we expect positive mix. And we have announced up to a 6% price increase in all our businesses effective in the first quarter of the year. As always, with a consumer-based business like residential, macroeconomic, political uncertainty remains a risk. We're also assuming a COVID glide path that we're on now. If that changes, all bets are off. Taking a slightly longer view of the market, the new housing bubble of the early and mid-2000s will drive our replacement business, as we said, over the next few years. Through this installed base, we believe our end markets will grow at a multiple of GDP. Talk about Lennox Stores strategies. After taking a 2-year hiatus in building new stores due to a tornado, the derecho and COVID-19 pandemic and shutting down support-performing stores, we are back on the attack in 2021. We will be opening 30 new stores. For those of you new to our story, our Lennox Stores strategy is an important driver of our market share growth. An average store is about 10,000 square feet, about 80% warehouse, 20% front-end wholesale. About 80% of the sales are equipment and accessories, with 20% of the sales being parts and supplies. These wholesale distribution points allow us to sign up new distributors and serve our -- excuse me, new dealers and serve our existing dealers more effectively. Costs about 100 -- approximately $150,000 of capital and onetime expenses to open a new store, and operating expenses are about $300,000 a year. We are operational breakeven in a little over 12 months. Revenue per store opened at least 3 years is about $3 million, with half of it incremental and half of it business with existing customers. Our goal is to fill out the North America market with store locations with a 30-minute drive of dealers in the markets that can support a dealer. Right now, our intermediate goal is to have 350 dealers in place by 2025, starting with 30 new stores next year. This strategy works. This is a great growth vehicle for us. Our one-stop -- or excuse me, our one-step model allows us to be selective where we open stores that have a scalable backroom to support our network. We're excited to be back on the attack here. Another initiative that's been on hold to the tornado and pandemic has been our parts and supplies initiative. It's an initiative to leverage this brick-and-mortar that we've built. As you can see on the chart, in 2017, 16% of our revenue was parts and supplies. The initiative was showing real traction. We were up to 20% in 2019. But due to the tornado and the pandemic, we stalled in 2020. We have set a target to get that number up to 24% by 2024, growing our parts and supplies revenue at a 15% CAGR. When we do that, it will be worth about $300 million of revenue for us. Revenue is similar to profitability to our equipment business. To accomplish this, there are a handful of initiatives we'll be driving, initiatives we showed in 2017 to 2019 work. New business efforts in the stores have primarily been virtual in 2020, as you can imagine. But as we begin to enter more normal post-COVID environment, the store teams will regain their focus on walking traffic as well as specifically targeting account growth. Two, our marketing teams, along with our category managers, consistently drive focus on merchandising opportunities to drive additional sales in our showrooms. And third, a key pillar for our same-store sales has been defined focus on operational excellence. So a continued focus on adding to the systems and support we have to drive growth within our stores. The overall strategy of Lennox Stores in driving a higher penetration of parts and supplies is exciting, and the results are clear. Again, we're really glad to be on the attack here. Our residential digitization strategy continues to be a major area for us. And again, I'm going to spend a little bit of time on this chart. Our strategy is focused on building better service -- or better serving our customers, making it more productive and profitable, our customers being our dealer contractors, and increasing their entanglement with us. Starting on top, you have screen shots of our repair parts finder and our product detail page. Here, we're showing our latest investments to drive a more intuitive experience on LennoxPROs to buy parts and equipment. The repair parts finder is moving to an exploded view of our equipment and makes it much easier to identify the right repair part when needed. We continue to improve our product detail pages to ensure the customer has all the information that they need. This includes imagery, specifications and manuals. It also includes suggestions on installation parts and accessories, thermostats and other equipment that it's often sold with. It will soon leverage AI to make recommendations based on geography as well. Every distributor talks about their ability to do e-commerce, just like every retailer says they're Amazon. Our investments in things like the repair parts finder and product detail page allows us to drive a user experience unlike others. On the bottom are examples of digital tools designed to assist customers in selling, installing and servicing Lennox equipment. The bottom left is our tech experience on LennoxPROs, launching earlier next year. Here, a technician can scan a bar code and gather all the necessary information to troubleshoot that product. With single bar code, you can access the service literature, determine warranty status, review the repair part's exploded view. If the product is communicating, you can access system performance information error codes with corresponding troubleshooting steps. On the bottom right is our service dashboard that was launched in 2020. That's a command center that allows the dealer or service manager to stay very connected to the homeowner where they can, a, monitor; b, proactively diagnose; and three, troubleshoot Lennox equipment without having to enter the home. The purpose of these tools is a dealer success -- is for dealer success and dealer entanglement. Next, we'll continue to invest in digital strategies that deliver value for our dealers. We'll focus on areas where we can deliver differentiated value such as e-commerce, which help dealers buy and track purchases or digital tools that I've talked about. Again, we're excited by the progress we're making in this area, and we'll continue to make investments. Let me switch gears, talk about another segment, and let me talk about commercial. Starting at the right side of the page, the commercial segment is comprised of 2 businesses: HVAC business in North America, 75% of the revenue; and National Account Services, or NAS, as we call it internally, which is 25% of revenue. We're in replacement cycle with about 70% of our revenue coming from planned or emergency replacement. This is good and brings stability to market demand. Moving back to the left side of the page, the green bars, our revenue in the blue line, again, is EBIT ROS. In 2020, our top line was significantly impacted by the COVID-19 slowdown, with revenue down a little over 15%, most predominantly driven by a slowdown in planned replacement with our national account customers. However, nice cost-containment actions by the team limited the ROS deterioration to just 70 basis points. Similar chart to what I showed on resi. The left side shows industry shipment information. 2020 North America unitary commercial market will be down mid-teens. The market reached its nadir back in Q2, with the industry being down 30% and has been bouncing back off that low for the balance of the year. Looking at Lennox data, we are exiting the year with backlog up double digits. Our experience during the Great Recession is that pent-up demand is created through the postponement of planned replacement like we saw in 2020 and is released over the next few years. We're calling for the market in '21 to be up mid-single digits, maybe with a little luck, maybe even better. We, in the industry, expect price leverage to continue and as we continue to drive mix up with customers with our new Model L. On the downside, macroeconomic and political uncertainty and the risk of slower-than-expected recovery from COVID-19 continue to bring potential volatility to the market. And our national account customers continue to fight for capital dollars for rooftop replacements versus spending on e-commerce initiatives. Over time, Lennox has been recognized as the market leader in national accounts with hundreds of accounts in our portfolio. National account HVAC equipment sales is roughly half of our equipment sales. We'll keep adding to the list of customers with over 26 new accounts this year on top of the 26 that we added last year. Lennox has the most efficient rooftop product line in the industry, and it's even going to get more efficient with our Model L launch. Our configured order factory with the shortest lead times in the industry is part of our success in national accounts. Increasingly, our national account customers want units installed, commissioned and maintained. In those cases, we're able to provide that with our National Account Services arm. On the right side, we're experiencing a lot of success by extending our national account program into nonretail verticals. In 2016, traditional retail represented 25% on our overall equipment sales in North America commercial. Now it represents slightly under 15%. Other important verticals that we target include DIY, restaurant, supermarkets and discount. And we're continuing to grow the critical distribution vertical. We have a strong relationship with Amazon, business more than doubled in 2020. And we have established national account programs with key distribution property owners, like Prologis. We're excited that we continue to win in national accounts, and our diversification efforts are paving the way for continued success. National Account Services. We have over 100 service branches across North America, and so the footprint to provide shelf-performing service to more than 94% of the North America customer sites. We perform planned maintenance, planned replacements and provide asset management services for national accounts, with the benefit of HVAC performance certainty and budget certainty. We have recently started to offer EMS monitoring and technical support for our national account customers who have legacy EMS systems installed. Because of what we offer, we have tremendous relationships with many well-known customers or brands, some of which you see on this page, and have strong customer retention and are successfully acquiring new customers as we scale -- continue to scale the operation. After a lull in growth due to the pandemic in 2020, we'll be back on the growth path in 2021 with a revenue target in 2023 of $250 million. The other major equipment segment is our -- what we call our local regional share or local/regional market, which is things other than national accounts. You can -- we think this market accounts were about 2/3 of the North America unitary market, and it only makes up 50% of our revenue. So you can see we have an opportunity to continue to grow share there. Local contractors service business verticals like schools, office buildings and mixed-use development, to name a few. Local contractors also perform the majority of emergency replacement, which we focused on over the last 6 or 7 years as well as building owners reach out to the contractor they trust to take care of their urgent needs. Moving to the left of this chart, our investments in products, driving specifications with engineers, local availability, dedicated support have all been part of our growth strategy and continues to be where we will focus in 2021 to grow our share in this market. Our third segment is Refrigeration. Over the last few years, we made adjustments to our Refrigeration portfolio. And you look on the right-hand side of the slide, you can see that the makeup of the segment, just over half of its sales in North America commercial refrigeration space, while the remaining portion of it's in Europe to include exports to the Middle East and Africa. About 2/3 of our sales in Europe are commercial HVAC where the balance is Refrigeration. From an end market standpoint, you can see we have a pretty balanced portfolio of solid and stable applications with good, long-term potential. Moving to the left side of the slide, revenue and ROS of the Refrigeration segment. As in commercial, the profitability of Refrigeration segment has been negatively impacted by COVID-19. Lower volume, factory inefficiencies, and we were hardest hit due to factory inefficiencies in Europe and our Georgia refrigeration factories. So it had the most negative impact there. A negative mix impact driven by a more profitable North America business down more than our European business. 2020 was a tough year for our Refrigeration segment. We expect '21 -- 2021 to be a better year. After the markets being down mid-teens in 2020, we expect a bounce back in 2021 of mid-single digits. And like I said at commercial, with a little bit of luck, maybe even better. Looking at our Refrigeration backlog, we are exiting 2020 with our backlog up double digits. We have the right portfolio of businesses, and the keys to driving growth and profitability are clear: continued investments in product innovation, which I'll discuss here in a moment; but also increased focus on operational improvement on our factories and digitization across the segment to drive profitability and better support our customers. One initiative in Refrigeration I want to talk about, refrigeration product leadership. This page gives some flavor to that. Our Department of Energy, or DOE-compliant product line, we revamped 80% of our total product line in North America due to these new minimum efficiency standards that went into effect earlier this year. The transition has gone very smoothly, and we feel we're in a good position to grow share with this revamped product line. Our new Magna industrial refrigeration product, a more industrial-grade product than our traditional North America offering. It's a nice organic expansion for us into an adjacent market we weren't currently serving. We've begun quoting on the new product line, and sales will begin in midyear of 2021. We're also working with our Turkish partner -- or better stated, working with our Turkish partner, we have established a low-cost Turkish factory for our European rooftops. And we're looking at opportunities to expand our product offering there and grow our business in low-cost countries in Europe. And finally, our European process cooling business. We're a market leader and continue to make investments to improve our product line, and equally important, leverage our investments in North America to automate engineering tools to improve effectiveness and speed of the engineered-to-order process. With that, I'll turn it over to Joe to walk us through financial guidance and updates, and I'll be back on for Q&A later. Thanks. Joe?

Thanks, Todd, and good morning, everyone. I'll start by updating our 2020 guidance points, which were included in the press release that we issued this morning. Collectively, revenue is projected to be down 4% to 6%; GAAP EPS within a range of $8.85 to $9.05; and adjusted EPS within a range of $9.55 to $9.75. Corporate expenses will be approximately $90 million. We expect our full year tax rate to be between 19% to 20%, and our guidance for free cash flow is increasing to $475 million, resulting from strong residential demand and driving inventory levels down. Capital spending will be approximately $85 million for the year. And we've completed $100 million of share repurchases for 2020, and we'll be resuming share repurchases in 2021. Now let's turn to 2021 and an overview of what we had planned. Todd gave you an overview of our 2021 plan, but these are some of the dynamics driving the plan, starting with end market growth. We expect to see end markets in all 3 segments continue to rebound in 2021. Residential markets remain resilient, as Todd mentioned, and bounced back quickly in 2020. And we expect to see the continued growth in 2021. In commercial HVAC and refrigeration markets, we continue to see steady improvement, and that's evidenced by order rates and backlogs that continue to climb. Market share gains will complement end market growth. We have share gain initiatives in all 3 segments in 2021. Share gains are driven by our continued investment in distribution, industry-leading innovative products and advancing digital capabilities that further enhances the value that we deliver to our customers. Announced price increases will provide a $50 million benefit in 2021, which is approximate at 1.5% top line yield. Productivity is always a priority and increasing on several fronts. We anticipate sourcing and engineering-led cost reduction efforts to generate $25 million in net savings in 2021. In addition, productivity gains from manufacturing initiatives will deliver approximately $20 million in benefit across the businesses. Now let's turn to the headwinds that we anticipate. SG&A will increase in 2021. Discretionary SG&A spending will remain tightly controlled until we see how markets are behaving. However, we will be reinstituting advertising and incentive programs that drive top line growth, and there will be inflationary effects relating to employee compensation next year. Commodity costs, including tariffs and freight rates, are escalating in 2021 and creating a $40 million headwind. Commodities in the form of raw metals will be a $30 million increase. Tariffs will add another $5 million, and increasing freight rates will be an additional $5 million. Strategic initiatives and investments remain focused on driving profitable growth. The initiative to expand our share in parts and supplies is projected to continue to grow at a mid-teens pace with very attractive margins. We will be resuming our investment in Lennox Stores in our residential distribution network and adding new stores to drive growth. Over the years, we have demonstrated success with our continued investment in distribution, industry-leading product innovation and superior customer support capabilities as we continue to digitize the businesses. And this momentum will continue in 2021 and complements the end-market growth. And finally, macroeconomic uncertainty, no surprise here, remains a bit of a wildcard. But hopefully, the pandemic is behind us in early 2021, and the political environment stabilizes so we can get back to really some semblance of normalcy. Now turning to our 2021 guide points. Top line growth is expected to be between 4% to 8%. The top line growth is both from market growth and the share gains we've discussed. Price yield will contribute approximately 150 basis points to the top line. GAAP and adjusted earnings per share are planned to be within a range of $10.55 to $11.15. Corporate expenses are expected to be approximately $90 million. Our effective tax rate will be approximately 21%. And capital expenditures are planned to be approximately $135 million, and we continue there with high -- with investments in high return on investment projects focused on fueling growth, driving innovation with industry-leading technologies and capabilities, and enhance the value proposition to our customers and increasing profitability with continued investment in cost-reduction initiatives. It also includes $25 million for the final Marshalltown reconstruction that is funded with insurance proceeds that we've already received and approximately $25 million for the reconstruction of a third facility in Saltillo, Mexico. Free cash flow will be approximately $325 million and includes replenishment of residential inventory. And share repurchases are targeted at $400 million for 2021. Now when you boil down all the guide points for next year, the plan will be to deliver our targeted 30% incremental margins. I'll now touch on our capital deployment philosophy. Our philosophy on cash deployment remains consistent. We plan to deliver free cash flow that approximates net income. We will have a targeted debt-to-EBITDA ratio of 2.0. Interest, pension and other expenses will be approximately $35 million. We will continue to drive investments in our businesses focused on profitable growth. Organically, we continue to identify growth opportunities that enable us to seize market share, continue to support distribution expansion and innovative new products and solutions that enable us to outpace the competition, along with continued investments to lower our product costs. And then inorganically, we will consider acquisitions where they make sense, and we maintain flexibility in our capital structure to invest efficiently. Lennox remains shareholder-friendly, and we look for efficient ways to return cash to shareholders. We will continue to grow our dividend steady with earnings. We've returned $1.5 billion to shareholders in the form of share repurchases over the last 5 years, and we'll continue to return cash to shareholders, supplementing a competitive dividend with share repurchases. Now I'll turn to a history of our performance and our 2023 targets. This chart reflects, once again, historical trends in revenue and return on sales and our projections for 2023. And after a few years of navigating through disruptions, first, the tornado that hit in 2018 and the recovery that took place through 2019 and now the pandemic, we will be returning to our more normalized trends of 6% top line growth, delivering 30% incremental margins that drive margin expansions -- margin expansion. Now turning to margin targets. Here are our long-range targets for each segment. For our HVAC businesses, both residential and commercial, 2023 targets are between 19% to 21%. In our Refrigeration segment, our most geographically dispersed business, margins are targeted between 12% to 14% by the end of 2023. And now I'll end where Todd began with our investment thesis. And in summary, our momentum continues with the effective execution of our core strategies that deliver value, centered on innovation on multiple fronts enabling Lennox to continue to outpace our competitors, enhance profitability and deliver superior returns to our shareholders. Thank you again, and that concludes the formal part of our presentation this morning. And now we'll go to Q&A.

[Operator Instructions]

Todd, we already have some questions in. So the first one is from Julian Mitchell. Any initial thoughts on seasonality for 2021 on sales or margins?

You know what, obviously, 2021 is going to be different than prior years have been given the impact of the pandemic. And right now, sort of the way you should build your models is we expect about half of the EPS to come in the first half of the year and about half of the EPS to come in the second half of the year. And EBIT can sort of be answered the same way. So we're ending fourth quarter in a good position. The momentum in the market continues in residential, and I talked about backlog up in both our businesses. And so obviously, second quarter was depressed this year. Third quarter in residential had a huge bounce back. And so we'll see more profitability in second quarter or second half than we did this year and less during the second half of the year.

Thank you. The next question is from Nigel. He's asking, can we talk about investment spend in a little more detail? Trane is upping investment, and we are hearing something similar from Carrier. Is investment spend on a upward curve from here?

Yes. I mean I -- we don't give dollar spend on those sort of things. What we do is talk about the initiatives that we have in place, and we've continued to make significant investment in new products. I can give you the number. I can point to the Model L and point to the 28 SEER, the most efficient product line we have in the marketplace. I can talk about digital investments in the dollar where I can just point to the things that we're having around e-commerce and digitization. So we're armed. We're ready to go. We're making 30 new stores. And so we're absolutely on the attack. And so -- yes. Yes is the short answer.

And the next question also from Nigel and Julian as well on this topic. Why is Refrigeration a core business? No real channel synergies, and the outlook on margins continues to decline. Alternatively, do you want to scale in Refrigeration? And then Julian's question, related, is bridging the margins between current Refrigeration and our targets down the road.

This is sort of a funny way to do Q&A because, Steve -- when I answer the question, I look at Steve, and he has a pleasant look on his face, like he believes everything I said. I wish you'd see it. And then the others, when he asked the question, there is cynicism and sarcasm in the question -- on that question. Look, I think our position on Refrigeration has been consistent and clear, which is, at some level, everything is core; at some level, nothing is core. If you walked into a refrigeration factory, you'd see the same kind of compressors we use in HVAC business. You'd see the same kind of sheet metal processes, same kind of heat exchanger processes. You would see the same kind of controls because we leverage across all our businesses. And so the actual product, the design of the product, the manufacturing of the product is very, very similar. Where it differs obviously is then customers in the channel and how they use the product. So I think that's -- we're not selling washers and dryers here. It's a lot of [indiscernible] with what we do. I think that's point number one. Point number two is we've shown a discipline that we identify where we think we can win, where we can compete. And that's where we'll -- and we've sold things where we didn't think that was the case, China, Brazil, Australia, Kysor Warren display cases. In the businesses we have left, Europe, North America, we think the fundamentals are strong that allow us to make money there. We think we have the right teams. We think we're critical mass. I said in the comments 2020 was obviously a tough year. The pandemic hurt our Refrigeration business more than anywhere else. Our factories in Europe were shut down for a couple of weeks. Our factories in Georgia were shut down. We also had an impact of mix down. And so we're confident that we have the right team and the right initiatives in place, and we're going to focus on turning around the factory performance once we get to the other side of COVID, driving volume across the business with investments in product and digitization. And so we like our Refrigeration business. Now in terms of growing it, I think we're already in scale in the markets we play in. And as I talked to the team about it, I think you have to earn the right to do acquisitions. So we're not looking to throw a whole lot of new capital in this segment by doing acquisitions right now. But as we continue to grow the margins of the business, then maybe if the right opportunity came along, we'd look at it. Next question, Steve?

[Operator Instructions] The next question, Todd, is from Tien San Lucas. Do you expect high inventory in the independent distributors to pressure pricing in the overall market next year? And will it be more of a first-half event?

No. Our experience in this industry is distributors and dealers don't panic when they have a little bit of inventory. It's not lettuce. I mean toilet paper is a good example. I mean it lasts. And so if their warehouses are full, they don't panic, so I don't expect any pressure on pricing. I think we're passing on price. I think the other OEMs have announced price increases even for things that are being bought here at the end of the year. And so we have commodity inflation. We have tariffs, and we have freight inflation. And so we'll be passing on price, as will others. So I don't expect any then. And in terms of the phenomenon, yes, I would expect it to be first quarter -- excuse me, first half of the year. As we get to the summer selling season, I think inventories will be righted, and people will reload as needed.

Next question is from Jeff Sprague regarding the AHRI and HARDI color that we provided. Do dealers hold much inventory? Or is it LII sale to dealer effectively a sale to the end customer with very little lag?

Just what you said: a sale from LII to dealer to customer is almost simultaneous. The -- to be little in the weeds, some dealers -- our large dealers may carry a couple of weeks of inventory. But over the last 6 or 7 years, they carry less and less because of our ability to supply them with our parts -- our Lennox Stores or direct distribution -- or direct delivery the same day or next day. So we model and demand very closely.

The next question is from Gautam Khanna. Todd, can you elaborate on your view of how long the resi HVAC echo boom may last? And how much that adds to resi unit growth, i.e., how much would the unit demand growth soften once the boom subsides?

Yes. I mean, I have to be consistent with what I've said over the years, which is I think we're getting to the point where there's another year or 2 left. And this I've publicly said before. When we build a model, because there's these sequential set of bell-shaped curves around installed demand, there's never a year where it crashes, but there's going to be a year in the next year or 2. We don't think it's 2021. I don't think it's 2022. But beyond that, there'll be a year where the market starts to flatten out. Our model actually says that it goes down a couple of percent, 2% or 3%. But I think that's false precision. And if it's a hot summer, we won't see it. Or if there's other forces at work that drives the volume that year, we won't see it. But I think longer term, once we get through this echo, I think that we'll have a sort of a decrease, or the market will flatten out for a couple of years. And then what our model shows is after a couple of years of flat, that it starts to grow low single digits, sort of a GDP market. But we're real confident even in those years where the market is flat in a couple of years, if we gain half a point of market share, that's worth 3 points of revenue. We get a little bit of price, we get a little bit mix, we're mid-single digits, maybe 6, 7 points of revenue growth in residential sort of on a normal year, if you will, once we get past this echo boom. So we think this is a great end market and will continue to be a very good end market for us.

And Gautam was also asking, with 30 new PartsPlus stores, how much incremental market share will that drive in 2021 and 2022?

I think -- I don't know how much -- well, I think I know. The answer is 2021, it won't be a major driver. We'll have some of the stores we open up beginning of the year will have some impact, but stores we up the second half of the year don't have a major impact. The way -- the algorithm I think about is if you do the math of 30 stores, you have the flywheel going, you get about 0.25 point a year in market share in residential. So do all the math of $3 million a store, half of it incremental. And so I think that's the impact that it will have in 2022. The investments we're making this year will have some impact to 2021, but more in 2022 and beyond. I think the share gains in 2021 are going to be driven by the new product, leveraging all the digitization tools that I spoke about as well as continue to grow on the share that we gained this year from dealers because we are able to handle the pandemic better than others in terms of supply assurance.

And this question is from Ryan. And again, I probably can't capture the tone of the question correctly, but commercial margins have declined for a few years. What happened? And what drives margins higher beyond this?

Yes. I mean I'm going to spin it the other way. If you had told me that commercial markets are going to be down 15% and that you're going to have COVID impacts to your factories, i.e., absenteeism in Stuttgart, Arkansas, and that margins would only be down 70 basis points, I'd say, sold. Over the last few years, they've been down because we've just been making significant investments in the business in digitization and new product. And again, we're real comfortable as we end the year around 17% operating margins that -- on our 3-year target of getting it to '19 to '21. And again, it's leveraging factory productivity with the increased volume that we're going to have next year, material cost reduction and then the share gains that we're going to make with the Model L and our new product launch. So I understand the jab on Refrigeration. On commercial, I'm a bit more defensive. I think they've done a very good job on margin in a very tough market.

Questions from Nigel and Julian. Are you able to quantify SG&A headwinds as a placeholder? Or how big will SG&A headwinds be in 2021?

Yes. I mean we're not going to put a number on it. I think the way I think about it is we initially said we're going to have $115 million of cost takeout this year. And now we're saying it's half of that. It's $58 million or so. And the big difference was a major onetime cut this year was salary reduction and no incentive bonus, and we're paying all those now this year. And so you're not going to have the bounce back next year that you typically have. So I would think about it more as SG&A growing a little less than revenue. Typically, we say as a fraction of sort of half of revenue. I think a year like this, I would sort of build a model, having it grow with revenue would be how I would model it.

Question from Ryan Merkel as well. Can you frame the commercial outlook in '21 by business type? So what is your view on structural challenges in office, retail and hotels?

I -- the area that we -- I'm going to slice it differently than the verticals that you asked. I'm going to slice it more on how we think about it internally. The area that's going to bounce back the most is going to be the one that was down the most in 2020, which is planned replacement. And so sort of at the nadir in the second quarter, our planned replacement business, order rates were down 60%. That's discretionary spend. That's very large. That's national accounts who just say we're not going to spend on replacement this year. Our experience is if that comes back, it comes back quickly. And once they have a green light to spend, they not only -- they reach back to what they deferred during a prior period, during a pent-up period, and then they make investments that were scheduled for the current time period. And so that's what comes roaring back. And we think that will come back, maybe not all the way back or all the roar in 2021, some of it will be in 2022. But our national account business was down materially more than our nonnational account business this year, and that's what we think bounces back. I mean you then sort of look at the verticals and the national accounts to support that. It's the large retailers that are doing well who are major customers for us, people like Lowe's, people like Home Depot, people like Best Buy, people like Walmart. Those are the verticals that come back. Also, I talked about in my comments that distribution is a major market for us and, obviously, our rooftop market, Amazon is a major customer. And so those are the verticals that we expect the most in. I think the area that will continue to be soft would be mid-rise office buildings until we get to the other side of COVID. I think that would be a softer end market. But yes, that's -- planned replacement makes more of it.

And Julian is asking, how is LII thinking about the margin expansion by segment in 2021 relative to the overall LII goal.

Yes. We don't give segment targets. I understand the question. We don't give segment targets. I think the one thing I would say is that they're all going to have similar 30% incrementals. But we don't give segment targets.

Steve Volkmann, I think, just needs a clarification around the expectations for price costs next year. I mentioned price increases so...

Yes. I think the headlines are commodity inflation of $30 million, headwinds from freight to $5 million, headwinds from tariffs $5 million. So total $40 million between commodities, freight and tariffs. And then we're targeting $50 million benefit of price, which is about a 1.3%, 1.4% yield on revenue. We've announced up to a 6% price increase. A few years ago, you may recall, we got $75 million in price. I think that's the power of this business that in good markets and bad markets, we're able to get price. And next year, we're going to have volume up in our end markets. We're going to have commodity headwinds. Also, when we talk to our customers, although we haven't quantified the number for investors, COVID obviously has been attacks to the entire -- all manufacturers. And so there's this COVID inefficiency that's built into our cost structure that we're also going to need to pass on to customer. So our competitors have announced similar price increases, some maybe even more. And so we're confident that we're going to get price in 2021.

And Nicole is asking, can you give more color around investment spending in 2021, perhaps quantify? And what level of steel copper price is embedded in your commodity outlook?

Well, I'll answer the second question first. What -- we hedge copper and aluminum, and we're about 50% hedged out 12 months out. And then steel, we buy on based on the market spot price during the prior quarter. And we also have some discounts negotiated with the mills and service centers off that price. And so what's baked in there is that, what our hedges are, and then for the unhedged portion, we take a look at what the future spots are or the futures are that we bake into our number. In terms of investments, I think I've broadly covered it on a prior question. We're not going to give an exact number. I would assume that our SG&A investment this year will be, because we're going to have some bounce back, will be something short of revenue growth, but in that ZIP code.

And John Walsh has a question. You talked about raw materials. What about inflation in components with a focus on what you still source in China or Asia more broadly?

The $25 million of material cost reduction, that's always in that number. So that's -- after all the price increases we get, we have to take out that much more cost to get there. So if there's $10 million of price increases, we have to take $35 million of cost out to get to a net $25 million. So that's all baked in. So the answer is yes, there's more inflation right now than in prior years, but that's obviously a good thing. That means the economy is heating back up. We have a handful of agreements with some major suppliers where we have commodity escalators or de-escalators if there's a lot of copper steel in their product. And so some of that's contractual, and some of it is suppliers want to raise prices. And obviously, our ability to have everything be second sourced and be able to move it to other low-cost sources is a big part of our opportunity to head all that off. So the answer is it's in the $25 million, and we're aggressively looking to minimize it.

Next question is from Walt Liptak. He's asking about the new stores. I believe we covered the sales aspect to his question. But he's asking, is there a specific geographic location that we're focused on with the new stores.

No. I mean not one I'm going to talk about. What our team does is, as I've publicly spoken about before, is we understand all the dealer contractors in North America, those that we do business with, but also those that we don't do business with. We then have an algorithm setup that scores them A, B, C of how high quality they are for us or how the ease of us to convert them. We understand what the issues are and why we're not converting them. And then we understand what the -- our market share is in each market and what the opportunity is for growing. And so then with that high-level algorithm, we're able to rank how we want the stores to be entered for the next 18 months. We then put that against -- sitting down with the sales leadership team, they look at the list. And that's sort of an auction, if you will, where if you get a new store, you got to raise your quota. That's sort of an acid test to salespeople of whether they really want the store. And then we work through that, and then we come up with a list of how we roll them out. And that's what we've done for 2021.

Tim Wojs is asking, Goodman has had operating challenges in 2020. Are there some concern that they'll be more aggressive to regain share in 2021 and that the industry has borrowed share from Goodman in 2020 that reverts in 2021? Can you frame how this may impact LII next year?

Yes. We should have a PhD on borrowed share, right, after all the conversations we've publicly had about what happened with us in the tornado. So we understand the dynamic, I think, pretty well of what happens when you have a catastrophic event like this and you lose share and how you hang on to it. Or how, in the end, you lose it. And so we were pretty clear-eyed when we took advantage of Goodman's issues of who we signed on. And what I mean by that is if you sign up a dealer who may have volume but is a very tight Goodman dealer, and you have a sense of once you meet their needs, they're going to go back to Goodman, that's not what we did. We signed up -- or we supplied dealers who we were confident would stay with us or high confidence they would stay with us. The other thing is what we did was we armed our own traditional dealers to go out at the homeowner level and take business from Goodman dealers. So if Goodman didn't have product, we can win it through existing Lennox dealers or we could support the Goodman dealers. And we always opted where we could to support existing Lennox dealers to win the business. And so they growed -- they grew their share in the marketplace. And again, the dealers that we did sign up, we did it with our eyes wide open of what we needed to hang on to them. So we're pretty confident we're going to hang on to a lot of it. Again, Goodman has the dilemma of being a market share leader. Are they really going to try and start a price war to gain back a little bit of share that they lost when they're the market leader? I mean that's self-defeating. We're not even the market leader, and we certainly didn't do that after the tornado. We matched other people's deals, engaged some back-end rebates in line with what they had with the current supplier that had taken them from us. But we didn't get in a price war, and I'm pretty sure Goodman won't either.

Next question is from Jeff Sprague. We touched on this perhaps a bit earlier. But can you size the magnitude of the temporary cost returning on compensation, advertising, et cetera?

Approximately $5 million. If you do all the math of the things we give publicly, it's, I think, $7 million or so of incentive comp bounces back. The rest of it were headcount reduction and what we call discretionary spending. And quite frankly, we'll throttle that as need be as what the markets -- as the markets behave.

The next question is from Jeff Hammond. Based on your comments on distributor stocking, would you say we have gone from understocked to now overstocked in the industry? And then also, how is furnace season shaping up given more mild weather?

Yes. I think the answer is we're either overstocked or heading that way with independent distribution. And again, I don't know for certain because they're not our customers. We have a little bit of a lens through Allied, which is 20% of our business. And what you see is, as we talk about almost all the OEMs -- I'll just say all the OEMs, to some level or another, had issues during the summer selling season either because of their own factory issues or because of the supply base and had trouble meeting demand. And so then you have that in the distributor's head. And so they want to have as much inventory as they can have going into the selling season to protect themselves. And so yes, I think when you look at a number of September and October of AHRI being up 45%, that's just not reloading for last year. That's pulling some forward. So I don't know how much more there is in independent distribution, but I think there's some. Was there a second part of that question, Steve? I forget.

Yes. How furnace season is going so far?

Yes. Furnace season is fine. I mean I -- it's, again, I think the weather matters but obviously matters much less than have it be hot in the summertime, so or -- yes,l hot in the summertime. So the fact that it's not as cool as normal, I think on the margins, had some impact. But you saw we raised our guide for fourth quarter, so we're doing fine as we end the year.

And also from Nicole, what is driving the confidence in 12% to 14% margins in Refrigeration by 2023?

Again, it's our taking a look at the business and understanding the impact of improved factory productivity. We changed the leadership in all our factories in the last 18 to 24 months, the negative impact from COVID. Prior -- as we exited -- not sure I have the right notes here. As we exited 2020 -- excuse me, as we exited [ 2019 ], our margins were near 12% in Refrigeration, 11.5% or so. And so we had this significant downturn in 2021, and that's in large part because of COVID, 15% lower volume impact to the factories and then a negative mix impact because North America was harder hit. You sort of play all that back, we're back to close to 12%, which is spitting distance to where we need to be for our targets of 12% to 14%. So we got to get some volume across the business. We have to improve our factory productivity. We have to gain some share, and I think we're set up to do that.

The next question is from John Walsh regarding the 25% attach rate in IAQ. What is the experience more recently? How high can it go? And does IAQ drive 10 points of incremental price versus a standard unit?

Well, I don't know what cause and effect is. Well, yes, the cost of an IAQ system's $500 to $1,000, depending on what they buy. And a normal systems is $5,000. So it's 10% -- maybe 10% to the top line number. But I think more importantly, if you're selling IAQ, you're getting high mix, too. So no one buys -- or very few people buy -- I don't know if anyone buys an entry-level SEER unit with an IAQ package. So if you're skewing up the IAQ, you're mixing up on the higher product line. We focused just on IAQ for years, and we think we're as good as anybody. And some of our competitors, I think, have breathlessly talked about IAQ with response to COVID. And I've always, I think, been a bit more balanced publicly on this. I think it's an opportunity. I don't think we ever -- the thing to always remember is, with all the good things we do on mix and new products that the industry is over 0.5% entry level. So I don't think you ever get higher than that on IAQ because half the people just want to buy the lowest-cost units that they can. But we continue to focus on mix. I think longer term, because I'm optimistic on COVID, then we'll get to the other side of this reasonably quickly, and then it's going to be the more traditional IAQ conversations about my children have asthma. I have animals in the house. There's dust particles that I'm sensitive to, and that's where IAQ helps out longer term.

Todd, this question is from Jeff Hammond. The compound annual growth rate in parts and supplies is steep versus a much more modest ramp over the past few years. What needs to change here strategically to up your mix and hit these aggressive growth targets?

I think it's in part what happened in 2020 is, I think, the actual parts market is down. I think people replaced units maybe at a higher rate than what they've typically done. And so I think we're down with the market. I think there's a bounce back in market growth on parts and supplies. I also think we, quite frankly, haven't been focused on parts and supplies in the stores. We haven't been able to go out and call on customers. We haven't been able to bring them into the stores. They wanted to take delivery or pick up equipment at our windows. And so I think it's areas that we spoke about. I think it's a focus on new business development. It's a focus on the operating system, and then it continues to be a focus on making sure we have the SKUs to support it. So if you look from '17 to '19, we took it from 16% to 20%. And now we're going to go from 20% to 24%. So I think it's roughly the same growth rate of what we need to do.

Another question from Tim Wojs. "Are there higher costs related to higher efficiency standards for 2023 that are embedded in 2021 or expected to be in 2022? Or can existing productivity, et cetera, offset that?

I think it's existing productivity can offset it. I mean we always use -- the industry does, too, so just not us. I mean you use these breakpoints and efficiency standards to revamp your product line. So we're talking about the Model L, the new -- highest energy-efficient rooftop product line. That's part of the broader strategy as we revamp everything for 2023. And so that's a new high end. So we've talked about we have minimum efficiency standards go up. You need to raise your high end or you'll be compressed and mixed down. And so the Model L is a way of doing that, similar on residential. And so that's all just baked into the normal cadence of the business. There's not a big ticket investment that we're going to talk about in 2022 to get ready for 2023.

The next question from Chris Dankert, how do you think work-from-home impacts the appetite for commercial property improvement and investment going forward?

I think that's probably a better question for our larger competitors who are involved in applied. I -- we're in a building -- I'm in a building that it's 9 stories high or 8 stories high. So we need an applied system. I think those are the buildings that are going to be more impacted. I think the verticals that we play in is not going to affect distribution, not going to affect retail. Obviously has affected restaurants, but those will come back. In terms of working-from-home, I think that's more of an applied large-office question. I don't know what's going to happen with Midtown Manhattan, but we don't sell any equipment there. So it's not my concern.

And also from Chris, with new residential SEER standards on the horizon in '23, do your long-term targets assume a similar 2022 boom like with the last round of standard increases?

Ask that question again, Steve.

Sorry. With new residential SEER standards on the horizon in 2023, do your long-term targets assume a similar 2022 boom like the last round of the efficiency increases? Or how will it...

Yes. The 2023 targets encompass the 2023 regulatory change, if that's the question. I don't know what's meant by the boom that we saw last time. We didn't have I don't think much of a boom last time. We had a boom in 2006, 2007 when there's minimum efficiency standard, but there wasn't much of a boom the last one.

And a question from Jeff Sprague. Is over absorption in the factories as you rebuild inventories the significant margin driver?

It's all baked in the guide, but maybe a more responsive question would be the $20 million of factory productivity. So we called out that we had $10 million, and I think it was just residential, $10 million -- all right. Let me look at my notes, make sure I say the right thing here before I give away a number. That we called out that we had $10 million of headwind from factory inefficiencies this year. Part of that's under absorption and the pandemic. And the $20 million of factory productivity next year is all the good things we're doing, but it's also greater volume that's going to flow to the factory. So the short answer is yes, it's good news and it's part of the $20 million.

Next question from Steve Volkman, how much volume is needed to hit the low end of the 2023 refrigeration margin target? Or is it more around cost controls or improvement?

Well, I think it's both. We don't give segment guidance, but I think I would tend to think about it as the overall revenue guide of 6% supports the midrange or the midpoint of the targets that we gave. And so if it's below 6% for Refrigeration, we're closer to the lower number. And if it's more than 6%, we're closer to the higher end of the range.

This question from Steve Tusa, JPMorgan. What are the segment growth rate assumptions through 2023?

Yes. We -- I understand the question. We don't give them, right? So we don't give segment growth rates. We just give the overall enterprise growth rate for the 3 years.

The next question's from Nigel, question on the free cash flow bridge for next year. Are you able to more finely run through the moving pieces between inventory, working capital, CapEx, et cetera?

Yes. Well, inventory is part of working capital, right? So high level, I think, as what Joe said, it's --let me pull my notes, make sure I have the exact right numbers in front of me. That our guide is $325 million of free cash flow, and there's $50 million of CapEx. That's greater than this year. So we did $85 million in 2020. We're going to do $135 million in 2021. That $50 million, about half of that is steel factory; about half of that is rebuilding Marshalltown, where we already have the insurance money for. So one way to think about it, which I know is unfair, but I'll say it this way, is if you take the $325 million and add $50 million to it, you get $375 million. That's sort of what our number would be if we weren't having these major factory rebuilds or new factory build and a rebuild where we already have insurance proceeds. And then the delta between that, which I think, if you do the math, is about 90%, 91% of net income, the delta between that, and 100% of net income, I would just assume is working capital. And again, it's the 3 elements of working capital, to state the obvious, inventory, payables, receivables are all intertwined. But that's sort of the -- how I would think about it given what we've said.

And a question from Brian Loftus. Could you talk about the longer-term market demand shift towards the heat pumps? Do you believe that will happen? And/or is it mainly in new construction or some replacing the furnace for heat pump in some regions?

No. I mean heat pumps in the southeast has grown over the last 20 years, and we have a competitive product line there and an important part of our product offering. Having cooler weather, heat pumps, I think, support for energy efficiency. So we're focused on that also. So I think it's both -- it's obviously a new construction product, but it's also a replacement product. Because if you have to replace the furnace and the condensing unit, you can just replace them both with a heat pump and then bring in an indoor AHU or fan coil to handle it for you. So it can be -- it's a replacement product also, and we play there and have a strong product offering, and it continues to grow.

We have another question from Steve Tusa. We answered some of this earlier. But how big is warehouse as a percent of the market? And is data center a factor? Or is that served by a different type of product?

Yes. I mean we -- I don't think we've ever sort of broke out warehouse distribution as its own segment, but it's increasingly an important part of what we do. As I said, we doubled our business with Amazon, growing part of what we do. And then what was the second part of his question, Steve?

Related to data center and also warehouse, how big it is.

Yes. I mean warehouses distribution, I just answered. In terms of data center, we do a little bit there, primarily in Refrigeration, because we sell refrigeration components into crack units and other people who are focused on cold rooms. I'm going to make sure I got it, Steve. Was he talking cold rooms -- was it cold storage or IT facility?

Data centers. So IT, I believe.

Yes. I'm anticipating questions. Yes. So data centers, we sell through refrigeration to crack who provides equipment, but we don't -- it's a different type of product line. But I would also tell you, it's obviously an interesting market. Because at first blush, you'd say, man, you want to be in data centers because it's growing. There's so much more footprint going in, which is true. But I don't know, 10, 15 years ago, they cooled the whole rooms. Then they moved to -- they were just cooling the computers, the racks. And now they're moving to precision cooling where they're just cooling the chips. And so even though the total capacity of data centers continues to grow dramatically, the cooling requirements isn't growing near that amount. In fact, it may even be shrinking for the reasons I just said. So we've looked at it over the years, but it's a different type of product, and there's already players there, and it doesn't appear to be, for the reasons I said, that go-to-market.

And we have a question from Joe Ritchie at Goldman Sachs. If growth turns out to be slower in 2021, what happens to free cash flow in 2021? And is your expectation to get back to 100% conversion by 2022?

Yes. Tough audience on free cash flow. If you back out the CapEx, we're at 91% next year, and we are 135% this year. So yes, we'll definitely get back to 100 -- the target will be get back to 100% in 2022, unless there's a reason not to. And then the question will be what will happen if the markets turn. Well, if the markets turn, again, from where they are now, working capital won't be reinflated. And therefore, we won't be taking that out of free cash flow. And so again, we're a distributed product business. And so when markets are soft or down, we continue to generate cash, and we would do that in 2021 if the markets turn down.

And another question. Could you talk about the VRF market progress in general? Is that getting some traction in the market with experience? Could VRF help drive the commercial recovery in 2021?

No. The last part of the question. Look, VRF, there wasn't a chart in the presentation, and that wasn't by accident. We continue to offer the product. It continues to be a part of what we offer. It allows us to meet with engineers. It's $20 million or so revenue for us. We think it's a growing end market, 10% or so, but it's not going to drive a recovery in 2021. What's going to drive the recovery in 2021 for us is going to be our large national accounts, who deferred planned replacement in 2020, make the decision to buy in 2021, and they are. And that's why our backlog is up, and that's why the order rates are up. And so that's what's going to drive revenue in 2021.

Next question is from Gautam. What is the long-term goal for percentage of product produced in Mexico in 2023 or 2020, however you'd like to discuss it?

Yes. I mean for obvious reasons we don't publicly talk about that, right? But we're going from 40% to 50% of hours. And so half of all our labor is going to be in -- for residential is going to be in Mexico. We think it's a great option. But I would tell you that a tornado later or a pandemic later, having multiple factories for a business is probably a good thing. I don't want to speculate too much on Goodman's issues. But when you have one factory and it's, whatever it is, 5 million square feet and you have everybody in one factory and COVID hits, you're in trouble. Where we had COVID hit one factory, and we produce it in the other or have absenteeism in one factory and produce it in another, so having multiple factories will continue to be our strategy in residential.

And from Ryan Merkel. For robotics, what inning are you in on this rollout? Discuss the benefits that you've seen so far.

I think we're third or fourth inning. When you walk into one of our factories, broadly speaking, you'll see about 1/3 of the factories, fabrication, sheet metal cutting, slitting, forming, bending of copper tubing, stamping of aluminum onto the copper tubes or aluminum tubes to make heat exchangers. And then the balance of the factory is final assembly and test. And what we have done with automation is primarily -- to date, it's primarily been in fabrication, so auto brazers, auto sheet metal, auto fabricating of copper and aluminum. Where we still have big opportunities is automating assembly. And it's high SKU, different parts, and we don't have the same kind of volume as washing machines or autos. So we're just getting to the right price point of robots to be able to do that for us. And so that's still in front of us. So we still have lots of opportunities. We've taken some good steps. We're doing some pilots on the areas I've talked about. So that's still in front of us. And when I think about 2020, the $20 million of productivity, that's obviously a combination of leverage and as I said earlier, that Jeff asked about more volume flowing through the factory. But some of that's the investments that we've made in robotics in fabrication. That's going to help us in 2021.

And back on Refrigeration from Steve Volkmann. He's working on some math and assumes a 7.5% compound annual growth rate on Refrigeration sales at a 30% incremental would be needed to hit the low end of the 2023 target. So your view or comment on that.

Yes. Thanks.

Okay. And I think we're at the end of our questions and time. So Todd, if you'd like to close.

Good. I want to thank everybody for the interest, thank everybody for taking the time out. Be safe. I will tell you, I will be ready to travel and be back out once we get the vaccines. But I got to tell you, I'm glad that when I turn off my computer, I'm in my office, and I'm not fighting traffic to get to LaGuardia. So everybody be safe, and we'll talk to you -- if we don't talk here in the next few weeks, we'll talk to you at the beginning of the year. Thanks.

This concludes our program. You may now disconnect.