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

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International 2021 Investment Committee 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.

Thanks, Christine. Good morning, everyone. It's good to be here today, even if it's virtual, although it's sort of a hybrid of what we did last year. We're all together here in Richardson, Texas, right outside of Dallas, and when we ask the questions, if the technology works, we'll be able to see you whether you are in your offices or you're in your bedroom. Joining me here today is Joe Reitmeier, our Chief Financial Officer; Steve Harrison, our VP of Investor Relations, as I point to them, they're actually sitting here. Doug Young, our President of Residential; Elliot Zimmer, our President of Commercial and Gary Bedard, our President of Refrigeration. Forward-looking statement. What we're going to do today is consistent with what we've done in prior years. I'm going to do a short LII overview to get things kicked off. I'll be followed by the 3 presidents who will do a more in-depth overview of their businesses. Joe will come up and go reiterate our 2021 guidance and go through 2022. And then Joe and I will handle questions at the end. And as I said, technology willing, we will be able to reach out to you all. This is our investment thesis. It's been consistent for a decade and it works and it's continuing to be our investment thesis. Resiliency. We're capitalizing on growth markets, resiliency of our North American residential market. And Doug will talk more about that, but we expect the end market in residential will be strong for the next 3 to 5 years and then a bounce back of commercial and refrigeration off to low -- pandemic lows of last year. We're ending the market -- excuse me, we're ending the year with extremely strong end markets, and near record, in some cases, record backlog. Well positioned for margin expansion, and our road map continues to be consistent. It's material cost reduction, factory productivity to include our third factory in Saltillo that we opened in 2021, and we'll be ramping up in 2022 as well as SG&A leverage through technology and very important in the current environment, the pricing power. We're going to get order of magnitude 3% price in 2021, and we're going to get 5% price in 2022, and Joe will talk more about that. Investments. We're continuing to gain market share, investments in our Lennox store strategy. We reinvigorated that program in 2021, and we're going to targeting to add 30 stores in 2022. Great new industry-leading products, and Doug will spend a few moments talking about some of our industry-leading residential products and continued investments in our digitization strategies. I'll talk a moment about that, and then the 3 presidents will all discuss it. And then driving shareholder value with the disciplined use of free cash flow, dividends growing with earnings, continued share buyback. We did -- we targeted $400 million of share buyback in 2021, but we outperformed on cash flow of what we had guided. And so we're doing $600 million of share buyback in 2021, and we're targeting $400 million next year. Very consistent chart, 3 legs of the business, residential North America HVAC, North America Commercial HVAC and Refrigeration segment, which includes commercial HVAC in Europe as well as Refrigeration in Europe and then the largest business is our North America Refrigeration business. I think the thing that's changed over the last few years is the red has grown and that just reflects the strength of our residential business, both on revenue growth as well as earnings power. And then those of you who know our story, we're primarily at this point in North America-based business. We love the fact that 3/4 of our revenue comes from the replacement market. So while we're impacted by the cycles of new construction, both in residential and commercial, we're very much insulated. And then, as we've shown, 2/3 of our business is tied to residential. It's always a busy chart. Let me walk through it. On the left-hand side, you see revenue and return on sales. And on the right-hand side, you see free cash flow. For 2019, we sort of adjusted for a pre-tornado number. As you recall, we got some insurance benefits that inflated the number. And so showing 14.7% to give a better perspective of what the trend line has been. Our 2021 remains unchanged with the guidance that we had at the third quarter earnings call, adjusted EPS of $12.10 to $12.30, that's a midpoint obviously of $12.20. Just as a matter of perspective, at this time a year ago, the midpoint of the guidance that we gave for 2021 was $10.85. So 12% better than our guidance, and I think that reflected the uncertainty we had going into 2021 given the pandemic. In many ways, that reflects where we are today, also. Revenue, 13% to 15%. After the tornado and the pandemic, it's nice to see revenue growing to over $4 billion, first time and return on sales up year-over-year. We can also see our 2022 guide, and Joe will get into more detail here in a moment. Let me back up on the 2021 guide, I want to just make this point to get out of the way for Q&A. As we spoke about on the Q3 call, our 2021 guide includes $150 million of negative revenue impact and $50 million of negative EBIT impact from supplier challenges, which is about $1.10 of EPS. And so the number has all that in, and that's still our thought and about half of that in the fourth quarter. So the 2022 guide, again, that Joe will talk more about it. Core EPS of $13.40 to $14.40. And while you can see a revenue number of $4.5 million on this page, later, Joe will talk about a revenue range of 5% to 10%. If you do all the math on the midpoint of those numbers, it will be revenue up 7.5%, return on sales up 50 basis points and incremental drop-through in the low 20s, which is a bit lower or just maybe just lower than our 3-year guide of 30% and our normal target of 30%. This reflects 3 things: the continued headwinds from inflation pressures; lagging impact of supplier shortages, things are getting better, but will still have some impact in the first half of the year; and quite frankly, reflecting the uncertainty of the pandemic environment that we're in. And so we're giving a number that sort of is baked into the uncertainty that's in front of us. On the right side, you see our free cash flow. You can see 2021. We're -- we targeted to be reinflating for the build in working capital. But what we saw was not building as much working capital as we had hoped because of supplier shortages and so we're coming in about 90% of net income, we expect it to be more like 75%, 80%. And then in 2022, the expectation is, we'll start to build back inventory as we get through the supplier challenges and so it will be 80% of net income. Over the last 6 years, so if you look at the 6 years on this chart and do the math, you'll see that our free cash flow is almost exactly 100% of net income, which is our long-term target. A couple of important strategies. Material cost reduction remains constant on our story over the last 15 years, moving to low-cost sources to include increasingly Mexico, although it's not shown on the chart. Second, continued focus on designing out costs and a major part of that is the key enabler of our accelerated life sort of qualification testing. It allows us to dramatically reduce the time to implement cost savings. Because of component inflation we're talking about MCR a little bit different this year. We've always given you a net number. Net number of -- you take all the price increases and then you do all the cost reduction and then you have a net number that we talk about. This year, we're going to sort of break it into 2 pieces, the sort of gross cost reduction that we're doing. So all the good work we're doing is sort of the traditional $30 million, and that's design out and changing suppliers. But component inflation impacting our -- excuse me, commodity inflation impacting our component suppliers is about $60 million of headwind in our components year-over-year. As you can imagine, when you think about what we buy, compressors, motors, the components have a lot of steel and aluminum in it and that's been hit by inflation. Joe will talk in a moment about the guide for 2022, just sort of pure commodity inflation, raw copper, steel and aluminum is $110 million of headwind. So if you add those 2 together, the commodity inflation impact in our components as well as the raw copper, steel and aluminum, it's about $170 million of headwind from inflationary pressures. And that doesn't include the wage increases that we've had to pass on as well as the impact from factory disruptions because of supply chain shortages that we'll feel in 2022. Continue to leverage digital investments. This is a consistent story for us. 3 presidents will talk a little bit more about it. Focused on e-commerce. We're a distributor focused on controls, the user interface, then the factory productivity as we leverage technology to drive productivity. Switching to the next chart, factory productivity initiatives. After having headwinds or better stated, lack of productivity or negative productivity, I think, as the business speak, we're back on track to have productivity in 2020. Really sort of 3 drivers: the Mexico expansion. We completed our third factory and are in the process of ramping it up to full production. When it's fully ramped up, over 50% of our residential production will be out of our Mexico campus. And as we talked about, this project is worth about $0.20 of EPS, which was split between '21 and '22. Automation and then information flow. Well, finally, while it's not on the chart, the improvement on supplier shortages will be a tailwind to factory productivity. We expect that sort of midway through the years, things will get noticeably better, although I would tell you today, they're better than they were 5 months ago, but we're still having issues with suppliers. And that will be sort of absence of badness becomes goodness for us in 2022. These are all the important factory productivities for 2022 and beyond. ESG. We're an industry leader in ESG. And while we haven't publicly talked about it as much as some of our larger competitors, we've made great progress. And we came out at the end of 2020 with our -- excuse me, at the end of 2021 with our 2020 ESG report, sort of dramatically more disclosure than what we've had in the past. We've been hiding our candle underneath a bushel basket and we decided to take the basket off. And over the last decade, as I've talked about, we made significant progress. 70% reduction in greenhouse gases adjusting for volume and 32% reduction in energy usage adjusting for volume. While at the same time, producing the most energy-efficient product in the industry. Also, you can see in the report, we've made great strides in our diversity representation, our safety record. And we take great pride in these achievements. We spent a lot of time discussing it and communicating our results internally. But as I mentioned, quite frankly, haven't done near as good a job externally, and we're doing better at that. We'll have another ESG report for 2021 that will come out in midyear 2022, that again will allow us to communicate to investors all the good things that we're doing in the area of ESG. Okay. I'll be back up after Joe to answer Q&A. With that, I want to turn it over to Doug Young, our President of Residential. Doug?

Thank you, Todd. Now a little bit more detail on residential. On the left-hand side of the chart, you see our revenue and ROS. This year, we will achieve record revenue and income. This year, we expect to grow revenue by approximately 18% and our ROS to exceed 19%. This will bring us to the low end of our ROS target we have provided you, and we expect to grow at higher in the range. After several challenging years, it's nice to see that we're back on year-on-year margin expansion and share gain. Our mix of business in 2020 is approximately 80% replacement and 20% new construction. Lennox makes up 80% of our equipment sales, selling direct to contractors, while Allied sells exclusively through intermediate distribution, making up the remaining 20%. Next is -- excuse me, I apologize. Next is an overview of the overall North America residential market. The left-hand side shows industry information on a year-on-year change in units. We're forecasting the market to be up low double digits in 2021 and up low single digits in 2022. Given the pandemic and challenging supply chain we have dealt with in 2021, we have better visibility now than typical for the next 1 to 2 quarters and what we see is a very healthy backlog. The replacement market remains very robust, driven by a number of factors. First, because of the pandemic and the work-from-home element, we have seen extended run hours on residential systems. This shortens the system life and accelerates replacement demand, which gives us a lot of confidence in the residential industry over the next horizon. Additionally, we all see the daily temps and understand either higher average temperatures or an elongated cooling season also increases run time, adding to our confidence in the replacement market. Another reason we're bullish on the residential replacement cycle for the coming years is that there will be more complete HVA system sales taking place as old R-22 refrigerant systems come into the replacement window. While R-22 refrigerant is still available in the market, it is significantly more expensive than R-410A. In many cases, it is cheaper to replace with a new R-410a system, which is also more efficient and comes with a new warranty than to repair the old R-22 system. This accelerates the replacement cycle. On the new construction front, we see continued housing demand and builders working frantically to meet their customer demand. And we don't see that market changing materially in 2022. And lastly, as we regain normal supply of components used in more of our higher-end products, we expect to see improvement in mix. And as far as price is concerned, we announced our latest price increase up to 13% to take effect in January. Our goal is to offset inflation, and to the extent possible, have it be accretive to our margins. And as always, with a consumer-based business like residential, macroeconomic, political uncertainty remains a risk, and same goes for the impact of COVID-19. Lennox Stores is an important component of our overall growth strategy, and we continue to see the benefits. This year, we regained traction opening up new stores, and we have 232 stores in our portfolio to-date. Our plan was to add quite a few more this year, but as with most things during the pandemic, we found it difficult to get locations identified and leases signed as quickly as we did pre-pandemic. In 2022, we plan to add another 30 stores, and we still have our sight set on having 350 or more stores, pushing out our goal by just 1 year. Every new store we add extends our one-step reach to our customers, and in less than 18 months, they're profitable. Our goal is to fill out the North American market with store locations within a 30-minute drive of our dealers in the markets that can support a store. Our store model remains relatively same. An average store is about 10,000 square feet, about 80% of that warehouse and 20% is the wholesale store. About 80% of the sales are equipment and accessories, with 20% of the sales being parts and supplies. It costs approximately $150,000 in capital and onetime expense to open a new store and operating expenses are about $300,000 to $400,000 a year. Average revenue per store at maturity, over 18 months in, is $3 million with half of that being incremental business. This remains a very exciting growth strategy for us, and it really works. Our focus on parts and supplies growth is as strong as ever. We see ourselves achieving 25% revenue by 2025. We slightly pushed out our time line, but we remain committed to achieving the goal. Holding our percent of revenue flat in 2021 is a boost as we head into 2022. With industry shipments up in the low teens in 2021 and still driving 20% revenue from parts and supplies, it's a nice accomplishment. For 2022, we've increased our focus on parts and supplies by driving to a more dedicated organization, where we will have people who only eat, drink and sleep, parts and supplies. We have enhanced our pricing sophistication and are laying in additional inventory for specific markets and customers. From an operating perspective, we've grown immensely. Compared to just a few years ago, we have a much more mature model and systems capability. Our ability to monitor and manage stock replenishment and forecast demand is significantly better, and this will continue to be a source of growth for us. The top half of this chart focuses on owning the high end by excelling at the customer experience and broadening in our market reach, by adding products that fill in the gaps in our portfolio. The bottom half focuses on sustainability and regulatory compliance. We are excited about our product introductions for 2022 as we plan to launch over 20 new products. In 2021, we launched an industry-leading 28 SEER air conditioner to complement a 99% efficient furnace. We also introduced our 24 SEER 12 HSPF cold climate heat pump targeting the northern markets. For 2022, we will introduce an industry-leading thermostat, the S40. Its feature set will include a remote smart room sensor and an air quality monitor along with an updated advanced diagnostics, remote monitoring and control capabilities as well as an improved user interface that our dealers helped us develop. We're most excited about the new indoor air quality monitor that is the only monitor that tracks 3 key air quality categories: particles, CO2 and total VOCs and then activates the system to clean the air. Part of our share growth initiatives will be focused on expanding our reach within the addition of a hybrid ductless inducted mini-split heat pump. This provides better access to markets with 0 lot lines and also addresses the growth segment where remodelers are using the combination of ductless indoor units, where ducts are not present along with a ducted unit. The lower half of the slide speaks to our focus on sustainability and regulatory compliance. Leading the way will be new models focused on efficiency and future utility and tax rebates. We will also be introducing new models optimized for the 2023 efficiency standards change. Our lineup will provide regions of the country to be well positioned for the upcoming regulatory changes such as a new 2-stage value line AC and a new 18 SEER heat pump. We are continually improving our digital experience in 2 core areas: one, e-commerce; and two, the Internet of Things or the Lennox smart equipment. We are driving our customer base to buy more online and interact more deeply and more frequently with us across our suite of digital tools and platforms. We find that our most digitally engaged customers are our best customers. They spend more, they grow faster and they buy more high-end equipment, and they are more loyal. So we are actively driving our dealers to engage with us online. From an e-commerce perspective, we're making it easier and more convenient for our customers to buy online. We're making both foundational improvements to the site like search and store as well as more sophisticated improvements on personalization and recommendations using artificial intelligence. We are continually introducing new features that help our customers with their day-to-day execution. An example is our quick proposal tool, which will be an easy, simple way for our customers to mark up their products to create proposals for homeowners. The majority of our customers create proposals on paper, and this new feature will be simple and easy, which is what matters most to our customers. From an IoT perspective, we're making our sophisticated prognostics and diagnostics more accessible to technicians at the job site by enhancing the LennoxPROs Mobile App. For example, when a technician is servicing the equipment, he can pull up equipment-specific information using a mobile bar scanner, see specific performance information and also see curated troubleshooting information. We're also releasing a new mobile app for homeowners alongside our next-gen thermostat, the S40. We're very excited with our digital progress, and we will continue to invest in areas that make our customers more efficient and us easier to do business with. And now I'd like to turn it over to Elliot Zimmer, President and Chief Operating Officer, Commercial.

Thank you, Doug. Good morning. Now let's review our commercial segment. Starting on the right side of the page, the commercial segment is comprised of 2 businesses: the HVAC equipment business, which is 75% of our revenue; and National Account Services, or NAS, which is 25% of revenue. We're in a replacement cycle with 2/3 of our revenue coming from planned or emergency replacement jobs, which brings stability to end market demand. On top of that, we're seeing positive trends in new construction activity. Various indexes that we track -- that track this activity are trending positive and recover more quickly than the previous 2 recessions. Moving back to the left side of the page, green bars are revenue and the blue line is EBIT ROS. In 2021, our top line rebounded nicely from 2020, with revenue up roughly 7%. However, ROS is down, most prominently impacted by broad inflationary costs and investments in operations to address labor and supply chain issues. The left side of this page shows industry shipment information. After being down 15% in 2020, the 2021 North American commercial unitary market will be up mid-single digits in 2021, and we expect it to be up mid-single digits again in 2022. 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 created through the postponement of planned replacement, like we saw in 2020, is released over the next few years. As I mentioned previously, we are also seeing positive trends in new construction. We in the industry expect that price leverage will continue and customers continue to mix up to more premium products, namely with our new Model L. On the downside, we see inflation, supply chain, volatility and e-commerce trends continuing to put pressure on the market in 2022. We continue to leverage our product and service strengths to provide customers with solutions as their strategies evolve to navigate the current environment, and we continue to focus new business efforts on diversifying our customer portfolio. Over time, Lennox has been the recognized market leader in national accounts with hundreds of accounts in our portfolio. National account HVAC equipment sales is roughly half of our equipment revenue. Lennox has the most efficient and most flexible rooftop units available in the market, which provide the lowest operating cost to meet any building need, which is extremely important for the national account customer. Our one-step direct-to-customer distribution strategy enables us to provide complete control of the supply chain from manufacturing to the job site, ensuring equipment is ordered, built and delivered to meet construction time lines. This has been invaluable in 2021, enabling us to grow with key accounts and opening doors for more new business into 2022. Increasingly, our national account customers also want units installed, commissioned and maintained. In these cases, we're able to provide our national account services, which I'll get into on the next page. On the right side of the chart, we continue to experience a lot of success extending our national accounts program in the nonretail verticals. In 2016, traditional retail represented roughly 25% of our sales, and now it represents roughly 15% of 2021 sales. Other important verticals that we target include DIY, supermarkets, restaurants, convenience and discount. And we're continuing to grow in the critical distribution vertical where our business grew by more than 50% with Amazon in 2021, for example. We're excited that we continue to win in national accounts, and our diversification efforts are paving a path for continued success in this channel going forward. National Account Services, or NAS, is the gem of a business that continues to generate double-digit ROS and strong growth. I'll start by saying that NAS only services national accounts, and this is important because there is no channel conflict with our local contractor customers whom we sell directly to and have a tremendous relationship with. We have over 105 service branches across North America, and so have the footprint to provide self-performing services to more than 97% of North American customer sites. By not having a subcontract to work, we were able to provide the consistent quality experience that national account facilities teams require. We provide national accounts with the benefits of HVAC performance certainty and budget certainty, by performing the complete suite of HVAC asset management services, from planned placement to emergency replacement, to indoor air quality upgrades and planned HVAC replacement. We also offer building management system monitoring for our national account customers, proactively managing alarms across their footprint of building locations and improving their operations. Because of what we offer, we have tremendous relationships with many well-known brands, some of which you see on the bottom left. We have strong customer retention, and we are successfully acquiring new customers as we scale operations. After a lull in our growth due to the pandemic, we got back on track in 2021 and have a revenue target in 2024 of $260 million. Roll all this together, and we're excited about how this business fits into our portfolio and its potential for the future. Local contractors or nonnational accounts serve roughly 70% of the North American unitary market, and this makes up the other 50% of our commercial equipment revenue. So you can do the math and see that we have opportunity to grow. Starting on the right side of the page, local contractors perform the majority of new construction and emergency replacement work. They typically use the specified HVAC brand in new construction and planned replacement jobs, which is poised for growth and drive the HVAC brand they are most comfortable with in emergency replacement jobs. Local contractors service business verticals like schools, office buildings and mixed-use development, to name a few. Moving to the left. Our investments in products, direct distribution, dedicated support have all been a part of our growth in the local and regional markets. Building off our strength in national accounts, Lennox has a strong portfolio of specified products, like Model L, enabling us to win with engineers who are specifying Lennox as basis of design on new construction and planned replacement projects. This is increasing Lennox share in these projects now and positions Lennox to win more replacement projects in future decades using the advantage of like-for-like replacement. We also have the most comprehensive portfolio of replacement products like radar, which fits on the carrier footprint to provide everything contractors need in emergency replacement projects. We continue investing behind both our direct distribution network and our dedicated support ensuring that products are easy to find, order, deploy and commission on local job sites, saving contractors, time and money. Now let me turn it over to Gary Bedard, President and Chief Operating Officer of Refrigeration.

Thanks, Elliot, and good morning, everyone. Let's look at the makeup and the performance of the Refrigeration segment. Starting on the right-hand side of the slide, I'll review the geographic and end market profile of our business. Geographically, about 60% of our revenue is in North America, with the balance in Europe. Now from a product application point of view, 75% of our sales are in different aspects of refrigeration, while 25% of the total is in commercial HVAC, all of which is in Europe. And if we view the business through our end market exposure, you can see that the refrigeration products are used in grocery and convenience stores, restaurants and fruit preparation, cold chain distribution, and finally, process and nonfood cooling to include pharmaceuticals. Now moving to the left of the slide. Let's look at our performance. In 2021, the Refrigerant segment achieved both a sharp increase in revenue, along with increased profitability. Sales are up about 18% versus 2020. Now when compared to the more normal 2019, we're up mid-single digits in revenue, and we will end the year with record backlog. Profitability increased 140 basis points, making steady progress towards our longer-term goals, even while overcoming supply chain headwinds and the delayed impact of significant pricing actions to offset input cost inflation. This segment is well positioned for continued top line growth and margin expansion. In 2022, we expect solid underlying growth in all of our end markets. We forecast the North American refrigeration market will have robust mid-single-digit growth, while both of our major European end markets look to experience low single-digit expansion. The headwinds we confront are not much different than many other businesses or industries. We face inflationary pressures along with the uncertainty around COVID variance, both of which impact virtually everything in our value chain. In addition to these common headwinds, our products face a complicated and changing regulatory environment worldwide as governments tighten efficiency and refrigerant selection rules. Now our key growth initiatives, which I will detail shortly, provide us with the underlying momentum to meet our 2022 plans. In addition, we expect a strong operational recovery from the supply chain disruptions experienced in 2021, and digital investments we've made over the last several years along with news for early 2022 will help improve our back-office productivity and throughput. Finally, although it's not on the slide, we feel confident that the pricing environment is favorable to offset the higher input inflationary cost that I mentioned earlier. Now let me review these key growth initiatives. As I mentioned earlier, markets in both North America and Europe face an increasingly complex regulatory environment as countries seek to reduce carbon intensity. For us, that means higher efficiency products as well as refrigerants with lower global warming potential. We are in the middle of a multiyear plan to upgrade existing products to achieve higher efficiency using both natural and lower global warming potential synthetic refrigerants. New rooftop units and chillers using R32 are among our fastest-growing products, and we are executing plans to expand the offering. We also continue to grow our refrigeration product lines with an all-new CO2 gas cooler line and systems optimized for lower GWP refrigerants. These new offerings are helping us to enter new markets and gain share by meeting the growing need for environmentally friendlier products. In the past, we've talked about an untapped $300 million light industrial refrigeration market in North America. We introduced a new brand that we call Magna to penetrate this market. I'm happy to say that we've had great success in 2021 with nearly 10% of the segment's revenue growth coming from this initiative alone. As we move into 2022, we are perfecting our sales approach and driving towards a more uniform sales execution throughout the new distribution channel that we've established. The pandemic brought some ongoing changes in how food is delivered and stored and these changes are showing up more in this particular segment of the market than others. So we see both market growth and share growth opportunities with Magna. It's an exciting development and a welcome addition to our available market. Lennox has a leading share in the European rooftop market. This market is considerably smaller than its North American counterpart. In Europe, we also sell small and midsized chillers into a market that is roughly 4x to 5x the size of the European rooftop market, but our share in this space is quite low. In 2022, we will complete the rollout of a full line of new efficient chillers using alternate refrigerants. While the product is very important to attract new business, it's not the only story. Our direct sales team has solid relationships with both installers and key accounts. In my experience, the combination of relationships, presence and a great product is compelling, and our initial results show we can gain share as we have the right product and focus on areas and customers who are underserved by the competition. Finally, we're targeting key geographies where we have lower than average share. Our manufacturing partnership in Turkey is allowing us to offer lower price point products in markets adjacent to the European Union, while new distributor acquisitions in parts of Europe and North America give us opportunities to scale sales quickly. Finally, we are also executing OEM agreements to drive sales with local brands to gain share in underserved areas. Now in addition to our top line initiatives, we also have focus areas designed to help improve segment profitability. Our factories performed well in delivering product and finding workarounds to satisfy customers in the face of significant supply chain and labor shortage issues in 2021. Now normally, factories are focused on key productivity initiatives. 2021's focus was largely on throughput. As we move to 2022, we have an opportunity to not only reap the benefits of previous productivity products -- projects whose results were masked by inefficiency, but to renew our pursuit of new opportunities as well. In 2019, Lennox signed a licensing agreement with a long-term partner in Turkey to help them retain domestic sales in the face of trade barriers by using our designs. In 2022, we'll use this partnership to supply certain products in targeted geographies to both gain share as well as profitability. Success here will lead us to look at other similar opportunities. Now looking at SG&A productivity. As part of our extensive redesigns and the run-up to the U.S. Department of Energy changes in 2020, we structured our engineered-to-order product lines in such a way that we can use robotic process automation to continue to provide customized designs in a fraction of the time that it looked previously. As an example, we were able to implement a design change on over 3,000 customized models complete with CAD drawings over a single weekend. This would have taken weeks in the past. The productivity benefits here are threefold. First, consider the operational leverage as the company grows. Secondly, the engineers we do have can pursue higher-value activities like cost reductions or new products. And finally, the automation of front-end selection and back-end engineering leads to a quantum leap in quality. It's much faster with higher quality. And one final point here. This capability allows us to more completely design a specialized product before even quoting it, giving us a competitive advantage in both lead time and understanding our cost. We are continuing to apply this approach in other businesses with a similar engineer-to-order business model. Finally, in both Europe and North America, we have sales and service processes that are frankly under-automated, leading to higher SG&A requirements and ultimately lower customer satisfaction. We are behind the other segments in the digitization of these processes, but we have work underway to improve. The good news is the playbook is well worn, and we are executing to it. Thanks again for your time today. After a solid 2021, we are excited about the path ahead for us in Refrigeration. Now let me turn it over to Joe Reitmeier, Executive Vice President and Chief Financial Officer.

Good morning, and thank you for joining us this morning. I'll start off by reiterating our 2021 guidance points that remain unchanged from our third quarter earnings call and were included in the press release that we issued this morning. Collectively, revenue is projected to be up 13% to 15%; GAAP EPS within a range of $11.97 to $12.17; and adjusted EPS within a range of $12.10 to $12.30. Corporate expenses will be approximately $95 million, and we expect our full year tax rate to be approximately 20%. Our guidance for free cash flow is $400 million. Capital spending will be $135 million for the year and includes our investment in a third residential manufacturing facility in Saltillo, Mexico. And we've completed $600 million of share repurchases during 2021. Now let's turn to 2022 and an overview of what we have planned. Todd gave you a view of our plan, and here are some of the dynamics driving the plan, starting with end market growth. Residential markets remain resilient, and we expect to see continued momentum in 2022. In commercial HVAC and Refrigeration markets, we continue to see steady growth, evidenced by strong order rates and backlogs that position us well as we enter 2022. Market share gains will complement end market growth. We have share gain initiatives across all 3 segments. Share gains are driven by our continued investment in distribution, industry-leading innovative products and the advancing digital capabilities that further enhances our value that we deliver to our customers. Announced price increases will provide a $235 million benefit, approximately a 5.5% yield and includes carryover from price increases instituted throughout 2021, along with announced price increases that are effective in early 2022. Factory productivity will generate a $20 million benefit in 2022, including benefits derived from our new residential manufacturing facility in Saltillo. Now let's turn to the headwinds we anticipate. Supply chain disruptions plagued 2021, and while conditions are better than they were 5 months ago, we anticipate that those disruptions will continue to challenge us with the expectation that bottlenecks will ease later in the year. Inflationary headwinds impacted 2021 and are continuing in 2022. Commodities in the form of raw metals will be a $110 million increase. Component costs are up $60 million and nets to a $30 million headwind after benefits generated from engineering and sourcing initiatives. Salary inflation is 4% compared to our traditional 3%, with wage inflation even higher in the factories, and increasing freight rates will add an additional $5 million of costs. 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 continue our investments 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. This momentum will continue and complements end market growth. Macroeconomic uncertainty remains a wildcard, but hopefully, the pandemic is behind us in early 2022 and inflation eases as supply chain conditions improve. Now I'll turn to our 2022 guide points. Top line growth, we expect to be within a range of 5% to 10%. The growth is in the form of both market growth and share gains. Price yields planned to be a significant and contribute approximately 550 basis points to the top line next year. Earnings per share are planned within a range of $13.40 to $14.40. Corporate expenses are expected to be approximately $95 million. Our effective tax rate will be approximately 20%. Capital expenditures are planned to be approximately $125 million. And we continue to invest in high ROI projects focused on fueling growth, driving innovation with industry-leading technologies and capabilities that enhance our value proposition to our customers and increasing profitability with continued investment in cost-reduction initiatives. Free cash flow will be approximately $400 million and includes restocking of inventories in our distribution networks that have been depleted due to continued strong demand and limitations and replenishment due to COVID disruptions and supply chain bottlenecks. And share repurchases are currently targeted at $400 million for 2022. I will now touch on our capital deployment philosophy. Our philosophy on capital 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, and 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. Inorganically, we will consider acquisitions where they make sense, and we'll 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 will continue to return cash to shareholders by supplementing a competitive dividend with share repurchases. Now this is a summary of our past performance and our 2024 targets. This chart reflects the historical trends in revenue and return on sales and our projections for 2024. After a few years of navigating through disruptions, first, the tornado that hit in 2018 with the recovery through 2019 and now the pandemic for the last 2 years. Over the 3-year horizon, we plan to grow revenue at an average annual rate of 6% and deliver 30% incremental margins over that horizon. Now turning to the margin targets. Here are a long-range targets for each segment. They remain unchanged. For our HVAC businesses, both residential and commercial, 2024 target margins are 19% to 21%. In our Refrigeration segment, our most geographically dispersed business, margins are targeted between 12% to 14% by the end of 2024. Now I'll end where we started, with our investment thesis. Our momentum continues with the effective execution of our core strategies that deliver value centered in our innovation on multiple fronts, enabling Lennox to continue to outpace our competitors, enhance profitability and deliver superior returns to our shareholders. I want to thank you for your attention while we give you the formal part of the presentation this morning, and now we'll go to Q&A.

Okay. We'll do now the Q&A. Hopefully, you can see me here. And we have the ability to sort of pull people in. And what I will tell you is, stay on your toes because I reserve the right if I don't like the questions to just cold call you. So the mic and the camera may go on in your bedroom without you knowing it, so be prepared. With that, I'll turn it over to the operator to pull in to Q&A.

Our first question is from Julian Mitchell with Barclays.

Maybe the first question, Todd, just around seasonality next year. I think you emphasized a couple of times that the slightly lower operating leverage assumption is because of sort of first-half pressures continuing to weigh as you exit this year. So maybe help us understand kind of any difference in earnings seasonality? Anything to call out on the top line that's maybe different in terms of the weighting?

I'll maybe make 3 points. One point I'd make is, there's been years where we've had different calendar issues. There's no calendar issue on a year-over-year basis. So that won't affect it. I think the second point I'd make is, The last couple of years have been strange because of COVID in terms of the earnings by quarter. I mean, we had a really, really strong second quarter, which you normally don't have. It's usually third quarter strong. And so 2022, the EPS layout will look much more historical. And so what I mean by historical is, I go pre-tornado, sort of 2018 and below, and look how the EPS is spread out by quarter. And then the final point I'd make is to just agree with what you said, although I'm not going to directly quantify it, is margin expansion will be more pronounced second half of the year than first half of the year because price will have bitten supply, chain issues will be behind us and commodities year-over-year will start to flatten.

Great. And I think your commentary on residential market demand has stayed fairly consistent through recent months and your outlook for next year reflects that. So maybe I wanted to ask about the commercial business. Any thoughts around the split of kind of new construction versus replacement revenue growth in 2022 that's in your guidance? And also, should we expect the commercial margin rebound to exceed the other 2 divisions, just given that kind of low starting point ending this year?

In terms of new construction replacement, as you know, Julian, but for others, we're 2/3 replacement in commercial. So we're much more exposed to that than we are in new construction. We think the replacement market will grow better than the new construction market in 2022. In terms of the margins, we set a 3-year target for commercial to get to 19% to 21%. Prior to COVID, they were at 18%. So you're right, so this precipitous fall, they were the most impacted by the supply chain issues, factory issues as well as not being able to get prices quick. I would think about it over a multiyear period. We'll see expansion of commercial margins greater than the other 2 segments. In 2022, given some of the overhangs I talked about the first half of the year, that will impact commercial to supply chain issues as well as still catching up with commodities on price. So I wouldn't see an outsized growth in commercial margins in 2022, but over the next 3 years, I certainly would.

We have a question from Jeffrey Hammond with KeyBanc.

I saw Nigel. I saw Jeff. I mean this is like an LSD nightmare to sort of bouncing from guy to guy with a blurry background. So Jeff Hammond, go ahead. I'd also -- I'd point out now that I'm getting to the end, I can make these comments on public lines, but there'll be a game on January 3 that I don't think will matter to either one of us, but it should be a good game.

Well, I apologize if I'm distracted. I'm getting the Browns COVID updates. I mean I with you. You're not going to have a team Sunday. Maybe just jumping in on supply chain, I think 2 things. One, maybe just level set us on anything that feels like it's getting better or worse? And then two, just in the 2022 guidance, how should we think about supply chain disruption? Because it sounds like it's a headwind in the first half and a tailwind in the second half. Should we think of that as kind of net 0?

I think the way I'd level set it would be, we're better off than we were 5 or 6 months ago but still not whole. The places we're better is getting enough employees, hourly labor to work in our factories. That was an issue through midyear this year, and we think that's broadly behind us. COVID impact in our factories as of today is dramatically less than it was 3 or 4 months ago. But I mean sort of implied in our guidance is an uncertainty around COVID. And if things -- I read one article, as you do, that says, Omicron is nothing, and I read another article that says it's going to be the Walking Dead. And so we built a plan somewhere between those 2. If things come out to be more benign then we'll do much better than our plan. I think to just go back to your question, employee shortage better, COVID better; supplier, it depends on the component; integrated circuits, much better because we've sort of worked aggressively to requalify and then buy in many cases a year or 18 months of inventory to buy us over, but there's other commodities or components that are now sort of more challenging. So it's a bit of whack-a-mole. So if I knew the future, I'd be able to predict the future but what we built into our guide is a belief that things are much better now than they were 5 or 6 months ago that, that will continue and then sort of midyear get better. I think the way you will see it on the P&L will be -- we said $20 million of factory productivity. If things go better than what we expect, then it will be more than $20 million of factory productivity because we have sort of baked in bad news associated with supply chain issues, which sort of bleed into factory issues. The other area that you would see it is, we'll be much closer to the high end of our range of revenue because we'll have product to sell. And right now, we remain supply constrained, not demand constrained, and I think that's certainly through the first half of the year. And so if we get healthier, quicker, then we'll see even better revenue growth than what's in the number.

Great. And then maybe this is -- you can handle this or for Doug, but you're kind of...

I'm not letting Doug get near a mic, so I'll go ahead and handle it.

So you're reaccelerating your PartsPlus growth. The parts growth that you have in '22 is like 20% plus. And I'm just wondering what the confidence level given, one, supply chain; and two, just all the permitting issues and slowness around new construction and getting kind of stores open, what the gating factors are to hit those?

I think I can answer that for Doug. Although Doug is in the room; if he wants to jump up, he can. I was just joking. The issue with opening more stores as you hit on it, it's a tough market for light industrial sort of commercial wholesale sort of locations that we put these stores in. And we've learned over time, you've got to get the right location, obviously, or you're not successful. And so we're holding out to get to right locations. And so I think Doug would say if he was at the mic is, 30% is to target, it may be plus or minus 30%, but that's the way to go. And then in terms of growing, as you said, it's a great strategy. It's working. And the percentage of revenue didn't go up, but that's just because equipment grew 15%, right? The parts and supplies, they have the formula. We're focused on it. We're going to try and open as many stores as we can in -- excuse me, in 2022 with the caveats that you said that it's tough to get land. The permitting is not that big a deal. It's just define the right lease, the right location, and we're particular about how we do it.

Next, we have a question Nicole DeBlase with Deutsche Bank.

Okay. Excellent. So I have to ask the requisite question, Todd, about the CEO search, obviously, getting a lot of questions from investors about how that's going. And I know you can't obviously provide a ton of information probably but figured made sense to hit on the topic?

Yes. As you suggest, I really can't answer, but I'll do my best. I mean the independent directors, as I said before, the independent directors are leading to -- excuse me, leading to search. When they have my replacement, we'll announce it. And then I think the message I want to leave as I have from July is that my hands are firmly on the wheel. I'm focused on driving the business with the Lennox team. And so I learned a long time ago mixing metaphors, you don't stop swing until the bell rings or you get knocked on your b***. So I continue to swing.

Got it. Okay. And then when you guys put together the outlook for the resi HVAC business, did you embed anything for prebuy ahead of the SEER standard change? And any early thoughts on if you have embedded that, what that could mean for 2023 demand or if you still feel good about the multiyear replacement cycle from here?

On to the last first because I always feel required to say I feel confident about the multiyear replacement cycle for resi. But specifically about the prebuild we're assuming that there's not much of any prebuild because our sort of base case, both for the market and for us, is that we'll be supply constrained to meet normal demand, and we won't be able to prebuild. And so if there's not sort of the normal prebuild, then that sort of makes 2023, all things being equal, more robust because people will have to buy the equipment in 2023 rather than 2022. All that being said, I would think even a normal -- even if we didn't have supply chain shortages as an industry, given the minimal increase and minimum efficiency, I wouldn't expect too much of a prebuy. But the short answer to your question is, we haven't -- I don't think we've baked anything in for prebuy.

We have a question from Gautam Khanna with Cowen.

Can you hear me clearly?

I can. I don't think you're from Goldman, but go ahead. Go ahead.

So I had just a follow-up to Nicole's question actually on 2023 and the SEER kind of -- the SEER mandate where presumably mix just naturally improves, right, as the minimum efficiency goes up. What does that do for pricing, just broadly? I mean, I presume is it linear with the -- an increment of SEER goes from 13% to 14%, is it a 7% increase in price?

I think the way I would think about it would be, you figure out the portion of the product that's minimum efficiency for units. I know that number, it's about half for the industry. Dollars, it's -- I don't know what it is 35-40 back into the math. And then that portion would go up by the minimum SEER efficiency. And then as we've often talked about, sort of the goal was to make it margin-percentage neutral. So you have to pass on enough price to offset the cost increase and the margin percentage, but that's sort of broadly how I would think about it.

Okay. So if that's true, we do see a bump up just naturally year-to-year in both price and margin in '23?

I think you certainly see it in price, all things being equal. And you see it in margin dollars, all things being equal. But it's not clear that you'll see in margin percentage. I think margin percentage, all things being equal, will be flat and maybe down if we can't sort of get the full price increase to offset the cost plus the margin.

Fair enough. And then just -- I know you have a framework out to '24. Any comments on '23's incremental margin and where that may lie? Is it -- do you expect it to revert back to 30% as a kind of normalized inputs and what have you?

Yes. I mean, broadly speaking, I mean, if it's a 3-year number, and it's 30% in the first year is low 20s, that means the next 2 years are going to, on average, be better than 30%. And I think 2023 starts to get there and then 2024 maybe even better. Because there's going to be a year that commodity fever will break, and we won't have to give back price as much as the commodities go down if we have to get back any price at all. And so what we've seen on these cycles, and you've seen we had a downturn in '08 and then we had a downturn in '11, and commodity inflation in '12, and I think in '09. What happens is you have the commodity inflation as markets were back and then you pass on price and then you never lower the price, but then you get commodity windfall. So there will be a year or 2 if that happens. And I think we'll see some of that over the 3-year period, maybe some of it outside a 3-year period.

Next, we have a question from Joe Ritchie with Goldman Sachs.

So I wanted to get back to Lennox Stores. You guys mentioned this is consistent with what you've said in the past that the Lennox Stores get to breakeven in 18 months. So by that point, you're generating, call it, roughly $90 million in revenue on an annual basis from a 30 store per year count. I guess I'm just wondering what kind of scale do you need to get the Lennox Stores to Lennox residential average margins? And typically, how long does that take?

I'm going to sort of tease a little bit what you said. When we say we get to operational breakeven, that's not max revenue. So what we say is, we get to the $3 million per store about 2.5, 3 years in, so I think about it as 3 years in, we're at $3 million per store, 30 stores, gets you to $90 million. The mix of the business is incremental to our overall operating margins, and it's somewhere between 1.5 years to 3 years, it sort of crosses over the normal mix. And we get there because parts and supplies on average have a higher mix percentage in our equipment because wholesalers typically sell those things at 35%, 40%, 50% as do we. And then if customers are picking it up, we save the travel expense of the final miles, and so we're able to sort of share that expense with our customer. So they are accretive to the business.

Got it. Okay. That's super helpful. And then just maybe switching gears a little bit to the commercial side of the business. It looks like your national account strategy has been working in the last couple of years. It helps cushion some of the blow, the cyclicality that you sometimes see in the commercial markets. I guess I'm just trying to understand maybe just again, from a margin perspective, how does your national account business compare to the rest of your commercial business from a margin perspective?

It's counterintuitive in some ways because you tend to think of customer consolidation leading to lower pricing. But the other driver is the more sophisticated the product, the more differentiated is the more price you can get for it. So we actually make better margins on our national accounts than we do than the other part of the business, the contractor side of the business. And so we make reasonable margins. For any customers listening on the call, any of our national accounts customers, it's every other customer except you. You have our best price. But sort of on average, we do well with national accounts.

I guess maybe the quick follow-on to that one is, what's the limiting factor then in terms of trying to grow that business even quicker than your expectations?

I think it's -- we're the market leader. And so when you have strong market share just becomes incrementally harder. I mean we're focused. We're growing. We're not backing off an inch. But the other guys are attacking and coming at us. And so we lose some, we win more than what we lose. So lot of answers. We're growing at it as quick as we can. And our service business that I talked about it sort of bundles it together, you have the service, you have the equipment, you have VRF and you can sort of tie all that together with national account customers as needed.

We have a question from Jeff Sprague with Vertical Research.

We reopened our office in June of 2020. Just a couple of things. First on price, can you just square away for us what -- how much of that 5% is kind of the carryover benefit? What's already loaded versus kind of new actions you're doing here at the beginning of the year? And with those kind of actions you've announced here for December, January kind of be the extent of what's planned in your guide?

Order of magnitude, a little over half is pricing that we've already stuck for price increases that we did in 2021. So the lingo is the carryover. And then the balance is the price increase that we've announced in all our businesses effective January 1 in the HVAC business, February 1 in Refrigeration. And our expectation of what we are sticking and will stick in this final price increase gets us to the 5% plus or minus percent that Joe spoke about.

And then just on the headwinds, and I think you ticked through them pretty well. I just want to be totally clear. On purchase commodities, it's $60 million gross, but $30 million net after supply chain actions and -- could you give us some sense of what the labor headwind is in dollars? You threw out a percentage number, I think?

Let me just sort of recast the numbers, as you suggested. So what you said, which is raw copper, steel and aluminum, that's $110 million of headwind. And so the steel, copper that we buy and bring into our factories and fabricate $110 million of headwinds. And then the compressors and motors and parts that we buy from others, there's a $60 million price increase that they're passing on to us from the commodity increases that they've seen. So I would say commodities in total is $170 million. Raw commodity is $110 million and our components in $60 million. And then the 4% wage increase for salaried employees, I'm not going to give a number, but I mean, obviously, I think you can back into it, that's broadly SG&A. You can sort of look at an SG&A number look like what the normal growth is and assume it's 25% more because that's tied to increase in wages. And then the final piece that I didn't even try and quantify because I don't really want to talk about it directly is, we've had to raise wages in our factories for direct labor to get people to work in the current environment. And then we've also had these significant costs from supplier disruption that bleeds into the P&L. And so I would think about the $235 million of price offsets the $170 million of commodities, raw commodities plus components, plus some of the other things I just spoke about. And I think order of magnitude, they're about the same.

And then just one last one, just on cash flow. I think if you do $400 million in 2022, that's going to be 4 of the last 5 years. Your free cash flow has roughly been $400 million. It was better than that in 2020 when we had kind of a drawdown kind of liquidation mode. Just give us a little color on why we can't grow cash flow here? I get -- like when I look at any particular year, we're taking growth and we're going to supply chain, and I get all that, but it would seem over the scope of 5 years or so, we should be seeing this free cash flow number move up a bit with the higher revenues and earnings?

I mean I'll repeat what I said, and then you can push on me. I mean I think the way to look at it, given the tornado, given COVID, given deflation, given inflation of our inventory or working capital over the 6-year period is 100%. So there's a year like 2020, where we're 150% or whatever it is, then there's a year like this year that we're at 90% and then a year like next year that's 80%. The sort of decrease in free cash flow as a percentage is just reflecting that we're very low on inventory right now and we need to reinflate. But I would tell you the guides to guide. But if things come together in a world where we're able to produce and build inventory, we're going to sell more than what we have in our guide, and so I think it will be a little bit self-correcting. And so we guided to have a lower cash flow this year than what we executed on. We guided coming in 2021, we'd have $400 million of share buyback. We did $600 million. Let's see how 2022 evolves. But that -- I know you're pushing on the free cash flow number, but I would say, over the 6 years, it's 100%, and that's sort of what we're committed to doing.

We have a question from Nigel Coe with Wolfe Research.

So thanks for the detail, obviously. I just wanted to maybe zoom into 4Q a bit more. Based on the numbers you put out the segment numbers for '21. It looks like resi might be up double digits, low double digits in 4Q and commercial down double digits, again, down low double digits. So just was wondering, commercial, not a huge surprise, but resi, if that's the right number, it's certainly well above where we were. So just wondering if you could give some color on what you're seeing in resi do in fourth quarter?

I'm going to respond directly to the up 10%, but I mean, you can do the math. And the answer is, our resi business, as Doug said, the demand is strong. We have very good factory team there. As you can imagine, these are the men and women who are battle hardened by the tornado and so they know how to get things done. And so our factories in resi have recovered better than anywhere else in the business, although Refrigeration has done well. Commercial has been more challenged. And commercial could have revenue up double digits if they have the product. They just don't have the product.

Okay. That's great. Just that the AHRI data has been down in October. So just I guess you must have seen November and December coming up quite nicely, so that's great.

I also think just to AHRI, as you know, I mean, there's just lumpiness, and we're selling directly to dealers, and in those AHRI numbers, carrier, that's their number selling to Watsco, an independent distributors. And so it can reflect lots of different things. But the end demand to the consumer isn't down, although the AHRI numbers are down.

That's good point. And then on the $110 million raw material inflation for next year, how sensitive is that, Todd, to changes in commodity prices over the next 3, 6 months? And the spirit of the question is, we're seeing steel prices falling quite rapidly. So just wondering: number one, what have you dialed in to steel potential deflation? And how sensitive is that number to X number of changes in commodities?

We -- on copper and aluminum, we're hedged. So we're about 50% hedged out, maybe a little bit more roughly 50%. On steel, we were relatively conservative. I've been telling our -- I've been doing this long enough that I'm adamant that integrated mills will get greedy, they will add capacity and the fever will break, but we haven't seen it yet. So our team was relatively conservative. So we've sort of taken the current spot pricing for steel, mixed out with some future forecasts, but there's not a whole lot of steel decrease in the number.

Next, we have a question from Steve Tusa with JPMorgan.

So is the dates -- just remind us what the kind of end date is on your kind of search in tenure here? Like, what was the -- just remind us of what that marker was again?

What we said in the press release was, I think, the exact words were, by midyear. So I tend to think about it as -- if it was bully and logic, we'd say less than or equal to midyear. And the answer will be when they find a person, I'll exit stage left.

Got it. So will you likely be on the second quarter conference call?

I don't know. To put it this way, I told Joe, we should double the numbers for the 3-year plan, and he wouldn't believe me. But I don't know if I'll be on the second quarter call.

That is a great idea. Go out with a bang, for sure. And then just on the cycle side, you guys used to give a little bit more kind of like mid-single digit for 2 to 3 more years with that waves crashing on the beach chart you guys used to give. Any kind of more specific color on what you'd expect in growth and kind of timing? Or we're just throwing out that playbook and it's mid-single digit as far as the eye can see from here?

We will just pause because -- I mean the question you're asking is fair, obviously. And I think I'd characterize it this way. For all the reasons you've heard me say ad nauseam, I'm very comfortable next 3 to 5 years going to be up mid-single digits when I look at the numbers, and that's tied to more run hours, that's tied to warmer weather, that's tied to '22. The challenge has been -- it's tough to model. I mean I don't know how you guys have felt, but I sort of look at the last 2 or 3 years of demand compared to the model that we did 5 or 6 years ago, it's sort of been much higher. And so the natural sort of -- that's what got my head scratched and said, "Look, I would have thought it would have come down and it hasn't". And so there's variables that are unaccounted for. So then I get nervous about publicly sharing with investors a model that's hard to calibrate. So it's not quite -- it's mid-single digits as far as the eye can see, but I think it's mid-single digits for next 3 to 5 given the things I've spoken about. And then I think over time, the corporation will try and model it better. But it's not an easy equation to model because we haven't been right. And we've been right luckily on the low side, and it's been better than what we thought.

One last one for you. What do you think the cost by the end of this year when you kind of enter '23 -- what do you think the installed cost to the consumer will be up since the beginning of COVID? And then are you seeing any inventory at contractors?

I think there's very little inventory of contractors. I think you can find some of the larger ones will carry 2 or 3 weeks. But that's just not the business that they are in. And you can argue maybe your question is leading to an inflationary environment, maybe they try and buy some to protect themselves. But that's a dangerous game for a contractor to do and most of them don't do it. Over COVID, I mean, we got, say, 3% material this year past pricing. We'll get 5% next year, just around that to 10 for easy math. And then I think wages at the dealer level probably up as much, maybe more. And so just say 10%, 5% a year for wages at a dealer level, that may be underestimating it. So I'd say, over a 2-year period, probably up 20%.

And then you add on the '23, and that's another you said like 7% or 8% or something like that. I mean, the year is changing...

Fair enough. For minimum efficiency of people who are buying. And again, that's 35% of the revenue dollars, 50% equipment. So yes, at minimum efficiency, that's what it is. Now the cash...

Is it a zero elasticity in this market, like, just zero?

I don't think it's 0. I think it what happens with other things a little bit. So Emerson compressors are going up just as fast or faster. So the price on an Emerson compressor is going up, my guess is over this time period, 35%, 40% for the replacement market, although they can answer that themselves. And the labor to install it for the dealer, the labor rates are going up the same 10% that I spoke about over a 2-year period. So I think in many, many parts of the country, if you're buying a furnace, you have no choice. If you're buying an air conditioner, you have no choice. And so I think people can either repair it or replace it. And if the economics are still a payoff of 2.5, 3 years of replacing rather than repairing and you get a 10-year warranty and better efficiency, I think that's what they will do. And then we continue to make the product that we sell today so much better than what we did 15 years ago with controls, with indoor air quality, with monitoring indoor air quality, we give them reasons to do. So nothing is 0. You can't rate -- if we could raise prices indefinitely, it'd be $1 million to buy an air conditioner. But I think there's inflation sort of everywhere right now. And if we were unique in an island, the only place where there was inflation, then I would say I'd be concerned. But there's inflation everywhere and people, I think, are adjusting to a world where you got to pay more for things than they used to.

We have a question from Josh Pokrzywinski with Morgan Stanley.

So just a question within kind of the guidance range. With 5 points of price and kind of 5% revenue growth on the low end, I mean, is, in your mind, not that it's something that you're necessarily spending a ton of time planning for but is that 5% on the low end a supply-constrained environment, an environment where demand sort of rolls over because you've had a strong few years and some tough comps or like price leakage as steel comes down and the industry sort of relaxes a little bit because it's not quite as inflationary as maybe it was to start the year? Like, which of those 3 is sort of more prevalent in the low end?

It's the first one. It's the case of Omicron, if not the Walking Dead has major impact to the supply chain, can't produce product, people get scared, and we're not able to sell as much. But I mean, to your point, I mean, look, we're getting 5% of price. And we think the market is going to be up, and we're going to gain share. And so it's a reflection on the whole market gets throttled just not us, but the whole market gets throttled because there's not enough equipment to sell. And then I would say sort of normalize -- the guide is the guide, but normalizing. If it's a more benign environment, then we're much closer to the high end, both to the EPS and the revenue because then we'll have equipment, we'll be able to sell. We're going to be able to get price. And so I feel, out of everything we're guiding, maybe price is the most I'm confident about. The end markets are uncertain and supply chain is uncertain, but I'm confident we're going to get price.

Got it. Yes, I think you're weighing risky equivalent quote of you miss 100%, the stock shots if you don't take the guide as a guide...

Yes, exactly. The guide is the guide.

For a time or 2 over the years. So I guess a follow-up question on supply chain. I guess first point, you still have a very Southeast Asia heavy kind of charter map that you show us every year. Anything that you've sort of rethought about that, just what the last 2 years have gone like? And then with furnace season maybe having a slightly different supply chain in terms of the components, does that get easier over the next kind of quarter or 2 as a function of just maybe more localized or different or less complex supply chains relative to the growing product?

No, I think there's maybe 3 things that we've done on supply chain, and we've made great progress more still to come. We moved quite a bit out of China over the last 2 or 3 years, starting with the tariffs, COVID and then just a geopolitical tension between the 2 countries. So we move as much out of China as we can. We continue to do that. And we've moved some to South Asia. We moved quite a bit to Mexico. Now there's always this trade-off of where you put it because historically, we've thought about cost and quality and then reliability, resilience of supply chain is just a given. And so that's now become the third thing that we look at, but we can't optimize on that and more cost and quality and so we sort of balance it. I think the other thing that we've learned has been -- you design a product and under the pressure of launching it, you have a sole-source component and then you tell yourself, you'll get back to it later to qualify alternatives and then you sort of never get back to it. And in a normal world, that's fine. In a world that we live in now, that's very dangerous. And so you want to -- I think we want to wake up in a world and we're getting there, where you -- even if you source from South Asia, 80% of what you buy, you have localized suppliers, you could tap into, obviously, at a higher price point, but you can use them if you need them. And then the third has been -- and certainly in a low interest rate environment, which maybe is going away, but in a low interest rate environment, make sure you have the inventory of raw material that you need to do what you need to do. And so -- and I think the world is doing this, but we're certainly -- we're not going to let our factories to be shut down for a $10 integrated circuit. And so when we recall -- right now, we can't get it or we couldn't get it. We requalify somebody else, then we buy 18 months of inventory, and that's what we're doing. And so we have a lot more inventory of what I would call, low-priced, high-value hard-to-change parts that we have sitting in inventory. So I think those are sort of 3 things longer term that we continue to focus on.

We have one more question from Jeff Sprague with Vertical Research.

And just a quick one on this whole kind of R-22 kind of question. Do you not see some of these attempts to market drop-ins to R-22 having any material effect on the market? Maybe you could just give us a little color on what, if any, traction some of these guys are getting with that sort of thing?

I mean there's some very minimal traction. But what we've seen when we initially went to R-22, so I was back in my Carrier days. And what we're seeing now is -- man, if you're a dealer that has any understanding of how the world works, your goal is not to sell a drop in refrigerant that may or may not work that may or may not have issues. Your goal is to sell the customer, and it's in your own best interest, quite frankly, a new system was a 10-year warranty, much higher efficiency control systems. And even sort of the drop-ins are still higher priced than going with 410A, although they're certainly less than R-22. And so short answer is, you see them online, if you go to the Internet, you can see them. But certainly, our dealers are wired to say to a homeowner, "Look, your units" -- and we've said this from 2005 to 2010, the last 5 years of our 22, 60% of the units were R-22. So if I bought a unit in 2010, it's obviously 12 years old. I have a coil leak on my refrigerant -- excuse me, I have a refrigerant leak on my coil. Refrigerant is not covered by warranty, neither is labor by any of us. And so if it's an R-22 system, and I have a 5x unit because I have a 2,500 square foot house, that's $2,300, $2,400 just for the refrigerant charge to have it -- to do it with fill up the coil. And if I was doing 410A, it'd be more like $1,000. And so if I'm a dealer, I just say, "Look, you're $1,200 out by going to R-22. And I can use this 407C or this alternative refrigerant, and I've never used it, it hurts the warranty of the OEM. Just let me sell you a whole new system for $5,000. So those are the conversations that take place daily. And quite frankly, dealers like the refrigerant changes because it sort of forces people to upgrade systems.

There are no more questions from our analysts. I will turn it over to Steve for any webcast questions.

We just have one question that hasn't already been answered. Just wanting to touch base on the VRF market. How our VRF business is doing?

Our VRF business continues to do well. We were up 20% or so in third quarter, and it remains -- the growth is -- continues to be -- go well for us. I think as we've said over the last 4 or 5 years, the overall market isn't growing -- I mean, there was breathless forecast of it becoming like Europe where it was as large as the applied market in the unitary market. I don't think that's happening anymore, but we have a very competitive product line in VRF, and we continue to sell it, and we think it helps the portfolio of our business. Is that all Steve?

That's all the questions we've got.

Okay, good. I want to thank everyone for joining us today, and have a good day. Thank you.

This concludes our program, and you may now disconnect.