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

Good morning, everyone. Welcome to Lennox Investor Day 2026. I want to take a moment to welcome everybody who's here in the room in Richardson, Texas, and also everybody who's joining us online. As you would have probably known, we are proud of what we do, and we really appreciate the time you are taking to learn about Lennox and how we create value for our customers and our shareholders. As is our usual practice, I want to start with safety. We have an excellent safety record, and we'd like to keep it that way. There is no safety drills planned for the day. So if there's an emergency event and the alarm goes off, please proceed towards the nearest exit as shown on these maps. In case of a severe weather emergency, we will shelter in place away from these windows in the hallways, in the stairwell, all in the restrooms. In case of other evacuation emergencies, we will walk down the stairwell towards the emergency meeting point outside the building entrance. Please follow me or one of your other hosts in a red Polo shirt in case of an emergency. Before we begin, our legal team and Chelsey have asked me to remind you that during today's event, we will be making certain forward-looking statements, which are subject to numerous risks and uncertainties, as outlined on this page. We may also refer to certain non-GAAP financial measures that management considers relevant indicators of underlying business performance. Please refer to our SEC filings available on our Investor Relations website at investor.lennox.com for additional details, including a reconciliation of GAAP to non-GAAP measures. I want to start today's main session by highlighting our core values and our guiding behaviors that shape our winning culture. Our core values of integrity, respect and excellence are and have been for the past 131 years, the foundation of our success. Our guiding behaviors that define these core values were updated in 2022 with increased emphasis on accountability and customer experience. One of the benefits of hosting the Investor Day in the DFW area is that you get to experience our culture and meet our talented leaders who drive our success. I want to thank all the leaders who are presenting our story over these 2 days. In addition, I want to thank everybody who was part of organizing this event, the volunteers who have worked tirelessly for weeks to ensure that the event runs smoothly. Now I do want to take a moment to introduce our executive leadership team who run this high-performance company. Let me start with Dan Sessa, our Chief Human Resources Officer, who has assembled this talented team over his illustrious 18-year tenure at Lennox. Michael Quenzer, our Chief Financial Officer, has been with the company over 20 years and in the role for 2 years as my finance partner in driving accountability. Prakash Bedapudi, our Chief Technology Officer, who's led the development of all the world-class products and information technology for the past 17 years. Joe Nassab, the President of our BCS segment who's been with the company for over 15 years and started his current role on the same day that I joined Lennox. Sarah Martin joined Lennox last year as the President of our HCS segment, and brings a fresh perspective on how to accelerate profitable growth at Lennox. Monica Brown, our Chief Legal Officer, has been with the company for over 13 years and been in the role for 14 months with a passion to fully harness the power of intelligence -- artificial intelligence in the legal department. Mary Ellen Mondi, our VP of Marketing, joined Lennox 3 years ago, and her impact is apparent in the digital enhancement we are making to improve customer experience. Finally, John MacQuarrie joined us with the recent DuroDyne and Supco acquisition, to ensure that we deliver double-digit growth in our aftermarket parts business. At this moment, please join me in thanking all our leaders and event organizers for driving the success of Lennox and this event. During the main stage session, I will share an overview of the strategy followed by Sarah Martin and Joe Nassab, who will highlight the transformation underway at HCS and BCS segments, respectively. This will be followed by a short break that will allow you to mingle with our leaders, after which Prakash will give you an overview of our advanced technologies that are fueling our transformation. And finally, Michael will wrap it up by summarizing the anticipated fiscal impact of our strategy over the next 5 years. We will welcome all your questions at the end of the session. Let me start my presentation with a video that recaps the progress we have made since our last Investor Day in 2022. [Presentation]

I have 4 messages that I want to emphasize during my presentation today. First, as the industry continues evolving, Lennox' competitive differentiation will be even more powerful given our one-step direct-to-dealer model. Second, we remain bullish about the long-term potential of the North American HVAC industry. Third, we have invested in initiatives that will continue driving above industry growth from Lennox while also delivering margin expansion. Finally, we remain committed to continually enhancing the shareholder value through flawless execution and while remaining disciplined with capital deployment. Our disciplined capital deployment is reflected in a strong ROIC of 39%, which is one of the financial metrics that we are immensely proud of. If you're new to the Lennox story, I should also mention that we have delivered top-tier shareholder return since our IPO 27 years ago, and we were welcomed into S&P 500 in December 2024. Lennox was founded with the differentiated value proposition of serving our contractors directly and even 131 years later, 75% of our revenues come from a one-step channel, which provides us greater intimacy and insights compared to our competitors. Over 80% of our revenue comes from nondiscretionary equipment replacement, which makes us more resilient during economic cycles and less reliant on growth from new construction. The last point I want to make on this slide is that our BCS segment formed post-European divestiture in 2023 is now a significant contributor to our overall success, delivering approximately 40% of our total EBIT. Having 2 strong segments has made Lennox more resilient and was a critical factor in the company delivering over 20% EBIT in 2025 during the residential channel destocking. Our recent successes are built on a strong history of innovation dating back to our founding in 1895. Since then, Lennox has continually innovated to better serve our customers' evolving needs. Recent innovations include our expanded heat pump portfolio, our advancement in control technologies, our digital data infrastructure to leverage AI and our JVs and acquisition to expand our market reach. As the industry evolves, our core differentiators will create an even stronger structural advantage for us. Our greatest asset is our direct-to-dealer relationship where we are shoulder to shoulder with a 10,000 contractors who are served through our own 250 stores outlet and supported by a proprietary digital e-commerce platform. This approach is going to be even more valuable as our channels continue to consolidate and advanced AI technologies make it even more efficient for us to serve our customers. Our single ERP platform, combined with the united data infrastructure, creates the best opportunity for usage of AI tools to generate insights and fuel productivity and growth. Our recent acquisitions and partnership allow us to expand our addressable market and better serve our customers' evolving needs with a portfolio that includes dockless equipment, water heaters, accessories and expanded commercial service offerings. These acquisitions and partnerships will further increase our competitive differentiation as there is more convergence between traditional HVAC industry and the plumbing industry due to channel consolidation and heat pump technology overlap. The long-term attractiveness of our industry is due to 6 mega trends that enable above GDP growth for the HVAC industry. Electrification and the associated energy efficiency are accelerating demand for heat pump, which can be 300% more efficient than traditional gas furnaces. The industry's equipment is becoming environmentally friendly as required by regulation and as demanded by the consumers. The refrigerant change from R22 to 410A in 2010 addressed the depletion of ozone layer and the refrigerant change to A12 reduced the global warming potential of HVAC product. We expect this trend to continue as more states start implementing their own regulation. The introduction of new refrigerants makes it more expensive to repair older equipment versus replacing it with a new unit. As weather patterns become more extreme, they create greater stain on HVAC equipment. For example, when the ambient temperature goes from 80 degrees to 90 degrees, the strain on the cooling system goes up by 30%. This additional strain can shorten the average useful life of the equipment which then requires more frequent replacement. The focus on healthy living and air quality has increased consumer awareness and demand for additional equipment and accessories that protect indoor air from pollutants, allergens and even harmful bacteria and viruses. This is a long-term tailwind for both residential and commercial HVAC industry. The ongoing migration to southern climates with warmer weather helps with overall equipment penetration, it also shortens the average equipment life as heat pump equipment in harsh southern climate often has equipment life of 10 to 12 years, while the legacy gas furnaces in Northern Climate have equipment life of 20 years. Finally, the advancement of AI and digitization is giving consumers more information, more control over the HVAC equipment, resulting in greater indoor comfort. This consumer awareness is also driving growth of equipment brand preference, slowly shifting the brand reprint selection from the contractor to the consumer. This shift will benefit equipment manufacturers. In addition to these mega trends, the North American HVAC industry is also shaped by specific industry trends that also accelerate growth. Consolidation among OEMs continues as today, there are at least 2 fewer North American-focused HVAC manufacturer versus last Investor Day in 2022. This creates stronger brands, more scale efficiencies, improve quality, all of which increase the consumers and the installers trust in the replacement equipment. Our installed base is aging and there is pent-up demand as many owners deferred replacement during the last few years as the industry was dealing with supply chain shortages, and 2 back-to-back regulatory transitions. There is convergence between the trades given the overlapping heat pump technology. Convergence is also fueled by consolidation among contractors and distributors, each of whom are positioning themselves to be a multi-trade service. The shortage of skilled labor and trade professionals is not getting better despite higher labor rates. This is increasing the relative cost of repair versus replace while also placing a premium on easy-to-install equipment and accessories. Finally, advancement in digital controls and connectivity has created an opportunity for manufacturers to offer post-install engagement service options for both consumers and contractors. Putting it all together, let us spend a few moments discussing the growth algorithm for the North American HVAC industry, considering both the mega trends and the industry trends. There are many variables that influence the growth algorithm and some of them are listed on the left-hand side of the page. Similarly, there are different type of quantitative models that can be applied to these variables to predict the HVAC industry growth rate. In addition, there are various different types of growth rates, sell-in, sell-out which can often have wide divergence, especially during periods of uncertainty. In my short 4 years of HVAC industry, I have observed that none of these algorithms are perfect. In fact, they offer 25 different predictions between 10 different experts. Hence today, we are not going to talk about industry unit forecast for 2026 or any other year. But instead, I want to reiterate our view that the HVAC industry units are growing to grow at least 3% CAGR over the next several years. Personally, I feel that the growth rate will be higher than 3%, especially because of the low starting point at the 2025 year-end. I'm not discussing this to convince the skeptics but I'm discussing it to share with you why we are convinced about the attractiveness of the North American HVAC industry and why we are 100% focused on it. Anyway, let's turn the page and talk about more exciting things like Lennox. When we last held the Investor Day in New York in December 2022, we guided you towards a set of financial and strategic targets for 2026. 18 months after the Investor Day, we increased our 2026 financial targets given that we had a fast start. As we stand here today, even after a challenging 2025, we are pleased to report that we are on track to meet or exceed the long-term targets for both revenue and ROS. We used our strong cash flow to invest heavily in accelerating organic growth. These are high ROI investments, and we are confident that they will position us well for the future. Our cash conversion for years '23 to '26 will be over 90% at the high end of our cash flow guidance range for this year. I'm grateful for the trust of our shareholders and our partners, and I want to thank our 13,000 employees who have worked hard to deliver these results. This is our accountability in action; promises made, promises kept. In 2021, Lennox' full year segment margin was 14.4%. That improved in 2022 due to growth, productivity and the divestiture of the European business. Since then, we have further increased our margins by 400 basis points, achieving a record margin of 20.4% in 2025. While we are pleased with the progress on the transformation plan, I want to emphasize that many of the recent investments and initiatives are yet to deliver their full potential. The growth benefits of heat pump investments, emergency replacement initiatives, parts and service acquisition, and our JVs with Samsung and Ariston are going to become meaningful only in the next planning period. Similarly, the margin upside from enhancing our distribution network, elevating pricing excellence, bolstering supply chain resiliency and investing in cost productivity initiatives is yet to be realized. This makes us excited and confident to unveil our 2026 through 2030 transformation plan. Our new transformation plan also has 3 phases. We are currently in the growth acceleration phase that we started last year. After this, we'll move to the expansion phase for 2 years before entering the elevation phase, the final phase of the 2026 to 2030 transformation plan. In the growth acceleration phase, our focus would be to further improve our Net Promoter Score by improving fill rates through our distribution network while also generating productivity post-A2L conversion. In the expansion phase, we will grow our share of wallet as our momentum expands from new heat pump products, joint ventures and acquisitions. Our digital investments will make it easier for customers to do business with us. We are also planning for margin expansion as network optimization and factory productivity initiatives start to deliver benefits. Finally, in the elevation phase, our impact will be elevated as technology and channel convergence starts gaining momentum. And the regulatory changes required for heat pump water heaters and higher efficiency furnaces goes into effect further benefiting our elevation phase of transformation plan. Our revamped distribution network will elevate the impact of our core initiatives, such as emergency replacement and growth in aftermarket part. Putting it all together, our value creation framework has 4 differentiated growth vectors, 3 drivers of margin resiliency supported by core enablers of technology, talent and LUMS. Let's go to the details of each of these. The 4 differentiated growth vectors that will drive Lennox's above-industry growth are: one, heat pump; two, emergency replacement; three, attachment rate for parts and services; four, total addressable market expansion. We expect each of these growth vectors to drive at least 50 basis points of differentiated growth for Lennox. For those who went on the tour of our product development and research center yesterday, you witnessed the investments we are making in new heat pump technology. And later in today's presentation, you will hear about this from Sarah, Joe and Prakash. Sarah will also highlight the opportunity for us to expand our total addressable market through joint ventures and then Joe will highlight the investment to grow emergency replacement and service attachments in his presentation. We have made significant investment in developing these 4 differentiated growth initiatives and are looking forward to the accelerated growth momentum in our planning period. Just like growth, we have 3 well-defined initiatives that will expand our margins over the next few years. The investment in our distribution network to establish a hub-and-spoke network that relies on consumption-based replenishment pull system versus the legacy push system will generate significant cost savings while improving customer service levels. The frequent regulatory changes in our industry will continue improving our mix and the investment in upgrading our pricing processes to enable dynamic pricing will further expand our margins. Finally, we are investing in automating both our manufacturing and SG&A processes to generate productivity and expand our competitive edge. As a reminder, we have a very resilient manufacturing footprint, single ERP, a world-class data lake that is being utilized to unleash the power of AI on our entire operation. Technology enables our success at Lennox, whether it's a front-end technology to delight our customers, AI technology to accelerate growth and productivity or a sustainable innovation that develops leading energy efficiency product. Later today, Prakash will get into the details of each of these. I don't want to steal his thunder, so I won't spend much time on this slide. However, I do want to spend a few moments talking about AI and how Lennox is maximizing the potential of AI. We believe we have a unique opportunity to benefit from AI given that we have a single MRP system, common engineering platform and a really rich historical database. To take full advantage of AI, we have created a unified data lake that works with leading AI engines to maximize impact on our business. We are driving AI impact in 4 different areas. First, we are challenging and enabling our employees to become more efficient using AI. Example of this will be our legal tools such as iManage and [ iCloud ] that make our legal team more productive. Secondly, we are using AI capabilities to rewire our core processes to generate enterprise excellence in key areas such as pricing, software, SIOP and new product development. Thirdly, we are embedding AI into our own products and solutions, such as control, e-commerce and dealer service dashboard. This is making it easier for customers to do business with us while increasing their loyalty and our share of wallet. Fourth, we are also working diligently to incorporate our products into other people's AI investment. For example, our rooftop products are often used to cool data centers. Our DuroDyne products are critical for installing duct works in data centers and our refrigeration technology can be used for liquid cooling. While we don't have the chiller technology that is common in today's data center cooling application, we remain optimistic that our development and investments will create new applications for our technology in data center liquid cooling. Our business operating system, the Lennox Unified Management System, or LUMS for short, is a set of efficient management processes and a digital repository of our best practices. This includes key elements like a balanced score card for gold deployment. LUMS helps us execute better and helps us leverage our scale to punch above our weight class. One example of LUMS is the introduction of company-wide digital tools and processes to make it easier for customers to collaborate with us. We have introduced Net Promoter Score process and the resulting insights have led to investments in upgraded marketing and e-commerce technology stack. We are standardizing and upgrading our software tools required for contact center, digital asset management, product information management and many more. We know that our greatest asset is our lawyer dealer base, and we know that our data assets used with AI tools, make it easier for our customers to work with us. Another aspect of LUMS is a relentless focus on improving customer experience at Lennox. As part of LUMS, we are making significant digital investments to deliver exceptional service to our customers. This includes attracting, converting, servicing and retaining our customers. We are managing these initiatives in a unified way across all of Lennox and the early results are very encouraging. We are happy with the improvements in our Net Promoter Score, yet we know that we have many remaining opportunities to delight our customer. This remains our greatest asset that's not on our balance sheet. Let me wrap up by summarizing why we have great confidence in our future. We participate in an attractive growth industry and have solid initiatives to accelerate differentiated growth. We are expanding our margins and making them more resilient by strengthening our supply chain and expanding our BCS business segment. Lennox Unified Management System drives our execution consistency, and we are very disciplined with the capital allocation decision. Advanced technological solutions fuel the loyalty of both our unique one-step and two-step customers. Our talent and culture driven by our core values remains our primary differentiators that make our customers want to work with us. With that, I welcome Sarah Martin to stage to discuss our Home Comfort Solutions segment. Thank you.

Good morning, everyone. My name is Sarah Martin, and I lead our Home Comfort Solutions business, or HCS. It's a little less than a year ago that I joined Lennox, and I spent my first months listening and learning, listening to dealers, to technicians, to our field teams and to our leaders across the organization about what we do well, but critically about where we can improve. Through this process, it became clear very quickly that HCS does have many of the characteristics of a high-quality business, but also has significant untapped potential. We're working on unlocking that potential by refining our investment and focusing on correcting where we've either underserved the market or where we've not yet delivered fully on our commitments. Our end goal is twofold: firstly, to enhance the power of our direct model to deliver strong growth and margins; and secondly, to amplify the impact of our indirect model with investments in new products and distribution capabilities. And so I'd like to take time today to walk you through some of those enhancements and focus areas which will underscore why I believe the HCS business is well positioned to accelerate growth and expand margins over the next several years. Before I talk about where we're going, I do want to spend a little bit of time on our segment highlights as well as our view of the current environment and an assessment of how we delivered in HCS on the commitments made at the last Investor Day in 2022. This should demonstrate not only the resilience of the organization, but more importantly, that we've laid a strong foundation for building long-term growth and profitability. HCS is made up of 3 businesses and that allow us to service the residential end market, whether direct to dealer or one step or indirectly through distribution or 2 steps. These businesses are led by some of the most experienced and passionate leaders in the HVAC industry, including Lanessa Bannister, who has 12 years with Lennox under her belt and over 25 years in HVAC overall; and Bobby DiFulgentiz, who has 20 years of Lennox behind him. At our core is Lennox Residential, which is a one-step direct-to-dealer business. Being direct gives a competitive advantage through proximity. We're closer to contractors, to technicians and ultimately to the consumer. This gives us a tighter feedback loop, earlier insight into demand patterns and a real-time view of customer sentiment. Allied and ADP are predominantly 2-step businesses selling to HVAC distributors. This allows HCS to leverage our technology in manufacturing to serve the independent distribution space, and this extends our reach. It allows us to support different customer needs and to remain disciplined about how and where we deploy capital. Whether 1 step or 2 step, the nature of the demand we serve is exactly the same. Approximately 80% of our business is replacement driven, which is nondiscretionary. What that means putting in a different way, when a homeowner system fails, it gets replaced. And that's important because it makes this business fundamentally more resilient regardless of economic cycles and much less dependent on residential new construction activity. To support this model, we have a significant organizational footprint comprising 5 manufacturing facilities, nearly 30 distribution sites and almost 250 Lennox store locations, plus we have more than 6,000 dedicated employees that make all of these results possible. As we operate in a replacement-driven world that we are structured in scale to ensure products and services are available and reliable and that expert support is local really, really matters. Dealers, contractors and distributors need to be confident we're supporting them with speed and with certainty. HCS' strategy is unique in that it combines both a direct and indirect model. It's focused on nondiscretionary replacement demand and it's enabled by technology, real physical distribution reach and a customer experience mindset. These things provide the foundation for everything else that I'll talk about today. It is well known that the residential environment is experiencing near-term volatility. In fact, it will be disingenuous to suggest otherwise. In the last 2 years, we've experienced 2 regulatory transitions, channel destocking, significant affordability pressures driven by higher inflation and interest rates. These dynamics have introduced short-term volatility influencing both contractor and homeowner behaviors. Despite all of this, what's most important is recognizing what we can control. In other words, we don't set the interest rates, we don't dictate weather, we don't control timing of regulatory transitions. What we do control is how effectively Lennox operates within that environment and how we could outperform the industry even when conditions are challenging. To do this successfully, we make a key distinction between what's cyclical and what's structural and it's what's structural that's really important. Structurally, the fundamentals of this industry remain the same. Equipment continues to aid, repair costs continue to rise, efficiency and refrigerant regulators continue to add complexity to systems. And of course, we see increasingly extreme weather continuing to shorten equipment life. If we prioritize positioning HCS to respond to the structural characteristics of the industry, then our focus shifts from chasing short-term volume to controlling the controllables, protecting the economics of the business and improving execution. And this requires continued investment in the capabilities that allow Lennox to grow faster and more profitably than the industry over time. And simply, this means having the right products in the right place at the right time to support replacement. It means making it as easy as possible for customers to do business with us when it matters most. It means improving fill rates, pricing discipline, enabling the attachment of parts and supplies, all while delivering an exceptional customer experience. And these are all areas where execution and not demand determines the outcome. And this is how HCS is thinking about outpacing the industry, not by assuming a different demand environment, but by executing perfectly within the one that we have. And finally, before looking ahead, I think it's important to reflect on the commitments that we made coming out of the last Investor Day cycle. The expectations that we set in '22 were very clear. Lennox committed to executing through regulatory change, strengthening how we go to market, improving customer experience, adding capacity where it matters most and unlocking more value from its unique distribution model. These were 5 key commitments that would deliver growth, and we delivered against those commitments. We work successfully through 2 major regulatory transitions, CO2 and the move to A2L refrigerants while remaining competitive and maintaining our customer trust. At the same time, we strengthened how we go to market in HCS. Revenue operations were built, pricing processes were upgraded and new business development resources were added. These changes improved execution discipline and gave the organization better tools to manage complexity, which has been key to navigating volatile market conditions. We also focused on improving customer experience through investment in fill rates, adding digital tools and creating structured feedback loops. This makes it easier for dealers to do business with Lennox and over time, this focus has been reflected in sustained improvement in our Net Promoter Scores. In parallel, we expanded capability in heat pumps, coils and air handlers and in multifamily, reinforcing execution discipline and reliability across the business. And finally, the team made good progress on our distribution excellence journey, restructuring sales and distribution to establish regional P&Ls and updating incentive structures to reflect margin performance, not just revenue. These changes improved accountability at the right levels, sharpen decision-making and directly contributed to improving our fill rates. And while we're encouraged by what we achieved, it's also important to be clear about where we fell short. We set an expectation to significantly increase heat pumps as a percentage of total sales by '26. There was progress but we did not deliver the growth that we had set out to achieve, and I don't want to gloss over that. What matters most is that we understand why and that we have taken steps to address the gaps, and I'll spend more time on heat pumps later in the presentation. So in reflection, what stands out for HCS is that we were not perfect, but we believe we've been credible. And Lennox has demonstrated the ability to execute complex commitments and to recognize when adjustments are needed and to invest where the business requires it. And that consistency exactly what we mean by stating promises made, promises kept. It's also the foundation for the growth opportunities that I'll walk through next. So earlier, Alok talked about the overall strategic framework, and I'll double down a little bit on heat pumps, attachment rates, distribution efficiency and pricing. I'll also talk about some of the core enablers such as technology and LUMS. Our focus is on using that framework as a basis for consistent execution. In the next few slides, I'll demonstrate what this means for HCS. As I mentioned earlier, Lennox missed its goals for heat pump expansion. The biggest reason for this is that we have portfolio gaps that reduced our ability to service customers. We lacked heat pump and air handler offerings that would appeal to customers in the warmer southern climate, specifically in the Southeast, where cabinet size and form factor really matter. In response, we've expanded the portfolio meaningfully by adding products that meet the form factor requirements, including side discharge units to address tighter lot lines. And at the same time, as technologies improved, we've developed and launched a cold climate heat pump to support the northern regions. We also revitalized our ductless offering, the Samsung joint venture launched in 2025 really strengthens our position in this category. The JV brings a technologically advanced product portfolio with strong quality, global brand recognition as well as integrated controls. This enables a more seamless customer experience, something many of you will have seen yesterday on the PD&R tour. Adding strategically to our portfolio gives Lennox a more complete and competitive lineup designed to meet a wider range of applications and customer needs. And this means we have a much greater opportunity for growth acceleration over the next years. Today, heat pumps represent roughly 15% of our total sales. That includes low single-digit penetration in ductless and low double-digit penetration in ducted systems. At an industry level, heat pumps represent closer to 30% of sales, with approximately 10 coming from ductless and 20% from ducted. And that gap is really important. It reflects areas where we have underperformed historically, but it also highlights the opportunity ahead. With a more complete lineup, we see the potential to gain share across a broader set of applications, and that's why we describe heat pumps as a multiyear entitlement opportunity rather than a single inflection point. The second growth driver I want to spend time on is attachment, particularly of parts and supplies. This is where our thinking has changed and evolved in a very meaningful way. Historically, parts and supplies existed alongside the equipment business, but they were not managed with the same level of focus or intent, and that limited our ability to consistently grow attachment even though the underlying demand was absolutely there. And today, we're taking a much more deliberate approach. Parts and supplies are being treated as a distinct growth engine across the enterprise, not only in HCS, but increasingly across the commercial business. This includes OEM parts, aftermarket components and installation supplies, all managed with a focus on availability, category breadth and ease of doing business. And a key element of this shift has been the addition of dedicated expertise. Through DuroDyne and Supco, we've brought in teams that come from a purpose-built parts and supplies business. And that talent brings deep knowledge, strong supplier relationships and an operating mindset centered on breadth, speed and reliability. This gives us confidence that parts and supplies attachment is now embedded into how the business operates day-to-day. There's an innate understanding of customer need, inventory strategies, systems and incentives that are more aligned. And our leadership attention is focused on making parts and supplies a more consistent component of the overall customer experience. And to put this in context, our attachment rate today is in the mid-teens. We view best-in-class as operating at levels around 40%. So just like heat pumps, that difference highlights the opportunity that exists within our own customer base if we act with intention, leverage the skill sets that we now have in the wider business. And also as with heat pumps, this is not about a single year or a single initiative. It's about building a steady, repeatable capability that expands our share of wallet over time and strengthens our long-term customer relationships. As we think about growing share of wallet with the customers we already serve, it's equally important to recognize that the direct model is not the only way that HCS serves the market. Our 2-step channel through our Allied and ADP brands plays an important role in HCS and allows us to expand our addressable market. We participate in this space with the same discipline and consistency that defines our direct business. Our 2-step model leverages long-term distributor and customer relationships in key territories, and it offers portfolio options that target unique segments that are underserved by the one-step business. At Allied, the multifamily line, including the flagship MagicPak brand, continues to be a good growth engine and the coils and air handlers at ADP give us the strategic advantage of servicing the widest available range of system configurations. We continue to refine and invest in our 2-step businesses, adding new distributors, launching new products, including an entry-level AC and developing new strategic partnerships that will drive growth over the next years. As we look at the expansion in our addressable market, we've identified strategic partners who are helping us to accelerate our ambitions, broaden our reach and enhance the customer experience overall. Let's have a look at this video, which illustrates well how we're leveraging partnership to add value to our Lennox customers. [Presentation]

Our partnerships with Samsung and Ariston strengthens our ability to participate in adjacent markets where complementary technology, product breadth and category expertise accelerates our path forward. These collaborations matter even more as the industry moves towards higher energy efficiency requirements, broader electrification and increasingly technology overlap between HVAC and water heating. Success in this environment will require integrated platforms, new technologies, shared controls and unified home automation experiences. A great example of this can be found in the convergence of heat pump HVAC systems and heat pump water heaters expected later this decade, including the 29 regulations highlighted during yesterday's PD&R tour. Partnering with Ariston allows us to expand into hybrid solutions that combine our HVAC expertise with their leadership in water heating technology. And through Samsung, we gain advanced ductless capability in a controls architecture that connects naturally to the home ecosystem as well as support for product innovation that fits emerging applications and installation constraints. And finally, these partnerships allow us to move faster, meet more customer needs and position Lennox for a more electrified and integrated future. Whether we deliver from partnerships or from in-house expertise, our success relies heavily on operating a highly efficient, agile and effective distribution model. Product availability has a significant impact on both customer satisfaction and share. And as mentioned earlier, Lennox has invested heavily in this capability, and we've delivered on our initial commitments, but our strategy continues to refine as customers' needs evolve. Our distribution organization has come a long way. While the physical footprint is not yet fully optimized, we continue to improve it with intention. We're taking deliberate steps so that each change strengthens the system without disrupting the supply chain or the consistency our dealers depend on. We've redesigned the organization to clarify roles, improved accountability, allowing decisions to be made closer to the customer and aligned our sales and store teams to operate as a single frontline. To ensure we're measuring success and identifying opportunity, we've built standardized dashboards to improve visibility and drive consistency across the entire system. We also upgraded the core digital tools and systems that support our network. This includes new warehouse transportation, point of sale and contact center systems. We've strengthened our focus on parts and supplies, as we've already seen. So we've made meaningful progress, but we're still early in realizing the full potential of this network. The work underway will transform distribution into a true competitive advantage rooted in consistency, responsiveness and a superior customer experience. We're pushing fill rates higher and elevating the reliability our contractors expect. We're advancing and simplifying our hub and spoke model through the FTC to improve speed, inventory placement and overall flow. We also see clear opportunities in margin entitlement, automation and labor management systems, all areas where disciplined execution can unlock structural improvements over time. This next distribution phase is all about momentum. It's about taking the progress already made, building on it with purpose and executing with the discipline required to capture the full benefit of the network that we are creating. And later today, some of you will see this firsthand at the FTC tool, where our recent investment in a 1.2 million square foot facility demonstrates how we're redesigning and simplifying our distribution and planning platforms to improve performance over time. We are certain that pricing discipline is critical in volatile markets and continue to invest in our capabilities remains a priority. We've built a strong pricing foundation, regionalizing our P&L to empower the teams closer to the customer, streamlining the back office and redesigning our sales incentives from revenue to profitable growth. We're now taking steps to invest in systems that provide not only efficiencies but which also create differentiation, provide upscale analytics and offer deeply segmented and dynamic pricing, leveraging the power of AI. As with distribution and heat pump initiatives, pricing is not about short-term actions. It's about reinforcing the economics of the model with agile systems so we can continue investing with confidence. LUMS provides the operating discipline and framework that connect strategy to execution, enabling our businesses to deliver on the commitments that each makes in that customer charter. And the customer charter is not just a piece of paper. It's a powerful tool because it sets clear expectations, creates transparency and reinforces accountability, and we share this with our customers as we are transparent about our ambition to improve our service levels and seek feedback and engagement about what they see and what they want to see from Lennox businesses. And it works because performance is visible and our leadership teams are held accountable for execution and attainment. This drives the level of ownership that delivers results and keeps the customer experience front and center of everything that we do. [Presentation]

Ultimately, ease of doing business is felt day-to-day by dealers and technicians. We continue to enhance our dealer and technician experience and are fully committed to investments in digital tools with around 50% of our sales in residential now through LennoxPROs, building self-service AI training tools, product information and other key resources to support our dealers' needs anywhere and any time. These investments reduce friction and increase customer confidence that Lennox is agile, responsive and serious in our support, which is exactly what you want in a replacement-driven business. In closing, when I look at Home Comfort Solutions today, I see a business that's structurally resilient, operationally improving and increasingly focused on its highest value opportunities. It's a business that's simultaneously delivered on its commitments while recognizing where we must do more. It's also a business that understands that we are accountable for focusing on what we can control, our customer experience, ease of doing business and building an agile and responsive organization that executes and it's this that delivers sustained long-term outcomes in a replacement-driven market. And this is why we continue to invest in major initiatives like distribution, portfolio, expanding attachment, partnerships, 2-step opportunities as well as critical systems and tools. And executing these initiatives well will deliver the value we need to support our growth and profitability ambitions over the next years. This is so that we can continue to gain share and deliver margins that are appropriate as both the manufacturer and the distributor. Thank you. I'd now like to introduce Joe Nassab, President and EVP of Building Climate Solutions.

Well, good morning, everybody. My name is Joe, and I lead the group here that we call Building Climate Solutions. I've been with Lennox for 15 years now, and in this assignment since the middle part of 2022. We had the opportunity that year in December to visit during the Investor Day, I remember it well, recognized lots of faces in the crowd, but also very nice to see new faces in the crowd. So a few years have passed since. I'm encouraged by the solid progress that we've made. And from this update, I hope you take away the following: first, that we put in the investment and the effort to build a very resilient foundation. That was critical to earn back the trust of our customers. We're turning our attention to growth. Second, we're laser-focused on expanding margins, ensuring that our work shows up where it matters the most. And third, we're scaling up with terrific talent and teams. They're deep, they're skilled, they're humble, and they're very, very hungry. What I'd like to do is begin with a 30,000-foot view of the segment. Building Climate Solutions consists of 2 equipment businesses and a service division. Here, you see our sales mix, financial history and other highlights. Since 2022, we've grown consistently. Sales are up by over $0.5 billion. Return on sales has also grown consistently from 15% to over 23%. We've meaningfully increased manufacturing capacity. Equipment is distributed from 19 fulfillment centers across the country, and we have 140 service branches where our service teams operate from, roughly 4,400 people are part of our team. So a few words on each of the businesses. Our commercial rooftop unit is all about delivering comfort and air quality. They serve many different markets from national accounts to schools, warehouses, restaurants, convenience stores, grocery stores. Lennox units sit atop thousands of buildings in North America. The business is led by Geoff Dethlefsen, many of you met Geoff yesterday, he is in the back of the room. He's been in his role now for 2 years. Our Heatcraft division competes in the refrigeration space. They design and they manufacture climate control solutions for the cold chain. Heatcraft systems keep food safe and fresh in grocery stores and convenience stores, cold storage warehouses. Bob Landi is coming up on 25 years with the company. Bob leads our Heatcraft team. And rounding us out is Lennox Commercial Services. LCS consists of our national account business and AES, the company which we acquired in 2023. The services that we provide encompass now the full life cycle from initial system installation to ongoing preventative maintenance, to plan replacement activity, ending in the recycling of decommissioned equipment. Chris Drury is a 22-year vet. His anniversary is this coming Sunday. He leads our service team. Here's a very important point. Each of these 3 businesses, they deliver essential solutions. They're essential to the environment. They're essential to the economy and they're essential to the flow and to the movement of commerce. Alok touched on this a little bit earlier in his discussion, but I think it's worth repeating. We're very bullish on our prospects, and we are for many different reasons. We serve industries which are heavily replacement driven. In any given year between 70% and 80% of total shipments are replacements. The installed base is large and it's very old, old systems, as you know, are less efficient. They're costly to service and they're difficult to maintain. And so at a certain point, a smart economic decision is to replace. As it relates to weather, there's no debating the trend of extremes extra cold winters, extra hot summers, they tax equipment, that shortens life and it also fuels demand. Advanced indoor air quality is shaping system design in the commercial HVAC space as well. Industry standards are elevating ventilation and outdoor air requirements. And as a result, we see attachment rates for these things increasing. And then we have electrification and efficiency. The world is slowly moving away from fossil fuels. We see this especially with our national account business, many of them have made bold sustainability commitments that require replacing thousands of systems annually well into the next decade. These trends, they play in our favor, and they do so, as Alok said, over the long term. So as I said, we've come a long, long way since 2022 when we were last together. I told you then that we'd be focusing on a handful of things. I told you that we worked to solidify our foundation, manufacturing and quality in the supply chain. I told you that our teams would execute with discipline, robust operating systems, they make all the difference. And I also said that we delivered consistent growth, both top line and bottom line. Well, since then, we've successfully completed 2 regulatory transitions, fortified the supply chain. We've improved our operation in Stuttgart. We doubled capacity with the new factory in Mexico, improved quality, expanded points of distribution, increased front-end resources, and we enhanced our portfolio with that AES acquisition. We're encouraged by our progress. We're also encouraged with the improvements on the financial side. Encouraged for sure, but I also tell you we're very far away from being satisfied with where we are. And so I'll spend the balance of our time addressing these 4 areas, beginning with innovation with a little bit of a focus on heat pumps, service efficiency and low GWP refrigerant. Next, we'll touch the emergency replacement market. That's a biggie for us. We're constantly fine-tuning our operations and looking forward, factory productivity will be a major source of margin expansion; and fourth, we're scaling up services because demand is robust, and it's increasing. Lennox, as you know, has a very proud history of innovation and our direct model provides a distinct competitive advantage. Being the industry's only manufacturer and distributor and servicer enables unique customer access and intimacy. The power of direct demands consistent communication and collaboration and on-site presence. Every single interaction sharpens our understanding and raises our insights. Our product management and engineering teams are focused on developing solutions for building owners and specifying engineers, installing contractors and service technicians. They all matter, all of them and all of them have unique needs from total cost of ownership, to installation ease, to speed of service. Highlighted here, we have 3 examples, beginning with our ultra-high efficiency heat pump many of you saw yesterday. Technology for this originated out of the DOE cold climate challenge. Now concurrent with that, our team works side-by-side with one of our largest customers. In fact, over 50 separate meetings engineer to engineer to develop heat pump technology specific to them. And as a result, we designed the system backwards compatible with their electrical infrastructure. The electrical side of the equation has been one of the biggest barriers to heat pump adoption. This ultra-high efficiency system will save hundreds of thousands of dollars per store. Another commercial rooftop example is our Xion platform, also showcased last night. Last year, Xion won the HVAC All-Star Award and was recognized by contractors with the most service friendly design. Xion delivers technician-focused features in the standard efficiency category. This platform is ideally suited to the emergency replacement market. And on the refrigeration side, Heatcraft was the first OEM to release an A2L offering. They actually designed a dual convertible solution that allows customers to install equipment initially using A1 refrigerant and then upgrade in the field with an A2L conversion kit. This versatile design is both a financial and peace of mind win for contractors, for end users and also wholesalers. Now after the break, Prakash will expand more on this topic of innovation and share many of the other exciting things that are on the horizon. On to emergency replacement, one of our largest growth opportunities. You touched this often with Alok and Michael. It's a big part of the market. And due to pandemic-related supply challenges, we were forced to pull back, but we've aggressively reentered. Geoff and his team have very clear eyes on what's required to win. It's a combination of 4 elements. We call them here the 4 rights: the right products in the right place at the right time at the right price. It's very simple in theory. The trick, though, as with most things, lies in the consistency and quality of execution. To that end, we've made lots of changes, and we've made plenty of investments. Started with that new factory in Saltillo effectively doubling our capacity. We have leading platforms in Xion and Raider. Inventory is fully deployed across our network. Today, we have 40% more locations than we did in 2022. And I expect that number will increase meaningfully in the next few years. We've staffed a team with a dedicated group of sellers and to make things easier for customers developed a quick quote tool to maximize transaction, ease and speed. While starting off with a fairly small base, emergency replacement sales grew 50% plus last year. We expect them to grow higher than that this year and continue to grow at an accelerated rate for years to come. All right. Shifting to operations. Like most every other company, we learned painful lessons during COVID, and it's why we've worked tirelessly to retool our supply chain. We made a major push to dual source our most critical parts and components. That had been a significant issue. It's not any longer. We built a new factory dedicated to high volume, low variation equipment, equipment tailor-made for the emergency replacement market. A few years ago, capacity was a significant issue. It is not any longer. And having the second factory, while it simplifies Stuttgart enables them to focus on premium configure-to-order products systems that are in demand with our national account customers and out of the verticals like education. It's exciting for me to see our operations folks are now charting the future with strong seasoned leaders with fully staffed factory teams with the complexity of 2 regulatory transitions now in the rearview mirror and a much more robust supply chain. We plan to reduce factory costs every year, every year, and this will drop millions of dollars annually to the bottom line. Then we come to another growth engine, services. Here are a few interesting statistics. As I said earlier, we have 140 branches around the country. We employ about 1,000 technicians. That number has increased steadily, and I expect that will continue. We have 900,000 rooftops under contract. The average age is 15 years. The systems that we service, heat and cool, over 180,000 commercial buildings. Last year, we recycled 15,000 units and recovered a bunch of refrigerant. Now due to the size, the age and critical nature of these systems, demand for services is extremely consistent, and it is consistently increasing it's true in good economic times. It's also true during the challenging times. As you know, this is a people business, and it's a technical business. And our growth is regulated by both human and technical capacity. We're increasing both in 2 ways. We hire and train about 200 technicians every year. Most of them come out of trade schools. These young folks apprentice under a lead technician for a year in what we call our Build Detect Program. We're also keenly focused here on productivity. And with each of our 1,000 technicians, our goal this year is for each of them to perform one extra service call a month, it all adds up, it all adds up. Few years back, services comprise less than 20% of our segment revenue. It's grown to 25% today. As you see, we aim to increase that even further. Our growth will come from cross-selling AES services and solutions from increasing the attachment rate on parts and accessories, including products from DuroDyne. And while we have a strong base with our national account customers, there are many that we're seeking to go even deeper with and there are many others that we're working actively to convert. Growing services will make Lennox better and more predictable and even more valuable. Now before I wrap up, I wanted to spend a moment on our investments in digital tools and training, which ultimately enabled this business to work at scale. These investments are all about making things easier for customers to work with Lennox. That commercial quick quote tool I talked about is one example. So too are the extensive training programs that we develop and deliver to contractors and technicians and counter reps and wholesalers. We aim to ensure that Lennox customers are the most highly trained and competent and confident in the industry. You got a little taste of that yesterday at the new training center just down the road. Beyond that, we're implementing new tools in our service division to make it easier to schedule and complete calls. We're very confident that these investments, too, will enhance loyalty and also accelerate growth. So that was a very quick spin around building climate solutions. My hope is that you take away a couple of important points. We have solidified our foundation. We're pleased with our progress, but as I said to you, far away from being satisfied, we've made promises and we've kept the promises. Bob and Chris and Geoff and our 4,400 associates have put -- points on the board. They have terrific energy and momentum. I feel it and see it every day in every one of these operations. I'm exceptionally confident in this team and excited by what is to come. And so as I wrap, we wanted to share with you another short customer testimonial. [Presentation]

All right. Well, thank you very, very much. We're going to take a short break. Many of the Lennox leaders will be in the back of the room. As you know, the restrooms are out in the hallway there, and we'll reconvene at 11:10 AM. Thanks again. [Break]

Welcome back. I trust you had a pleasant break and an opportunity to engage with our team members. As referenced by Alok earlier, my name is Prakash Bedapudi, and I've had the honor of leading global technology function at Lennox for more than 17 years. To begin with, I want to emphasize 3 key messages that will guide my presentation. First, front-end customer experience. We are investing in smart thermostats and digital platforms that make Lennox easier to do business with and easier to own. The objective is to reduce friction for dealers and homeowners strengthen engagement and create a connected experience that drives satisfaction and loyalty. Second, artificial intelligence and automation. We are applying AI to enable better diagnostics and faster service, helping technicians resolve issues more quickly, improve the consistency of service and reduce equipment downtime. AI also helps us streamline processes internally, so we can move faster and scale best practices across the company. Third, sustainable product innovation. We are building on our track record of flawless regulatory transitions and moving aggressively into next-generation products that deliver efficiency, performance and reliability. This is about designing for the future and creating a portfolio that can win across climates, segments and price tiers. With that framing, let me start with our technology capability and capacity, and then I'll walk you through a few proof points to highlight product innovation, digital experience and AI. So this slide gives you a sense of the scale, depth and breadth of Lennox' global technology capability and why it's a real competitive advantage for us. In recent years, we've broadened our innovation capacity in North America and worldwide to speed up product development, boost product vitality and maintain differentiation. In Carrollton, Texas, where some of you visited yesterday, we continue to invest in advanced labs and engineering capabilities that support our core residential and commercial platforms. At the same time, our India technology center has scaled significantly, giving us 24/7 development capability and access to top-notch talent. Thanks to these investments, we've seen a significant rise in product vitality shown by a higher share of sales from products launched within the past 3 years. This is an important sign that our R&D efforts are effective and that innovation is having a real impact on our business results. We have over 0.5 million square feet of lab space, a strong and growing patent portfolio and a global team of more than 1,500 technologies focused on delivering real customer needs, whether that's efficiency, reliability, affordability or ease of installation. The key takeaway here is Lennox has built a scaled, global and highly connected technology organization that enables faster innovation, better execution through regulatory transitions and sustained product leadership. While our technology capability has expanded significantly, we're not done. Many of you joined us last night at the new Waterview Campus, and that facility represents the next step in our capability build out. The new R&D lab we are adding will let us conduct large commercial test chamber work in-house, boosting development speed and cutting outsourcing costs. We're launching a customer innovation center at our Heatcraft Refrigeration business headquartered in Atlanta, Georgia, dedicated to developing and testing high capacity, low GWP and CO2 refrigeration systems, including liquid cooling for high-density heat rejection applications. In addition to product development, [ each ] facilities support customer and partner engagement by providing practical training, installation, servicing and maintenance of our products. Looking back at the commitments we made at the last Investor Day, I am proud of how the team delivered on the promises. We have had 2 major regulatory changes in a very short window and our team executed both transitions on time with safe, reliable and high-quality products. At our last Investor Day, I shared that we would scale our new product launches contributing to 50% to 55% of revenue by 2026. We are well on our way to achieving the target this year. We also committed to advancing our digital solutions to improve customer experience. Over the past 2 years, we've added AI-enabled diagnostics across product and strengthened online tools, our dealers rely on for product access and coding. On the innovation and product leadership, we promised meaningful progress, and we delivered. We launched next-generation high-efficiency cold climate heat pumps, the most compact air handler platform and introduced the L40 smart thermostat, which has already earned recognition for its intuitive design and features. We're doing all of this without sacrificing quality. In fact, the expanded capability and more rigorous validation allowed us to raise our quality standards as we increase our speed. Finally, our commitment to driving productivity and enhancing our supply chain has yielded positive results. Through engineering and sourcing led cost reductions as well as significant productivity improvements within our manufacturing facilities, we have increased our product cost competitiveness while consistently upholding Lennox' high standards of quality. This page reinforces an important point. Innovation leadership at Lennox is recognized externally by our customers and validated in the marketplace. During the past decade, our commitment to sustainability, efficiency and customer focus design has been recognized with over 40 dealer design and HVAC All-Star Awards. These distinctions cover both residential and commercial sectors, underscoring the strength and leadership of our product portfolio. What matters is why we earned recognition. Our solutions provide greater efficiency, improved connectivity, easy-to-use interfaces and dependable performance. Our sustainable product innovation strategy has grown very effective. It is achieving success with dealers appreciated by customers and clearly differentiated within the marketplace. This aligns directly with my initial remarks, sustainable product innovation at Lennox is a demonstrated track record, not merely an aspirational concept. And that's a perfect lead into my next section because it isn't just about innovation. It's also about flawlessly executing regulatory transitions. So this slide highlights how Lennox has successfully navigated through 2 of the most complex regulatory transitions in our industry, SEER 2 and low GWP, and turn them into a competitive advantage. The SEER 2 transition was executed smoothly with minimal design modifications and very little disruption to our dealers since our solution left the indoor units unchanged, only the outdoor units required design changes. The low GWP transition was a major multiyear initiative that required coordinated efforts from engineering, product management, marketing, operations and sourcing teams worldwide. We prioritize product safety and ease of installation by integrating refrigerant leak detection into furnace and air handler controls, streamlining installation. Innovations such as Flex Coil supported seamless transition for dealers without workflow disruption. We have also brought to market our cold climate heat pump technology, which won the DOE Challenge and further establishes our leadership as the electrification megatrend gains momentum. We address supply chain issues, including refrigerant canister shortage by pre-charging units at the factory for longer line settings. This transition did not slow us down. It strengthened our position and build confidence with dealers, customers and regulators alike. This page explains our commitment to product differentiation after the A2L transition, highlighting how this approach matches customers' top priorities. First, on product differentiation, we are focused on leadership where it matters, higher efficiency, better comfort, ease of installation and serviceability. We are regionalizing core climate heat pump technology, ensuring performance is optimized for the environment where the systems operate, not just designed to a single operating point. Second, controls and integrated solutions. We are the industry leader in OEM manufactured thermostat attachment, and we are continuing to build integrated system solutions that include indoor air quality, zoning and connectivity. Third, regulatory compliance. We are developing advanced system architectures that not only meet future low GWP and natural refrigerant regulations but also -- but do so while maintaining leadership in cooling, heating and furnace efficiency. And finally, cost, reliability and quality. Through value engineering and in-house development of key technologies like variable speed drives, we are lowering the cost while maintaining the reliability and quality our brand is known for. Together, this portfolio ensures we are not just compliant post A2L, we are delivering differentiated solutions that strengthen our competitive version and support long-term growth. As we advance innovation across these 4 pillars, a key facilitator supporting our efforts is LUMS, Lennox Unified Management System. This operating model standardizes our product development processes, enabling disciplined execution by integrating lean principles, automation, collaboration and continuous improvement to accelerate progress and deliver superior results. This slide shows how we are using AI to fundamentally accelerate product development, not just to work faster, but to work smarter. By applying AI to optimize design, we've been able to redeploy roughly 10 weeks of development time to more value-added tasks, delivering better performance at a lower cost. That's a meaningful improvement in speed to market while strengthening product economics. Artificial intelligence supports every phase of the [ NPV ] life cycle from initial ideas to product launch and post-launch review. This integration enables faster, better decisions and reduces rework. As we accelerate how we develop new products, heat pumps are one of the clearest examples of where that speed and focus really matter. Yesterday, you heard the team talk about heat pumps. And today, you heard from both Sarah and Joe reinforce the strategy. This slide highlights how our heat pump system portfolio designed to win across regions, price tiers and applications. On the indoor side, we have streamlined and optimized our air handler lineup to be size and cost competitive, including air handlers to replace traditional furnace applications and multiple mounting options that give contractors flexibility in the field. On the outdoor side, we are taking a very intentional approach to regional optimization, matching the system design to climate conditions while improving the cold climate performance and overall efficiency. At the same time, we are driving material cost reduction and long-term differentiation by investing in our own power electronics, giving us greater control or performance, cost and supply resilience. This portfolio meets regulations, broadens the markets and adds value to dealers and homeowners, allowing Lennox to gain market share as heat pump adoption grows. This slide highlights how controls and connectivity are becoming a powerful differentiator for Lennox. We've broadened our thermostat portfolio to cover the full range from entry-level smart thermostats with simple, elegant controlled ultrasmart thermostats with richer functionality while delivering a consistent, unified app experience across the board. Equally significant, connectivity enhances dealer relationships by facilitating greater utilization of service dashboards, improved diagnostics and seamless integration with broader ecosystems like Samsung SmartThings, Ariston IoT Cloud and emerging standards like Matter. Ultimately, controls and connectivity improve customer experience, strengthen loyalty and bolster Lennox's [ status as ] preferred system. We are applying AI across 2 complementary value themes: first, growth in customer delight. Using AI to make Lennox easier to do business with, improve the homeowner experience and increase win rates; second, organizational efficiency and productivity. Using AI to eliminate manual processes, improve decision quality and reduce cycle time in core workflows. Let me share how we are using AI to materially improve the customer experience, not as a concept, but at scale and in day-to-day execution. We are already seeing a strong adoption of our agentic AI tools in the field. More than 9,000 technicians are actively using our AI tool, and the feedback has been exceptional. 95% positive, which is a strong signal that we are improving both ease of use and quickly resolving problems in the field service and tech support. We've logged over 41,500 support sessions across technicians and homeowners and the tool can recognize and interpret more than 250 error codes, helping users to move faster from symptoms to diagnosis to resolution. We use AI across enterprise including tools for technicians and homeowner support, software coding agents like GitHub copilot, AI-driven selling platforms such as LennoxPROs as well as dynamic pricing and process automation. In summary, AI is helping Lennox win on experience and efficiency at the same time. That's a powerful combination as we scale growth and expand margins. This slide brings together why we are confident in our ability to win both with AI, with evolving regulatory and customer needs. First, our front-end digital technologies are focused on one simple goal: delivering the best customer experience, making Lennox fast, reliable and easy to do business with. Second, artificial intelligence and automation. These are increasingly integrated into our operations, expediting decision-making process, enhancing productivity and supporting more rapid and high-quality execution. Third, sustainable product innovation is central to our strategy, creating solutions that address efficiency and regulatory needs while providing value to customers. Finally, we built a strong technology infrastructure that is secure, scalable and ready to support advanced digital capabilities across enterprise. Together, these capabilities position us extremely well to lead through change, outperform competition and deliver sustainable growth. Thank you for your time and the opportunity to present Lennox technology and innovation efforts. Innovation is most important when it is reflected in our financial results. With that, let me welcome Michael to the stage.

Good morning. It's great to be here with all of you today. As you heard from Alok and our business leaders, our strategy is centered on our customers, strengthened by technology and brought to life through disciplined execution. Now I will walk you through the financial engine that this strategy enables including the results we've delivered, the levers driving sustained performance and our path to our 2030 financial targets. Let me start with how we've been performing recently. Over the past several years, we have delivered strong results and growth, higher margins and cash flow through operational excellence across the business. Our revenue reached $5.2 billion, up 16%, and margins expanded to just over 20%. This is solid performance, especially given the industry work through 2 regulatory inventory destocking cycles in 2023 and 2025. And with those cycles now behind us, we see additional growth ahead. A significant achievement has been our margin expansion. We've increased adjusted operating margins by more than 400 basis points through strategic divestitures, pricing excellence and productivity gains. We're also converting profit into cash at a high level, delivering an industry-leading ROIC of approximately 40%. That performance reflects targeted capital expenditures with good ROI, working capital optimization and acquiring businesses at attractive valuations, all while maintaining healthy debt utilization that keeps our leverage near 1.5x. The results you see on this page are driven by what matters most, a strong management team and the Lennox Unified Management System, which keeps us focused in delivering year after year. Let's take a closer look at our key drivers behind our profit performance. Over the past 3 years, we have increased profit by $325 million. This chart shows how our team delivered that improvement through product mix gains, pricing cost management and sustained cost productivity improvements. The mix benefit comes from upgrading our products to meet the new 2023 DOE and 2025 EPA regulations. On pricing, we've protected our margins by offsetting more than $475 million of inflation with $625 million of price. We've also remained committed to investing in the business. Since 2022, we have deployed more than $50 million to improve the digital customer experience, launch new products, advance our ERP systems and expand distribution capacity to improve fulfillment rates. Let's shift now from profit to cash flow. We convert profit to cash at consistently high rates, generating approximately $2.2 billion since 2022. Free cash flow remains solid, even with capital spending running $100 million above depreciation and with about $200 million of temporarily elevated inventory in 2025 that will convert to cash flow in 2026. We also see improved accounts receivable and accounts payable, unlocking more than $100 million of cash flow. We achieved this through better processes and increased IT automation, and we see additional opportunity ahead. Next, I will show you how we have deployed our cash flow. We take a balanced approach to capital deployment using each option to strengthen the company. Our strategy begins with capital expenditures. We've been investing above depreciation to make up for past underinvestment and to support growth and productivity initiatives. We expect capital expenditures to normalize relative to depreciation after 2026. From there, we deploy capital through consistent dividend growth, opportunistic share repurchases and selective M&A at attractive valuations. All of this is supported by maintaining an investment-grade debt profile that gives us the flexibility to execute through economic cycles. Let's now dig deeper into each of these deployment methods starting with dividends. Our dividend philosophy is straightforward. We aim to provide a modest and reliable dividend that grows over time and reflects the strength and consistency of our cash generation. Since 2022, we have increased the dividend each year, delivering nearly a 14% CAGR from our IPO. We expect dividends per share to rise with earnings in the years ahead. Let me now turn to share repurchases and how we have used them over time. Like our dividend performance, we've been consistent with our share repurchases, buying back stock when it trades below intrinsic value. Since 2006, we have repurchased more than 60% of our shares outstanding. We currently have more than $1 billion remaining on our board authorization, and we expect additional authorizations as we deploy the substantial cash flow we will generate in the years ahead. Next, a look at our portfolio actions. We've been active in shaping the portfolio, beginning with the divestiture of our European operations in 2022, which positioned us to pursue complementary acquisitions and strategic joint ventures. In 2023, we acquired AES at an attractive 6x multiple, strengthening our relationship with large commercial national accounts through a complete offering that includes equipment sales, installation maintenance and end-of-life recycling. In 2024, we formed a joint venture with Samsung to sell ductless product through a Lennox distribution channel, enhancing both brand quality and product offering. In 2025, we expanded our product portfolio in 2 ways. First, we formed a joint venture with Ariston to sell water heaters. Then we acquired DuroDyne and Supco, which expanded our ability to manufacture and distribute a wider range of commercial and residential parts and accessories. Looking ahead, we will continue this bolt-on approach. We plan to expand our parts and accessories platform, building on the Supco and DuroDyne acquisition. We also see opportunities to expand commercial service presence and accelerate our controls and indoor air quality offerings. With that, our review of the past several years is complete. Now let me turn to where we are headed and outline our new 5-year financial targets. As we introduce our new 5-year financial targets, our approach remains consistent with the framework we have used in the past with a focus on revenue growth, margin expansion and strong cash flow conversion. We are targeting revenue of $6.5 billion to $7.5 billion, profit margins expanding from roughly 20% today to between 22% and 23% and cash conversion of more than 90% of net income. These targets reflect the investments already in place and a record of management meeting the commitments we set. Next, I will walk through the specific revenue and profit drivers behind each of these goals. Our plan to achieve our revenue growth target starts with healthy underlying market growth. As Alok noted, we expect solid demand in both residential and commercial markets over the next several years. We've analyzed the past 20 years of industry shipment data. When we look at a typical equipment replacement cycles, repair patterns and the impact of new construction expanding the installed base, our modeling across multiple simulations indicates market growth above 3%. That gives us confidence that our baseline assumption of 1% to 3% growth is realistic and achievable. The next growth driver is share expansion. We see meaningful opportunity where our share is below the industry average and in product categories that customers currently source elsewhere. Sarah and Joe highlighted these areas earlier, including heat pumps, parts and accessories, attachment, water heaters and commercial emergency replacement. Across these initiatives, we expect an additional 1% to 2% CAGR. Importantly, the midpoint of these growth initiatives reflects only about 40% of the full opportunity we see today. With no major regulatory changes on the horizon for the next 5 years, price and mix should normalize to typical levels of 1.5% to 2.5% per year. Our 2025 acquisitions of Supco and DuroDyne will add another 0.5 percentage point to our revenue CAGR. Taken together, healthy end markets and execution on our growth initiatives position us well for sustained sales growth. Now let us turn to our long-term profit targets. We have already expanded profit margins substantially, and we see more opportunity ahead. First, we expect cost inflation of 1.5% to 3% per year, which will pressure margins. But our pricing actions, better pricing processes and cost productivity initiatives will more than offset inflation and lead to net margin improvement. These cost productivity initiatives include optimizing our distribution network, value engineering cost out of the products, in-sourcing select components, advancing manufacturing automation and using technology to improve SG&A productivity. Together, they are expected to deliver 1% to 1.5% of annual cost productivity. As we have done consistently, we will reinvest a portion of these cost savings into initiatives that drive future growth and additional productivity. And combined with the 30% incremental margin on higher sales volumes, these actions support profit margins expanding to the 22% to 23% range. That same margin discipline shows up in our free cash flow. Over the next 5 years, we expect to generate more than $4.5 billion in free cash flow. That gives us meaningful capacity for both share repurchases and bolt-on M&A. Now let me close by bringing it all together with our long-term financial algorithm. As I said at the start, we have a proven record of setting long-term targets and delivering on them. Using the midpoint of our new long-term targets, our financial algorithm compounds consistently. It starts with solid revenue growth from our markets and targeted initiatives. From there, our manufacturing, engineering and distribution teams drive cost productivity that expand operating margins. We then convert a high percentage of net income into cash and deploy that cash to repurchase shares and repay debt. This approach is expected to deliver double-digit returns for our shareholders and makes Lennox an attractive investment opportunity. I will now hand it back to Alok for a few final closing comments.

Thank you, Michael. Appreciate you summarizing the fiscal impact of our simple long-term strategy. I'm going to wrap up by recapping our long-term strategy. On top of the pyramid, we have 4 growth vectors that will drive our differentiated growth. We've talked about all of them throughout the presentation. Then we have 3 margin drivers below that, that will expand our resilient margins. Supporting growth and margin expansion are our 3 core enablers: advanced technology, execution consistency and talent. Advanced technology establishes product supremacy and enable success by using digital and AI as core competencies. Our execution focus through LUMS, makes it easier for customers to work with Lennox. And finally, our talent and our values are the bedrock of our strength and critical to our success. We started today's presentations with our values. So I'd like to highlight our talent initiatives before we end our formal session. We have a very strong employee value proposition that allows all of us to be unified in saying, we are Lennox, come, grow and stay with us. To maintain and enhance this value proposition, we have been investing in developing leaders, building bench strength and strengthening our culture. We measure success through employee surveys and our balanced scorecard that shows that 70% of our leadership roles are filled internally. Our culture is the leading reason for our employees staying with us and our customers doing business with us. To sum it all up, I just want to say that I'm more excited about Lennox' value creation potential today versus when I joined the company 4 years ago. I'm confident that our best days are still ahead of us. With that, I want to invite all the speakers back on the stage for the Q&A session. As they make their way back to the stage, I do want to take the opportunity to thank our employees and leaders who have worked tirelessly behind the scene to organize this successful event. To manage the Q&A process, we will start with the questions from the front row and then make our way back slowly. You would have noticed that we have reiterated our 2026 guidance this morning, which means that we have no meaningful update on 2026. Hence, I'm really hoping that your questions will be focused on the long-term strategy that we presented today. If you have a question, raise your hand and either Sam or Alison...

It's Joe O'Dea from Wells Fargo. Can you start on some of the growth opportunities around kind of penetration when it comes to attachment rates and where you're setting targets on those as well as the heat pump kind of time line on targets. So you go from an attachment rate of 18 to 40 or 25 to 40 when we think about HCS, BCS on the service side or where you think about kind of heat pump as a percent of sales? Where do you expect those to be when we next come together for an Investor Day?

Sure. I mean that's a good internal and healthy debate we have been having. But I'll give you some insight. We don't think we get to full opportunity within the next 5 years. I mean some of these are much longer-term penetration opportunities. So what we have built into each of those, and then Michael obviously hedges that appropriately from a financial sense, that we would be between half and 3/4 of the way of those full opportunities. So in each of these opportunities, we had a bar on where we are today, and we had a bar on where we have full opportunities. And we said we'll be between 50% to 75% of that full opportunity in the next 5-year period. And that's what led to our growth algorithm saying each of those initiatives contributes about 50 basis points of growth.

And then just one on investment priorities because you talked about kind of a large opportunity set as the portfolio gets bigger, it expands those opportunities. And so as -- if you kind of narrow that focus within HCS, BCS, kind of -- if you kind of rank order in terms of over the next, call it, 12 to 18 months, 12 to 24 months, just how you're thinking about those investment dollars and sort of the highest priorities within the portfolio?

I think I'll start by saying that a lot of the investment needed for the next few years has already been made. And the -- as Michael says often, the costs are in our P&L, the benefits are not. So I think that should probably give you the bigger overview of the answer. At the same time, on things like distribution, on things like parts and supplies, which are across both the segments, and we share those investments, there's still more to be done. Prakash highlighted the opportunity for us to invest more in testing, product development, customer experience and training, which is also across both the segments. But I think from each of the segment perspective, the core investments, whether it's manufacturing in BCS, distribution in HCS, those are already in our books. So I wouldn't expect anything significantly incremental to that. And that's why in Michael's walk, you didn't see a drop down for extra investment beyond what we get out of our just regular drop-through on volume.

Tommy Moll from Stephens. I wanted to ask about the parts and supplies attach rate for the resi business. Ultimately, you're asking customers to break a old habit. They've been buying parts and supplies from someone down the street. You got to get them now to do that in your stores. So I'm just curious what additional detail you can provide on how you're going to make that happen. Alok, you mentioned shoulder to shoulder, is that going to be enough to get it done here?

It is. I mean it's frustration of ours that they don't buy it from us. It's a frustration of theirs, our contractors as well because now they need to make 2 stops versus one stop. Yes, they've got used to it because equipment is very good. They like buying from us. We need to make sure of something what Joe said in his segment that applies to parts and supplies as well. We've got to have the right part. We got to have it at the right place, right? We got to have at the right price, and we got to make sure that it is at the right time when they need it, whether it's to deliver to their place, to pick up from the store. I mean the 4 rights that Joe mentioned [ are same ]. We've done lots of surveys, applies to residential and commercial, it is just something we are learning, and Tommy, you know this is, it requires investment. It requires category management. It requires parts distribution centers. It requires small package shipping capability. But we are getting to a stage where we want to deliver one order, one invoice, one shipment. And when we do that, our contractors would rather buy from us because it's maybe annoying to us, it's frustrating to them to have to make 2 stops.

Tim Wojs from Baird. Maybe as you move from kind of a factory driven or a centralized model that something that's maybe more regional or local or decentralized, how do you make sure there aren't any sort of like unintended consequences that may change as you go through that process? And what are some of the, I guess, internal incentives that you changed? And I guess is that all kind of fully implemented at this point?

Yes. We'd like to think that we were always customer-centric model. But you're right. I mean a lot of it was factory-centric is to make products in the factory and then push them into the distribution center. And now what we are doing is we are going to hold the factory inventory at the FTC and pull it. Quite a few things we are doing to make sure it doesn't upset the [ Apple cart ] or doesn't change. First of all, the rollout is going to be slow. And when we go to the FTC this afternoon, we're not going to take all our regional centers and start moving the model immediately, right? We're going to do it one at a time to minimize the risk. So that's kind of the #1 thing, right? Second is, and you heard Prakash and others talk about it, we are using AI heavily because this is going to be as good as the forecast we can get to and the pool system we can do. So it's significant rewiring of this. For the past few years, some of the investment that Michael highlighted was in a new WMS system. So we do have the new warehouse management system, a new TMS, a new transport management system. So all that's already done. So this is not new for us. We've been preparing for this for about 2 years, and we have already built the digital blocks, taking care of the outdated tools, and have done a lot of process improvement such as sales inventory operation planning to make sure that happens. And the best way to do it is not a big bang approach, but a slow, one at a time to minimize risk and roll out. So far we feel very confident about this working.

Sure. So you've done a nice job of articulating the growth drivers across the 2 segments of the business, they're different, right? I mean there's different opportunities here. There's also different opportunities for margin expansion. Can you give us how in the 2030 outlook, you think about both revenue growth and margin expansion between the 2 segments, understanding that they're starting at a different point?

I'll let Michael answer that.

Yes. So if you look at the total revenue growth to the midpoint of our guidance, it's 6%, and BCS will grow a little bit faster than that, mostly because of the inorganic acquisition side of it. When you look at organically, though, we see about a 5.5% organic growth across the organization, pretty much equal across HCS and BCS. From a margin expansion, it might lean a little bit more toward the HCS, some of those cost productivity and the pricing process improvements will lean a little bit more to that direction. But in general, both should be growing at about the same rate organically for the next 5 years.

Thanks for all the detail. On the kind of resi assumption of the 3-plus units, is that something that you're kind of the shape of that recovery? Is that above that range as you kind of bounce off the bottom in '27 and '28 and then settles in? Or are you thinking this is a bit more of a steady progression of 3% from here through 2030?

We think there's obviously a short-term bounce that we are going to experience. We don't know when, and that's going to commit it. The bigger point, Steve, is no matter what the industry does, we are very confident of the differentiated growth initiatives that we are going to drive. But listen, we are not good at predicting an industry growth rate. So that's at least something we have established over the past 4 years. That none of us are great at predicting the industry growth rate. So I think what we're going to focus on is differentiated growth. Here are the 4 things we are going to do, that's going to be in addition to the industry growth rate. Listen, if it grows above 3%, that's great for all of us, right? If it goes below, we're going to fight harder on the differentiated growth to still make our long-term targets.

Yes, I was going to say I'm not very good at forecasting either. So we're on the same page on that one.

It makes both of us together on that.

Yes. And then just on the capital deployment side, I mean, your share count is pretty low. I know that really doesn't matter from a market cap perspective. But like, is there any pivot to -- like does the appetite for buyback just like run out a little bit? Or -- and maybe a little bit more M&A? Maybe how much buyback are you kind of thinking about on a run rate basis every year?

Yes. Obviously, we're going to generate a lot of free cash. You saw $4.5 billion. So we're going to use that in one or 2 ways. We're going to opportunistically look for M&A, but it has to fit the criteria that we want for the right price, around the core business, around parts and accessories, around service offering. If that happens, we'll definitely want to do that, but it's more bolt-on. But we also believe that consistent share repurchases over time add a lot of value. So we can continue to see that over the next several years as well.

Thanks, UBS. I wanted to ask, could you just mention about the stuff that's in your control versus not in your control in terms of outgrowth. And you do have a forecast for 1 to 2 points of outgrowth. I think it was 1 to 2 points. I don't have the presentation in front of me. But maybe you can attribute that -- I assume that a lot of that's in building and winning back some of the emergency replacement, I think the Mexico facility really helps you do that. Maybe just attribute that outgrowth to specific, either segments or products and how confident you are in delivering on that just given that you have visibility on that, that is in your control?

No, that's a great question. So we operate the company in 6 business units, 3 under HCS, 3 under BCS. Each of them have a very specific set of growth initiatives. In some cases, it's about regular conversion like of dealers and contractors that kind of drives our regular share. We've been doing that for years and that continues, right? So if you think about it, others are more about specific initiatives like emergency replacement. But if we build that all up together, what we are driving towards is 2 points of growth that's differentiated above the market. And on a very simplistic basis, I take the 4 ones like heat pump, emergency replacement, attachment rate and TAM expansion and it's equally spread among all of that. That's come the way I look at it. But Michael can give you a little bit more detail because he's actually -- his Excel often is more detailed than my PowerPoint. I don't know how that happens. So maybe he'll [ give you more ].

It's why we balance each other well. So yes, this $500 million revenue opportunity, I think you saw on the slide, if you break it down about $150 million for parts and accessories, $125 million for emergency replacement, $125 million for water heater and Samsung, and then about $100 million for ducted heat pumps as well. So that kind of breaks down to $500 million. Again, that's to the midpoint of our guide, and it's still less than 50% of what we think is the full opportunity that Joe and Sarah are going to push and execute against.

Great. And just -- that's very helpful. Just one follow-up. Look, you had mentioned this refrigerant opportunity in data centers. Maybe just give us a little -- I assume it's small and a long way out, but maybe you can just provide a little bit more color around what specifically you mean, what opportunity that can be?

Yes. I mean it almost was a point of saying, we don't have any meaningful exposure to data center today. Our products do make it a data center one way or the other. In future, when I think the data center cooling technology evolves, and it becomes more about 2-phased direct-to chip cooling, that's where technology will apply. But at this stage, we have no meaningful revenue and nothing really to declare to talk about that. We are focused on our 4 core growth initiatives. And maybe the next Investor Day, the technology would have moved far enough advance along then we can talk about how our technology could apply in data centers.

Barclays. Maybe a first question just around the water heater push. You mentioned that what is it, $125 million revenue opportunity. You've got well-capitalized strong competitors there already, kind of how much market share should we think about Lennox trying to take over what kind of time period, what kind of counter success there on the market share front? And then secondly, Alok, just following up on the data center point. Help us understand kind of what are your discussions with customers like and maybe flesh out a bit more of the reticence to get bigger in that market sooner?

So on the first one, just to clarify, when Michael gave you the number of $125 million, that was water heaters and ductless from Samsung. So that was a combination of those 2. And I'll be a bit of a phasing because Samsung, we launched last year, which means this year would be kind of meaningful from revenue. Ariston, we're launching this year, so it will be next year before we reach meaningful revenue because there's always a 1-year lag from the launch to getting to meaningful revenue. So it's a combination of those 2. On water heaters, listen, we're not going to talk about us being the leader or being 20%, 30% share in -- well, that's not our goal. We are doing this to serve our customers better to make sure we can provide them the convenience of one-stop offering. We have 250 locations, typically, within 20 minutes drive from one of our contractors and [indiscernible] that deliver their products every day. We're going to make it easy for them to buy water heaters and these guys are not big buyers of water heaters like a big plumbing contractor. So for our the goal is that, I would say we are looking at small market share. I don't think this is about displacing #1 or #2 or even #3 in that space. It's about getting our share from our dealers by making it easy for them to order both from us. I was hoping to avoid that, but thanks for the reminder. Julian, I mean, listen, in data center, we are not reluctant to get in the market. We are not anti-data center. We just don't have the product or technology. Most of the data center business today is using chiller technology. For good or bad, the way Lennox is, we just don't have the chiller technology. My comment was all about at some time we're going to go beyond the chiller technology and data center, and some of you are more of an expert on that than I am. At that point, there will be opportunities for Lennox to participate. So we are skipping the current technology of chillers because we just don't have it.

Chris Snyder from Morgan Stanley. So there's a lot of -- in the presentation about the direct selling approach. I guess, is that really just a margin opportunity for the company, like we could look at OEM plus distributor margins? And is that what you are going after? Or I wonder, is there also maybe some opportunity to -- I mean, if you're taking margin from someone else in the channel, are there any ability to like donate that back or give it back to the homeowner, which could maybe help drive some share for you guys through a -- just helping out with the affordability challenges?

There's clearly a margin opportunity. And we've talked about and Sarah mentioned that a couple of times is, we have the entitlement to take margins for manufacturer and distributor. And that's more of an intellectual thing. We got to make sure we wring out the inefficiencies, whether it's in our distribution network, manufacturing network, pricing processes so we can benchmark ourselves against the best-in-class manufacturer, best-in-class distributor and do both. But actually, the bigger reason we emphasize that, it positions us very well for the future. If we were not direct, we could not be selling water heaters, right? If we were not direct, we could not be doing the JV with Samsung. If we are not direct, our parts initiatives would not have the appropriate team and the connection to the dealer. Being shoulder to shoulder, or Joe right to say, belly to belly with the dealers is more about being serving them properly, serving them better. And as the distributor channel consolidates, the dealer channel or the contractor channel consolidates, puts us in a great position to work with them to eliminate unnecessary middlemen, which I would call it unnecessary inefficiencies between us, the manufacturer and them as a channel. So that's where I think the bigger opportunity lies. I don't think it translates into pricing going to homeowners because one thing that's very well established in this industry is pricing cuts do not lead to share gain. That just doesn't happen in this case. We sell to somebody, who sells to somebody, who sells to homeowner, with labor, with accessory, with warranty, with financing, the whole chain does not work with price cuts from us leading to market share. That just doesn't happen.

I appreciate that. And then, Michael, you kind of talked about when you guys are modeling out growth, looking at the installed base. So I would just be curious on how has the installed base for Lennox grown? Because I would think that at the industry level, the installed bases have slowed over the last 15 years. We've seen the housing stock growth has slowed and I imagine HVAC is hitting or maybe not yet some sort of like theoretical ceiling on where the penetration rates go. So just be interested on how Lennox's installed base has trended?

Yes. We think the installed base continues to grow. Every year you have new construction additions. Every year you have add-on replacement, putting air conditioning in your garage or different units. So that's where a lot of mini split has actually expanded the cooling and the installed base. So we see the installed base has continued to grow. We've also seen the average life of the system shortening for all of the reasons that Alok put on the page. And when you combine that with shipments over the last 20 years and especially more shipments toward the south with heat pumps, we see a relatively normal kind of failure rate going into the future. And assuming replacement rates are also normal, we'll see at least 3% growth from that algorithm.

Jeff Hammond, KeyBanc. Alok, you touched on different pieces of kind of distribution profitability and how you're getting there, but maybe hit it more head on, like I think a couple of years ago or a few years ago, you were saying, hey, distribution is breakeven, we can make it much more profitable. Just give us the big progress steps you've made over the last few years on that end? And what are the big next steps to kind of continue to push on that?

Sure. We 3, 4 years ago did not look at distribution and manufacturing as separate. We even today do not incentivize people necessarily those being separate. But what we have gotten better is benchmarking and creating regional P&Ls. So everybody from a territory manager to a regional director, to a district manager, all have profits as part of the incentive. That's created a lot of visibility and incentives to make that happen. So that part is done, right? Second piece on distribution that was getting efficiency is our network, which I think Sarah described as a ball of yarn, I call it as a spaghetti on the wall. Going from that to a hub and spoke, there's going to free up significant efficiency opportunities. And that starts happening this year with full impact on next year. So that's the next big step on that it comes out, right? Third thing on that to come down to is our network and our stores are still under leveraged. So my sales per square foot in a store has an opportunity to be much higher. So I don't need to open more stores to sell more mini splits, more water heater, more parts and accessories. So if you think about those 3 factors and for intellectual reasons, let's just say they are equal. I would say the first one, we are probably 60% there. We have made good progress. We're going to redo the incentive plans, again, to keep going up the profit chain. The other 2, we are just beginning. So I would say we are less than 1/3 of the way towards the final goal of freeing up distribution profitability and getting to more reasonable profitability level and distribution. Sarah, do you want to add anything to that?

I think you've covered it pretty well. I think you said it. The second one, I think, is the most immediate one in front of us that creating -- going from a push model to a pull model, and that will be over a year or 2, is going to have an impact all the way through our supply chain as well as creating efficiency in the factory. So I wouldn't add anything specifically except that's probably the one that I think is going to add the most value in the first couple of years.

Ryan Merkel with Blair. My first question is on incremental margins. The targets imply like a 29%, 30% incremental margin, which is more or less the 5-year average. My question is, which initiatives provide the most upside to that target in your mind?

I gave you the revenue initiatives. If you think about that, the commercial emergency replacement is one of the highest ones there, really great margins within that. Outside of that, the rest of the margin expansion is really going to be about cost productivity, redefining our distribution network, getting all the cost productivity within that. We've just launched our new products, the new regulatory change within 2025. Normally, after that, we go back and redesign and reengineer, Prakash can add to this. We take a lot of cost out of the product after we go through a regulatory change. And it's going to be about manufacturing productivity. We have not delivered over the past several years much manufacturing productivity at all, and we think there's a lot of opportunity there. So those are going to be the main drivers of margin expansion. The source products will be a little lift to margins, but not as much as the others.

All right. And then my second question is you've talked about improving fill rates to the high 90s. I think that's at the store level, correct me if I'm wrong. But what is baked into the guide for fill rate improvement by 2030? And then can you help us think about quantifying the revenue opportunity if you achieve that?

Yes. I think at the -- we give you ranges on revenue opportunity, which I think was appropriate. On a high end of the revenue opportunities, you should think of us getting to a 96%, 97% fill rate, probably still not at the 98% level. I think we're going to get closer to that. On the low end, you should think of us as being at 92% to 93%, just -- I mean there's a statistical correlation to fill rate and market share. And there's a correlation to NPS and market share. And those are the 2 variables we constantly optimize. And I need to raise bar on both of them, a higher NPS, higher fill rate gets me to higher market share and higher end of the revenue guidance range. Now on fill rate, the challenge has been quite a few things, right? The centralized planning thing was just not working. So I think the decentralized nature that I mentioned earlier, that's going to help more where there's supply chain experts for every regions that make it happen. AI is going to play a huge role in that. I mean we are spending significant amount of time, effort and resources upgrading so that we can use SAP IBP versus a lot of manual spreadsheets and planning. Just like we are bad at forecasting industry growth rates, turns out we're also bad at forecasting what products are going to be needed in what ZIP code. So this is where, again, AI is going to help us get to what products we can expect to go in which region and getting a more agile thing. Finally, getting our product classifications to the A,B,C,D level, like big distributors and Ryan, you're familiar with all of them. I want to have a more sophisticated dialogue with you next time we're saying, okay, I'm filling As at 99, Bs at 94, we want to have that level of discussion. And when we have that level of discussion, Ryan, then I will say we are closer to the goal than where we are today.

Great. Thanks. So just a quick one on the margin target, the 2 points roughly of margin expansion. Is it similar across the 2 segments? And the spirit of the question is that BCS is really high level. So...

Yes. The margin improvement will lean a little bit more to the HCS, but both will drive margin expansion.

Okay. Great. And then on the free cash conversion target, 90% plus. It strikes me that a good number of the initiatives, [ growth ] initiatives around parts, around maybe what the JVs requires inventory investments. I'm just wondering, is there going to be a significant inventory investment in the next couple of years? And do you think you can still be within that 90%...

Yes. We feel we've greater than 90% in our current working capital as a percent of sales, we can work within that target. We also have opportunities on accounts receivable and accounts payable to help fund this and even raw materials within the factory. In the end, that's what we want to do is deploy those savings to more finished goods and get them closer to the customer, to Ryan's point, try to win fulfillment because that's what matters for the customer.

And then just a quick one. Sorry, I know this is the third question. So the earlier question about changing customer behavior, getting them to come in for parts or whatever else. Is there any kind of direct marketing initiatives behind this plan?

Yes. I mean from our marketing perspective, realize that majority of it is tailored towards a dealer. So when you could direct marketing for, it's more about educating our dealer. We do a pretty good job with our captive dealer base, like the Lennox dealers through our own internal pieces. And a lot of it is now moving to digital. So over the next few years, we have to be better at lead generation. We are working on that. That's what get loyalty. We have to be much, much better at training our dealers, so especially using digital tools. So we are working through that. We have to be much better at retaining our dealers. So as we look at some of our digital tools, we realize that often we are able to attract that dealer, but we don't do a good job retaining. That's where marketing plays a bigger role, whether it's about doing the value proposition. And if you're in the tool, you would have seen our CRI index. So we will look at customer retention index, customer engagement index and using marketing as an effective tool to go back to the dealers and confirm the value proposition and take any course corrective actions that we need to take. But this would not be -- we would not be going in after a football stadium. We would be not doing TV advertisement. Our primary channel will remain online or direct to dealer. Any other questions in the room? I think open to the whole room at this stage. If not, thank you very much. We still have a few more minutes to mingle. We will -- and we have box lunches and then Chelsea will let us know when the buses are ready to leave for everybody is going to the FTC. Thanks, everybody. Appreciate it.