I think we're ready, we're ready to get going with our next presenters. We're really excited to have Alok Maskara and Michael Klenzer from Lennox International here with us today. Thank you both for being with us here today. Really enjoy get a chance to meet you guys. Alok, to see you again. Let's get going with. Look, Alok, it's been about a year now, that you've been the CEO. You've done a lot in terms of simplifying the portfolio, working on the margin expansion opportunities, you know, investing in the future. Just talk to us a little bit about, like, what you're most excited about, what the team actually has accomplished and what's left?
Sure. No, thanks. And great to see you. I think it's been quite a few years when.
Yes
Learning about IR and tough act to follow after Johnson Controls in this room. People I respect quite a lot. George Oliver used to be my boss back in the GE days. Jim Lucas, who used to be the IR person. It's a small world. Delighted to be here. Thanks for hosting. I completed 1 year yesterday. I got the email from the system saying, "Congrats on 1 year." All those who were shorting saying the new CEO won't last 1 year, you were wrong, you know. I did last 1 year.
I don't think there were many people, but go ahead.
As I look back on one year, and if I look forward the next few years, the thing that I'm most excited about and the most proud of is driving a cultural change at Lennox. Lennox is a great company. We were a better company five years ago than we are today. The first 10 years of my predecessor, he did great things. In the past five years, we kind of got into a pickle/an internally driven quagmire that we're getting out of. We're driving a significant culture change at Lennox. That has two different aspects to it. The first aspect on that is truly reinforcing our culture with guiding behaviors, getting accountability to be one of our core guiding behavior, getting to a stage where digital customer experience is part of our core guiding behavior.
We mentioned that in a PowerPoint, but I just wanna emphasize how important that is to us. Internally, because we were very successful for the first 10 years, we became a bit complacent. We were good, and we let that become the enemy to becoming better. We became very internally focused, and we are changing that. That is kind of a huge portion. Each and every employee at Lennox is going through training. We took our top 200 people through a whole session, but it's not just a session, it's about the tools that's gonna be used for all our talent measurements going forward. That's in people's annual performance, and that's a significant portion of. If you wanna be with Lennox in the future, you must live our guiding behaviors. You must be accountable for what you do. You have to be customer focused.
You have to believe in sustainability, and that's who we hire, who we retain. Second aspect of that is an operating system. We have put a very disciplined operating system driven by scorecards. Think of the old balanced scorecard type methodology, given with the lean principles on truly how we operate factories. Michael has actually led that from our perspective, getting into very disciplined every month, every quarter, every year, how do we put a very disciplined operating system at Lennox? That would make sure that we're never, ever surprised by things like Stuttgart. You know? The fact that we didn't know about Stuttgart, we as in the corporate. Those things will just not ever happen again. Those are two things I'm super excited about. We are early innings in that journey, but the results are quite positive.
We have a team that's super excited. We have given everybody a choice. If you don't wanna be on the bus, and you've done great for 15 years, given our stock price has been good, we don't want you to sit on the office chair. We wanna sit on the beach somewhere and enjoy all the wealth you've created. Let's pick that choice. Get on the bus. We are here to win.
That was a great answer.
I'm curious on the people side. Has there been a lot of change at this juncture? It's been 12 months. I know that you're probably looking to y ou know, see the type of talent that you have on board. Has there been much change from that standpoint yet?
There has been. As you can see, new CEO, we have two new segment leaders, both experienced and both fired up, both in this journey together. Like, you know, residential new segment leader, Gary Bedard, he grew up in the Lennox residential area. Has strong relationship with the dealers. These are the dealers who are upset at us. These are dealers who left us. Like, these are smaller dealers who are higher margin and have been Lennox loyalists for decades. Gary has 24 years of experience working with them, and having him as a segment leader is a refreshing thing, right? Our dealers are really excited about it. On commercial side, Joe Nassab is our new segment leader.
He grew the Allied business from $200 million to $800 million while taking profitability from low single digits to one of the best in the company right now. He's really fired up about commercial. I mean, he really wants to do the same journey at commercial. He's the one who says, "It's not about share or margin, it's both." Right? "The way we're gonna do it is both together." I think two leaders. If you go to our plants, essentially, except for one, maybe all our plant leaders are new now. We need plant leaders to really work on what customers need versus we had come to the stage, we were selling what the plants could make. No, it's gotta be the other way around. They're gonna be what the customer needs, and that's what the plants will make.
Not having the sales people say, "Hey, this is what you can sell, because that's all we can make." That's a huge cultural shift for us. Then take it across the thing. Like, you know, we are putting new folks understanding pricing, so we can do pricing more sophisticated way instead of brute force pricing. On our go to market front, we have worked with outside help to do external benchmarking, and we are revamping that both on the commercial and the residential side. How do we go to market? We have added more salespeople in residential in the past six months than we did in the past six years. We are funding that through G&A reduction and making sure we take out waste and administrative processes and add more feet on the street.
There is a whole transformation that's going on that's beyond the numbers that, you know, that's supporting all the numbers that you see. It's easy to talk about numbers and to. I thought I'd take this opportunity to talk about the real transformation which is happening at the plant level, which is happening at the salespeople level. Opening stores is interesting, but if you don't have sales people who are helping you sell, that doesn't matter. Now we're actually doing the hard part of adding sales people who will bring traffic into the stores.
That's, that's great to hear. I'm sure everyone's gonna wanna talk about the commercial recovery, but there are a couple jumping off points there that I wanted to ask you about. Number 1, in terms of getting some of the dealers that you lost, you know, are you starting to see any traction at this point in bringing them back into the fold? Any caller around that would be helpful.
We are. It's early stages, you know, and it's easy to lose. It's hard to win back, we know that. We are seeing traction. Many of these have been historical loyalists, and one reason we lost them is because we didn't have the Dave Lennox Signature Collection products, and our service levels were low. Our inventory in the system was really low. Our service level are back up over 90%. Our inventory position is all green now versus mostly red just about 12 months ago. From that perspective, yes. It's a long journey. Like, you know, our value proposition to a high-end dealer remains superior, and it's getting better. One big way that's being driven, Joe, is e-commerce. E-commerce has now become over 30% of our residential sales. Like, over $1 billion in our sales are purely through e-commerce.
These are people who are ordering on their app or the website. They're not coming to the store anymore.
They are purely relying on that. They love the fact that they can scan the QR code and get prognostic diagnostic decisions and pulling that together. The way we lost it was poor service, not enough products in hand, not enough premium products. The way we're winning them back is digital capabilities, fully stocked products, and frankly, more feet on the street. Some of them left because they didn't have a sales person to talk to.
You know, there was a dealer in the south of Atlanta who called me in my first week saying, "I've been a lifelong Lennox dealer, but you got rid of my sales person. My sales person is now two hour north. Rheem guy is right next to me. I'm gonna go to Rheem," right? I mean, just those are things we are addressing straight up. Yeah, we are winning them back. It's a slow journey, but we are gonna get there.
An interesting dichotomy, right? You've got your e-commerce sales now 30% of your business, but you're adding more people locally to the stores. I understand you wanna be closer to your customer.
I guess maybe just help us understand, like, do you have the right amount of stores? Do you have to continue to expand your store presence? What's the right, like, leverage model, like sales leverage model?
that you're getting in the stores versus where you were before?
Sure. Two things. We know when we open stores, we win share in that market. That part has not changed. The timeline to get there can be faster. We also know that our distribution right now does not have world class operations and efficiency. Our sales per square foot is much lower than people who do it well, and I admire people like Watsco who do a really good job at this. The good news is we have role models. We know what good looks like for us to be able to see from the outside in and learn through that. There are lots of opportunity. You have to think of our salespeople not as people who take orders, but people who are the product specialists, who can go help the dealers with the product questions. They shouldn't be order takers and carry a notebook to take orders.
That all happens on the e-commerce. They need to be able to train them on the latest, greatest heat pump technology. They need to be able to talk about Dave Lennox series products and how that's gonna help them make more money. They are the ones who are calling new dealers and saying, "Hey, can you switch back?" E-commerce doesn't help me win back the dealers if the dealers don't know about it. Somebody needs to be knocking on dealers' doors and saying, "Hey, here's a new capability." Here's a new offering. That's what our salespeople do. They should not be transacting. If they are taking transaction orders, we got this model wrong. That's part of the go-to-market revision that we talked about. We are revising how we go to market. Our dealers are no longer like ordering through our salespeople.
They order through the website, but they have the direct support when they need to.
That's why we gotta make it easy for them to process warranties, easy for them to get training, and get to the stage where we help them win, cause that's how we win. It's an interesting dichotomy, but it's the right division of labor for us.
Then, outside of the Lennox stores and outside of your direct channel, it was interesting, you know, the comments that you made around growing the Allied business and now that being one of the, you know. H ighest margin businesses that you have. What's the ambition at this point with your independent distribution channel? I know it's not just Allied.
What's your ambition here?
Listen, our market share on direct and indirect in both is very low, right? I mean, we are the smaller player in both those, and we have a huge opportunity to grow. I'm not gonna say I prefer one versus the other. We like both of them to grow. The reason indirect has become larger, Joe, is because direct stumbled and remained flat for a while, right? They both should grow. Both have opportunity to grow. On the indirect side, it's gonna be about adding more independent distributors. Our penetration is still very low, and we have a long backlog that we can convert now that the product position is better. On the direct side, historically, it was about opening new stores. Now I talk about how do we make sure that we serve more dealers the same day or next day.
I can serve them through local distribution centers. I can serve them by dropping a container in their parking lot that is a VMI and has got RFID technology. When they take products out, we automatically bill them. There's a lot more technology that we are going to use, going back to e-commerce, to serve our dealers. It doesn't have to be of more stores. We need to make our current stores more efficient, for sure, right? They're not as efficient they could be. That's about having more parts and supplies. That's having a more velocity through them. That's what a good distributor would do. We need to act more like a distributor when we run our stores, but not be afraid of experimenting with smaller stores, container drop-throughs, and other pieces that we work through.
We are now no longer gonna talk about opening X number of stores per month. That led to some bad behaviors, right? I mean, we opened stores without having a fully fledged plan of how we're gonna make them profitable.
Makes a lot of sense. Let's switch gears. Commercial margin recovery happening a lot faster than we we anticipated. Maybe not what you anticipated internally. It's what you communicated externally. Talk about, you know, what's been better. What's happened faster?
You know, what's the plans going forward?
Sure. I'll let Michael answer that question. He was the CFO of the commercial division until last year, when I pulled him to corporate and got him more of a G&A type role.
That's right.
He's also helping us with the whole metrics-based system that we are using to drive the performance turnaround.
First off, very pleased with the recovery in the commercial business. You can see in our Q1 results, we had operating profit up 800 basis points. Definitely good progress there. Couple elements when you break down the recovery in that business. The first was that this time last year, we were seeing cost increases coming in significantly faster than pricing. Second half of the year, we had to go out and reprice a lot of our national account contracts, a lot of our backlog. You're starting to see that benefit come through in the first quarter. Definitely the price cost dynamic is coming a little bit faster than we expected. On top of that, we're also seeing in Q1 some favorable mix as we transition to the new minimum SEER product.
We're starting to see some mix benefits as well in Q1. That's one element of the recovery. The second element of the recovery is predominantly around production, getting more output out of our factory in Arkansas. If we could get more production out right now, we would sell more products. It's still definitely a journey in that space. I think it's gonna be kind of a multi-year journey, but we think we're gonna be building more in Q2 than we built in Q1 and more in Q3 than Q2. By the end of the year, we should see volumes up in the commercial HVAC segment. That's after being down 6% in Q1. Overall, we're seeing really good progress there. Production is really the remaining element that we're working on. Super helpful.
Michael, maybe just a follow-on question for you. Where are you in terms of your production today? I think as of, I remember a number. As of 4Q, I think you were at 20%. Correct. Like, where are you in terms of? And what's the limiting factor? Is it still labor? I mean, a little bit of distortion in Q1. We obviously had to transition nearly 70% of our product to the new minimum efficiency product. We knew there was gonna be a bit of a more ramp-up challenge in Q1, but we are seeing component shortages still. A lot of our competition is seeing those on some of the new components that are going into the product, but things are improving, and they're definitely getting better.
We had, you know, 20 or 30 issues this time last year. We're down to 5 to 10 right now. Oh, great. We're seeing that improve. It's predominantly a component issue. The labor issue in the factory is definitely solved at this point. Okay. Great to hear.
Joe, if I can just add on the commercial side. I wanna paint the vision of where we are going there. I think there's a brute force $100 million. We talked about it. We are more than halfway through. We'll get it. It's all about blocking and tackling, right? We have good role models on the commercial side. I mean, I look at AAON. That's what our Stuttgart business used to be. High-end products, configured to order, quick lead time, working with the key accounts and getting engineered, right? I think AAON has borrowed a lot of share from us, and we need to get Stuttgart back in that thing, right?
Our future factory in Saltillo, that's targeted towards replacement, Carrier curbside, get to a stage where that product is in stock and available within the same day or the next day, locally delivered to you, made very efficiently because that's more competitive, and both can be good margin business. That's the vision we are going towards. To get there, we had to first stop digging a hole in Stuttgart, and which we did. We have stabilized it. There's a long way to go before we crawl out of that hole. Output at Stuttgart is still 20%-25% lower than 2019. All I'm saying is, we are not in a demand-constrained world. In future, we may be in a demand-constrained world, right? It happens in every industry.
When we get there, we are working with our go-to-market, with our sales team, with external help, redoing our go-to-market. We are clearly focused on one end, getting the AAON type margin and serving that customers. The other end, getting the Carrier type volume and pulling that together. That's where we went wrong. We tried to be all things to all people using one single model. That didn't work for us. We will fix our current issues. Future for us, we still believe we have margin for improvement on both sides, way beyond the $100 million we talked about.
Look, just maybe, as a reminder for everybody, the facility that you're building in Mexico, just talk a little bit about, like, your confidence on when it will be up and running? Then secondly, sometimes where companies misstep.
Is in making sure that their supply chain is appropriately set for that specific facility. Talk to us about what you're doing to ensure that you're gonna be in a good place.
Sure.
when you're ready to produce.
Sure. This is a new factory, commercial factory in Saltillo. As a reminder, we have 3 existing factories in Saltillo, so this would be our 4th factory in Saltillo. We share a lot of infrastructure. It's kind of greenfield, but it's next to our existing factories, right? I think that reduces our overall risk. Everything from sheet metal benders to other places from a supply chain. We have a very good, well-established supply chain. They need to come up with different components and things like that, so that we are working through. The factory will be up and running next year. We have targeted it so it gets online with the new low GWP. We don't want this factory to go through a transition.
End of next year, along with the new low GWP product, it'll be focused only on standard products, no configuration, made to stock. We have significant experience in building factories in Saltillo, and have done it successfully. Now we are making sure the supply chain, everything from corrugated boxes to skids, to metal bending capabilities, are all leveraging our residential supply base. Some of our suppliers, core suppliers, are actually coming up with operations next to us in there because, you know, that's become the new hotbed as we are reshoring so is our supply chain, putting it all together. Never be 100% confident in this thing. I live paranoid every day. So far, like, you know, we are doing all the right steps, and we remain very confident. We are at or ahead schedule 6 months into that journey.
That's super helpful. I'm gonna turn it over to the audience in one second. Just I'm sure top of mind for everybody is, you know, resi HVAC volumes, and you referenced de-stocking in 1Q in the high teens, but an expectation that things are gonna get better from here. Just maybe talk about your visibility and your confidence in that, and maybe we'll start there and we'll go from there.
Sure. Michael, do you wanna take that and?
In the residential markets, we're seeing definitely resiliency still on our 80% of our business that goes direct to contractors in Q1. We saw shipments about flat to prior year. In the other side of our business that ships into distributors, it's kind of 20%-30% of the business. We definitely saw some volumes down kind of 15%-20% in line with what the industry expected. Right now we're seeing everything kinda behave as we went into the year. We think full year our units will be down in the residential space, mid-single digits. Definitely wanna see the Q2 progress happen, but right now it's all in line with the guide that we've given.
There's, you mentioned Watsco earlier, right? I think Watsco built inventory this quarter. How do you kinda think about like the disconnect between, I mean, it's one public distributor, I get it versus what you're seeing in your business?
You know, I can't speak for Watsco. They're a very well-run company. I admire the amount of value they have created, and I think AJ and all of them. It could also be driven by their negotiations with their manufacturers and how they operate, and was their year-end numbers. I don't know, right? I mean, the way I look at it overall, I'm keeping seasonality in mind too, right? I mean, a lot of people are gonna be hesitant about inventory reduction going into the peak season. You have the SEER transition, and the SEER transition left everybody with some inventory that was the older SEER. There could be too many factors that went into Q1.
Net-net, I think overall, the whole industry has opportunity to improve 1 or to 2 turns of inventory compared to pre-COVID level, if there was any such normal. Same for us. We are working with our independent channels who all believe that they have 1, 2 turn more inventory, but none of them are in a crisis mode trying to reduce inventory either. They're all coming and say, "Let's do it in a disciplined fashion. Let's do it in an organized way." Our distributors are reducing inventory because they have more confidence in our supply chain and our lead time. Our lead time in quite a few cases has been cut down by half compared to a year ago.
Automatic calculation, they're reducing their safety stock, and they got more and more confidence. I think that's just. To me, distributor inventory reflects the confidence that they have in the manufacturer's ability to deliver or not deliver. We're working through that.
Assuming demand stays.
Assuming demand
stays the same, right.
Assuming we don't have weird SEER shifts and all of that. By the end of the year, I think all of us would be in a lower inventory position just because our supply chain is giving us more and more confidence. Same for true for us for raw material as well. You know, we bulked up on raw material, and now we see supply chain improving, we are reducing our raw material inventory as well. I think that's a very classic effort, and it's a very disciplined process. We think that helps with our cash flow this year, and we'll see how the rest of the industry evolves.
Makes sense. I'll turn it over to the audience, see if there's any questions, or of course, I can keep going? Okay, no questions. Okay, then thinking about the dynamic that you just described and your direct volumes being down, what, low single digits or so this. This quarter. As we exit this year and start to look at the refrigerant change that's happening in 2025, how do you think this all plays out for your business? I know that, you know, we don't have a crystal ball.
I'd love, like, just your.
Sure.
Your best guess at this point.
Yeah. I think next year becomes more normal in terms of there's no de-stocking. I mean, whatever the de-stocking is, it's gonna be done this year, right? Next year becomes more normal from no de-stocking. The things that could impact next year, first is new home construction, assuming replacement remains steady as it has been. We've gotta watch that. Starts will tell us, and they are down less than we all thought, so that's a positive. The next thing that happens is the low GWP transition at the end of the year. The question is there a big inventory build-up before that? Either from our own perspective or a distributor or a dealer perspective. I don't think it's gonna be as big as it's happened in the past. Part of it is the industry's got used to these transitions.
Even with the SEER change, there wasn't a massive buildup. You know, it was all normal supply chain. I think the same thing happened with the low GWP. We are gonna go these transitions every two to three years, something or the other with regulatory. We are getting experience with it. Our dealers should have more confidence in us, and distributors should have more confidence in us. I think 2024 will be a more normal year, but who knows? Some of it's a game theory, right? If I don't build inventory and if our competition builds inventory, then am I left behind from share perspective? A bit of that is gonna just play out as we go through the process, but I think if it is, it's gonna be a 1 quarter impact here and there, but not a substantial change between 2024 and 2025.
At least that's what we are planning for.
Can you maybe talk about pricing? Price cost was a very big theme, you know, coming out of the quarter for a lot of companies. I know that you guys raised your expectations for tailwind for this year to $175 million.
Just talk about how disciplined, you know, folks are being in the market today. Are there any competitors that aren't being disciplined either across the, you know, residential or commercial space?
You know, listen, if I talk to my salespeople in the street in Houston, for example, he or she will always tell me that the competition is not being disciplined and how they're losing share because of pricing, and they'll blame everybody, right? They'll name Goodman and this and that and all. You gotta go through that noise and try and filter it out and think, okay, let's look at real data. The real data will show that the industry remains pricing discipline. We are often blamed for that as well, right? Just like our salespeople blame otherwise. You really look at data, look at price cost and look at. Are there gonna be a small region, a small store where we might be lower than others? Yeah. Is it gonna be small region, small store where others might be lower than us? Yeah.
That's the journey we are on in Lennox right now, is to make sure we continuously look at that in a more sophisticated way, especially with the kind of tools we have today with machine learning and other things. We can get pretty sophisticated. If my win rate is too high in a region, I probably lower price there, right? I mean, I can look at my own internal data, compare the thing and start adjusting. Our midyear effort, which goes into effect June 19, is more around that. Is let's find pockets where we may be underpriced. Let's find pockets where we may be overpriced, and let's make sure we correct that so we increase both our share and our margins. Target areas that we believe have the most opportunity for us to succeed. I think the industry remains pricing discipline.
We have room to improve. We are taking the step forward in June 18th to get our pricing more in line where we were not. At the same time, we have to keep this in mind that for a consumer, the price of an equipment is a small portion of what they pay. It's the labor cost, it's the installation, it's everything else that puts it in the package together. We need to help our dealers sell more to the consumer to make sure the repair versus replacement dynamic doesn't go through. It's a multifaceted effort. We think we did a good job with brute force pricing over the past few years because we had to, but now that inflation is calmer, we can go back to being more sophisticated and systematic.
If there are opportunity areas like often in larger accounts, new home builders, places where we might have had a contract that didn't give us the flexibility, but those contracts are coming up for renewal. You know, we just have to get them back up to the current market pricing.
Oh, we've got a question here from the audience.
Michael?
More expansive and taking on greater importance, are there new metrics that you're tracking at the company now that weren't given the prominence they were given before or new things that seem a little more nuanced about what you're learning about the business?
I'd say lots of new metrics that we're tracking. Alok mentioned that we didn't see a lot of the turnover that was happening within the factory, so it's very visible now. You're gonna start to catch some of these problems before they arise. It's a balanced scorecard approach. We have a series of financial metrics that we look at in the health from a financial perspective. We look at it from a customer experience perspective, making sure that the customer metrics are all online. We're winning share, we're pleasing dealers and contractors. We look at it from an HR talent development perspective. It's a balanced approach, and a lot of these metrics, some existed, but they definitely didn't exist in the forum, in the regular cadence to review them like we're doing right now.
You mentioned the repair replacement market. Obviously something that investors have been paying a lot of attention to. What are you seeing on the ground right now versus repair replacement for your business today?
We don't see a significant shift on the residential side. The cost of repair has gone up faster than the cost of replacement. I think that's just a shortage of tradesmen or tradespeople in the country that we are facing, and also the spare parts have remained in short supply. From our perspective, we haven't seen a shift. You know, we watch it continuously. One thing that's giving us more confidence is all the data now suggests that majority of the mortgages are fixed rate mortgages. A lot of people are stuck with it in terms of if they switch to go to a new home, they'll end up getting a mortgage that's at a higher interest rate. People are more accepting the fact that they're gonna be in the current home longer.
If a unit breaks, the conversation is typically, "Honey, we're kinda stuck. We're probably gonna be here another next 10 years. Maybe let's get a new unit versus do a repair, which means you'll be back in the repair market 1 year or 2 from now." That's a positive dynamic for us that we are, like, you know, benefiting from and watching very closely, is people are stuck in their home because of the low mortgage fixed rate. The switching to the new or upgrading the house is turning out more challenging. No indications of any negative trends there.
In your comment earlier around pricing, I know you mentioned Goodman, it makes a lot of sense, right? Depending on which region you're in.
I think just broadly across the portfolio, did you put through pricing increases this year?
We did, yes. At the beginning of this year, we announced an 8% price increase both in residential and commercial. We just recently announced that we're gonna do a more targeted specific price increase in the residential business, mid-June.
Okay, great. Great. Right now, the framework for this year is what? About 4 points to price or so?
$135 million, yeah.
Okay. Okay, great. Maybe turning to the longer term again. You know, heat pump opportunity is something that's been talked about by all the HVAC OEMs. Obviously, there was a big acquisition announced recently by Carrier. I think it's about 15% of your sales, I could be wrong, but maybe just talk about your position in the heat pump market, and then specifically, what's your ambition to grow either the residential side versus the commercial side?
Sure.
what you would need to do to actually.
Sure. Yeah, our heat pump penetration today in U.S. is lower than others, and that's more geographically driven because our market share in the North is higher than our market share in South. Remember our headquarters in Marshalltown, Iowa, and some other in the industry are more in the Florida, right? I mean, I think that's historically driven. We see this as a big opportunity. We have all the technology we need. We are leading in the cold climate heat pump, which is what you need to increase penetration up in the North. We are making a big push and are leading in the hybrid heat pump, which is a dual fuel system. If you live in Minnesota or Wisconsin, chances are you wanna have a gas furnace, very high efficiency one, which we make, and a heat pump.
Heat pump could be in spring and fall, and in winter, you will need a cold, like, you know, furnace to work through that pieces. We are leading in those things. We are confident that we are gonna continue getting more than our fair share in those markets and get to a 30% or so heat pump penetration in the next few years, which is where the industry is. The European stuff, that's totally different technology. I mean, that's probably why some of our competition making acquisition. That's an air-to-water model.
not air-to-air, as you know. On the air-to-air, our position is strong. We got all our heat pumps we build internally using compression technology that's commercially available. That's true for commercial as well. I mean, our heat pump position in commercial is also very strong. We don't look at that as an area that we are lagging for any other reason besides the geographical spread of our market share. If we increase our market share in the South more, we automatically get more heat pump share 'cause our technology is very good, and we are very happy with that.
Got it. Just to put a bow on that, you don't think you need to do a lot of additional investment here in the U.S. It doesn't seem like you have a lot of ambitious ambitions in Europe.
That's right. Europe, as you know, we are divesting. We like being laser-focused in North America. You know, we think when everybody else gets distracted with other things, us being laser-focused in North America, it's a big market. We are the smaller player in the big market. We have so much room to grow here. We have the technology there to a heat pump and other places to win. Yeah, the laser focus in North America, get share, deliver cash, get more growth. It's a simple model. We like being simple and boring company, so.
Simple and boring is usually good.
Last question for me, just around same lines around like M&A and capital deployment. You know, what are your priorities right now, from a capital deployment standpoint? If it is M&A, what are the kind of right adjacencies for you?
Sure.
What are the right technologies for you? Also just the addition by subtraction. You mentioned, you know, you're getting out of Europe. What does refrigeration look like over the long term for your business?
Sure. Michael, do you wanna start on that?
Yeah, the first objective is obviously the cash flow generation. Over the 3-year window, we've targeted 90% to 100% of free cash flow generation in that income. It'll be a little bit lower this year as we invest in the second factory in Mexico, as well as some equipment to transition to the alternate refrigerant in 2025. Definitely focused on cash flow generation. What we're gonna do is we'll de-lever a bit, targeted to go down to 1 to 1.5 times debt to EBITDA, which gives us some room to do some smaller bolt-on acquisitions. Think of kind of service, small bolt-on acquisitions in that area is where we're really focused on. I don't know if you wanna answer the other side of it.
Sure, yeah. I think that all makes sense. From a small bolt-on, the two areas that we are primarily focused on is, one, where we can increase the service as a portion of our revenue. We love our commercial service business. We just wanna do more. Second, addresses a key gap on our distribution side. Our parts and supplies are lower as a % of sales. Things that we can pump through our 250 outlets or the e-commerce channel that we can do that. That could be acquisition, that could be partnerships. We are heavily focused on that. There's a geographical footprint thing, right? I mean, we keep mentioning that the areas in the country where our geographical outreach or the share is lower. If we could do something there.
I mean, those are 3, they're all bolt-on natures of thing. Like, you know, we're gonna stay away from adding a third leg to the stool or fourth leg, whatever you wanna call it. Again, we wanna be simple, boring, 100% focused on HVACR. Going to the refrigeration piece, we like our North America refrigeration business. It's high margins, it's high profits. We got a great share. We would like to build on that for more service perspective, see the near adjacencies. It's a good area for us.
Way to put the R in at the end. Great to see you guys. Thanks for coming.
Thanks, Joe. Pleasure to see you. Thanks for having us here.
Yeah.
Appreciate it.
Thanks, Joe.
Thanks.
Michael. Thanks.