Good morning. Welcome to the Trane Technologies Q3 2021 Earnings Conference Call. My name is Paula, and I will be your conference operator for the call. The call will begin in a few moments with the speakers' remarks and the Q&A session. At this time, all participants are in a listen-only mode. To ask a question during the Q&A, please press star then the number one on your telephone keypad. If you would like to remove yourself from the queue, simply press star one again. In consideration of time, we do ask that you please limit to one question and one follow-up question. I will now turn the call over to Zac Nagle, Vice President of Investor Relations. Please go ahead, sir.
Thanks, operator. Good morning, and thank you for joining us for Trane Technologies third quarter 2021 earnings conference call. This call is being webcast on our website at tranetechnologies.com, where you'll find the accompanying presentation. We are also recording and archiving this call on our website. Please go to slide 2. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our SEC filings for a description of some of the factors that may cause our actual results to differ materially from anticipated results. This presentation also includes non-GAAP measures, which are explained in the financial tables attached to our news release. Joining me on today's call are Dave Regnery, CEO, and Chris Kuehn, Executive Vice President and CFO. With that, I'll turn the call over to Dave. Dave?
Thanks, Zach, and everyone for joining us on today's call. Let's turn to slide number 3. As we do each quarter, I'd like to spend a few minutes up front on our focused sustainability strategy, the engine that enables us to deliver differentiated shareholder returns over time. Long-term sustainability megatrends continue to intensify, and our innovation leadership is transforming the climate industry as the world decarbonizes. Our aggressive goals and bold actions can dramatically reduce carbon emissions and accelerate the world's progress. This is more critical every day as the clock is ticking on climate change. That's why we are calling for businesses and governments to take stronger action at COP 26, and why we continue to set aggressive science-based emission reduction targets to push our innovation further and faster.
That innovation also extends to emerging trends as we see heightened focus on indoor air quality and strong momentum in aging infrastructure in our schools. We continue to make a difference consistently, relentlessly, and over the long term. This unyielding approach drives market outgrowth over the long term, which in turn helps us drive strong margins and powerful free cash flow to deploy through our balanced capital allocation strategy. The end result is more value across the board for our customers, for our team, for our shareholders, and for the planet. Moving to slide 4. Our global team delivered solid execution in the third quarter, and we continue to target top quartile EPS growth for 2021. Bookings were once again exceptional in Q3, building on strong growth in both Q1 and Q2, and bringing our year-to-date organic bookings growth to over 25% for the enterprise.
Underlying demand for our innovative products and services have never been stronger, and our Q3 ending backlog reflects this strength. In fact, Q3 ending backlog for the enterprise is up more than 70% or approximately $2 billion from year-end 2020, with all three of our business segments at record levels. Americas and EMEA have backlog that are up over 90% and 65%, respectively, from year-end 2020. We're well-positioned to close out 2021 on a strong note and to enter 2022 with unprecedented levels of backlog as well. As we highlighted on our second quarter earnings call and in subsequent forums, global supply chains, logistics systems, and labor markets remain tight and inflation is persistent.
Our global teams are focused on meeting the unique needs of our wide-ranging customer base and helping them solve complex challenges on a daily basis as we navigate a challenging yet positive demand and supply environment. Temporary supply chain delays on key materials impacted portions of our product portfolio, shifting the timing of approximately $150 million or 4% of our revenue out of the third quarter and into future periods. Working closely with our key suppliers and with our customers, we anticipate that between $50 million and $75 million, or roughly 2% of the Q3 impact, will shift into the fourth quarter, leaving our 2021 revenue guidance unchanged. We expect the remaining balance to shift into 2022.
We also highlighted on our second quarter earnings call that persistent inflation would require us to execute an incremental $150 million in pricing actions in the second half of the year in order to neutralize the impact. Strong execution of our business operating system has enabled us to keep pace with the inflationary curve. In the third quarter, we realized approximately $150 million or 4.3% incremental price, offsetting approximately $150 million of inflation. Leverage was negligible, as you would expect on flat volume. While adjusted operating income was modestly higher in the quarter, primarily reflecting nominal pull-through on M&A and FX growth, consistent with our expectations and our guidance.
We continue to execute the business transformation projects we discussed in detail at our Investor Day in December and are on track to deliver approximately $90 million of incremental savings in 2021. These savings support leading innovation across our end markets through relentless high levels of business reinvestment. They also enable us to stay on track to deliver incremental margins of approximately 30% organic for fiscal 2021, despite persistent inflation, tight logistics systems, and supply chain challenges. We're also on track to deliver powerful free cash flow of equal to or greater than 100% of net earnings. This provides us with strong optionality to deploy significant cash to opportunities now and in the future, including M&A and share repurchases. Lastly, we never lose sight of our long-term purpose-driven strategy and the tremendous leadership role we can play in bending the curve on climate change.
By changing the industry, we can change the world. Executing our purpose-driven strategy is how we will continue to deliver top-tier financial performance for our shareholders. Please turn to slide number 5. While we're still in the midst of our planning process for 2022 and anticipate providing guidance in conjunction with our fourth quarter earnings call, we thought it might be constructive to spend a few minutes discussing our initial thoughts on 2022 and some of the key dynamics we believe will be in play. While this is not a comprehensive list, it will highlight some of the key reasons why we're so excited about what the future holds for Trane Technologies, as well as some of the key challenges we see on the road ahead. First, we expect to have strong fundamentals entering the year.
Exiting Q3, backlog in our Americas and EMEIA segments are both at unprecedented levels, up over 90% and up over 65% versus December of 2020, respectively. Asia also has record backlog, up nearly 20%. If we very conservatively plot out bookings through the balance of 2021, we anticipate entering 2022 with at least 70% more backlog in the Americas and EMEIA than we entered 2020. I've been in this business a long time, and I've never entered any year with a stronger backlog position, which bodes well for us in 2022. Another fundamental strength entering 2022 is the foundation of our business operating system.
Strong execution of our business operating system has enabled us to stay ahead of the persistent inflation through 2021 and position us well to manage additional inflationary pressures and deliver strong price realization again in 2022. We'll continue to drive transformation savings in 2022 that will support high levels of business reinvestment and continued innovation. These savings will also support healthy incremental margins in what we expect to be another year of tight conditions for supply chain, labor markets, and logistics systems. Looking out to 2022, we also expect to see continued acceleration of the strong secular sustainability mega-trends that are so tightly aligned with our purpose-driven business strategy. Decarbonization of the built environment is accelerating. U.S. education stimulus dollars are being put to good use, upgrading our aging infrastructure, and momentum around indoor air quality upgrades, retrofits, and new projects continues.
Additionally, the global economy is expected to continue to recover in 2022, with solid underlying GDP and other economic indicators driving broader expansion in the non-residential markets. Lastly, we're excited about the future of transport refrigeration markets, where ACT and IHS are plotting a steady growth path forward in both 2022 and 2023. All in, we're exceptionally well positioned for strong performance in 2022 and beyond. Please turn to slide 6. Customer demand for our innovative climate control products and services continues to grow. We delivered another quarter of robust organic bookings growth, up 20%, with growth across all segments and business units. Customer demand has been high all year, with organic bookings up over 25% year to date, driving record backlog in each segment. Organic revenues were also up 4%, driven by continued strong price execution.
Our Americas commercial HVAC business delivered robust bookings growth in the quarter, with orders up over 30%. Strength was broad-based, with applied and unitary bookings both up more than 50% and service bookings up high teens. Demand for system-focused indoor air quality solutions remained strong and contributed to our mid-single-digit revenue growth in commercial HVAC Americas. The residential HVAC markets continue to be strong, and our residential team delivered low single-digit bookings growth, building on nearly 40% growth in the third quarter of 2020.
Revenues were flat in the quarter as demand outpaced supply, and we enter the fourth quarter with record backlog up more than 150% year-over-year and up from prior record backlog at the end of the second quarter. With year-to-date organic bookings up over 80% and year-to-date organic revenue up over 30%, our America's transport refrigeration business is significantly outperforming the North America transport markets. During the third quarter, with most of 2021 orders already in the backlog, we opened up our 2022 order book solely for the first quarter of 2022, which drove bookings growth of more than 20%. We are methodically managing our 2022 order book in order to mitigate inflationary risks. Organic revenues were also strong, up low- to mid-teens%.
Turning to EMEA, we continue to see strong demand for our innovative products and services that help reduce energy intensity and greenhouse gas emissions for our customers. Our EMEA teams delivered 25% organic bookings growth in the quarter, with strong growth in both commercial HVAC and transport refrigeration. Revenues were also strong, up 8%, led by high teens organic revenue growth in transport refrigeration. Our Asia Pacific team delivered bookings growth of 11%. Revenue grew 1% in the quarter. Though we saw growth in China during the quarter, the impacts of the COVID-19 pandemic continue to be challenging in the region, with low vaccination rates in some countries. Now I'd like to turn the call over to Chris. Chris?
Thanks, Dave. Please turn to slide 7. Organic revenue growth in the quarter was driven by continued strong price execution, yielding 4.3% incremental price in the quarter. Price over material inflation was positive in the quarter, and combined with mix, offset the net impact of productivity over other inflation and increased investment spending to support leading innovation. Organic volume, and therefore pull-through leverage, was largely flat for the enterprise in the quarter. At a high level, positive leverage was primarily the result of mix and a modest flow-through of M&A and FX, consistent with our guidance. Net adjusted EBITDA and operating margins declined by 70 and 60 basis points respectively. Adjusted EPS grew 5%, driven primarily by higher adjusted operating income. Please turn to slide 8. We discussed the key revenue and margin dynamics for the enterprise on the prior page.
The dynamics impacting revenue and margins were similar across each of our business segments as we've highlighted here, with strong price realization, productivity, inflation, and higher investments in innovation as consistent drivers. In EMEA, solid price realization was accompanied by strong volume growth, delivering good leverage and margin expansion in the quarter. Both the Americas and Asia Pacific segments delivered higher revenues on modest volume declines, impacting leverage. Asia Pacific also experienced price versus cost headwinds in the quarter, further impacting margins. We continue to expect Asia Pacific to deliver solid margin expansion for the full year and are pleased with our overall performance in the region. Now I'd like to turn the call back over to Dave. Dave?
Thanks, Chris. Please turn to slide 9. Commercial HVAC Americas has significantly outperformed the broader markets over a number of years through strong focus, agility, and execution, combined with relentless innovation for our customers. These defining characteristics, compounded by the strength of the underlying market conditions, power the business forward today, yielding bookings growth of over 30% in the quarter and exceptional backlog entering Q4. Booking strength was universal across nearly every vertical market and major product category, and markets continue to improve. Vaccination rates are improving, and end market indicators are generally strong, with ABI over 50 since February and a healthy GDP. Data centers and warehouse demand remain strong. Education and healthcare and market demand is also growing. We're benefiting from increased demand across our K-12 customers, with federal stimulus funds supporting both current and, more importantly, future growth.
We see this as a multiyear tailwind for our business, given our strong position in the education market and our direct sales force with deep relationships in this vertical. Our residential end markets remain strong. As I mentioned previously, we delivered low single-digit bookings growth in the quarter, compounding on nearly 40% growth in the prior year, and we are entering the fourth quarter with unprecedented backlog. I'm proud of our residential team that has continued to meet customer demand while ramping capacity after a February weather event in our Texas facility. The team delivered historically high revenues in Q3 and is on track for capacity expansion in advance of next year's cooling season. Turning to Americas Transport, we're significantly outgrowing strong end markets in 2021. ACT market forecasts are projecting strong growth in 2022 and 2023 as well.
I'll talk more about the transport outlook in our topics of interest section. Turning to EMEA, economic conditions are improving across the region. We expect continued improvement for the remainder of the year, with increased vaccination rates supporting the opening of an increased number and variety of venues. Transport markets have been strengthening throughout the year, and we're on track to outperform end markets in 2021, as evidenced by our year-to-date performance. Turning to Asia, we expect growth in China in 2021, supported by increased vaccination rates and strength in data centers, electronics, pharmaceutical, and healthcare. Outside of China, the picture is mixed, with vaccination and economic recovery rates still low in some countries. Now I'd like to turn the call back over to Chris. Chris?
Thanks, Dave. Please turn to slide 10. Given all the puts and takes we've discussed today, our guidance for 2021 is unchanged. Importantly, we continue to see our 2021 adjusted EPS growth guidance of more than 30% as top quartile among peers in the broader industrials. We've discussed the shift in revenues from Q3 to Q4 in 2022 throughout the call. Our fourth quarter revenues are supported by record backlog, and that backlog is firm. Supply chain, labor, and logistics systems will continue to be challenging and are the limiting factor to potential upside, not demand or backlog. We also continue to expect free cash flow to remain strong at equal to or greater than 100% of adjusted net income. Please go to slide 11.
As we outlined during our investor event in December, we're on track to deliver $300 million of run rate savings by 2023, including $90 million in 2021. Importantly, we continue to invest these cost savings to further fuel innovation and other investments across the portfolio. This consistent investment strengthens our high-performance flywheel, which has a reinforcing and compounding effect over time. Please go to slide 12. We remain committed to our balanced capital allocation strategy that is focused on consistently deploying excess cash to opportunities with the highest returns for shareholders. First, we continue to strengthen our core business through relentless business reinvestment. Second, we're committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve.
Third, we expect to consistently deploy 100% of excess cash over time using a balanced approach that includes strategic M&A that further improves long-term shareholder returns and share repurchases as the stock trades below our calculated intrinsic value. Please turn to slide 13, and I'll provide an update on how we are deploying excess cash in 2021. Year-to-date, we have deployed $1.8 billion in cash, with approximately $1 billion to M&A and share repurchases, including $250 million for the Farrar Scientific Life Sciences acquisition we closed in October. We have paid $422 million in dividends and $425 million to pay down debt. Our strong free cash flow, liquidity, and balance sheet continue to give us excellent capital allocation optionality and dry powder moving forward.
We are on track to deploy at least $2.5 billion in excess cash in 2021. Now I'd like to turn the call back over to Dave. Dave?
Thanks, Chris. Please go to slide number 15. I wanted to spend a couple minutes providing an update on the transport refrigeration markets for 2021, as we've seen the forecast shift a fair amount since our second quarter earnings call. I think the primary takeaway this quarter is that ACT is projecting an extended and more gradual upturn in the North America transport refrigeration markets than initially projected. North America trailers is probably the clearest example and one of the most watched by investors and analysts as a proxy for the overall transport refrigeration health. ACT started out the year projecting an almost immediate snapback in the North America trailer production in 2021, up 39% off the lows of the pandemic in 2020.
As trailer OEMs have had a challenging year producing enough trailers to meet the forecast, ACT has gradually pulled the forecast down and is now projecting a strong but more gradual improvement in 2021, up 18%, and continued improvement in production rates in both 2022 and 2023, up another 18% and 14% respectively. If you look at the all-in weighted average market forecast for North America transport refrigeration, 2021 is now expected to be up about 14% versus 24% projected in July. Year-to-date, our Thermo King Americas transport refrigeration business is up more than 30%, clearly outperforming the markets, and we expect to outperform the markets for the full year as well.
Looking at IHS and other key indicators for EMEA markets, the outlook has improved about 3 points, with the weighted average market growth now expected to be about 12% for 2021. Year-to-date, our Thermo King EMEA business is up more than 20%, clearly outperforming the markets, and we expect outperformance for the full year 2021 as well. Please go to slide 16. We added a second transport refrigeration slide to the deck this quarter to add more color around the North America trailer market from both backward and forward-looking perspectives. One of the things we've talked about over the past several quarters is the North America trailer market has not been particularly volatile over the past several years, and it's not projected to be particularly volatile over the ACT forecast horizon either.
On the left side of the page, you can see the visual depiction of what we've been describing. We chart ACT's reported actual trailer units built going back to 2015 and ACT's forecast for trailer builds through their forecast horizon of 2023. The 9-year average is in the mid-40,000-unit range, with the pandemic in 2020 being the only significant outlier. We also see that good growth is projected in both 2022 and 2023. It's important to note that our global transport refrigeration business is highly diversified. Trailer is an important part of the global mix at about 25% of the total. However, we're focused on strong execution across the transport refrigeration portfolio, which we believe will further help reduce variability of this business over time. Please go to slide number 17.
2021 is shaping up to be a strong year for us overall, despite a number of macro challenges that we expect to continue over the near term. We're seeing unprecedented levels of demand for our products and services across the board, and our backlog has never been stronger. We're executing our business operating system well and staying ahead of persistent inflation with strong price realization, and we expect to deliver top quartile EPS growth for the full year. Energy efficiency and sustainability mega trends are only growing stronger. We are uniquely positioned to deliver leading innovation that addresses these trends and accelerates the world's progress, supported by a business transformation and our engaging, uplifting culture. We are proud to have been recognized by Forbes as one of the best employers for diversity and best employers for women, and by Fortune as one of the best workplaces in manufacturing.
It's our people that power our innovation and bring our purpose to life every day. We have many reasons to be excited about our prospects for strong performance as we look to 2022 and beyond. When combined with our exceptional ability to generate free cash flow and our balanced capital deployment, we are well positioned to continue to drive differentiated shareholder returns over the long term. Now we'd be happy to take your questions. Operator?
At this time, I would like to remind everyone, in order to ask a question, please press star, then 1 on your telephone keypad. Again, if you would like to remove yourself from the queue, simply press star 1 again. Also, as a reminder, in consideration of time, we do ask that you please limit to one question and one follow-up question. Your first question comes from the line of Joe Ritchie of Goldman Sachs.
Thanks. Good morning, everyone.
Hey, Joe. How you doing?
Good morning.
Yeah, doing great. So maybe just the first question on the supply chain, helpful to have kind of like that visibility on the revenues that pushed out from this quarter. I guess just any other color you can provide. Is this predominantly occurring in your North America trailer business? And then just confidence that, you know, you're going to be able to shift these revenues and not see sustained supply chain issues in the next few quarters.
Yeah, sure, Joe. Great question. You know, tight supply chain, really globally. We talked about it during our second quarter earnings call. It caused us to push about $150 million of revenue out of the quarter. As we said, we think we'll get about $50 million-$75 million of that back in the fourth quarter. You know, our team is doing a great job of managing the supply chain constraints. You know, we chose not to include a slide in our deck, you know, telling you the 50 things that we're doing to manage our suppliers or help our suppliers. But I could assure you that supply chain resiliency has been part of our business operating system for a long time.
I can assure you that Trane Technologies employees around the globe are working hand in hand with our suppliers, ensuring that we could take literally pages out of our operating system and help them implement it. We think it's gonna be choppy for a while in the supply chain, at least, for the foreseeable future. I think I mentioned in the second quarter call, it's a little bit like when you were a kid, you played that game Whack-A-Mole, where we fix one problem and another problem pops up. If you're looking for overarching, kind of like, where are we seeing constraints, I know we're not any different than what you've probably already heard from the rest of the industrials that have reported.
Electronics, resin, semiconductors, wire harnesses, these are all areas that, you know, certainly at an overarching level, we're seeing supply chain constraints. That said, just a couple of points I want to make. One is we're working very closely with our customers. It's very important that in some cases, our customers are having supply chain constraints on the job sites, which is causing them to push out jobs. So we're working with them to make sure that we can deliver product when they need it. If you look at our Thermo King business, we're really aligning with our customers there around build slots that they're getting from the trailer OEMs, tractor suppliers. So this hand-in-hand relationship with the customer, it's pretty dynamic right now.
The last point I'd like to make, Joe, is that, you know, I know we talked a lot about supply chain constraints. We also have to be fair to our suppliers. I know many of them are probably listening to the call or will read the transcript. We are putting tremendous pressure on our suppliers with the amount of demand that we're seeing in the marketplace right now. If you look at our commercial HVAC business in the Americas, I mean, you know, Unitary and Applied both are up over 50% incoming order rates in the third quarter. With that kind of, you can imagine we're pushing that right on to our suppliers and putting orders on them. They're seeing some pretty big spikes that they're having to manage through. Your question on is there a particular business? It's pretty widespread.
You know, more acute maybe in our Thermo King business. We had a couple of suppliers there that we've worked through some of the issues with. We're pretty confident that we'll be able to rebound there in the fourth quarter. We're also seeing across the globe, but the other business I would call out is probably our commercial HVAC business. Certainly there, the resin impact and kind of the knock-on effect that we've been seeing now for several quarters.
Thanks, Dave. That was helpful. Maybe my one quick follow-up. One of your suppliers just did their conference call, you know, about an hour ago, and they talked about the price cost formula, you know, being roughly $100 million positive for them in 2022. You know, you did a good job with pricing this quarter. I'm just curious, as you kind of think about 2022, should we be thinking about, you know, a positive price cost environment given what you're seeing in your cost curves today?
Hey, Joe, it's Chris. I'll take the question. You know, we are in the middle of our 2022 planning. Going into 2022, though, we would expect some carryover price from the 3 price increases most of our businesses announced this year. We will start lapping price increases, though, really starting in the first quarter of next year. I would tell you, as part of our business operating system, we enter every year coming up with a plan of how we're gonna get about 20-30 basis points positive spread price cost. More to come in a couple of months as we release guidance for next year.
We're gonna go in with the mentality that we're gonna cover price cost, but it's also a very inflationary environment, which is why we're really trying to size that for pricing increases if we need to going forward.
Yeah. The only thing I would add to that, Joe, is that price is never easy to get, despite what people may think. When you have an innovative portfolio of products, it becomes that much easier. As you're selling additional value to your customer, being able to get pricing, it becomes a little bit easier.
Great. Thank you both.
Thanks.
Your next question comes from Scott Davis of Melius Research.
Good morning, guys.
Hey. Hey, Scott. How you doing?
Good morning.
Good. I want to talk about IAQ, if that's okay, and the 2-point tailwind that you noted in the slide is pretty material. I want to get some color on the sustainability of that. You know, how many years of project backlog do you probably have, you know, where, you know, is that 2% stay 2%? Does it become 3 this year? Any kind of view around that. Then what does a systems-focused solution really mean for practical purposes for us at least? Does that mean a service contract with monitoring? I mean, maybe just a little color around that too. Thanks.
Sure. Yeah. It's a good question. You know, as far as the demand goes, you know, we had said early on that we thought it'd be 1% to 2% tailwind. We're seeing 2% this year. Pipeline is strong. You know, what started out to be strong and really just healthcare and education, we're now seeing it in office and other verticals, so that's the good news. The other thing I would tell you that if you remember, we had an approach where we were doing indoor air quality audits, where we would do a day one activity, where we do the audit to make the environment as safe as possible today with existing assets, and then we kinda give a roadmap as to how you would do day two activity.
Those day two activities are really starting to come through for us, especially in the education with some stimulus funds flowing there. That's a good news story. As far as, you know, we see indoor air quality as a mega trend that's not gonna go away. It's top of mind. I mean, Trane Technologies has always had a robust focus on indoor air quality. It was always big in the healthcare vertical. It's now top of mind in all verticals, but we don't see this stopping. We see people, you know, constantly asking about indoor air quality. I would tell you that we're building it into our systems, which is kinda your second point, your second question there is. You know, this is now integrated into a system and we're seeing nice traction there in all verticals.
You know, what I'll add, Scott, is because it is embedded in systems now, it is becoming harder and harder to kinda spike out the impact of indoor air quality separate from a systems order. You know, I've offered Dave, we can hire a few more accountants to try to track those revenues in that level of detail, but I think the fact is it's really becoming just a long-term tailwind for the company.
Yeah. Just to add, Scott, we're really seeing a lot of traction, especially with our dry hydrogen peroxide solutions, and this is predominantly in the education vertical as we're building this into the systems. The dry hydrogen peroxide solution, the unique innovation there is that these molecules last longer. So if you think about a school room where you have students that are moving around to different classrooms on different desks, these molecules actually settle on the desk, so they clean the air as well as the surface, and we're getting a lot of traction around that.
That's very interesting. I'll pass it on to my peers, but thank you and good luck.
Thanks.
Thanks.
Your next question comes from Jeff Sprague of Vertical Research Partners.
Hey. Thank you. Good morning, everyone.
Good morning, Jeff.
Good morning.
Hey, good morning. I just wanna follow up on on backlog as it relates to price. Dave, you know, you mentioned open, you know, kind of measuring how you open up the order book to not get caught here. You know, to what extent do you have the ability, or are you in fact, you know, going back and repricing some of the backlog? Given the environment that we're in, perhaps you're changing commercial terms just to protect yourself better. You know, if you take an order today and you're delivering it 12 months from now, right, who knows what we're dealing with on the inflation front. Just any color there on how you're managing that, protecting yourself, and maybe adding some flexibility to commercial terms.
Hey, Jeff, this is Chris. I'll start, and then Dave can jump in. If I go business by business, let me start with residential. Really, we've had an ability this year to look at our backlog, and we price our backlog as we see higher inflation impacting orders that'll ship, you know, now a couple of months out, where the backlog in residential used to be a couple of weeks, now we see it continue to be a couple of months out. We actually have repriced the backlog already in 2021, but we've got that ability to reprice going forward should we see, you know, significantly more inflation. On the commercial HVAC side, when I think about long lead time on equipment, those contracts generally have price escalation clauses in them that allows us to reset pricing based on an index.
We have some protection there as well. On Thermo King, to Dave's remarks earlier, we've been really selective with opening up the order books for 2022. We wanted to get as much insight as we can get on the inflationary environment through the third quarter of 2021. We've only had the first quarter of 2022 order book open. We've now recently opened up the 2022 order book for the balance of the year. We did that intentionally to make sure we had the right input on books and increasing to reflect that in the backlog. I think we've got resiliency there in the backlog in terms of pricing, being able to keep up with inflation.
Yeah. The only thing I would add to that is, obviously, we've got pricing built in, we've got mechanisms in place. We also believe that our backlog is very firm, okay? We're not seeing cancellations of our backlog, and we don't anticipate seeing cancellations for our backlog in the future.
Separately, just on resi, I don't think you mentioned resi in terms of something you're positive on in terms of your 2022 outlook. Obviously, you've got this question that everyone's asking and isn't sure how to answer on, you know, how these comps play out and that sort of thing. Dave, what is your high level view on how, you know, kind of the resi market behaves next year? Certainly you might have a different view on how you behave inside that, but any perspective would be appreciated. I'll leave it there. Thank you.
Okay. Thanks, Jeff. Yeah, I mean, we look at our resi business at a very high level as a GDP plus business. If you could tell us what GDP is, you could tell us what consumer confidence is, we could dial in what our residential business and how it's gonna perform. That said, obviously, we have detailed models that we go through, and it's really just to validate our high level approach. GDP is projected to be positive next year, and we do not see the resi business falling off a cliff in 2022. We see it a GDP plus business.
Great. Thank you.
Your next question comes from Julian Mitchell of Barclays.
Hi. Good morning. Just starting with price cost, just to understand the sort of jumping off point into next year. You know, I saw you said that you have $150 million of price in Q3, similar sort of cost step up. Maybe just help us understand, you know, on those two numbers, what should we expect for Q4? Then what's the kind of total year, 2021 for price and cost, please?
Hey, Julian, it's Chris. Thanks for the question. Yeah, we were really pleased with the price realization in the third quarter. 4.3% of price realization, and really equals the revenue growth we had in the third quarter as well as we were very flat on volumes. And for the quarter Q3, we saw slightly positive price cost. When I think back a few years ago when we had our last inflationary environment, we were really trying to catch up on the price cost equation. I think it was about 6 quarters where the company was negative. Now we're able to keep up with that at least through Q3 of this year. Really, that goes back to the business operating system we continue to enhance in the company. Slightly positive price cost in Q3.
For Q4, I'm expecting price realization to get a little bit stronger, but I'm also can see inflation getting stronger in the fourth quarter as well. We're right now kind of expecting price cost to be flattish in the fourth quarter, and then we'll see how this kind of plays out for 2022, where, you know, we're always targeting 20 to 30 basis points of price over cost for a given year. I'm expecting that to be flattish in the fourth quarter.
That's helpful. Thank you.
Joe, the only thing I would add to that is that, you know, the operating system. I don't wanna don't underestimate the amount of work we've put into building our operating system to stay ahead of these inflationary curves. I mean, as Chris said, it was the last time we had this type of inflation, it took us several quarters to overcome it. Now we're in the quarter, you know, being able to offset it. We're very proud of what we've been able to do there.
That's helpful. Thank you. Maybe just, you know, following up in terms of overall firm-wide operating leverage. It looks like, I think in the fourth quarter, you're looking for maybe sort of 20% or so operating leverage year-over-year. Just wanted to check that's roughly the right ballpark. Do you think that's a good sort of entry point starting out next year, given you've still got price cost margin headwinds, at least in the first quarter or two?
Yeah, Julian, I think you're in the ballpark for Q4. You know, we left the full year guide intentionally intact given we can see the push out of some revenues into the fourth quarter, the $50 million-$75 million.
You know, really, from my perspective, our perspective, the backlog and the demand is very firm. It really comes down to supply chain, and that's why we got the $6.05 on the full year from an EPS, or just an EPS perspective. Could it be a little better? Could it be a little worse? I think we're right around that $6.05 based on how we see the supply chains today, but it's really gonna be dependent on that. Yeah, you're in the ballpark for fourth quarter. We'll see how leverage kind of plays out for next year. I think we're certainly expecting an inflationary environment next year with pricing actions.
We'll need to continue to moderate that, but we'll have more insight on that as we get into January.
Great. Thank you.
Thank you.
Your next question comes from John Walsh of Credit Suisse.
Hi, good morning.
Morning, John.
Good morning, John.
Maybe piggybacking off of, I think it was Jeff's question earlier. I think in your answer, it was mostly around the equipment. Wanted to hear a little bit about your ability to pass-through inflation on your service contracts, 'cause obviously labor availability and I think the wage inflation is something we're all expecting in the next year. Do you have those same kinda ability to pass through those inflationary pressures there?
Yeah. A good question. Yes, we do. Any kind of a long-term contract, we have price escalations built into it. That's taken into consideration when we have our service agreements.
Gotcha. Maybe coming at the backlog and orders question a little differently here. 20% order growth, it's not like you're comping a down 20, you're comping a +7. I mean, how do we think about just the orders rate and if you think you can actually build backlog next year, potentially? Obviously, I understand you're not in the business of guiding orders, but it's definitely a question we're getting from investors here. I would appreciate any color. Thank you.
Yeah. I mean, if you look at it's really phenomenal what's happening right now. I mean, we had 30% order growth in the first quarter. We had 30% order growth in the second quarter, and here we are in the third quarter talking about 20%. In some of our businesses, well, I call our commercial HVAC, I mean, and the equipment's up 50% there. I don't anticipate that bookings will continue at the 30% growth rates, but I would tell you that we're seeing a lot of demand right now for our innovations in the marketplace. Whether it be in the Thermo King business or in the commercial HVAC business, that's really driving a lot of this demand for us.
We also have these tailwinds behind us around sustainability and the decarbonization of the built environment that is only gaining momentum. We like what we see here going into 2022. We're gonna have record backlogs, and we'll see what 2022 is from an incoming order rates, but right now we really like the position we have going in.
Great. Thank you. I'll pass it along.
Thanks.
Thank you.
Your next question comes from Andy Kaplowitz of Citigroup.
Hey, good morning, guys.
Hey, Andy. How you doing?
Good morning.
Good. How are you? EMEA continues to be a significant outperformer versus your other regions. Maybe you can give us a little more color into what's going on there. How big has your heat pump business already become? Are products such as heat pumps and the Advancer just nicely accretive to margins, so they're helping? How sustainable is that 30% incremental you put up this quarter?
Yeah. I mean, innovation, you kinda hit on it, Andy. That's what's really driving us in EMEA, and it's just such a great place to be. I mean, the Advancer product in our Thermo King business, it's exceeding our expectations. If you look at what we've been able to do with the electrification of heating in the HVAC business, again, it's, you know, we're getting tremendous demand. So I don't wanna get into specifics as to how big we are or how large the market is there, but I would tell you that it is propelling our growth and we're excited about what the pipeline looks like in the future.
Rest assured, the innovations are continuing there as we continue to look to expand the, what we call the operating maps of how our HVAC product works. You know, we're going for higher temperatures on the heating side and lower temperatures on the cooling side, which are only gonna expand our market further.
Great.
Yeah. I'll add, Andy. Sorry, on the incrementals, you had a question there. Look, we've set up each of the segments to really have over the long term 25% plus incrementals. We think Europe is well situated for that over the long run to deliver.
Very helpful, guys. Then maybe you could give us a little more color into what you're seeing in Asia. You mentioned record backlog in the region. I did notice that transport revenue turned down a bit and, you know, the pandemic does remain a challenge in the area. Are you seeing overall China hold up well, and how are you thinking about that region in 2022?
Yeah. I mean, Asia Pacific's about 10% of Trane Technologies, important region for us. Let's talk about in two different pieces. Talk about China first. Obviously, GDP is pretty well documented, has slowed a bit in the third quarter, at least versus expectations. I think it was 4.9, and expectations were over 6. So it is slowing a bit in China. I would tell you, though, where it continues to grow. You know, think about electronics, pharmaceutical, data centers, healthcare are also verticals that we're very strong in. So we're seeing nice growth in China, and we expect that to continue in the future. You get outside of China, it really becomes country specific, and unfortunately, we're still having some countries that are going into different phases of lockdowns based on where the pandemic is.
It's gonna be a little bit mixed outside of China, at least into the fourth quarter.
Appreciate it, guys.
Thanks, thank you.
Your next question comes from Steve Tusa of JP Morgan.
Hey, guys. Good morning.
Hey, Steve. How are you? Morning.
Where are you gonna end on, you know, price and cost for the year now with this neutral back half-ish, neutral-ish back half? Like, what was the first half price and cost?
First half would have been positive but on much smaller numbers, Steve, right? Just given, price has grown, you know, considerably from Q1 now to Q3, expecting Q4 to be flattish price cost. You know, on the full year, I think we're probably around the flattish range. Maybe it could be slightly positive. Our goal here is to keep driving the innovation and then driving the pricing to reflect what we think the inflation is going to be. Really happy where we are, you know, year to date on the price realization. Like I said before, it's gonna grow a bit in the fourth quarter. At the same time, we're seeing inflation grow into the fourth quarter, and we're really just trying to stay ahead of it. I'm thinking flattish to slightly positive on the full year.
Yeah. I mean, Steve, we've already had three price increases in many of our businesses and, you know, if we still see the inflation be persistent, another price increase would be part of our business operating system, and we would execute on that.
Right. I guess I'm just looking for the $150. In the $150, what was that in the first half?
I don't know if we've actually probably given that number. It would have probably been less than 150 would be my guess, but I'd have to go look at that.
Okay, thanks. On commercial equipment, you said orders up 50%. Can you just split those out between, you know, applied and then, you know, how did the light commercial kind of unitary business fare within that?
Yeah. I mean, to be fair, Steve, it was more than 50%, and both our unitary and applied were both over 50%. The light being part of that number was very strong as you would imagine. We have seen unbelievable amounts of growth in our commercial HVAC equipment business. It's actually, and I said it earlier, but it's actually, you know, to be fair to our suppliers, we're putting that demand right on them, so it's causing them to have to spike forward as well.
Yeah, that's very positive. Then one more for you. What do you think movement was for your resi business, the stuff that you can sell-
Yeah
you know, to the customer? I think you've given that before.
On the IWD side, which again is about 50% of our business, sell-through was mid-single digits. Sell-in was flat, so obviously their inventory adjusted as you would expect in a shoulder season. You know, the next follow-on question there, Steve, would be, you know, what's inventory level look like in the IWD space. It's about what you would expect, maybe a bit lower than we would want this time of year, but it's nothing to call out.
Great. Great color. Thanks a lot.
Okay. Thanks, Steve.
Steve, to your earlier question, just to follow up on that for the first half kind of price for the enterprise, it was around 2.2%, so less than the $150 million we realized in Q3. We got a little less than that for the first half of the year. That price has really ramped up from the first half to Q3, and we're expecting that to be stronger even in Q4.
Yeah. Cost? The $150 in cost.
Yeah, I would say in the first half was positive. Again, it was less than $150, but positive in the first half, slightly positive in Q3, and we're expecting about flattish for Q4.
Okay, thanks.
You're welcome.
Your next question comes from Nigel Coe of Wolfe Research. Nigel, your line is open.
Hey, Nigel.
Sorry, I was on mute, and I had a very funny joke which I won't repeat, but, thank you.
We want, we wanna hear the joke, Nigel. We wanna hear the joke.
Yeah. I was gonna say, let's go back to that price cost question, but let's not. I do wanna go back to the backlog, 'cause obviously super hot, +70 in Americas. I'm just wondering, you know, how does the aging of that backlog look? I mean, do you expect the majority of that to convert in 2022 outside of supply chain pressures? I guess my real question is, and I know you're not gonna answer this explicitly, but, you know, we really haven't grown higher than, you know, 8-9% in climates over time organically. I'm just curious, you know, could 2022 be above that bar? Just curious if that backlog converts.
Yeah. As we said earlier. You know, we're still working through the 2022, but just talking about the backlog, I mean, you really need to. As far as when it burns, you really need to go through it by business. You know? If you think about, you know, our commercial HVAC business with applied orders, that backlog, when an order comes in, there could be a 6- to 9-month burn rate on those type orders, before they actually ship. In the TK, it's a little bit different this year than I've seen in other years. We had a lot of customers place orders in the first quarter and kind of lay them in through the rest of the year.
The other complication with TK we're seeing right now is obviously we're working with our customers on their, you know, their slots for trailers and tractors. So normally the burn rate in TK would be, you know, 2-3 months. That's been extended a little bit, just because of the constraints associated with, you know, the actual building of a trailer. On the resi space, I mean, our backlog turns. I mean, it's turning on a regular basis. Overall, I mean, we have a very large backlog. We have order demand that is some of the best I've ever seen in my career. But understand, our backlog is not stale. It continues to churn, and we're shipping out.
We're just getting order rates that, you know, we haven't seen in a very long time in this business that are continuing to build this backlog.
Okay. I'll leave that backlog question there. On price cost, you did call out APAC as challenging near term, and I think we're all tuned into the fact that APAC at the time has been a bit more challenging on price. Just curious, are we seeing some deflation in APAC and any concerns as we go into 2022 around that region?
Yeah, Nigel, I would say, yeah, price cost right now is a little bit challenging in the near term. We're really on track to having very strong full year margin expansion in the region. If I go back even just 2 years, kind of a 2-year stack, we're up over 400 basis points in margin expansion in the region. If you go back to when we invested in our direct sales force, it's up over 500 basis points. The region has had some great growth, being very selective around orders as well. I would tell you that, we'll continue to evaluate the pricing environment and make price increases where necessary. You know, I'd be looking for that region, like for the rest of the company, to be getting price cost positive going into 2022.
Near term, a little bit of challenges. It's also a little bit of the law of small numbers for, you know, revenue or margin contraction in the quarter for Asia, in Q3.
Okay. Thanks. That's great, Kuehn. Thanks.
Thank you.
Your next question comes from Josh Pokrzywinski of Morgan Stanley.
Hey, good morning, guys.
Hey, Josh. How you doing?
Well, thanks. So just on this, commercial equipment growth, I mean, look, for what is historically kind of a replacement business and with a pretty massive installed base, like 50% is sort of an eye-popping number. Obviously, supply chain and, you know, bottlenecks are kind of everywhere. Like, is there sufficient labor, whether it's, you know, in your own house or, you know, kind of out there in the independent world to actually install this stuff in, you know, a reasonable timeframe? Or is that gonna be sort of a, you know, a gating factor on, you know, converting that backlog as well?
Yeah. I mean, as far as labor constraints in our own four walls, it's really, we have seen some early in Q3. It's subsided a bit as we moved through the quarter. We're planning for it. It's just a matter of how your training mechanism and hiring of new people. That's happening. On a job site basis, you know, we have seen jobs push out, to your point, because of, you know, job site labor constraints. It's not anything that I would spike out and say it's super alarming, but it's certainly there. It's not just in North America. It's really on a global basis.
Got it. Then on the missed revenue that, you know, you're starting to make up in the fourth quarter, I mean, we've kind of heard similar metrics out of some other folks, but with the expectation that just we don't miss any more revenue in 4Q. You know, starting to make it up would imply that, like, not only are maybe some of those supply chain issues stabilizing, but starting to improve. Like, I don't wanna put too many words in your mouth, but, like, would you characterize the last, you know, kind of 30 days or so as seeing some actual improvement, you know, rather than just stability?
Yeah. I mean, you know, we had some acute supplier problems in our Thermo King business, and we've been able to overcome those. We have line of sight to what we're guiding to right now. That said, you know, supply chain is very volatile right now, okay? It is the whack-a-mole game. We fix one problem and then another one comes up. It's really about staying on top of where you are, working with your customers, working with your suppliers, and you know, it's a lot about communication. I would tell you that our operating system allows us to be working hand in hand with our suppliers to make sure they can meet the expectations that we're seeing, which again, is extremely robust right now.
Great. Thanks. Good luck, whacking those moles.
Your next question comes from Andrew Obin of Bank of America.
Hi, guys. Good morning.
Hey, Andrew. How are you?
Morning.
I'm good. Just a bit of a longer-term question. You know, you've highlighted strength on institutional, and I think after the first wave of stimulus came in. I think education was very much highlighted as an area, air quality improvement, et cetera, which we're going to benefit the industry. My understanding is that there is a timeline on spending that money. I think you have to do it over three years. Can you just tell us what you have seen so far and how do you expect the spending to play out over this period of time in the institutional vertical, and as I said, specifically education? Thank you.
Yeah. We're seeing funds flow, which is a good thing. 2024 is the date it has to be spent. That may get pushed out, obviously. You gotta think about when any work you're gonna do on a school, you're gonna do when students aren't there, so it tends to become a quote, "season" to do schoolwork. Funds are flowing. You know, the Elementary and Secondary School Emergency Relief Fund, or ESSER as they have it's flowing from the states down to the local levels. We're seeing really good traction where we did a phase one indoor air quality audit. We gave our customer a roadmap for the future. They're now executing to many of those roadmaps with upgrades in their facility.
Gotcha. Just a longer term question on residential as well. You sort of highlighted that it's a GDP plus business. How should we think about you know 2021 fitting into the overall sort of length of the cycle? Right? Do you think there was any pull forward or do you think just thinking out in the next several years you know as I said it just continues to be positive in 2022 positive in 2023 and you know it just keeps going until consumer gets tired. Just maybe the broader shape longer term shape of the resi cycles as you think about it particularly after a strong 2021. Thanks a lot.
Hopefully the consumer doesn't get tired, but I'm not sure the historical models on the cycles are, you know, have played out certainly in the past. Again, we look at it as a GDP plus business. We have models that you know that will go through replacement cycles and use of units, et cetera, and we have a lot of data on that. But at the end of the day, if you think about it as a GDP plus business, you think about consumer confidence, that's what drives that market. We're very happy with the performance that we had this year, and GDP will be positive in 2022.
Great answer. Appreciate it. Thanks a lot.
Your next question comes from Deane Dray of RBC Capital Markets.
Thank you. Good morning, everyone.
Hey, Deane, how are you? Good morning.
Hey. Doing very well, thank you. Just a question about your CapEx plans, and we're hearing from some companies who just are not able to get projects done, you know, also a consequence of supply chain labor constraints and so forth. But you know, you as a customer, are you seeing any of that and how is that factored into CapEx planning for 2021 and 2022?
Yeah. We have several upgrades that we're doing. It's really continuous as we continue to upgrade our lines. We've seen some pushout, but nothing that we can't manage.
Okay.
Yeah. I'd add that we're still tracking, you know, again, that 1%-2%, probably closer to the 2% this year spend on capital as a percent of revenue. You know, with enough advance notice and ordering within lead times, we've been able to try to mitigate some of that supply chain pressure.
Got it. Just a quick follow-up question on the whole whack-a-mole phenomenon is, are you doing much in the way of partial assemblies at your manufacturing plants? You know, you're waiting for a component, and so this would imply you're actually spending on work in progress inventory, and then when that product does come in, you ship them out. If it follows through to a you know, the subsequent quarter, that's actually a higher margin shipment since you've already expensed some of that. How does that factor into your planning right now? Are you doing partial assemblies and so forth?
The answer to partial assemblies is yes. We could have you come work for us in operations 'cause that's obviously as we're waiting for some components, in some cases you could do a partial assembly, in some cases you cannot. As far as the revenue recognition or the cost, Chris, I don't know if you wanna handle it, but the answer is no.
Yeah, no. I think if we've got a partial assembly, we can't recognize the revenue. We're capturing all the costs associated with it. It stays in inventory until we can ultimately recognize the revenue. You know, the following quarter we're adding the components we need to on that partial assembly to make it full, and then that's when the full cost gets expensed.
Okay, that's real helpful. Thank you.
You're welcome.
Your final question comes from Stephen Volkmann at Jefferies.
Great. Thanks guys for squeezing me in. Most of my question has been answered, but maybe kind of a big picture question for you, Dave. I'm wondering, you know, sort of the old model that we had in this industry of, you know, trying to keep inventories as lean as possible and so forth, kind of worked well for a slower growth environment, but it feels like we're sort of transitioning into something better than that. I wonder, you know, do you need some more capacity? Does it make sense to layer in some more inventory on a sort of structural basis to deal with a stronger growth environment?
Yeah, it is an excellent question, and obviously we pride ourselves in being a lean company. Maybe that's why we were out talking about supply chain choppiness in the second quarter ahead of many others, because we saw it in our planning horizons. That said, I mean, we have capacity for sure, but the inventory investment is something that we're working with internally. Inventory, don't think of it necessarily as finished goods. Maybe you would in the res business, but in our commercial business, it's really at the raw level where you're able to convert it more easily into WIP and then finished goods.
Super great. Just anything else that you've thought about over the last few months as you've taken on this role that might differentiate you a little bit from your predecessor?
Yeah. It's, you know, it's been, I don't know, it's been 150 days, and it feels like forever, but this is just such a great company, Trane Technologies. We're part of such a great industry. I mean, I couldn't be prouder to be the CEO of Trane Technologies. You know, I'm talking next week at COP 26, talking about not waiting for the next great invention to start decarbonizing the world. These inventions already exist today, so I'm excited to do that. The only thing I would add is, you know, we just completed our employee engagement survey, and here we are. I don't even know how many years it is, but top decile performance for engagement.
It is our culture that differentiates us, and I'm not sure that's gonna differentiate between me and Mike, but it is really our culture and how much pride we take into building a strong culture. Trane Technologies is in a great place today, and we're headed in an even better place in the future. Thanks for the question.
Great. I appreciate it. All the best.
Thank you.
This concludes the question and answer session for today's call. I will now turn the floor back over to Zac Nagle for any additional or closing remarks.
Thanks, all. I'd like to thank everyone for joining today's call. As always, we'll be available in the coming days and weeks to answer any questions that you may have, and hopefully we'll see you in person on the road in the not too distant future. Have a great day. Thanks.
Ladies and gentlemen, thank you for your participation in today's call. This does conclude today's event. You may now disconnect.