Good morning, and welcome to the Trane Technologies Q3 2020 Earnings Conference Call. My name is Mariama, and I will be your operator for the call. The call will begin in a few moments with the speaker remarks and the Q and A session. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer I will now turn the call over to Zach Nagel, Vice President of Investor Relations.
Thanks, operator. Good morning, and thank you for joining us for Trane Technologies' Q3 2020 earnings conference call. This call is being webcast on our website at trainingtechnologies.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 Michael Mok, Chairman and CEO Dave Bregneri, President and COO and Chris Kuhn, Senior Vice President and CFO. With that, please go to Slide 3, and I'll turn the call over to Mike.
Mike?
Thanks, Zach, and thanks, everyone, for joining us on today's call. Before we move into the details of our Q3 results, I'd like to momentarily step back and provide broader perspective on the unprecedented level of change we've seen around the world, both in business and in our daily lives and why this is particularly relevant for Trane Technologies. At present, we appear to be seeing an acceleration of COVID-nineteen cases in most parts of the world, particularly in the Northern Hemisphere. As the weather turns colder and more activities and time is spent indoors, we are at a very critical phase in the course of this pandemic and we can't let our guard down. Proper hygiene, distancing and the wearing of masks will all remain critical defensive actions in order to contain and eventually eliminate the spread of the virus.
Overall, our best estimate is that there is 1,700,000,000,000 square feet of residential and non residential building space in the world. Over 400,000,000,000 square feet of this represents nonresidential communal space. Importantly, in developed economies, people spend on average of 90% of their day indoors, which reinforces the need for healthy indoor environments. Building owners, tenants and every occupant of an indoor space are certainly looking at the overall health of the physical environment with a new sense of responsibility and concern, and there's no doubt all will be contemplating and taking some action to renew or bring indoor spaces to better overall air quality standards. Systemic holistic actions to assess and improve the health and safety of indoor environments is paramount right now and requires an industry wide response for support.
Over the past quarter, we formed a center for healthy and efficient spaces modeled after the Center For Energy Efficiency and Sustainability that we formed over a decade ago. To convene internal and external experts to collaborate and deliver innovation, thought leadership, market education and communication and to enhance the policies and standards required to meet the present and future challenges we're all facing. HVAC systems already drive 40% or more of a building's total electricity demand. However, we know that many indoor air quality strategies and enhancements can have a negative impact of further increasing building electrical demand by 15% to 40%. This represents a significant challenge for energy efficiency, energy costs for owners.
So as we help raise the overall indoor air quality of spaces, it is critical that we find additional ways to mitigate the economic impact to our customers through the implementation of more efficient systems, controls and broad based energy conservation measures that we can take on their behalf, which is critical to offsetting the unintended consequences of increasing overall carbon emissions through HVAC systems energy demand. At Trane Technologies, we want to be part of creating a better new normal. We will challenge the status quo to create a new normal where communities thrive, where quality is foundational and where the environment is protected for future generations. We're putting a stake in the ground that Trane Technologies will lead by example by setting historic and ambitious commitments and taking action to change our company, our industry and the world. Our Gigaton Challenge commits to reducing our customers' carbon emissions by 1 gigaton or 1,000,000,000 metric tons by the year 2,030.
To give you an idea of size and scale, that's equivalent to about 2 of the world's annual emissions. That's just our company alone. As other companies join us, we can bend the curve on global warming. We're also committed to creating opportunity for all with the goal to achieve gender parity and leadership by 2,030 and racial and ethnic diversity that is reflective of our communities. Our transformation plan for Trane Technologies is another example of how we're creating a new better normal for our team, customers and shareholders, executing against the new blueprint that culminated in May after approximately 1 year of analysis and planning.
Setting needs and other bold plans in action, our talented team around the world has exhibited all the commitment and passion for change that has marked our last decade. Our goal is simple, to create a new normal where opportunity is accessible for all, where healthy food, water and medicines are moved to people who need them, where emissions turn down and blue skies trend up. Our business sits right at the intersection of making those things happen. With our unique positioning as a focused climate innovator transformed and fit for purpose, we can tackle these pressing and complex challenges and drive differentiated returns for shareholders. Moving to slide 4.
As everyone listening to this call today can attest, the global COVID-nineteen pandemic continues to present ongoing challenges to virtually every aspect of our daily lives. As much progress as we've made, the questions we were all contemplating months ago regarding the depth and duration of the downturn and the speed and shape of the recovery are still very much with us. While there are several promising vaccines in process, timing, availability, the mass distribution capabilities that might radically change the trajectory of the pandemic remain open questions. Despite these ongoing challenges, our teams remain focused and agile, effectively navigating an evolving landscape to meet the needs of our customers in order to deliver strong financial results for our shareholders in the Q3. We outperformed our end markets broadly, delivering strong bookings growth, positive revenue growth, robust margin expansion, strong EPS growth and exceptional free cash flow.
Continued strong performance gives us confidence to once again raise our outlook for 2020 revenues and leverage, along with that for raising our outlook for operating income and EBITDA as well. But only do we expect our current outlook for 2020 revenues of down roughly 6% to significantly outperform our prior outlook of down 10% to 15%, we also expect to see some improvement in the 4th quarter as well. Assuming the current course and speed of the global economic recovery, we now expect the 4th quarter revenues to be down just 5% despite tough comps for our North American HVAC business and continued weakness in global transport markets. Additionally, we have improved outlook for deleveraging quarter 4 in 2020 to better than gross margin levels based on expectations for continued strong execution. Our prior outlook was for gross margin deleverage in the low 30% range for 2020.
We continue to take aggressive actions to emerge stronger and to thrive as business conditions improve and new opportunities develop. We maintained high levels of business reinvestment and innovation and growth programs throughout the Q3 and we expect to further accelerate our investments in the Q4. We have a strong slate high ROI projects in our core business as well as opportunities to accelerate investments in new IAQ and cold chain storage solutions. We set a course to accelerate our stranded cost and other fixed cost reduction initiatives in the first half of the year in order to deliver more bottom line savings in both 20 2020 21, and we are on track to deliver these savings. We remain in a very strong financial balance sheet and liquidity position, and we delivered strong free cash flow in 2020.
You'll recall we paused elements of our balanced capital allocation strategy through the Q3 in favor of capital preservation and optionality. Exiting the 3rd quarter based on strong performance and the current course of speed of the global economic recovery, we're well positioned to bring all elements of our balanced capital allocation strategy back into play at this time. Our core strategy remains unchanged. Secular megatrends of energy efficiency and sustainability are becoming more pressing every day, and these trends are now elevated with the increasing need to ensure the health and safety of the environments we work and live in. We excel at addressing these megatrends and challenging what is possible for a sustainable world, redefining a higher standard for what the world considers normal.
This passion powers us forward to deliver top tier financial performance and differentiated returns for our shareholders. Now I'd like to turn the call over to Dave to discuss our bookings and revenue performance in the quarter. Dave? Thanks, Mike. Please go to Slide 5.
3rd quarter impacts of the global pandemic drove further contraction from 2019 levels in the majority of our key end markets. Despite these headwinds, our global teams remain focused and agile and delivered positive revenue and 7% bookings growth in the quarter. In the Americas, the economy is slowly progressing forward, but the situation remains tenuous. Our Americas segment delivered growth in both bookings and revenue in the Q3, up 8% in bookings and 2% in revenues. In the Americas, our commercial HVAC business has remained resilient through 2020, with Q3 bookings down low single digits and revenue remaining flat with prior year.
Services continue to outperform equipment, but remain challenged by pandemic specific downturn impacts, primarily related to low building occupancy rates and other building closures related to ongoing health and safety concerns. Our teams have been effective and efficient at adapting to the changing landscape and capturing opportunities to outgrow market conditions in areas such as indoor air quality assessments and services. Strong performance in our residential HVAC business enabled us to take advantage of strong growth in both replacement and new construction markets in the Q3. Residential bookings were up more than 30% and revenues were up high teens in the quarter. Backlog remains at record levels entering Q4.
Our transport refrigeration business outperformed the overall markets, which were down more than 30% in the quarter. Revenues were down over 20%. Bookings were positive in the quarter, up low single digits. Turning to EMEA, the overall EMEA market continues to be challenged, but teams continue to execute well. EMEA delivered positive bookings growth of 6% in the quarter with growth in both commercial HVAC and transport refrigeration.
Revenues again outgrew underlying market conditions, down 6% overall. Commercial HVAC bookings were up high single digits, while revenues were down mid single digits. Services outperformed equipment, but are still constrained by pandemic specific downturn impacts noted earlier. EMEA Transport bookings were positive in the quarter, up low single digits. Revenues were down high single digits, outperforming the broader transport markets, which were down more than 20%.
Asia Pacific results continue to be mixed with overall bookings down 5% and revenues down 2%. China continues to show signs of relatively steady improvement, having made the most progress against the pandemic. Growth in China was more than offset by declines in the rest of Asia, where a number of countries have yet to turn the tide on the pandemic and begin on the path of recovery. Now I'd like to turn the call over to Chris to discuss the results of our quarter in more detail. Thanks, Dave.
Please turn to Slide 6. Dave provided a good overview of our revenues on the prior slide, so I'll focus my comments on margins. Adjusted EBITDA margins were strong, up 80 basis points with operating leverage better than gross margin rates. We delivered strong margin expansion through focused execution of our recession playbook to adapt to evolving market conditions. Productivity was very strong across the board in the quarter, reflecting strong execution and cost containment rightsized for the revenue declines we expected to see.
Top line execution exceeded our expectations heading into the quarter, which benefited margins given tight cost controls in each segment. Price cost remained positive in the quarter, while mix remained a significant headwind given steep declines in transport revenues in both the Americas and EMEA. We also maintain high levels of business reinvestment and employee safety measures, innovation and technology. Please turn to Slide 7. Turning to the regional segments, I'll once again focus my comments on margins as Dave provided a good overview of revenues earlier.
In the Americas region, strong residential revenues, productivity, cost containment and price more than offset headwinds from transport mix driving solid margin expansion. Similarly, the EMEA and Asia Pacific regions delivered strong productivity and cost containment to improve margin versus 2019. Please turn to Slide 8. We've consistently been able to raise our outlook for revenues and leverage from our initial scenario view at the outset of the pandemic, and we are raising it once again heading into the Q4 of 2020. Assuming current course and speed of the global economic recovery, we now expect 2020 revenues to come in down approximately 6% with better than gross margin deleverage.
This compares favorably to our prior outlook for 2020 revenues to be down 10% to 15%. We expect Q4 revenues to be down approximately 5%, with better than gross margin deleverage. We continue to operate from a position of strength and intend to continue to play aggressive offense through the downturn in order to emerge an even stronger company post pandemic. In terms of our outlook for Q4, we wanted to provide some additional items that may help with remodeling. We operate a CapEx light business model of 1% to 2% of revenues, and we are likely investing on the lower end of that range for 2020.
We expect free cash flow to remain strong and equal to or greater than 125% of adjusted net earnings for 2020. Quarterly interest expense is expected to be consistent at $62,000,000 in the 4th quarter. Our tax rate remains in the 19% to 20% range for 2020. And lastly, our share count is expected to be approximately 243,000,000 shares for 2020. Now I'd like to turn the call back over to Dave to provide our market outlook.
Dave? Thanks, Chris. Please turn to Slide number 9. As we've highlighted, North America commercial HVAC has significantly outperformed the broader markets through the Q3 through strong focus, agility and execution. We're seeing high levels of interest in and strong conversion for comprehensive indoor air quality assessments and momentum in this space continues to build.
The universe of opportunity is huge based on billions of installed square footage that could ultimately be evaluated and addressed, but the opportunity is still early stages. For Q4, we expect our North America commercial HVAC business to be down between 5% 10%, primarily driven by the extremely tough comps the business faces. Q4 twenty nineteen revenues were up nearly 20%, which is essentially equivalent to 2 years of 10% growth all in one year. Tough comps aside, our North America commercial HVAC business remains healthy and resilient, and we expect back in 2020. Turning to residential, we saw record bookings and revenue in the 3rd quarter, which puts us in a strong backlog position entering the 4th quarter.
Residential is still a book and turn business and it's unclear how November or December will shake out at this point. So too early to call Q4 at this stage. Turning to North America Transport, we're seeing some positive trends in freight rates and order rates and we're aligned with ACT that the overall transport market growth rates are likely to improve sequentially from Q3 to Q4. ACT is calling for the market to be down roughly 20% in Q4. So we're expecting continued headwinds for our North America transport business in the quarter.
Turning to EMEA, the recovery continues to be relatively soft and country dependent. Some countries are bracing for another round of restaurant and other venue lockdowns and border closures. It's too early to call the recovery broadly in Europe and we'd expect both commercial HVAC and transport markets to be challenging in Q4. Transport markets will be especially challenging as the market outlook calls for a 25% decline in the 4th quarter, which will only be amplified by border and venue closures should they occur in parts of Europe. Turning to Asia, we continue to be encouraged by the recovery in China, which we expect to have solid growth in Q4.
However, we expect to see similar results to the 3rd quarter in the rest of Asia, in which revenue declines more than offset growth in China. Please turn to Slide number 10. At the time we announced the industrial RMT transaction, we quickly mobilized the transformation office to focus on streamlining our organization to remove $100,000,000 of stranded cost from the business by 2021. As Mike discussed earlier, we are on track to achieve $100,000,000 in 20.20 and $140,000,000 in 2021. As we've discussed, we expect one time expenses of approximately 100 to $150,000,000 to eliminate the stranded and other fixed costs.
We have spent approximately $91,000,000 year to date with $15,000,000 in Q3. Now I'd like to turn the call back over to Chris to discuss our balanced capital allocation Chris? Thanks, Dave. Please go to Slide number 11. As Mike mentioned earlier, we paused on elements of our balanced capital allocation strategy through the Q3 in favor of capital preservation and optionality.
Exiting the Q3, based on our strong free cash flow generation and our current outlook, we're in a strong position to bring all elements of our balanced capital allocation strategy back into play. Our balanced capital allocation strategy is focused on consistently deploying excess cash to the opportunities with the highest returns for shareholders. Despite economic conditions, we continue to strengthen our core business with healthy levels of business investments and high ROI technology, innovation and operational excellence projects, which are vital to our continued growth, product leadership and margin expansion. We remain committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve. We have a long standing commitment to a reliable, strong and growing dividend that increases at or above the rate of earnings growth over time.
We continue to pursue strategic M and A that further improves the long term shareholder returns, and we continue to see value in share repurchases as the stock trades below our calculated intrinsic value. All in, we expect to consistently deploy 100 percent of excess cash over time. Now I'd like to turn the call back over to Dave and Mike to cover key investor topics of interest and to close with a summary of key points. Thanks, Chris. Please go to Slide number 13.
Indoor air quality is generating tremendous interest in the market and our pipeline for services and system enhancements is growing daily. Fundamentally, our customers are turning to us for our unmatched expertise, direct service channel and remote monitoring services to improve the safety of their buildings and build the confidence of their building occupants. We offer a holistic, layered, fully customizable approach, which balances key contributors to indoor air quality with energy intensity. At this stage, we're seeing solid activity for more modest sized projects aimed at immediately addressing the most pressing challenges for reopening buildings. As Mike highlighted at the outset, we believe indoor air quality represents a long term secular tailwind for Trane Technologies as businesses and consumers alike have come to think differently about the health and safety of the air they breathe everywhere.
With an eye on the longer term, we launched our Center for Healthy and Efficient Spaces during the quarter. The center is focused on driving long term strategy innovation within our business and influencing the establishment of codes and adoption of standards in the built environment. Please go to slide number 14. Another topic we know is on the minds of investors revolves around transport markets in 2020 2021. For 2020, the North American market is expected to be down about 35% and our numbers clearly show we're outperforming the markets.
The same applies for EMEA, where the markets are expected to be down roughly for 2020. We're on pace to outperform in EMEA as well. Turning to 2021, we are positive on the markets and consistent with the market outlooks from ACT and IHS, which calls for transport markets to be up approximately 31% in North America and 11% in EMEA. Now I'd like to turn the call back over to Mike for closing remarks. Mike?
Please go to slide 15. We've mentioned that we intend to hold an investor event in December and we firmed up what that event will be. We're looking at the morning of December 14, and we hope all of you can join us. It should be a great event. While the pandemic continues to present unprecedented challenges to visibility and how the markets will evolve over the near to medium term rather than conduct a traditional Investor Day with 3 year top line and bottom line targets, we believe it will be more concrete and constructive to talk about the things we control, which are the transformational activities associated with the new training technologies that we've been working on for the past year.
We're going to take a couple of hours in the morning of 14th to focus on the self help story as train technology supports continued margin expansion and growth across our business, that is not dependent on how our current end markets perform. We've touched on some of these we've been working on and this will be a deeper dive in order to provide investors continued confidence in our margin expansion and innovation story. This will be a virtual event given the current environment. We'll follow-up with additional details on the event, but please be sure to save the date. Please go to slide 16.
I believe it was Peter Drucker who said that culture eats strategy for breakfast and we couldn't agree more with that idea. The topic of what happens or changes with an organization's culture has been top of mind for many of these days and certainly for me. As we went through the very difficult work of the industrial separation and formation of the Reverse Morse Trust, re blueprinted the new train technologies and worked through and weathered the impact of the pandemic to this point, we've had plenty on our plate as a newly created train technologies. I'm proud to say that through all of this, the pride, energy and optimism that is emblematic of our culture has only gotten stronger. We recently received feedback from 90% of our associates globally, nearly 35 1,000 people in this year's engagement survey, with over 60,000 verbatim comments provided.
The results were overwhelming. Our engagement index achieved top quartile again of all companies and improved year over year. With pride in our company, energy for what we do in the world and optimism about training technology's future at the core of the feedback received. I'm proud of our people, our entire team and our shared inspiration that one company can change an industry and our industry can change the world. As I said at the outset of the call, energy efficiency and sustainability megatrends are only growing stronger as time passes.
And fundamentally, we excel with these global megatrends and sustainability intersect with our innovation and capabilities, which drives high demand for our products and services. The increased focus on the health and safety of spaces and our holistic approach to helping our customers navigate solutions to improve in their air quality is another opportunity for trained technologies to make a difference in the world. We've been investing heavily for years to build franchise brands and to advance our leadership market positions to enable consistent profitable growth and we intend to press our advantage during this downturn to leverage our strong financial and competitive positioning and to invest heavily in the future of Trane Technologies. Our message to our investors is unambiguous. We are stepping up to the challenges of today and tomorrow, and we will never stand still and we're certainly not going to slow down.
Our results in the marketplace are the ultimate barometer. And we're not only focused on relentless investments in innovation and growth, but investments in blueprinting and transforming into a leaner, fit for purpose, pure play company through the elimination of our stranded costs and the execution of transformation initiatives will fundamentally improve the margin profile of the company over the long term. Lastly, we remain committed to dynamic and balanced deployment of capital and we have a strong track record of both delivering strong free cash flow and deploying excess cash to deliver top tier shareholder returns over the years. And with that, Chris, Dave and I will be happy to take your questions. Operator?
Thank you. Your first question comes from Julian Mitchell with Barclays. Your line is open.
Hi, good morning. Maybe just the first question around the commercial HVAC environment in the Americas. Because I suppose, as you point out, the end market indicators, things like project starts are down or weak. Your own backlogs, though, you think is stable into year end. So when I think about that, would you think that the negative impact of those end market indicators and starts, you're already moving past the worst of that?
Or do you think that will hit your backlog early mid next year? Or alternatively, there's just no real trend to call out because of COVID. You're just taking kind of each quarter as it comes and the market's just too choppy to call a trend line?
Yes. Julien, it's probably a little bit too early to understand the trend line there. But remember that probably 15%, 20% of our business is really affected by Dodge data, the put in place data that you read and a lot more of it is predicated on how we're doing with creating demand around retrofits and indoor air quality. So I do think you're correct. I do think we exit the year relatively flat in terms of our backlog.
And based on everything that we've been through this past year, that's somewhat of an achievement to end with the flat backlog. So I think with the current course and speed going into 2021, we've got enough strength, enough health in many of our markets to have a decent year in 2021 run growth.
And then maybe just a quick follow-up question around the residential market. Any perspectives on what the total market you think is doing this year? And the extent to which you think that sets a high or normal or low bar for next year? And any updates on your thoughts on that replacement cycle in U. S.
Resi?
Well, it's strange here because demand was really shoved around, pushed around. I think everyone went into a recession playbook and a pandemic playbook is a bit different as people generally felt so good about their jobs and investing in indoor air quality at home. And so you drive toward not only replacing systems, but even mix for us that went up versus down through that. So I don't think that that continues indefinitely. I think it begins to normalize probably in quarter 4, certainly in quarter 1.
The unique thing is we're moving in from what was really an extended peak season into really the build that we would normally do in the Q4 and beginning of Q1 for the traditional peak season that we would see cooling season as well next year in 2021. So I think the best way to look at that is to look at 2020 as a bit of an anomaly. And then I think we move into a more normalized 2021. Everything that we're seeing around the setup for 2021 would be that we see a little bit of growth in 2021. But again, it's all predicated on the current course and speed of the economy and certainly how people feel about employment and overall consumer confidence as we get further into the end of 'twenty and into early 'twenty one.
Of course, that business is really a book and turn business, and we were booking and turning everything we could build in the Q4. Our teams did an outstanding job about being able to meet demand that we didn't forecast and get that turned into revenue and get nice margin expansion for the quarter. So I want to complement the execution there, but again, I think it normalizes.
Very helpful. Thank you.
Your next question comes from Jeff Sprague with Vertical Research. Your line is open.
Thank you. Hello, everyone.
Hey, John. Hey, Jeff. How are you doing?
I'm doing great. Thanks. Just back on the commercial question. The growth that you're seeing in services, I think you said low single digit in the quarter. Is it your view that's a kind of a pretty steady run rate for the situation that we're in or was it some catch up from site access in Q2?
Yes, Jeff, this is Dave. I'll start and Mike and Chris can add on. But we're very happy with our service businesses really globally. They've outperformed equipment despite the pandemic. And there's a lot of office buildings that are still thinly occupied.
There's a lot of buildings that are not occupied at all with closures. We have schools that vary some degrees of when students are actually coming back. So despite all of that, our service business is still growing and it's outperforming our equipment business. Yes, I'd say building availability is still a headwind. IAQ is certainly a tailwind.
But net of that, I think, is a positive setup for the service And I always said that service business was a great antidote to a recession. Of course, pandemic is different in that if access to buildings is denied, it's tough to grow service business. But we're very busy on the IAQ front. And as buildings continue to open, there'll actually be some deferred service, deferred maintenance that I would expect we'd see there as well.
And then I'm wondering on the IAQ, thanks for the additional framing of maybe the square footage that could be a target. So it sounds like it's still early days as you know, but I think Dave you mentioned you are starting to book some midsize projects. Is there anything we can kind of glean there, like what that means? A midsized project would increase your service opportunity and building XYZ by some percentage or and just some kind of rough framework to kind of get our head around the dollar opportunity here?
Yes. I mean, I would tell you that we continue to see strong customer demand and momentum in indoor air quality, number 1. And just to take a step back, when we do an assessment, Jeff, it's not a check the box, right? These assessments take 100 of hours to complete. And we take a very holistic approach when we look at the building.
So we it's not just changing out one item within a system. It really has to be a systems approach, otherwise you can make some very bad decisions for the end customer. Our audits follow ASHRAE's best practices. We ensure the building equipment is operating the way it was designed. We then start looking at opportunities to improve the indoor air quality, whether that be on the filtration side, whether that be on the fresh air exchange side.
We also look at sensors to improve the humidity levels, temperature, occupancy. That's all part of what we would do for our customers. What we do is we lay out for our customers a very layered approach. So we'll tell the customer what we will do on day 1, right, to get the building operating the best it can with the current assets in place. And then we'll give them a road map for the future.
And that road map could be if they wanted to increase the fresh air exchanges to a greater degree, they may need additional cooling capacity. It could be, as Michael alluded to earlier, on the energy side, where there's energy projects that could actually reduce the tax that we put on the building to bring the indoor air quality up. When we say modest projects, we're talking about what we call day 1 projects and that is let's get your building as healthy as we can get it with your current set of assets today and then we'll give you that roadmap for the future. Joe, that's why I think it's a long term play because everyone needs to do something right now and then ultimately if the building wasn't designed to do what it needs to do or your access to limitations of what those standards should be, where the building may change use over some period of time and never was adapted. Those are all necessary investments that need to be made.
One of the things, and I'll just offer this because people on the phone here just some advice on this, the opposite of a holistic approach is sort of a point solution. And one of the point solutions that we're seeing that's a little bit problematic is a lot of people have gone and just moved to really dense filter medium. And what's happening there is you're not getting often enough airflow out of spaces. And as you do that, you're actually making the situation worse at the ends of duck runs in buildings. And so you're not getting the air changes per hour.
And in fact, the systems and fans may not have the capacity to support that, then we're going back in at that point and putting some math modeling around what's the maximum filter media you could change, how do we impact that by maybe maximizing actual air changes, how do we get humidity for an aerosol contaminant, so it's a little bit heavier, falls faster? What can we use to kill it that wouldn't create environmental problems for occupants. And those are all of the things that holistically we try to put together as well as the back end energy conservation measures to mitigate the effect of all this. Great. Thanks for that color.
Best of luck.
Your next question comes from Josh Pokrzywinski with Morgan Stanley. Your line is
open. Hey, good morning all. Hey, Josh. Good morning.
Mike, with some of these upgrades that are coming through, especially the holistic stuff around IAQ, appreciate kind of the global square footage numbers that you threw out there and certainly the size and energy efficiency opportunity on the installed base is pretty large. I think in the past you've talked about in the applied world, kind of that dollar of equipment and $5 of parts and services through the lifespan. Any way to dimensionalize what these upgrades are worth in the context of that dollar? Is it $0.10
Is it $0.90 Like just maybe give us
a sense for how much these things cost relative to just full op purchasing a new system?
Yes. For a dollar spent in an applied system, it's a 30 year life cycle, we'd see a range of 8 to 12 times that in terms of the service and retrofit potential around that. So that's probably what you're referring to there, Josh. And I think that's true. I think the urgency probably on the front end to do something in terms of, as Dave explained, plan and that plan has to be consistent with someone's overall financial capacity to execute the plan.
We've got to work customers to be able to do that. So Dave said, day 1, what are the mitigating things we can do? Day 2 and beyond, what are the things that would need to have to happen in these systems to really put them at a standard or a best in class. But I think also too as people look at buildings, particularly tenants and landlords trying to lease buildings, there's going to be some tendency to be inquiring about this stuff and understanding to what degree have you made modifications or what visibility need to do to perform at a standard that should be best and healthy for occupants. And so that's going to play into this as well.
So I think we'll be busy doing some asset planning for customers. And longer term, I think that it probably accelerates some of the retrofits. It will also have the impact of things that are in design and things that are not yet in design, but will be built in the future, probably built to a higher standard, not just the installed modeled standard, but
the maintenance standards as well, because it's
really critical, as you know, that energy maintenance standards as well, because it's really critical. As you know, that energy can drop, as an example, from model to actual, it can drop 30% in a matter of just a couple of years through customers overriding system points. This is analogous to that, right? You can do all this great work around filters and outdoor air exchanges and dampers and linkages, but if you're not maintaining that stuff, you fall back right to where you were. So maintenance will be improved going forward, I think, as well as the ability to monitor the stuff remotely because there's just so much out there to look at.
You're going to have to do this digitally and look for anomalies in the systems.
Got it. That's helpful. And then just pivoting quickly over to the transport side of the house. Any sense for what the opportunity could look like or any inquiries customers are making about vaccine distribution and transportation there and the capacity that might be needed to support that?
Yes. Josh, this is Dave. I'll take that. And just to accept that Thermal King business, we have a complete line of products and services that is for the whole cold chain for distribution, whether that's air, truck, trailer, marine, rail, last mile, refrigerated containers. There are several vaccines, I'm sure everyone's aware that are being worked.
Some are in Phase III trials right now. It's unclear as to which will be first to market. And depending on the vaccine, they have different temperature requirements for distribution. So it ranges from a deep freeze, which could be as cold as minus ADC to frozen, which rewinds 10C to just like a pharmaceutical, which would be like 2C. The markets have sufficient capacity for trailer over the land.
Where we see opportunities is really in 3 spaces. 1 is in air, and we've been in the air business for decades. We have all the approved certifications, whether it's FAA or EISA, which is the equivalent in Europe. We also see some opportunities in last mile and we see a big opportunity in deep freeze cold storage. And we just have a new product that we introduced there a few months ago.
This is a product that in a typical hospital, your deep freeze capability is really about the size of your refrigerator at home. And our solution there is about 60 times the volume that a deep freeze you would find in a hospital could hold. So that's going to be a big opportunity for Thermo King. Who we're talking to? We're talking to pharma companies, distribution companies, 3PL, governments, healthcare providers.
We're talking to everyone and we're going to be ready with a distribution solution, storage solution when that time comes and hopefully it's soon when we start distributing vaccines.
And Steve, I'd
add the portable solution that's got the 60x capacity of the current market capability. It's still a mobile unit. And when you pair that with our rental and logistics capability through our rental businesses, we've got the opportunity to move these around as they're needed. I'm really proud of the work the team did here to take every pharma manufacturing vaccine, work with them specifically around their requirements and exactly how eventually these vaccines can be packed and distributed, but also understanding exactly what their supply chain looks like and where the break points could be in the cold chain, so that we can map out the capacities for every pharma company going through every distribution model all the way through to a CVS or a Walmart, for example, here in the U. S.
About how people would eventually be inoculated. So in doing that, it's allowed us to be able to look at constraints, look at capacities and make sure that we're selling product to the people that actually need it as opposed to just selling product into capacities that may not be required. That would be a real mess of that happening. We're being very conscientious about sort of reserving that capacity to put it into the best place.
Appreciate it. Thanks, Mike. Thanks, Dick.
Your next question comes from Steve Tusa with JPMorgan. Your line is open.
Good morning. Good morning, Steve. Good morning, Steve.
Paul, we're a long way from the dry ship R-twenty two changes, if you remember those days, Mike.
That's right. I do, Steve.
You don't have to. It's been nothing but up into the right. Congrats on continued execution, share gain, etcetera. On just thinking about all this kind of air quality stuff and the opportunity, I mean, what needs to come together from your perspective as a catalyst to kind of unlock some of this? I mean, I think, ASHRAE is very busy trying to kind of figure out standards and you've got obviously the messaging around the election around green new deals and ESG.
I mean, how fragmented
is this?
Right now,
it sounds very fragmented. What kind of brings it all
together and kind of catalyzes customers, do you think, to get kind of off the sidelines
on some of the stuff? Yes.
I think it just comes down to, 1st, looking at the behavioral science behind all this and what we as consumers and building occupants and building owners and tenants think about space going forward. And so it's not going to require somebody to kind of convene that into one demand or code or standard. Although I think what will happen is initially, particularly in the developed economies, there'll be immediate look back to looking at buildings and whether or not they're operating at standards and then what you do to mitigate that. I think it creates a step up where codes don't exist, they don't exist to the stringent level of a standard, where those become implemented much more quickly than perhaps would have happened. But particularly for us, when you think about our non residential opportunity, which is the bulk of our global business, we're really only in the res business, if you will, in the U.
S. And Canada. If you think about that, these are sophisticated building owners applied maybe more institutional critical systems, they get it. They get it immediately and they know to open a factory, a hospital, a university, a research center. They're going to you have to be at least at whatever the best standard is.
So I don't think anything actually has to happen. Of course, anything that could happen that would create more focus on driving codes and implementing them faster would be additive to that.
So I mean, you think that even without that, that there's enough will to kind of fund some of these big investments that would move beyond just something like that's ancillary at the margin for your business?
Yes. If you think about even just again our non res business being in the tens of billions of square feet that we've got as an installed base, that's a great starting point. And in situations like this, where you can't get to everybody immediately right away, that's why honestly it has to be an industry response to solving for 1,700,000,000,000 square feet of space. You're going to go to the people that get it first and want to do something about it. And so we're going to be selective about who we're talking to and how long we're talking to them before somebody does something, right.
It's a function of making sure that you disqualify opportunity as readily you should qualify opportunities when you've got that much opportunity in front of you. So we're going to spend our time prioritizing with the people that want to act on it quickly and making sure that we're going to where the action will be taken, which of course is going to drive outcomes for health and it's going to drive revenues for us.
Great. Thanks for the color. Congrats again.
Your next question comes from Scott Davis with Melius Research.
Hello. Hey, Scott. Good morning. Good morning, Neil. I am doing a collective question this quarter, but when you think about the resi side, do you guys have any visibility into how people are financing units?
Whether they once upon a time, I know home equity loans were real popular and then there were specialty finance companies and then it was back to credit cards. I'm just kind of curious to see what how people are paying for things now, if you've seen any change or have visibility in that far down in the channel?
Yes. I guess I'd start with U. S. Savings rates quadrupled. I think in quarter 2 and the first part of quarter 3, we were sitting around 20% versus the 4% or 5% savings rate.
People obviously aren't going out and taking vacations and doing the things they were doing. So I think there is actually more capacity. I also think that home values have increased and people feel that they're on pretty solid footing, at least at this point around home values. So I think between savings rate, home equity lines that may be open, that's the primary that we're seeing there. We're not hearing anything specifically about high grade grade
dancing. Okay, thanks. That makes sense. I figured that was the answer, but you never know. It's a strange time.
And then the other question I have for you guys is just visibility on non res in China and kind of looking out there? I mean, what are your local guys saying as far as project activity and things and general outlook?
Yes. Scott, this is Dave. I'll take that. We're pretty happy with the growth rates that we're seeing right now in China in our business. I think a lot of that comes back to the investments that we made 4 years ago when we developed a direct sales force there.
If you remember those days, we had we literally went out and trained 300, 400 engineers to have a direct sales force to actually go talk to engineers and architects and to help become the basis of design. So with that as a backdrop, what we're seeing strength in China is in data centers, electronics, pharma and healthcare. And those are areas that we have a lot of activity in. We have weakness obviously as well. Some of those spots would be office and retail.
But overall, the team and you heard Chris say in the beginning, our team in China has done just an excellent job and we're really proud of their accomplishments.
Okay. Thank you, guys. Good luck. Thank you.
Your next question comes from Joe Ritchie with Goldman Sachs. Your line is open.
Thanks. Good morning, everyone. Good morning, Joe. Good morning.
So my first question guys is is just on just the resiliency of your service business in North America, I'd be curious as you're thinking about 2021, whether it's how you kind of contracted the business, how you expect that to look like in 2021, particularly at a time now, obviously, where occupancy rates are a lot lower in commercial buildings? I'm just wondering if there's any headwind to potentially think through as we head into next year?
Yes. I mean, it probably helps to think about this a little bit as a bell curve as it relates to people that are out of business or will be out of business and are coming back in business. And there's going to be some space, obviously, some retail space as an example that restaurants, that's going to be the question. You've got people are absolutely coming back and investing warehousing, data centers, other businesses that relate to that. But the folks in the middle that are going to come back, it's a matter of sort of time and maybe density for how they pack and organize occupants and buildings, they're going to use the opportunity preopening to mitigate as much as they can, right?
I mean, do they have to mitigate the space in some way before people return to the office? And so we're sitting in North Carolina today and we're communicating to our population just as recently as last week about our intentions. And we don't see people coming back into the office here unless they need to do their work or they can and we put these protocols in place. But we're not expecting people to come back in at least until the early part of next year. And even that's up for grabs as it relates to what the science will tell us and case rates look like in the local community.
But having said that, we've gone through and taken enormous investment to get our space beyond a standard to have people feel comfortable coming back. And I think that you're seeing the bulk of the bell curve being companies and landlords and tenants that are requiring some mitigation to take place now. And so again, between not being able to get to some spaces and then the tailwind around providing some mitigating activity for people who are going to be opening as well as providing services for the people that are open. There's enough for us to do there and I think see some growth in services.
Got it. That's helpful, Mike. And maybe just my one follow on question. Focusing on U. S.
Resi HVAC for just a second, Clearly, the bookings growth has been really good. You guys seemingly are taking some share there. I guess my question is, as we kind of switch into the cooler months, the furnace season, are there any I guess, do you have any supply constraints in delivering on the type of bookings growth that you're experiencing? And then are there any issues to maybe think through as you kind of switch over into furnace season?
Yes, I'll take that. This is Dave. We're not seeing any constraints in our supply. I think if you go back to the end of March, we reconfigured all of our factories and put the right safety protocols in place. We also had a team that was working with our suppliers to ensure that they were able to provide us components.
That still is all in place. And right now, we have no constraints in front of us. Yes. I just would add that just absolutely heroic efforts by our residential team, our manufacturing and supply chain teams to make sure that we were able to respond to this demand, because again, this was not predicted. We didn't see these volumes coming in a typical recession playbook.
And this is a different set of human behaviors happening here around people thinking about indoor space at home. And the ability to respond to that was really a lot of hard work by some great people out in the organization getting it done.
Good to hear. Thank you all.
Your next question comes from Andy Kaplowitz with Citigroup. Your line is open.
Good morning, guys. Nice quarter.
Hey, Andy. Thanks, good morning.
Given the increased demand that you talked about for IAQ and service on the commercial side as well as the strength you continue to see in the residential. While I know you talked about expecting a more normalized year in 2021 in residential, are inventories generally across the respective channels still relatively low? Does that give you more confidence in the relative end markets as you go into Q4 and into 2021?
Yes. Inventory levels coming out of Q2 were about half of what they needed in the van, right? So if you think about 3 months, it's kind of more typical. It might have been sitting at 6 weeks and that drove incredible demand. We saw June, July, August and really continued.
I would say as an industry, it's been a bit hand to mouth. If you've got it, you probably could sell it. And that certainly was the case for us. And really, again, SEER wasn't important. People were taking what they could get and they were opting for higher SEER if choices were available.
So really, I think it hasn't changed much. And again, this is why I think that you run right in from an elongated cooling season in 2020, right into the normal build that we would have basis what we think to be 'twenty one demand. And that's not normal. Usually, there's quite a low reaction between August, September and call it December, January.
Thanks for that, Mike. And then I'm sure we'll get into, as you said, margin targets in December. But when we look at your adjusted margin in the quarter, that's 16.7%, we obviously know that's seasonally strong. But given the mix of residential, hopefully some improvement in Thermo King that's likely to happen in 2021, can we actually see operating leverage continue to be higher than gross margin in 2021? Is there any reason why your longer term target wouldn't be at or higher than the target you last gave us when you talked about Climate margin goals for 2020?
Yes, I wouldn't set that as an expectation, Andy. I think that we always like to tell people that the entitlement is probably maybe 5 points short of gross margin, giving us an opportunity to really innovate and invest in the business and make sure that we're staying out in front. And of course, incremental margins of 25% against margins that are 16%, 17%. It's all a good problem to have. And of course, we want to raise gross margins over time.
So that's a good thing to have happen. Occasionally, it happens that we had great productivity in quarter 3 and excellent price versus material inflation in quarter 3 and you can drive outsized leverage in a particular quarter. But in the long run, it's best for investors to think about it the way that we're thinking about it, which is something close to gross margins, leaving room for investment and some breakage around ideas that don't pan out. And that's the way I would tell you to shape up 'twenty one and beyond. We're not creating a lot of headwind going into 'twenty one.
All of the hourly increases that we would have given in terms of salary increases to hourly associates happen like they normally would have in the normal schedule. And then the delays in salary increases that we pushed out into 'twenty one, we brought back into 'twenty, right? So what you're seeing here is investment back in the salary increases. And so the only sort of headwind probably or tailwind is how much really travel and entertainment we would be doing in 2021 as an example. And I think that, frankly, we're rethinking a lot of those things right now as many companies are about how much business travel, how much entertainment do we need to be doing.
And certainly some will come back, but probably never at the levels or unlikely to get the levels that they were historically. So we're not setting up a situation in the reverse, which is really tough leverage coming into 'twenty one. So I'd cut it right in the middle and say 25% is a good number to think about.
Thanks, Mike. Very helpful.
Your next question comes from Andrew Obin with Bank of America Merrill Lynch. Your line is open.
Yes, good morning.
Hi, Andrew. Good morning, Andrew.
Just a question. How has COVID changed your thinking about consolidation in the HVAC industry? And do you think there's sort of rethinking as to what the setup should be along the term from a strategic standpoint? Yes. Nothing has changed in my thinking or thought process around that.
I mean, COVID really doesn't have an impact on that. I mean, obviously, it's going to dislocate earnings between companies, but doesn't really change the long term view toward that. It's likely something that could and should happen. Broader on the M and A question, I think as we think about some of the things that we're doing around the bolt ons, you've got sellers that want to use 2019 EBITDAs. And of course, we as a buyer need to understand the structural changes going forward and the future value of the cash flows that come from that.
Conversely, if we're looking at things that we're looking to acquire that could be technologies that are helpful in a pandemic, You've got seller expectations of breakout EBITDA margins. And again, you got to go back and structure look at those for future cash flows. But and then due diligence, a little bit tougher because most of that is, of course, remote now and that's not the best way to do the diligence. So other than that, it doesn't really change the long term view toward M and A or transformational M and A. And just a follow-up question, sort of thinking about key verticals and specifically offices and institutional, What are the conversations like with your customers about their ability to actually fund sort of the upgrades or even fund normal activity into next year.
Have you had those specific conversations? Yes, we have, Andrew. This is Dave. And obviously, it depends on the customer, but that's why we've really developed this whole layered approach in our audits. And we work with our customers to really say, here's your day one opportunity to make your building healthy as it can be right now.
And then we give them options to improve going forward. And some of that is I'll give you a real example. We had a customer the other day that wanted to dramatically improve their fresh air exchanges, right, which makes sense from an indoor air quality standpoint. Unfortunately, the way that building was let's get this level today let's get this level today, let's put a PO in the system for additional cooling capacity, we'll deliver that Thank you.
Thank you.
Your next question comes from John Walsh with Credit Suisse. Your line is open.
Hi, thank you for squeezing me in here. Appreciate it and good morning to everyone.
Good morning, John.
Good morning, John.
I guess just two really quick ones. We took a stab at trying to actually size the indoor air quality TAM for education, we came up with $3,000,000,000 on public disclosures that are out there. We took some liberty scaling that up to a number north of $30,000,000,000 for the entire opportunity. Are we in the right ballpark? As you're looking at it today, I appreciate you don't want to put a dollar number on it, but does that sound right
to you? Yes, John. I'll tell you the first thing, when you talk about 1,700,000,000,000 square feet of indoor space and 400,000,000,000 square feet of non residential space, the answer has got to do something in the Bs, right? So I don't think you're off. It's just a matter of how does that play out.
And my notion on this is a holistic layered approach mitigating and then offering solutions to improve going forward based on economic capacity of somebody to go undertake some of these initiatives is probably a very long term tailwind and a different way to think about space going forward. So it's probably not the size of the market that would be the question. It would be the timing, which in my view, it's going to be embedded in the growth rate for a very long time. How big is that growth rate? We still don't know.
We need to get more experience here as we go through this with our customers.
Great. And it's a question we get and you're actually talking to the customers, so I would love to get your perspective. But once we eventually get a vaccine announcement, do you think that actually slows any of this investment down?
I don't, because it's a vaccine for this virus, right? I mean, it needs to be a vaccine for any virus. And frankly, the reality around future pandemics, I think, is great. And the fact that people do want to have the surety peace of mind around indoor air quality, I don't think it changes. I think it helps open the economy.
And I think that that has positive benefit. But I don't think it's going to really change how people think about preparation. Just like generally, we used to think about hurricanes, right, hitting Puerto Rico and the Gulf and how we've prepared for those things and how we prepared for the aftermath of those things, both from a business continuity perspective, but from a health and welfare of our people perspective. A pandemic, which is something that we had planned for overall health and wellness. So we really, from a business continuity perspective, learned a lot about dealing with the pandemic.
So I have to imagine our playbooks are going to change for these pandemics and those playbooks for all customers are going to relate to the health of their space. Restaurant is able to stay open because they put in all these mitigating factors where transmission rates and canines are lower because we've done that all factored into a healthier economy when in fact we have the next crisis.
This concludes the Q and A portion of today's call. I will now turn the call back over to Zachary Nagel for closing remarks.
Good morning. Thank you everyone for joining the call today. Shin and I will be available as always for questions today and then obviously over the coming days weeks. And please mark your calendars for December 14 for our investor briefing. We'll do a deeper dive on Trane Technologies' transformation.
And that will be on the 14th with more details to follow. Thank you again, and have a great day.
Ladies and gentlemen, this concludes today's conference call. Thank you for joining. You may now disconnect.