Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International Third Quarter Conference Call. At the request of your host, all lines are currently in a listen-only mode. There will be a question-and-answer session at the end of the presentation. As a reminder, this call is being recorded. I would now like to turn the conference over to Steve Harrison, Vice President of Investor Relations. Please go ahead.

Good morning. Thank you for joining us for this review of Lennox International's financial performance for the third quarter of 2021. I'm here today with Chairman and CEO, Todd Bluedorn; and CFO, Joe Reitmeier. Todd will review key points for the quarter and Joe will take you through the company's financial performance and outlook for 2021. To give everyone time to ask questions during the Q&A, please limit yourselves to a couple of questions or follow-ups and requeue for any additional questions. In the earnings release we issued this morning we have included the necessary reconciliation of the non-GAAP financial measures that will be discussed to GAAP measures. All comparisons mentioned today are against the prior year period. You can find a direct link to the webcast of today's conference call on our website at www.lennoxinternational.com. The webcast will be archived on the site for replay. I would like to remind everyone that in the course of this call, to give you a better understanding of our operations, we will be making certain forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see Lennox International's publicly available filings with the SEC. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Before I turn the call over to Todd, I would like to announce the date of our annual investment community meeting. The event will be held the morning of Wednesday, December 15. The format will be virtual again this year. Please mark your calendars. Invitations and more details will follow. Now, let me turn the call over to Chairman and CEO, Todd Bluedorn.

Thanks, Steve. Good morning, everyone and thank you for joining us. Strong demand continued in the third quarter across all our businesses but global supply chain and COVID-19 disruptions to production and labor availability negatively impacted our financial results, approximately a $75 million impact to revenue and $75 million to operating profit in the quarter. Company revenue was up slightly to a third quarter record of $1.06 billion, with the benefit of strong pricing in the shipment-constrained environment. GAAP operating income was down 3%. GAAP EPS from continuing operations was relatively flat at $3.41 compared to $3.42 in the prior year quarter. Total segment profit was down 7% and total segment margin was down 120 basis points to 15.5%. Adjusted EPS from continuing operations was down 4% to $3.40, including approximately $0.55 of negative impact from the global supply chain and COVID-19 disruptions. Looking at business segment highlights for the third quarter. Residential revenue was down 2% and segment profit was down 6%. Segment margin was down 90 basis points to 20.3%. Residential revenue from replacement business is down mid-single digits. Revenue from new construction was up low-double digits. Lennox brand revenue was down low-single digits, and revenue from Allied and our other brands were up low-single digits. Market demand remains high entering the fourth quarter, and we remain bullish on the residential market as we look ahead to 2022 in the coming years. More people continue to work from home and run our HVAC systems than before the pandemic. With global warming, the hotter weather we are seeing has an exponential impact on reducing the life of cooling systems. And there are more complete HVAC system sales taking place with old R-22 refrigerant systems in replacement windows. This is driven by the EPA ban on the sale and distribution of equipment using R-22 refrigerant effective January 1, 2010, and the ban of the production or import of R-22 refrigerant effective January 1, 2020. While R-22 refrigerant is still available in the market, it's significantly more expensive than 410A. In many cases, it's cheaper to replace with a new 410A system, which is also more efficient and comes with a new warranty than to repair the old R-22 system. From 2005 to 2010, 60% of air conditioners and heat pumps sold were R-22. The need to replace these has a meaningful benefit to residential growth. We expect these dynamics to lead to strong residential market conditions for the years ahead. In addition, Lennox and Allied will be running a proven playbook for market share gains. Moving to our Commercial business; third quarter revenue was up 2%. Commercial profit was down 42%. The segment margin declined 800 basis points to 10.7%. On top of supply chain shortages and bottlenecks disrupting production, our Arkansas factory was hit the hardest by COVID-19 in the quarter and labor availability was a significant issue. At constant currency, commercial equipment revenue was down low-single digits in the quarter. Within this, replacement revenue was up low-single digits with planned replacement up more than 20%, and emergency replacement down more than 30%. New construction revenue was down mid-single digits. Breaking out revenue another way, regional and local business revenue was down high-single digits. National account equipment revenue was up high-single digits. The team won two national account equipment customers in the third quarter to total 11 year-to-date. On the service side, Lennox National Account Service revenue was up mid-teens. VRF revenue was up more than 30%. In Refrigeration for the third quarter, revenue was up 10%. North America revenue was up more than 20%. Europe Refrigeration revenue was relatively flat, and Europe HVAC revenue was down mid-single digits. Refrigeration segment profit was up 12% as margin expanded 20 basis points to 10.6%. Looking ahead for both our Refrigeration and Commercial businesses, demand remained strong. Backlog is up approximately 60% for Refrigeration and 90% for Commercial, and order rates continue to be strong. Demand is clearly not an issue. But as we look at the fourth quarter, we continue to expect a material impact to production from supply chain shortages and bottlenecks. We currently expect a similar negative financial impact to our business as we saw in the third quarter, approximately $75 million of revenue and $25 million of operating profit. We continue to see broad inflationary pressures, including for commodities and components, but we have enacted three rounds of price increases this year. The latest one was just on September 1 with a focus on staying ahead of inflation. The company yielded 4% price overall in the third quarter, including 5% in Residential. In addition to the carryover benefit next year from our June and September price increases, we're announcing additional price increases heading into 2022. Our Refrigeration business has announced a price increase of 8% in North America effective for December 1. Likewise, our European business has recently announced another round of increases generally from 5% to 10% to drive price in 2022. Our Commercial business has announced a price increase of up to 13% effective January 1, and our Residential business will be announcing another round of price increases in November to be effective heading into 2022. For 2021, we are narrowing our revenue and EPS guidance for the year. We are narrowing 2021 guidance for revenue from 12% to 16% to a new range of 13% to 15%. Foreign exchange is still expected to be a 1% favorable to revenue. We are narrowing 2021 guidance for adjusted EPS from continuing operations from $12.10 to $12.70 to a new range of $12.10 to $12.30. Our free cash flow guidance remains $400 million for the year. As the company continues to battle through the disruptions to production from the global supply chain in COVID-19, we are also positioning the company for the future. It's too early to set guidance for 2022, but as we think about next year, we expect strong pricing power to continue. The company yielded 4% in the third quarter which had just one month of benefit from the third price increase this year. For 2022, we'll have carry over price benefit from our June and September 2021 price increase. We have announced additional price increases next year with a strong price benefit to offset commodity headwinds next year. Looking at market drivers and our strong backlog position and order HVAC Residential, Commercial unitary refrigeration up in 2022, as we get more and more of the supply disruptions behind us, we expect to return to strong growth and profitability as we capitalize on market opportunities. Now, let me turn it over to Joe.

Thank you, Todd, and good morning, everyone. I will share some additional insights and financial information about the business segments for the quarter, beginning with Residential Heating & Cooling. In the third quarter, revenue from Residential Heating & Cooling reached $711 million, a decrease of 2%. Volume fell by 6%, while prices increased by 5%, and the mix declined by 1%, with foreign exchange having no impact on revenue. The profit for the residential segment was $144 million, down 6%, and the segment margin stood at 20.3%, down 90 basis points. This decline in profit was mainly due to reduced volume caused by global supply chain issues and COVID-19 disruptions affecting production, along with factory inefficiencies, unfavorable product mix, and higher costs for materials, freight, distribution, tariffs, and other expenses, though there were some offsets from favorable pricing and a reduction in selling, general, and administrative expenses. Now, moving on to the Commercial Heating & Cooling business, revenue in the third quarter rose by 2% to $212 million. Volume was down 6%, prices increased by 1%, and the mix went up by 6%, with foreign exchange contributing positively by 1% to the revenue. The profit for the commercial segment was $23 million, a decrease of 42%, with a segment margin of 10.7%, down by 800 basis points. This profit decline was largely due to reduced volume from global supply chain disruptions and factory inefficiencies, as well as higher costs for materials, freight, distribution, tariffs, and other expenses, although there were benefits from favorable pricing and mix. In Refrigeration, we saw revenue of $137 million, an increase of 10%. Volume went up by 9%, prices increased by 2%, and the mix dipped by 1%, with foreign exchange having no effect on revenue. The Refrigeration segment profit was $15 million, which is up 12%, and the segment margin reached 10.6%, up by 20 basis points. Nonetheless, global supply chain and COVID-19 production issues constrained both revenue and profit growth there as well. The segment profit was adversely affected by factory inefficiencies and rising costs for materials, freight, and SG&A, but positively influenced by higher volume and better pricing. Regarding special items for the quarter, we had a net after-tax benefit of $0.5 million, consisting of a $2.7 million benefit from excess tax benefits related to share-based compensation and a net charge of $2.4 million for various items not included in segment profit, including costs for personal protective equipment and facility cleaning due to COVID-19, along with a net benefit of $0.2 million for other items. Corporate Expenses amounted to $16 million this quarter, down from $28 million in the same quarter last year, mainly due to lower incentive compensation. Overall, selling, general and administrative expenses totaled $134 million compared to $152 million in the previous year quarter, and as a percentage of revenue, SG&A declined to 12.7% from 14.4%. In the third quarter, cash from operations was $222 million, down from $440 million in the previous year quarter. Capital expenditures were $23 million, compared to about $12 million in the prior quarter. Free cash flow was $199 million, down from $428 million in the year-ago quarter. The company distributed $34 million in dividends and repurchased $200 million of stock during the quarter. Total debt stood at $1.28 billion at the end of the third quarter, resulting in a debt-to-EBITDA ratio of 1.8. Cash, cash equivalents, and short-term investments amounted to $44 million at the end of the third quarter. Now, before we enter the Q&A session, I will go over current market assumptions and guidance for 2021. We still anticipate low double-digit shipment growth in the North American Residential and Commercial HVAC and Refrigeration markets for the full year. For our company, we are narrowing our guidance for 2021 revenue growth from a range of 12% to 16% to a new range of 13% to 15%, and we continue to expect a 1% positive impact on revenue from foreign exchange. We are also refining our guidance for 2021 GAAP EPS from continuing operations from $11.97 to $12.57 to a new range of $11.97 to $12.17. And we are adjusting our 2021 guidance for adjusted EPS from continuing operations from $12.10 to $12.70 to a new range of $12.10 to $12.30. As previously mentioned, the fourth quarter of 2021 will experience a 6% headwind due to fewer days compared to the prior year quarter. The first quarter of 2021 had a corresponding 6% benefit from more days than in the previous year quarter. For 2022, there will be no difference in days. Now, I would like to highlight key points of our guidance assumptions, both changes and consistencies for 2021. Firstly, we expect a benefit of $130 million from pricing for the year, an increase from the previous guidance of $110 million. However, due to ongoing inflation in components, we are reducing our expected net savings from sourcing and engineering-led cost reduction to neutral, down from an anticipated $5 million benefit. We now estimate LIFO accounting adjustments to be about $20 million this year, up from earlier guidance of $15 million because of rising material costs from inflation. Approximately 40% of that impact was felt in the third quarter, and we expect another 40% in the fourth quarter. Factory productivity is now forecasted to represent a $10 million headwind, a change from previous guidance predicting it as a $10 million benefit. The residential mix is shifting from a $10 million headwind to a $10 million headwind from a $10 million benefit, while corporate expenses are expected to reach $95 million, down from the prior expectation of $100 million due to lower incentive compensation. Overall, SG&A is now anticipated to be around a $40 million headwind, revised from the previous $45 million. Within SG&A, we are still prioritizing investments in research and development and IT for ongoing innovation and leadership in products, controls, e-commerce, factory automation, and productivity. As for unchanged headwinds from prior guidance, commodities are expected to maintain an $80 million headwind, freight a $5 million headwind, and tariffs also a $5 million headwind. Other guidance items remain consistent: foreign exchange is still anticipated to provide a $10 million benefit; net interest and pension expenses are expected to be around $35 million; the effective tax rate on an adjusted basis for the full year remains at about 20%; and anticipated capital expenditures are still around $135 million, with approximately $30 million allocated for the third plant at our Saltillo, Mexico campus, which is scheduled to finish by the end of 2021. Pilot runs of the initial products started in mid-October, and we plan to commence initial production before the end of 2021, ramping up to full production by mid-2022, with an expected annual saving of nearly $10 million from that third plant. We are targeting free cash flow to be approximately $400 million for the full year. In the third quarter, we repurchased $200 million of stock as part of our $600 million target for the year, and the guidance for our weighted average diluted share count for the full year remains between 37 million to 38 million shares. With that, operator, let's proceed to the Q&A.

First from the line of Julian Mitchell with Barclays. Please go ahead.

Thanks. Good morning. Maybe just wanted to understand from you how you're thinking about sort of the pace of the catch-up here from some of these issues, the $0.55 headwind in Q3, similar in Q4. How quickly can Lennox sort of come back from these headwinds when you're thinking about aspects like market share recapture, getting those plant inefficiencies down into 2022?

Yes. Let me break that down and address your question, as it is very relevant right now. When we analyze AHRI data through August this year, our market share is largely flat. Others seem to be experiencing challenges as well. Watsco did report a higher number, but their main focus is on top distributors. When looking at the top 80% of dealers and distributors, they are performing well; it's the 20% or 30% that are struggling significantly. In terms of market share, we feel we are doing reasonably well, possibly slightly better than average. We will see how other companies report their results. Regarding the timing of overcoming these challenges, we are making strong progress on both the impacts of COVID and the supply chain. Conditions are improving. However, financially, the fourth quarter appears similar to the third quarter due to costs being recorded on the balance sheet until sold, leading to absorption and overtime effects being visible. On the revenue side, we finished the quarter with less inventory than needed. That said, production line rates are showing good improvements. To delve deeper, around 65% to 70% of our challenges stem from supply chain issues, with the remainder related to COVID. Specifically about COVID, we have seen unplanned absenteeism in our Southern factory locations double due to the virus. Fortunately, the Delta variant seems to have peaked in our factories, and we believe that the worst of it is behind us for now. Regarding supply chain issues, we are facing challenges with components like integrated circuits, which are essential for motors and compressors, as well as basic materials like corrugated cardboard and pallets. We have been proactive in addressing these challenges by securing a year’s worth of inventory for critical components to safeguard our operations. We are also requalifying parts with suppliers and deploying focused teams in essential factories to ensure we meet our needs. While the news isn't ideal, from a competitive perspective, we currently believe we are not losing much ground. Other companies appear to be in comparable situations, though we are still awaiting the publication of all OEM figures. Based on the AHRI share data, we believe that we have largely put COVID behind us, and while challenges in the supply chain remain, conditions are improving compared to a month or two ago. We will continue to see some financial impacts into Q4.

That's really helpful, Todd. And maybe just one follow-up on residential market demand. You emphasized your bullishness on the market trend there as you look at 2022. The volumes in Lennox Residential, I think, were down about 6% year-on-year, Joe had said, in Q3. Are you sort of thinking that, yes, there's some noise in there from sort of inventory absorption and supply chain, and so that’s sort of flat-to-down slightly is a good sort of placeholder year-on-year for the next couple of quarters? And then as you go through 2022, momentum sort of year-on-year on volumes reaccelerate?

I think high level, it is yes, but let me put it in my own words which I think will be constructive to your question. If you adjust for the volume miss that we have because of production, our Lennox Residential revenue is up 2%, 3%, 4%. And I think compared against the very tough third quarter comp that we had from last year that people were really intimidated by, including us, quite frankly, I think would have been a very nice performance. And then I lay on top of that all the things you've heard me talk about around the units running longer, that R-22 systems 60% from 2005 to 2010, and the system sales kick in and the fact that it just continues to be warmer summer. So, I still feel as we've talked about, bullish about the market.

Hey, good morning, everyone. Todd, maybe you can jump into this mix shift. I think you swung at $20 million on the guide. Is that what people are buying or is that tied to the supply chain and COVID issues?

It's related to COVID challenges. We discussed how new construction in the residential sector increased while replacement work decreased. There are a couple of reasons for this: one is supply issues, and the other is that we focused on protecting our major builders for clear reasons, which influenced the outcome. On the supply side, our facility in Saltillo, Mexico, has been the most resilient in dealing with both COVID and supply chain challenges for various reasons, and it produces a lower variety of product categories. We could have had a more diverse mix if we had produced more from Iowa rather than South Carolina or Mississippi.

Okay. It seems the COVID situation is improving, though there may be a resurgence in the future. Regarding the supply chain, do you believe it will continue to improve into 2022? You mentioned improvements, but when do you expect things to return to normal?

I'm not sure that's the complete truth. From my perspective, when I meet with the businesses and review the supply chain, I can see that things have improved compared to last month. It's significantly better than it was two months ago and much better than three months ago. We're starting to resolve issues around integrated circuits because we are purchasing them as soon as we find them, and we have ample inventory to support us. However, I believe we are still close enough to 2022 to see that supply chain challenges in corporate America and industrial sectors are not completely resolved. Yes, we are expecting a significant price increase. As mentioned during the call, we achieved a 4% increase in Q3, with residential prices rising 5%, and our full-year guidance is set at $130 million. If you do the calculations, up until Q3, we've seen an increase of about $70 million, indicating that we anticipate over a 6% price increase at the corporation in the fourth quarter. This quarter is expected to be our best run rate. Furthermore, considering the price increases from the second, third, and fourth quarters, we should see a substantial carry-over heading into next year.

Next, we'll go to Jeff Sprague with Vertical Research Partners. Please go ahead.

Hey, thank you. Good morning, everyone. Todd, can you just pick up on price a little bit more? So it sounds like we should expect a normal kind of December-ish, January-ish bump of some reasonable magnitude also.

Yes, what we aimed to communicate during the call was that we have already announced a Commercial price increase of up to 13% effective January 1. The residential team is finalizing their plans, likely wanting to announce on their own, but we will be releasing a similar announcement for residential also effective January 1. Additionally, Refrigeration pricing increases were already implemented in both Europe and the U.S. in December. So, there is another increase taking effect at the end of the year. Yes. I think it's as is. I mean the search is ongoing; the Board's fully into it. And when we have something to say, we'll announce it, I think, is the long and short of it.

Hey, thanks. So first off, when do you expect to shift the $150 million of pushed res? And was the majority in commercial? Or what's the rough split?

I'll answer the second part of the question. In the third quarter, it was more Commercial than Residential, and the fourth quarter will be more Residential than Commercial. The split is approximately 60-40, with the third quarter being 60% Commercial and 40% Residential. In the next quarter, it will be the opposite. What was the first part of the question regarding when we're going to ship it? Yes. In the fourth quarter, we are seeing a shift as a backlog from the third quarter is carried over. When the AHRI data is released, it will indicate that third and fourth quarters are likely to show relatively flat to declining unit sales across the industry. This is due to ongoing production challenges we've been experiencing, and we're nearing the end of the season. While some demand is being met by Watsco and others, generally, long lead times for HVAC or air conditioning installations from local dealers are causing many customers to postpone replacements until the summer season in various regions of the country. However, this trend may not apply to places like Phoenix or Miami. I believe that as we head into 2022, production will improve and we will enter a strong summer selling season.

Yes. That makes sense. Okay. And then for my follow-up, you hit on this a little, Todd, but can you talk about the newer strategies you're implementing to offset the supply issues in COVID? And is there a timeline you can share for when the company is going to see improvements from initiatives?

I think the timeline was a month ago. We are already seeing significant improvements from our initiatives. It takes some time for everything to reflect in the profit and loss statements. I would say the peak of disruption in our business was in August and early September, and we have now moved past that peak. We're managing what feels like tens of millions of dollars in inventory of integrated circuits, buying a year and a half's worth of this inventory. Our engineering team is focused on qualifying new suppliers, and we are spending considerable time with key suppliers. The major issues seem to be behind us, but it's still a bumpy ride as we navigate challenges. When our motor suppliers contact us about issues, we need to address them promptly, and we have received such calls. There have been shortages that surprised me, like with pallets, and we have managed those as well. Financially, I know I’m repeating myself, but the outlook for Q4 remains challenging due to this issue. However, operationally, we are in a much better position. It just takes time for the costs captured in inventory to work their way through the system.

Hey, good morning guys. Todd, just to kind of pick up that last comment on some of the good work's already been done and it's just a matter of time. I mean, I guess maybe specifically in commercial, not to get ahead of ourselves on '22 guidance but can margins start to kind of flatten out or go up on a year-over-year basis in the first half next year? Or do we need to kind of fully lap annually some of these dynamics before stuff gets better?

I'll be honest with you, Josh, I'm not trying to be evasive. I can't visualize the specifics right now. However, I'll mention that we experienced a drop of 800 basis points in the quarter, which is an anomaly and we will recover. What I do know is that for the full year, we anticipate an increase in commercial margins next year compared to this year.

Got it. That's helpful. And then on the refrigerant dynamic that you talked about in residential, I think you're one of the only OEMs out there that's sort of pointing to that as a specific driver, Watsco included, hasn't really noticed that per se. But anything that you can sort of put around that number-wise that's kind of driving that delta to the consumer? And maybe as kind of a side point, I remember like 10 years ago, recycling was supposed to be a big thing. Like why hasn't that kind of stepped in to fill in some of the supply or shortages there?

I believe Watsco is addressing this issue as well, and those familiar with the business are aware of it. For example, if you have an 8,000 square foot home and are installing a 5-ton air conditioning unit, the cost of refrigerant will vary significantly. For an R-22 unit, the refrigerant charge of about 3 pounds per ton would cost around $2,300, which breaks down to about $153 per ton. In contrast, for a 410A unit, the refrigerant cost is about $1,100, or $70 per ton. This difference amounts to about $1,000 for recharging a 5-ton unit. If I have a leaking unit with a bad coil, I might be told it will cost $2,200 to refill the refrigerant, in addition to labor, or I could buy a new system for $5,000, which includes a $1,000 refrigerant charge, a 10-year warranty, and better efficiency. These discussions are happening, and dealers are very skilled at navigating them. While recycling is an option, it ultimately comes down to supply and demand. The price of R-22 has surged and is likely to continue rising.

Hi, good morning, Todd. Good morning, Jeff. Thanks for taking my question. First one, just looking at the fourth quarter and the guidance for organic sales. It looks flattish in terms of the year-over-year and I think you said price is about 6% and then you have a days sales impact which pulls down the revenue by 6%. I guess I'm coming at it and looking at it, I guess you're assuming flattish on volume on a selling days adjusted basis, that is. And my question really is what's your visibility to kind of improving that volume growth rate in the fourth quarter versus what it looked like was kind of low to mid-single-digit decline on volume in the third quarter. It just seems like from your comments, you're not really embedding improvement from like the disruptions from COVID and supply chain. So maybe it's availability related to furnaces versus AC or something like that. I'm just kind of curious if you could give some color on that.

I believe it's related to what I mentioned earlier. We are nearly a month into the quarter and started off with low inventory. My comments were focused on our production capabilities, which are significantly better now than they were a month ago and even more so compared to two or three months back. The guidance is to provide direction, but we are addressing the production challenges we faced.

Good morning. Thanks for taking my question. Todd, it sounds like the pricing environment is still rather constructive. So I'm just curious. Is there any sign of that momentum diminishing? Is there any lack of discipline among the players in the industry? And what's your confidence level that you can keep price cost neutral into 2022?

Yes, it still looks positive. That's quite an understatement, Tommy. I mentioned earlier that our prices are expected to rise over 6%. That's certainly more than just positive. To answer your question, we are actively increasing our prices. Despite starting the year with some challenges, we anticipate generating $130 million from price increases. This includes $80 million from commodities, $15 million from LIFO, $5 million from freight, and another $5 million from tariffs, totaling $105 million. This means we are effectively countering the inflationary pressures this year and expect even better performance next year.

Thanks. Good morning, everyone. So maybe just parsing out those price cost comments just a little further, Todd. So you mentioned the six points in the fourth quarter. I mean, should we be thinking about that as kind of like a run rate then into the next maybe the first half of 2022? And obviously, like those cost curves are starting to come down. So at what point do you think you start to get the benefit of that spread widening into next year?

I believe the cost curves are decreasing more than I expected. While steel prices remain quite high, copper and aluminum have seen slight decreases. Currently, steel is where we're most vulnerable as we transition away from larger copper coils. It may take some time to adjust. Considering the carryforward and timing factors this year, we anticipate that commodities will still increase, and we are preparing for that in our cost structure. We hedge and purchase steel based on various formats, including prior quarter CRU pricing, which leads us to expect significant year-over-year commodity price increases next year. That's why we implemented a substantial price increase at the end of the year. We will face challenges again next year, but we are confident that we can counterbalance them with pricing. To address your question, the price increases from last year occurred in the beginning of the year and continued into the second, third, and fourth quarters. Therefore, we expect a favorable momentum in the first half of next year.

Hey, thanks. Good morning, guys. Nobody asked about IAQ, so I figure I might as well. Can you comment on what you're seeing in terms of inquiries? How big it is maybe in the Commercial business?

Yes. I mean it still remains important but I'll be honest with you. I mean, it sort of gets pushed a little bit to the side, given the other issues that we have and how we're taking care of customers and how we're prioritizing customers. So the biggest market for us is probably schools and low-rise office buildings, and inquiries are still strong and residential is still an important part. But as you know, I've been a little less bullish than others. So when I think about our opportunities going into 2022, I mean we'll drive and we're focused on it but some of these other issues are obviously much more important. Yes. We're continuing to invest heavily in strategic areas at the corporate level and for sales and marketing, research and development, information technology, we are still confident about our long-term growth trajectory, our strong consumer brand awareness, and the significant potential in the clean air and comfort markets.

Yes, I was mute. Good morning, everyone. When we discuss the improving conditions in the supply chain, are we primarily referring to labor availability and productivity in the factory, or is it about labor and the supply of compressors? Additionally, regarding the commercial impacts on replacements, is that related to VRF imports from Medea, or is it a different issue?

I'll answer it maybe in reverse order. VRF was up in the quarter, so we weren't really impacted much there. But the emergency replacement was clearly impacted by availability because we were protecting our large national accounts. I mean we had to protect our existing customers before we went after new contractor business replacement. What was the first part of the question, Nigel?

Yes, has labor improved for you, or is it something else?

Yes, the issues we faced with unplanned absenteeism due to COVID are largely behind us now. The COVID case numbers in the Southern states, as shown in the New York Times, indicate significant decreases in regions like Arkansas, South Carolina, and Mississippi, which we've also observed in our factories. While we still encounter some supply chain challenges, the situation has improved considerably compared to two or three months ago. Our order inventory positions for critical components and investments in qualified new suppliers have contributed to this progress. Additionally, the supply chain itself appears to be recovering, even without our interventions.

Hi, good morning. Just wanted to come at the cost side of price cost a little differently here. Obviously, this year, demand has been, I think, better for the market than folks expected. So we've heard there might have been a little bit more spot buying of some of the commodities. Just curious if you would characterize this year as unusual on how much you buy in the spot market. I'm just thinking about next year, what you might have on hedged in terms of commodities versus what you had on hedged this year in terms of commodities?

I believe I understand your question. I'll touch on it while also discussing other related areas. Inflationary pressures have indeed impacted us, especially in terms of buying on the spot market. Looking ahead, we anticipate that commodities will remain significantly elevated next year. Additionally, inflation has affected us in a way we don’t often mention: our typical material cost reductions of $20 million to $30 million annually are closer to breakeven this year. This isn't due to a lack of cost reduction efforts; rather, suppliers are passing on price increases to us for materials containing steel and aluminum. As we enter next year, we won’t see our usual material cost reductions, but we’re countering this with price adjustments, which is why we expect higher prices by the end of this year. To wrap up, we're battling through supply chain disruptions today but also positioning the company for the future. We carry strong pricing power into 2022 to offset inflationary pressure. Looking at market drivers and our strong backlog position and order rates, we see residential, commercial, unitary, and refrigeration markets up in 2022. To get more and more of the supply chain disruptions behind us, we expect to return to strong growth and profitability as we capitalize on market opportunities. I want to thank everyone for joining us today.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.