Ingersoll Rand Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
August 3, 2022

There are 13 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Ingersoll Rand Second Quarter 2022 Earnings Call. Our host for today's call is Matthew Forte, Vice President of Investor Relations. At this time, All participants will be in a listen only mode. Later, we will conduct a question and answer session. I would now like to turn the call over to your host, Mr.

Operator

Fort, you may begin, sir.

Speaker 1

Thank you, and welcome to the Ingersoll Rand 2022 Second Quarter Earnings Call. I'm Matthew Forte, Vice President of Investor Relations. And joining me this morning are Vicente Reynal, Chairman and CEO and Vic Kinney, Chief Financial Officer. We issued our earnings release and presentation yesterday, and we will reference these during the call. Both are available on the Investor Relations section of our website, www.irco.com.

Speaker 1

In addition, a replay of this conference call will be available later today. Before we start, I want to remind everyone that certain statements on this call are forward looking in nature and are subject to the risks and uncertainties discussed in our previous SEC filings, which you should read in conjunction with the information provided on this call. Please review the forward looking statements on Slide 2 for more details. In addition, in today's remarks, we will refer to certain non GAAP financial measures. You can find a reconciliation of these measures To the most comparable measure calculated and presented in accordance with GAAP in our slide presentation and in our earnings release, both of which are available on the Investor Relations section of our website.

Speaker 1

On today's call, we will provide a strategy update, review our company and segment financial highlights and provide an update to 2022 guidance. For today's Q and A session, we ask that each caller keep to one question and one follow-up to allow time for other participants. At this time, I'll turn the call over to Vicente.

Speaker 2

Thanks, Matthew, and good morning to everyone. Moving to Slide 3, I would like to start by welcoming Matthew to his new role as the Head of Investor Relations After several successful years leading our power tools and lifting business as a finance leader and helping to return the business In addition, I am also very happy to welcome Catherine Freytag as our new Chief Information Officer. Those appointments demonstrate the deep bench of talent that we continue to develop at Ingersoll Rand. I would also like to say thank you to our employees worldwide for exemplifying our purpose through an ownership mindset and entrepreneurial spirit and delivering on our customer needs. Our teams continue to impress me on how we're leveraging our own IRX process To outperform in the most challenging macro environments, our performance in the Q2 year to date exemplifies how our employees think and act like owners.

Speaker 2

Demand remains very strong as we sit here today. And when we see the supply chain risk and geopolitical and macroeconomic uncertainties Continued to be a concern, we stay focused on what we can control while leveraging our strong balance sheet and operational mindset to deliver on our own 2022 commitments and beyond. We also remain very agile in this environment And you will see today how we continue to accelerate organic investments for growth around innovation and demand generation. We also remain committed Our capital allocation strategy that is very focused on inorganic growth through bolt on acquisitions and today we're highlighting 3 new acquisitions that are very well aligned with our stated M and A strategy and will enhance the quality of our portfolio. Turning on Slide 4, Staying true to our 5 strategic imperatives where operate sustainably is at the center, we continue to align our portfolio to sustainable high growth end markets supported by global megatrends.

Speaker 2

There are 4 points I would like to briefly highlight on this page. First is that we have a simple 2 pronged approach of growing sustainably and operating sustainably. 2nd, we released our 2021 Sustainability Report in June, highlighting our progress across all aspects of our sustainability journey and how we continue to remain on track to hit our 2,030 targets. 3rd, our efforts have resulted in another upgrade from MSCI to AA from A, which puts us in the upper quartile of our peer group. It is also worth noting that we now have moved from a BB Rating to a AA rating in less than 2.5 years.

Speaker 2

And this recent upgrade was done before the release of our 2021 Sustainability Report, So we will be watching carefully and we will expect to see continued positive momentum in our ratings from the other sustainability rating agencies. Last, I want to remind everyone to save the date for our annual sustainability webcast on September 22, where we will provide a comprehensive update on our current efforts around sustainability. Moving to Slide 5, we want to highlight today An exciting innovation, which is a testament to our commitment to sustainability and organic growth through differentiated technology. Later this year, we will officially launch this first of its kind water treatment system called Ion Solutions. This is a very compact solution in the box where a small compressor and liquid pump technology from Angus OR Rand are combined with our own patented cold plasma technology to produce nanobubbles that contain a high concentration of oxygen.

Speaker 2

This innovation allows for chemical free disinfection and enhanced oxygenation of water. You can see some of the incredible benefits this technology produces on the slide, including higher disinfection efficacy and increased oxygen concentration all while delivering and driving a lower total cost of ownership and footprint. We're officially launching this product later this year for indoor farming as well as water disinfection applications, And we will continue to expand our reach into other high growth sustainable end markets like medical, food and pharma. What excites me even more is the speed in which the team has moved to develop and commercialize the ION solutions technology Through the utilization of the Ingersoll Rand Execution Excellence or IRS, the team moved from the acquisition of the technology and IP behind Ion Solutions to the launch of the product in less than 15 months. In addition, the development was self funded within the PSC segment, and we continue to increase our investments in R and D to drive future organic growth opportunities like this.

Speaker 2

Turning to Slide 6, we're also very pleased to highlight the most recent inorganic investments, which remain our top priority The funnel remains over 5 times larger than it was in Q2 of 2020. Earlier this week, we announced the Signing of 3 bolt on acquisitions, which are well aligned with our strategic and financial criteria. In addition, These three companies have grown on an aggregate at more than 20% CAGR over the past 3 years. Let me quickly walk through the signed deals. First, Hopic, which is a leading provider of on-site systems that generate high purity nitrogen gas.

Speaker 2

This is a great example of a bolt on acquisition that extends our addressable market to very close adjacencies within the ICL business. In this case, the nitrogen generation can be connected to a compressor and produce nitrogen on-site. And there are huge benefits for these, including The elimination of large nitrogen storage tanks at a customer site, which typically also requires frequent refilling via trucks. In addition, the purity and quality of the gas can be much better controlled on-site with a drastic reduction in cost. 2nd is Hanye, which is a manufacturer of dryer technology that has served as a long term OEM partner of our ICS Asia Pacific business.

Speaker 2

Hanie brings differentiated and patented technologies to our China compressor business. Both Holtec and Hanie are great examples of expanding our solutions and offerings in the broader compressor ecosystem to better serve our customer needs And finally, Hydro ProCast, an India based manufacturer of progressive cavity ponds and retrofit spare parts. 5 year old ProCast generates more than 80% of its revenues through the sale of aftermarket parts and serves as a complementary addition to the recent As illustrated by the single digit aggregate pre synergy adjusted EBITDA purchase multiples for these three deals. In addition, we expect to have several more bolt on acquisitions to announce in the second half of the year as shown by the fact that we have 8 Additional deals under LOIs. As a result, we're confident on being able to reaffirm our stated target of 400 to I will now turn the presentation over to Vic to provide an update on our Q2 financial performance.

Speaker 1

Thanks, Vicente. Moving to Slide 7, we continue to be encouraged by the performance of the company in Q2. We saw a strong balance of commercial and operational execution fueled by IRX, demonstrating our ability to operate in a very agile manner In the current environment, we remain on track to deliver on our $300,000,000 commitment in cost synergies from the merger. In addition, as we have indicated many times, we have a funnel that stands in excess of $350,000,000 and we are ready to take incremental actions if warranted by macroeconomic conditions and market activity. Total company orders and revenue increased 10% 13% year over year respectively, driven by strong double digit organic orders growth in ITS and low single digit organic growth in PST orders.

Speaker 1

The company delivered 2nd quarter adjusted EBITDA of $335,000,000 a 15% year over year improvement Adjusted EBITDA margins of 23.3 percent, a 50 basis point year over year improvement and 60 basis point improvement sequentially from Q1. Free cash flow for the quarter was $165,000,000 despite ongoing headwinds from inventory due to the global supply chain as well as the need to support backlog. Total liquidity of $2,400,000,000 at quarter end was down approximately $700,000,000 from prior quarter, driven primarily by the execution of our capital structure strategy, which we will discuss shortly. Our net leverage is 1.1 turns, a slight improvement of 0.1 turns from prior quarter. Turning to Slide 8, for the total company, Q2 orders grew 15% Revenue increased 18% both on an FX adjusted basis.

Speaker 1

Overall, we posted a strong book to bill of 1.11 turns for the quarter. We remain encouraged by the strength of our backlog, which is up over 40% from last year. Total company Adjusted EBITDA increased 15% from the prior year. ITS segment margin increased 70 basis points, while the PST segment margin declined 390 basis points, driven by the impact of prior year acquisitions as well as the impact of investments for growth, such as the Ion solution innovation highlighted by Vicente and the impact of China lockdowns in 2 PST facilities. When adjusted to exclude the impact of M and A completed in 2021, PST margins declined by 190 basis points.

Speaker 1

It's important to note that both segments did remain price cost positive in terms of dollars in the second quarter, which speaks to the nimble actions of our teams by ongoing inflationary headwinds. Finally, corporate costs came in at $35,000,000 for the quarter, down year over year primarily due to lower incentive compensation costs and general cost savings and prudency offsetting incremental investments we made in the area of demand generation and IT. Adjusted EPS for the quarter was up 17% to $0.54 per share. The tax rate for the quarter was 23% and we anticipate the full year being approximately the same. Moving on to the next slide.

Speaker 1

Free cash flow for the quarter was $165,000,000 despite a $92,000,000 increase Inventory to support backlog.

Speaker 2

CapEx during

Speaker 1

the quarter totaled $21,000,000 and leverage for the quarter was 1.1 turns, which was an 0.1 turn improvement versus the prior quarter. Total company liquidity now stands at $2,400,000,000 based on approximately $1,300,000,000 of cash and $1,100,000,000 of availability on our revolving credit facility. Liquidity decreased by $700,000,000 in the quarter, which included deploying $621,000,000 for debt repayment, dollars 153,000,000 to share repurchases and $8,000,000 to our dividend payment. As Ascente mentioned, M and A remains our top priority for our capital allocation. Our funnel remains robust and active and we would expect M and A to be our primary usage of cash here in the second half of the year.

Speaker 1

On Slide 10, we show in more detail the strategic changes we have made to our capital structure. In an effort to create a flexible and efficient capital We took a number of actions within the quarter. First, we paid down the entirety of our euro term loan of $621,000,000 The debt pay down is consistent with our financial policies to prudently manage our growth debt and our commitment towards achieving investment grade credit ratings. We also executed a combination of interest rate swaps, cross currency swaps and interest rate caps to better balance our fixed to floating interest rate ratio and our currency mix of our debt. In addition, strong cash generation of the business along with a strong balance sheet enable us to execute on our growth strategy across all economic conditions.

Speaker 1

I will now turn the call back to Vicente to discuss our segments.

Speaker 2

Thanks, Vic. Turning to Slide 11. Our Industrial Technologies and Service segment delivered Strong organic revenue growth of 14%, including approximately 8% price and 6% volume growth year over year. Adjusted EBITDA rose 13% year over year with an adjusted EBITDA margin of 25.4%, up 70 basis points from prior year with an incremental margin of 32%. Organic orders grew 11% with a strong book to bill of 1.11.

Speaker 2

It is also important to know that on a 2 year stack, the IPS segment's organic Orders grew more than 50%, which is a higher rate than the Q1 2022 2 year stack of approximately 40%, Meaning that thus far, we continue to see accelerated demand for our products. If we move to the individual product categories, Each of the below figures includes the negative impact of FX, which you can see was about 5% headwind across the total segment. Starting with compressors, we saw orders up in the high single digits. A further breakdown shows orders for oil free products grew in the high teens And Oil Lubricated Products grew in the low single digits. The Americas team delivered solid performance with orders in North America up approximately 10%, while Latin America was up low 20s.

Speaker 2

In Mainland Europe, down low single digits due primarily to FX headwinds. And a further look into our leading indicators like demand generation lease shows stable growth in Mainland Europe. Despite yearly 2 months of lockdowns in Shanghai, China, the Asia Pacific team delivered orders in the mid teens. This was driven by low double digit growth in China and mid-20s growth across the rest of Asia Pacific. In vacuums and blowers, orders were down low single digits on a global basis, driven mainly by FX we spoke about before And also a tough comp given we saw mid-40s growth in orders during Q2 of 2021.

Speaker 2

Moving next to the Power Tools and Liftin. The Power Tools and Liftin team delivered strong performance with orders for the business up approximately 20%. And this marks their largest quarter for orders since Q1 of 2015. Looking at the sustainable innovation in action portion of the slide, we're highlighting our next generation oil free compressor. With a patented aerodynamic impeller design, This innovative centrifugal compressor is approximately 15% more efficient than the oil free rotary compressor it will typically replace.

Speaker 2

This technology is a perfect example of how we are continuing to address our customers' sustainability needs and goals by driving productivity through improved efficiency and reduced energy costs, decreasing their Scope 1 and Scope 2 greenhouse gas emissions. Moving to Slide 12, revenue in the Precision and Science Technology segment grew 6% organically. Additionally, the PSC team delivered adjusted EBITDA of 70 $8,000,000 which was up 9% year over year with incremental margins of 11%. Adjusted EBITDA margin was 26.8 down 3.90 basis points year over year. As illustrated on the table in the bottom left side of the page, the decline in adjusted EBITDA margin is driven primarily By the impact of prior year acquisitions, which drove 200 basis points of the decline, in addition, the impact of investments for growth such as our hydrogen business and the Ion Solutions product line that drove 80 basis points of decline and China lockdowns were the other Largest discrete driver has nearly 60 basis points given the impact to 2 China facilities in the PSC segment.

Speaker 2

Organic orders grew up 2% year over year as Q2 comps were challenging due to the prior year COVID related demand primarily in the Thomas Medical business. Adjusting for the COVID and the one time large non repeating orders, normalized organic orders were up approximately 9%. And on a 2 year stack, organic orders were up 22%. It is also important to note that in Q1 of 2022, The 2 year organic stack was approximately 19%, again showing some sequential acceleration of demand into Q2. Since the Investor Day in November, one of the key questions we have been asked is how we expect to achieve the mid-30s EBITDA margin profile for PSC.

Speaker 2

On the bottom right hand side of the page, I want to illustrate why we continue to believe a mid-30s margin is achievable, And we remain committed to delivering that in the medium term. As you can see, 25% of the portfolio is already above 35% EBITDA margins, with another 40% of the portfolio that is around 30% margin. That leaves us with a few targeted businesses that are We at or below 25 percent EBITDA margin with the vast majority related to new acquisitions and early stage innovations. We believe we have significant opportunity for margin expansion across the entire portfolio and we have a proven track record of margin expansion in both newly acquired assets and within our core business. And let me point out to 3 examples.

Speaker 2

The first example is Cipex. It illustrates how we plan to improve businesses that are in the less than 25% EBITDA margin bucket. As you recall, we acquired Cipex in September 2021, which had mid teens EBITDA margin at the time of acquisition and has already improved to the low 20s in less than 2 quarters. The next two examples point out to how we can continue to improve businesses that already has some very high EBITDA margin. First, Herd Dimensions, which was another recently acquired company in Q4 of 2021, which is less than which in less than 2 quarters has gone from mid-50s EBITDA margin to low-60s EBITDA margin.

Speaker 2

And then there is our legacy Gardner Denver Medical segment, which we now call our Thomas business. This is a core business where we have Showed an ability to grow its EBITDA margin from the high 20s in 2018 to the low 30s by 2021 and where it remains today. Overall, we continue to see strong runway on margin expansion across entire PSC portfolio and we will use IRX to ensure proper prioritization of Moving to Slide 13, once again, we're raising our full year guidance. We're raising our organic growth guidance for the total company to 11% to 13%, which is a 300 basis point increase from our prior guidance. The rate comes entirely from our IPS segment.

Speaker 2

The organic growth increase is offset by the negative impact of FX. FX is expected to now contribute headwinds of approximately 5% versus a headwind of 2% in prior guidance. And this leads to a full year 2022 revenue guidance at 11% to 13% total growth. We're also raising the adjusted EBITDA guidance to a range of $1,395,000,000 to $1,425,000,000 We continue to expect free cash flow conversion to adjusted net income to be greater than or equal to 100%. We anticipate our adjusted tax rate to be in the low 20s and CapEx to be approximately 2% of revenue.

Speaker 2

And although we don't provide quarterly guidance, the best way to think about the back half revenue and EBITDA facing is that the distribution between Q3 and Q4 is similar to what we saw in prior year. We expect pricing to improve slightly from the first half to the second half As we continue to work through backlog and we do expect the price cost spread to improve in the second half of the year. As a reminder, the new acquisitions mentioned on the Slide 6 are not included in this guidance as the transactions have not closed. Turning to Slide 14, as we wrap up today's call, I want to reiterate that Ingersoll Rand is in a very strong position. We delivered strong results in the first half of twenty twenty two, including record second quarter performance that was better than our expectations.

Speaker 2

2022 is poised to be a strong year despite known challenges and dynamic market conditions. We will continue to remain agile and leverage IRX across every facet of our business to deliver on our commitments. To employees, I want to again thank you for your continued engagement and making thoughtful action oriented decisions like the owners that you are. This engagement continues to drive the accomplishment of our mission to make life better for our customers, the environment and shareholders. And our balance sheet is very strong and with our disciplined and comprehensive capital allocation strategy, we remain resilient to have the capacity to deploy capital to investments with the highest return on capital as we continue our track record of market performance.

Speaker 2

With that, I will turn the call back to the operator and open for Q and A.

Operator

Please be prepared to ask your question when prompted. And our first question comes from Michael Halloran. Your line is open.

Speaker 1

Hey, good morning, everyone.

Speaker 2

Good morning, Mike. Good morning, Mike.

Speaker 3

So a couple of questions here. First question, Vicente, you talked about constructive or positive leading indicators that give you confidence in the demand through remainder of the year at least. Maybe you could just dig into that a little bit more quoting customer conversations and what really What some of those leading indicators are that are making you feel that level of confidence?

Speaker 2

Yes, Mike. I think one of the most important, I'll say, leading indicators for us It's well, we have spoken in the past about demand generation, qualified leads, which as you know, we have a very unique Marketing engine to be able to grab a lot of good new customers. And as we saw through the quarter, we continue to see Pretty good stability on the marketing qualified leads that the team is generating. And as we kind of move into July, we actually even saw So that's kind of what gives us confidence. And as we look into the order momentum into July, also Pretty strong, continue to be fairly strong.

Speaker 3

Thanks for that. And then good color on The capital deployment side of things, on the LOIs and what you're seeing in the pipeline, could you give a little more context to Size of the transactions and if there's any change to the type of things you're pursuing at this point?

Speaker 2

Sure. Mike, I mean, I'll say that we're very excited about what we see in the pipeline. I mean, very solid funnel. You saw that the 3 transactions that are highly strategic, I mean great growing companies, good technologies, Addressing expanding the addressable markets, I mean, it kind of hits all the marks and even also with the financial criteria. And as we look at to the other 8 We have in the LOI, I would say similar to what we have been doing over the past kind of 12 months to 18 months, which kind of bolt on, talking in nature, Great returns, good growing companies, elevating the portfolio of the company and ones that we see can be highly, highly strategic for us to continue accelerating the growth.

Speaker 3

Thanks for that, Vicente. Appreciate it.

Speaker 2

Yes. Thank you, Mike.

Operator

And we have a question from Julian Mitchell. Your line is open.

Speaker 4

Thanks. Good morning. Maybe just wanted to try and understand the sort of the second half EBITDA outlook a little bit more clearly. So when we're thinking about the sort of waiting between 3rd and 4th quarter, We think the Q3 is maybe a sort of high 20s share of full year EBITDA. Just trying to understand the margin ramp.

Speaker 4

And then by segment, any color you could give us on how much The margin step up into the back half is split between ITS versus PST?

Speaker 1

Yes, Julien. This is Vic. I'll take the first part of your question and I'll let Vicente answer the second. I think in terms of your first question in terms of I think Yes. About the phasing of EBITDA in Q3, yes, you're actually right.

Speaker 1

I'd say mid to high 20% in terms of the phasing. And what we would probably say and very consistent to actually what we've been saying all year is that the phasing throughout the year in terms of the quarters is actually very similar to what you saw last year In terms of the phasing, in terms of the Q3, Q4 weighting of EBITDA. So that's probably a good proxy to use.

Speaker 2

Yes. And maybe, Judah, in terms of the segments, I mean, if you think about it kind of first half to second half, which is the way sometimes we look at we like to look at it is that think about ITS, Flow through in the first half was approximately in the 30s. And as we get closer to the 40s for the second half And that's going to be driven primarily through a better pricing realization that we already have action as well So kind of continued movement in terms of the merger related productivity savings that so think about it, it's already actions that You could call it that we have, so to speak, in the bag or already action. And then from a PST, I think when you look at Again, same thing. First half to second half flow through in the first half was kind of in the low 20s with an EBITDA margin generating in the first half in the high 20s, Kind of 28% range.

Speaker 2

And as we go into the second half, our EBITDA margin should expect to grow closer to the 30s, which leads to that incremental flow through of the 50s. And again, when you think about the big pieces, it's fairly similar in terms of better price realization Given the actions that we have taken for the PST segment, it's a lot around the M and A synergy realization for the deals that we closed In the second half of twenty twenty one and also for the PST is kind of some of these non repeat China lockdown volume mix and Absorption related issues. So again, it feels like fairly doable and the team is executing through all those actions that we need to get done.

Speaker 5

That's very helpful. Thank you.

Speaker 4

And then just my follow-up would be around the IT and S EMEA orders progression, how comfortable you feel with that? And the demand outlook in that ITS compressor piece, I realize the order numbers you put up are including FX and so stripping that out, it's a little bit healthier. But are you seeing any change in demand on that piece? And then PST, how long does that kind of COVID headwind last?

Speaker 2

Yes. Julian, from an ITS, EMEA, no change in dynamic as we see even here With our leading indicators, as you very well pointed out, I mean, the Q2 pretty well affected by the FX. And that's why when you can even see it Q1 to Q2 sequentially, I mean, FX, euro alone was like a 5% to 6% headwind impact. So yes, I mean, FX, but even with that, the team continues We outperformed pretty well and confident on the execution with what the team continues to update in the coming quarters. From a PST perspective in terms of COVID, you're going to see one more kind of meaningful comp here in the Q3 That should be relatively about the same to what we saw in the Q2.

Speaker 2

And then basically after that, we should be kind of clearing the goal, mean, in the Q4.

Speaker 6

Thanks very much.

Speaker 2

Thank you, Julien.

Operator

Our next question comes from Nigel Coe. Your line is open.

Speaker 6

Thanks. Good morning, everyone. Just to put a final point on that 3rd quarter spacing deck. Is that I mean, my dumbass would get me to $375,000,000 of EBITDA. Is that in the right zone of where you see things?

Speaker 1

Yes Nigel, I think that maybe a little on the higher side. If you were to use kind of a mid, I'm going to say Mid to mid plus 20 percent phasing in Q3, I think you'd be in the right zone. So maybe a little on the high side, but you're not Dramatically that far off. Okay.

Speaker 6

So like $350,000,000 $360,000,000 Okay. That's really helpful. Thanks. And then on the PST side, We've talked about the margins a fair bit. You called out the COVID order headwinds.

Speaker 6

And I'm wondering when do we start to lap That impact, I think, is 4 points to orders. And how is that filtering through to revenues and margins? Are we seeing a headwind there as well?

Speaker 2

Yes. Hi, Nigel. So we'll see one more quarter here in the Q3 of the same kind of COVID COVID hit related one time from last year. And so what you see in the Q3 should be fairly similar to what we saw here in the second quarter From an orders and a revenue perspective.

Speaker 6

Great. Okay. I'll leave it at that guys. Thanks a lot.

Speaker 2

Thank you.

Operator

Our next question comes from Joe Ritchie. Your line is open.

Speaker 7

Thanks. Good morning, guys.

Speaker 2

Good morning, Joe. A couple of quick ones

Speaker 7

for me. Just trying to understand, I think, with A lot of our companies like how this the fact that like base metal pricing is starting to deflate and how that ultimately impacts The P and L out in 2023. So I'd love to hear some thoughts just around how much of the pricing do you think you're going to be able to hold on versus potentially give back and what happens do you think to your margins if you do see some deflation from a cost input perspective?

Speaker 2

Yes, Joe, I'll say that the way we think about it is that we're not we have not historically given out Any pricing back. And the reason being all the price increases that we have done even this year and last year have been list price increases. And the way to think about it too as well, our customers, they don't buy the same type of product every month. I mean, they buy a compressor now and they just probably buy another one 5 to 8 years later, so it's kind of difficult to compare that kind of price to price perspective. I mean clearly, I guess the market they do, but that's why We want to continue to create that highly innovative solutions and differentiated technology that will allow us to command that premium price.

Speaker 2

And so as we think and we look forward, yes, I mean, we're pretty excited to that you're starting to see some of these kind of base commodities kind of dramatically reduce. What we have here for ourselves and we told the teams here for the second half is, assume inflation stays constant And kind of work on what you can control, which is price and execution and productivity. And as we go into 2023 and we get a better visibility of what that deflation could happen, Yes. I mean, we see that, that could be a great margin expansion for us on an ongoing basis.

Speaker 7

That's great to hear, Vicente. And maybe just, I know we've talked a little bit about the PST margins. I liked the walk that you guys did on Slide 12, The year over year walk, if you take a look at those 4 buckets, M and A, growth, China and then other, And you think about 3Q, how should like maybe just talk me through like the buckets and how those buckets Change in the Q3, I'm assuming that your PSD margins are maybe down modestly in 3Q on a year over year basis?

Speaker 1

Yes, Joe, I'll take that one. So if we kind of think about the 3 buckets, the way I probably describe it is, first starting with the biggest one, the impact of M and A. 1st and foremost, we do start to lap the M and A. Obviously, the biggest drivers in there were coming from Q3 of last year's acquisitions, Particularly, CPEX being the biggest one and we've highlighted that one a few times. So obviously, as we lap that and clearly with some of the higher Synergy expectation that we expect to see, that will start falling off.

Speaker 1

So again, we would expect to see the impact of M and A Start to dramatically reduce here in Q3 given that we only had a 1 month impact last year Sorry, one last impact this year in terms of timing of when we purchased it. The impact of China lockdowns, we really wouldn't expect to see that repeat at all. Obviously, that was a very nuanced in Q2. The good news here is, exiting really through June, exiting June, our China facilities, Particularly in PST, we're operating right back on track and we don't have any expectations of any concerns here in Q3. In terms of the investments For growth, yes, that definitely will still be part of the equation.

Speaker 1

I think it'll be you should expect to be dramatically different In terms of Q3, a lot of these are areas like, for example, our hydrogen business and the ion solutions business that was highlighted in the deck. And those will continue. These are great innovations, things that we're really excited about, ones that we continue to invest in and execute on, Frankly, since last year even through this year. So again, I think that's how the 3 major buckets play themselves out. And then as Vicente indicated here, The price cost spread will continue to get better for PST not just in Q3, but also in Q4.

Speaker 1

Super helpful. Thanks guys.

Speaker 2

Thank you,

Operator

Joe. And our next question comes from Rob Wertheimer. Your line is open.

Speaker 8

Hi, thanks and good morning everybody.

Speaker 2

Good morning, Rob. My question is actually going

Speaker 8

to be on innovation and the Cold Park Plasma is something it sounds very interesting and how differentiated it is and really just wanted to see if you could Review your innovation sort of process changes that have gone on and any metrics you want to share on pacing change and so forth. And then Breakthrough Innovations may be slightly different. I don't know the oil free is a known industry thing. I'm not sure if this is Evidence of a different program that's been ongoing, or whether it's kind of a lucky opportunity or if it's a more Widespread effort. Thank you.

Speaker 2

Yes, Rob. Solid, very intriguing questions. I'll say that The innovation on the Cold Plasma Technology, it is highly differentiated and pretty unique. And actually, if you go out there in the market and we'll be able to talk more about it, It's the only one that has all in its own in itself contained unit,

Speaker 1

not only

Speaker 2

the ability of creating disinfection, but create the ability of Accelerated oxygenation in the water, which is kind of particularly very, very important for hydroculture markets and hydroponics Markets and things like that. So I think it's going to be really strong. We have built a very strong IP around it. And so we have a very big barrier in terms of IP protection around that. And again, speaks volumes to some of the things that we've been wanting to do, which is kind of Combination of several Ingersoll Rand technologies such as compressors and pumps into additive technology that can actually create a very unique solution.

Speaker 2

And again, here is Just one great example. In terms of how we think about innovation, kind of the cadence of innovation, We spoke, I think it was back at the Investor Conference, how from an ICS perspective and we kind of gave a bit of a highlight that innovation accelerated dramatically when the combination of the 2 companies. And we continue to do a lot of that work around global product summits that we have with the teams. And so I think it's a very exciting piece. We're just fairly recently here.

Speaker 2

Couple of weeks ago, we had our Strategic plan review with the teams and one of the core characteristics of the review in every business, It was around intellectual property and IP and patent technology because we believe that we have unique Technology that can be application driven and protect that as a protective IP. In regards to that breakthrough technology and Particularly to the centrifugal, I think it's just one example where again you take kind of core technology such as centrifugal compression that it is very unique for oil free products And in this case, oil free compression. And again, we created some IP protection around the aerodynamics Of the product inside and how the airflow moves inside. So again, we feel that, that allows us to create differentiation in energy efficiency. So Pretty unique model that we leverage IRX all in its own to drive the process.

Speaker 2

And I would say that this ION solution, the Coldplasma was one great example, acquire some IP, develop the IP, utilize IRX processes as a way to out The product and in less than 15 months we went from concept to launch of a product, which is pretty impressive. Great. Thank you. Thank you.

Operator

We have a question from Stephen Volkmann. Your line is open.

Speaker 9

Hi, good morning guys. I just wanted to ask about kind of what you're seeing in terms of the supply chain And sort of the productivity impact of that and I'm just trying to figure out if there's been any kind of margin headwind due All these issues that we're seeing?

Speaker 2

Yes. I would say, Steve, absolutely margin headwind, because if you think about it, we don't have All the components at the right time at the right place. So yes, that creates the factories to do heroics In terms of reconfiguring and try to maybe pre build a piece of the compressor, put it on the side and then wait for the part. So yes, absolutely. We've seen productivity hits due to the inefficiencies on the supply chain.

Speaker 2

And I think one thing we'll say is that we still see supply chain constraints and issues. So I don't think that Everything is perfect. I mean, I think we're what our teams are doing with the utilization of the IRX and the processes is incredible From the perspective that they're able to outperform, I mean, and you saw that very clearly with the team in ICS in China that just basically outperformed dramatically to even some of the expectations that we had when they came back with the lockdown. But yes, definitely some headwinds. So to your point, it's a very good point that as we go into maybe 'twenty three and beyond, we should see maybe the better efficiencies Productivity due to the ease of the supply chain being more stable.

Speaker 9

Right. And obviously, that's exactly where I was going Because it feels like for 2023, demand will be whatever it is, but you should see some margin tailwinds from sort of normalization of supply chain At some point, presumably. And then maybe price cost also turns positive. And so maybe it feels like incrementals could be pretty robust in

Operator

2023. Absolutely.

Speaker 1

Yes. I would agree. I mean, I think the only thing to add to what you said there is, we're pretty encouraged that price cost actually has been we've actually been positive The entire time from last year even through the first half of this year, we do expect it obviously get better into the second This year and then potentially as Asante indicated earlier, if commodities start to deflate in the next year and given how we deployed price, We definitely see that as a potential tailwind into 2023. I think the other thing we should probably mention here is and you saw it in the financials that Clearly, as a result of the supply chain, obviously, inventory continues to be at elevated levels. And I think as supply chain alleviates here, We obviously have a meaningful opportunity from a cash perspective in terms of deploying that inventory.

Speaker 1

So and the good news is the backlog is there to do it for the back half of this year. Again, it's just a matter of us continuing to execute and seeing a little bit more normalization in the supply chain.

Speaker 9

Super. Thank you.

Speaker 2

Thanks, Steve.

Operator

Our next question comes from Nicole DeBlase. Your line is open.

Speaker 10

Yes, thanks. Good morning, guys.

Speaker 2

Good morning, Nicole.

Speaker 10

Just maybe going back to the comment you made about July orders, Vicente, like You mentioned some acceleration in certain regions and markets. Can you elaborate a little bit on where you guys saw things improve?

Speaker 2

Yes, I know. Yes, I figured that we'll get the follow-up for sure. Yes. I think, Nicole, I think we it was to be honest, it was fairly broad based, if I were to categorize it. I'll say that we saw we're starting to see more, I guess, release, so to speak, for some long cycle projects.

Speaker 2

So we're seeing that some of these kind of large projects that have been in the pipeline and there's been a lot of conversations, they're getting released. So we're seeing some good momentum on that And some of these are energy transition related and or expansion of capacities And also in some cases onshore into as well. So we're seeing some good momentum on that perspective. But to be honest, it was fairly global From a global perspective across all regions and very exciting movement in the U. S, China, but even also Europe.

Speaker 2

So I think it was fairly broad based here on the call.

Speaker 10

Thanks Vicente. And Vic, maybe just to follow-up on the comment you just made about free cash Hello. Can you talk a little bit about the path you see in the second half to get to the 100% plus conversion? Like is this very 4Q Q weighted based on your plans for reducing inventory?

Speaker 1

So, I'd say it's probably second half weighted is probably the to say it, if you look, last year is probably a good example. Typically, we are seasonally more second half weighted. I would say that's probably a combination of 2 things. 1, Following the profitability of the company as well as the typical movements in working capital, I think in terms of this year, sure, you are going to see probably a stronger 4th quarter comparatively speaking. But yes, a lot of that is also predicated on the working capital, Let's call it continued rightsizing, which inventory obviously being the biggest piece.

Speaker 1

You kind of see that through the first half that we have built a meaningful amount inventory about a $200,000,000 I'd say for the first half headwind from a cash flow perspective. But despite that, we're actually quite pleased with Generated $165,000,000 of free cash flow still in the Q2. So again, pretty pleased with the execution of the team despite what I would call a working capital headwind. But The good news here is we have the backlog and the path to be able to execute and free up that cash.

Speaker 10

Thanks, Dick. I'll pass it on.

Speaker 2

Thank you, Nicole.

Operator

Our next question comes from Vlad Bosticki. Your line is open.

Speaker 11

Good morning, guys. Thanks for taking my question.

Speaker 1

Good morning, Michael. So

Speaker 11

So maybe just on the capital allocation front, a lot of good color around, obviously, the 3 deals you've announced and then the additional LOIs on the bolt ons, but can you talk about, just given how leverage has come down, How you're thinking about your appetite for larger deals, especially given maybe

Speaker 2

Yes. I'll say, Vlad, When you look at our funnel, I think the funnel characteristics that we have are still fairly talking bolt on in nature. So I'll definitely speak in terms of what we see today in the funnel. It's nothing around those $1,000,000,000 plus acquisitions and not because there might not be other, but because we're being very focused more On this kind of more bolt on in nature deals that can be highly accretive to us.

Speaker 11

Okay. That's really helpful, Vicente. Thanks. And then maybe just going back to the organic Growth outlook here. So you took your organic growth outlook up on stronger IT and S growth.

Speaker 11

So can you just talk about What's really changed in the environment since 1Q? I mean, investors are more focused on potential slowdown and worried about the macro, But you're seeing organic growth accelerate. So can you just talk about the drivers and how you think about the sustainability of that growth

Speaker 2

So Vlad, I'll say that maybe to keep it more or less kind of simplistic in nature is that We're seeing definitely better price acceleration and realization. You saw how sequentially Q1 to Q2, we improved price, I mean almost 200 basis points in terms of price, whether IPS or PST. So again, we and those are actions that we have taken that is already built already in the backlog. So basically shipping the product and realizing that higher price realization that gives us that increase in organic as well as also as Vic said that Price cost margin amplitude that will continue to get better in the second half. And to the volume, organic volume Then in terms of the just again supply chain constraints getting released and be able to accelerate some of the shipments From be able to deliver to what customers want.

Speaker 2

So again, it's better price realization and better supply chain

Speaker 11

Great. That's helpful, Vicente. Nice momentum. Thanks.

Speaker 2

Thank you. Thank you, Vlad.

Operator

We have a question from Nathan Jones. Your line is open.

Speaker 2

Good morning, everyone. Good morning, Nathan.

Speaker 5

I wanted to start off with a question about the long cycle projects, Vicente, you talked about some of those getting released and helping to drive the order book. I think by the time those projects get ordering products from Ingersoll Rand, they're likely to go ahead regardless of the macro

Speaker 2

backdrop. Can you

Speaker 5

talk about any information or insight you might have on some of those larger, longer cycle projects that might be might have been in the planning stages That maybe customers are reconsidering with higher interest rates, macro uncertainty or anything like that. Have you heard anything about customers reconsidering or Delaying kind of moving forward with earlier stage projects like that?

Speaker 2

I'll say listen, to be honest, it's It's an interesting question, but I would say that nothing that we see dramatically customers just put in a big pause And rethinking, I think on the contrary, I will say that because of current energy prices being so high and the fact that Our technology is allowed to drive these energy efficiency and improvements. We're seeing customers making the acceleration of Let's just get it done here now because they see energy prices to be high for the longer or kind of medium to longer period of time of perspective. So I think that, again, this cost benefit equation that we have with our products and solutions and how our teams are positioning that from a total cost of ownership to the customer, That equates to a better carbon footprint for our customers. It is actually seeing some good momentum on getting projects even more Through the accelerated pipeline, in my view.

Speaker 5

Thanks. Maybe for Vik, On the capital structure, swaps, caps, can you talk about any detail you can give us on notional value, how it impacts The interest expense here in the short term and what the plans are for maybe Putting actual fixed debt in place over the next couple of years here, just any details you can give us on your intentions with the capital structure?

Speaker 1

Yes, sure. So let me maybe just for completeness here, I'll kind of just summarize kind of what we did here. But we did a number of things here in the second quarter I'd say execute on our capital structure strategy. And it's important to note that ensuring that we're on our continued path to an investment grade credit rating. And we obviously want to make sure that we're coxswain of balancing further interest rate exposure by balancing our fixed to floating ratio as you indicate.

Speaker 1

And so what we did was, I'd say 3 distinct things or 3 to 4 distinct things in the quarter. 1, we did pay off the full amount of the euro denominated term loan, which was in dollar term $621,000,000 Then we executed €1,000,000,000 Of USD to euro cross currency swaps, 3 year term and 50% of that swap to fixed, 50% floating. And then the final piece is we executed a $1,000,000,000 of U. S. Dollar interest rate tax capped at 4% on the base interest rate.

Speaker 1

So again, we've meaningfully changed fixed Loading ratio here in the context of where we were exiting Q1 for example to where we are now exiting Q2. And I think in the context of your kind of second part of your question, yes, I mean, I think this is just a step in the consistent evolution of our capital structure. As indicated here, we do continue to see a path to investment grade credit rating, at which point in time, clearly, we would expect The nature of our capital structure to continue to evolve and change at which point we'll probably go into more of a fixed rate structure at that point in time. The good news here is, the maturities of our best towers right now are all out to 2027. So that gives us some time here, to continue to Both evaluate, but execute and change that structure.

Speaker 1

And I think the good news here is we still have a considerable amount of flexibility as well as coupled with the strong free cash flow as well as with the I'd say the amount of cash and liquidity we have exiting Q2, it gives us I'd say a lot of flexibility to continue to execute On our capital allocation strategy, which you heard from Vicente, obviously, will continue to be very M and A centric and clearly the funnel continues to support that.

Speaker 5

And maybe just the bottom line, what's the quarterly run rate for interest expense?

Speaker 1

Yes, you'll probably be, I'd say, closer to The high 20s to in the back half of the year on average, roughly speaking, is probably good from an interest expense perspective.

Speaker 12

Thanks very much.

Speaker 2

Thanks,

Operator

And we have a question from Joe O'Dea. Your line is open.

Speaker 1

Hi, good morning.

Speaker 2

Good

Speaker 12

morning. I wanted to ask on the M and A contribution to growth based on the Deals this quarter and then based on what you have under LOI, when you think about the framework of the 4% to 5% annual target And given kind of what's in motion right now, what kind of a contribution you think that's setting up for next year? Are we looking at something Better than that based on the number of deals that we're looking at

Speaker 1

here? Yes. Joe, I think the best way to think about this is maybe 2 pieces. And what we still are reaffirming here today is the ability to execute 400 to 500 basis points on an annualized basis Inorganic growth. So let me take it in 2 pieces.

Speaker 1

You can see in the guidance, we still are committed to about $225,000,000 of in year impact. Now the reality is that's largely coming from the deals that you saw already announced primarily in the second half of the last year as well as You'll see, remember, we did one small bolt on in the Q1, a business called York. So that's really what's driving the $225,000,000 The three Deals that were announced earlier this week, they are actually not in guidance yet because they have not been closed. We expect them all to close in the second half of the year. And based on what Vicente indicated, the LOIs and what's in the funnel, again, the annualized impact of Those deals as well as ones we just announced, again, we would expect to get to 400 basis points to 500 basis points on an annualized basis.

Speaker 1

So, we actually see that whether you want to look at The in year impact of revenue, the annualized impact of what we expect to be able to purchase this year, all of us all of those Lead to the 400 to 500 basis points whichever way you want to look at it, which is actually setting us up nicely here if I'd say the M and A impact So revenue as we go into 2023. So again, I think Joe, depending on how you want to look at it, it actually probably leads to the same answer. But I just want to make sure We understand that the 3 deals announced here earlier this week, they're technically not in guidance yet and they won't be until we actually close the deals.

Speaker 12

Understood. And then circling back on the ITS Asia Pac orders and up low double digits China mid-20s Rest of Asia, can you talk a little bit about the degree to which you have insight into outperformance In the market, some of what's driving the growth that you're seeing in the region there?

Speaker 2

Yes, Joe, I mean according to the teams, there's actually not a third party report in Asia Pacific or in China, but you can do a little triangulation. And yes, I mean according to our teams, we continue to outperform what we see in terms of our peers from a compressor perspective, I'd say. And I think also the teams continue to leverage really well the technologies that we have around vacuums and blowers and really expanding That penetration in the market where our market share is today fairly small. So we have a very big great opportunity to accelerate that. And the last piece I'll say Joe is that our team in the Asia Pacific, the ITS team has been incredibly agile In terms of being able to take the technology that we have in our kind of palette of all technologies, compressors as well as vacuums, And really moved pretty quickly to create applications to those areas where they're seeing kind of the good areas of growth momentum.

Speaker 2

So I think this is something that I would say, still it's kind of not that well understood externally, but the fact that we have these kind of great technologies That you can make them applicable to the end markets and to the growth trends that you have, it is something that is unique to what we have in our portfolio and that has been pretty well executed by our team here in Asia Pacific and in other regions, but Particularly China team has done a phenomenal job just executing to that strategic aspect.

Speaker 1

Got it. Thanks very much.

Speaker 2

Thank you, Joe.

Operator

And we have no further questions in queue at this time. Will turn the call back over to Mr. Reynaud.

Speaker 2

Thank you, Paul. I'd like to say a few things here at the end. I just want to say that I'm very proud And we're all very proud of the work our teams have done over the second quarter and the first half of twenty twenty two. I mean, in terms of performance Navigating in this challenging macro environment, you can see that Ingersoll Rand continues to be very financially strong, operationally fit and our business is quite resilient. And more important, our culture of agility and ownership and while leveraging IRX is the essential piece to our continued momentum.

Speaker 2

And we importantly want to highlight that we continue to build a stronger team for long lasting performance. And with that, we're super excited about the announcements of Mark Stephenson and Michael to the Board, adding them to the Board. I know both will add incredible value as we continue to transform our company. So with that, just want to say thank you

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Earnings Conference Call
Ingersoll Rand Q2 2022
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