Ingersoll Rand Inc.

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ingersoll Rand Third Quarter 2019 Earnings Conference Call. My name is Denise, and I'll be your conference operator today. At this time, all participants are in a listen-only mode. After the speaker's remarks, there will be a question and answer session. To ask a question during this session, you'll need to press star 1 on your telephone keypad. We ask that you limit yourself to one question and one follow-up and rejoin the queue for any additional questions. I would now like to hand the conference over to Zach Nagel, Vice President of Investor Relations. Please begin.

Thanks, Operator. Good morning, and thank you for joining us for Ingersoll Rand's third quarter 2019 earnings conference call. This call is being webcast on our website at IngersollRand.com, where you'll find the accompanying presentation. We are also recording and archiving this call on our website. Please go to slide two. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our SEC filings for a description of some of the factors that may cause our actual results to differ materially from anticipated results. This presentation also includes non-GAAP measures, which are explained in the financial tables attached to our news release. Joining me on today's call are Mike Lamac, Chairman and CEO, and Sue Carter, Senior Vice President and CFO. With that, please go to slide three, and I'll turn the call over to Mike. Mike?

Thanks, Zach, and thanks, everyone, for joining us on the call today. I'd like to start out today's call with a brief overview of our global business strategy that's enabling us to consistently deliver strong financial results for our shareholders. Fundamentally, our strategy is that the nexus of environmental sustainability and impact which has strong secular tailwinds for our business. The world is continuing to urbanize while becoming warmer and more resource constrained as time passes. At our core, we are focused on and excel at reducing the energy intensity in buildings, reducing greenhouse gas emissions, reducing waste of food and other perishable goods, and we excel in our ability to generate productivity for our customers, all enabled by technology. Unless you think the world is getting cooler, less populated, and less resource constrained as time passes, these strong secular tailwinds will continue to provide opportunity for shareholders and purpose for our vision. As we continue separation and integration planning activities related to the combination of our industrial segment with Gardner Denver and transformation activities related to our move towards creating the premier pure play climate business in 2020, Our aggressive pursuit of excellence in driving solutions to mitigate the impact of these secular trends only intensifies. Our climate businesses squarely focus 100% of our portfolio at the nexus of sustainability and global environmental impact, where our products and services can reduce the impact of these megatrends and further advance the platform for the company to grow above average global economic conditions. Moving to slide four, We continue to deliver strong financial results by effectively managing through an evolving global landscape. In the third quarter, we delivered 6% organic revenue growth and 14% adjusted EPS growth, compounding on tough comps of 10% organic revenue growth and 22% adjusted EPS growth in the third quarter of 2018. We remain bullish on our strategy. The opportunities that lie ahead in our end markets broadly and particularly and our team's resilience and their ability to execute using our business operating system to deliver against the top-tier organic revenue growth and adjusted EPS guidance targets we provided for fiscal 2019. We continued to deliver strong and differentiated performance in Q3 in our climate segment globally. Climate segment organic revenues were up 8% against a tough comp in 2018. Our global HVAC business performance was particularly strong with approximately 10% organic bookings growth and approximately 10% organic revenue growth. Our performance was also broad-based, with North American commercial HVAC, European commercial HVAC, and residential HVAC all significantly contributing to the growth. Our backlog, pipeline, and order rates continued to be solid and support healthy growth in the fourth quarter. This is reflected in a revised full-year climate segment organic growth guidance of 7% to 7.5% revenue growth, which is a full point above the top of the prior guidance range. Delivering strong climate performance has enabled us to effectively offset persistent softness and global short cycle industrial spending, which drove organic revenue declines in our short cycle industrial businesses, mainly in compression technologies and tools. In 2019, long cycle larger compressor orders have shown more resiliency and small to midsize short cycle compressors, and we're building a solid backlog for these products year over year. However, the majority of these units won't ship or deliver meaningful revenues until 2020 and 2021. Despite revenue declines in our high gross margin compression technologies business, the steps we've taken to restructure and fundamentally improve our operations and service mix over the past several years enabled us to manage the leverage of the business within our gross margin target rate demonstrating what we believe is a more resilient business, better able to weather economic downturns. In transport, we delivered low single-digit revenue growth in the quarter against a tough comp in 2018. We also expect revenues to moderate some in the second half versus the first half, again comparing to tough comps in the second half of 2018. Fervid softening of the European economy combined with ongoing Brexit uncertainty has softened our European trailer outlook for the back half of the year for the region, but we expect this to be largely offset by strong North American revenues for 2019. Our outlook for mid single digit organic revenue growth in 2019 for our overall transport business remains unchanged. We continue to effectively manage tariff and inflationary headwinds and deliver a positive price versus material cost spread. Volume and productivity are also strong, enabling us to drive solid margin expansion. As always, delivering strong free cash flow and directing capital deployment towards high ROI projects remains core priorities. Lastly, we're excited about the pending reverse Morris Trust transaction with Gardner Denver, creating a premier industrial company while simultaneously creating a leading pure play climate technologies company focused on HVAC and transport refrigeration. We believe both businesses have the potential to unlock value for shareholders. Please go to slide five. This slide provides a visual depiction of organic bookings and revenue growth in the third quarter. As I discussed in the prior slide, we delivered strong, broad-based bookings and revenue growth in virtually all businesses and regions in our climate segment in the third quarter, and the business was up approximately 10% in organic bookings excluding transport and up 8% overall in organic revenues. Asia continues to see the impacts of trade tensions and broader economic uncertainty, but remains a stable market. Commercial HVAC Asia organic bookings were up mid-single digits in the third quarter. Climate Asia organic revenues were down mid-single digits against a tough low-teens revenue comp in China in the third quarter of 2018. As I outlined in the prior slide, our compression technologies and industrial products businesses continued to be impacted by slowing industrial short-cycle spending. Our small electric vehicle business has continued to deliver strong growth driven largely by our consumer vehicle strategy. All in, industrial organic bookings and revenues were essentially flat in the quarter. Please turn to slide six. We've encapsulated a number of takeaways for our major end markets on this slide for your reference. I've covered much of this content already, so I'll just add a few brief comments before passing the call along to Sue. First, focused execution of our business strategy is enabling us to continue to deliver very strong global HVAC performance, particularly in North America, Europe, and in our residential business. Our end markets are largely healthy, and we believe we are outperforming the underlying growth rates in these markets. The transport markets have softened a bit versus our view when we exited the second quarter, primarily driven by a softening of the European market, which continues to be impacted by weakening economic fundamentals and uncertainty surrounding Brexit. Overall, we believe focused execution of our strategy is enabling us to outperform global transport market conditions. We are on track to deliver mid-single-digit growth in transport for 2019. Lastly, I've talked at length about slowing industrial short-cycle spending, impacting our quicker book and ship small and mid-sized air compressors and industrial products businesses. We expect this softness to continue through the fourth quarter, consistent with our updated 2019 guidance. And we expect to offset the softness with the strength we're seeing in global HVAC. And now I'd like to turn the call over to Sue to provide more details on the quarter. Sue?

Thank you, Mike. Please go to slide number seven. I'll begin with a summary of a few main points to take away from today's call. As Mike discussed, we delivered strong financial results in the third quarter with adjusted earnings per share of $1.99, an increase of 14% versus the year-ago period driven by strong performance in our climate segment. We continue to execute well in an evolving global landscape and remain on track to deliver against our full-year organic revenue growth, EPS growth, and margin guidance. Third quarter organic revenue growth was strong, particularly in our climate segment. Orders were also strong in our climate segment. When excluding our transport business that saw outsized order growth in 2018, organic bookings were up high single digits for the enterprise and approximately 10% for our climate segment. In our industrial segment, organic revenues were flat versus a tough year-over-year comp of 9% organic revenue growth in the prior year. Strong revenue growth in small electric vehicles largely offset the softness in the industrial short-cycle markets we mentioned previously. During Q3, we expanded adjusted operating margins 70 basis points and delivered 25% operating leverage consistent with our full-year expectations. We continue to leverage our business operating system across the enterprise to manage direct material, tariff-related, and other inflationary headwinds. As we look to the fourth quarter, we will continue to leverage our business operating system to drive further margin expansion. As Mike mentioned, we continue to expect strong free cash flow in 2019 of equal to or greater than 100% of net income. Through Q3, we have delivered approximately $1 billion in free cash flow and are on track to hit our full year expectations. Importantly, we continue to deliver on our balanced capital allocation strategy and During Q3, we deployed approximately $124 million in dividends and approximately $250 million on share buybacks. Looking forward, we expect to consistently deploy 100% of excess cash over time. Please go to slide number eight. Taking a step back from the details for a moment, Q3 was a very strong quarter with top quartile performance. We delivered organic revenue growth of 6%, adjusted operating margin improvement of 70 basis points, and adjusted earnings per share growth of 14%. Organic revenue growth was driven by global HVAC strength in our climate segment. Continued disciplined focus on pricing and productivity actions enabled us to effectively manage inflation and tariff-related headwinds and drive margin expansion across the enterprise. Please go to slide 9. Our climate segment delivered another strong quarter of operating income growth, enabling us to drive solid year-over-year EPS growth in the quarter. Our industrial segment delivered $0.05 of EPS growth with solid small electric vehicles growth and the addition of our precision flow systems acquisition that we closed in Q2, more than offsetting revenue declines in other industrial businesses. In addition to good segment performance, third quarter corporate costs were lower than prior year, due to ongoing cost management activities, lower stock-based and incentive compensation, and the timing of unallocated corporate spending. We now expect our full-year corporate costs to be less than $240 million, down from our previous guidance of approximately $250 million. Please go to slide number 10. In Q3, strong execution drove 70 basis points of adjusted operating margin improvement on strong price versus material inflation and productivity versus other inflation spreads. During the second half of 2019, we are lapping strong pricing implemented in the back half of 2018. Consistent with expectations, we delivered 40 basis points of margin expansion from price versus material inflation. This represents our sixth consecutive quarter of positive price cost. We delivered solid margin expansion from volume growth in the quarter. Margin expansion was tempered by mixed pressure as we delivered outsized growth from commercial HVAC applied systems as compared to other initially higher margin products like unitary or transport equipment. Over a 20 to 30 year life, an applied system carries high margin service and aftermarket parts, but the initial sale creates pressure on margin mix. Additionally, consistent with last quarter, we saw mixed pressure from softness and short cycle industrial revenue, which also tend to have high margins. Productivity versus other inflation across the enterprise improved margins by 80 basis points in the quarter. In both our climate and industrial segments, we delivered strong productivity from operational excellence and restructuring savings. Reduced corporate costs also contributed to the margin expansion. We continue to invest heavily in growth and operating expense reduction projects with high returns on investment. Incremental Q3 investments totaled approximately 30 basis points. Please go to slide 11. Our climate segment delivered another strong quarter with 8% organic revenue growth and adjusted operating margin expansion of 30 basis points. Consistent with our expectations, we delivered strong volume growth, price realization, and productivity. Please go to slide 12. In our industrial segment, organic revenues were flat against tough comps of 9% organic growth in the prior year. Strong revenue growth in small electric vehicles largely offset softness in the industrial short cycle markets. Over the past several years, we have built a stronger, more resilient industrial business. In our compression technologies business, for example, pricing, productivity, and restructuring savings partially offset volume declines to enable deleverage within gross margin rates for the second quarter in a row. Industrial segment adjusted operating margins expanded 40 basis points in the quarter. Our high EBITDA margin PFS acquisition continues to improve our industrial EBITDA margins. We expanded adjusted EBITDA margins 110 basis points in the quarter. Please go to slide 13. We remain committed to a dynamic capital allocation strategy that consistently deploys excess cash to the opportunities with the highest returns for shareholders. We maintain a healthy level of business investments in high ROI technology, innovation, and operational excellence projects, which are vital to our continued growth, product leadership, and margin expansion. We continue to make strategic investments in acquisitions that further improve long-term shareholder returns. We remain committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve. We have a long-standing commitment to a reliable, strong, and growing dividend that increases at or above the rate of earnings growth over time. With the proposed transaction with Gardner Denver growing closer, I'd like to highlight that we expect to maintain our annualized dividend of $2.12 per share post-closing and through 2020. This will deliver a very attractive dividend yield for the new Climate Co. For 2021 and beyond, we will evaluate dividend increases in line with earnings growth consistent with our long-standing capital deployment priorities. We continue to see value in share repurchases, and we expect to consistently deploy 100% excess cash over time. Please go to slide number 15. When we are on the road, we often get questions about the status of the proposed transaction to combine our industrial segment with Gardner Denver. We continue to be excited about the prospects of creating a premier industrial company, as well as a leading pure play climate technologies company focused on HVAC and transport refrigeration. I'll give you a brief update today. First, the transaction with Gardner Denver remains on track for deal closure in early 2020. In reviewing our priorities between now and deal closure, our first priority is and will continue to be running the business and taking care of our customers. To maintain focus on our customers, we have dedicated teams carrying out separation and integration planning as well as climate co-transformation activities. Separation activities encompass separation of technical and financial operating processes and systems, manufacturing operations and supply chain services and real estate and along with all business regulatory filings. We have a detailed project plan, and we are executing against that plan. When necessary, we are creating transition services agreements to support day one operations for certain processes and services. At this stage, we anticipate one-time separation and transaction-related costs to be at the high end of our previously communicated range of approximately $150 million to $200 million. Given that, we in Gardner Denver continue to operate as two separate companies and compete in the marketplace until the close of the transaction. The integration planning work must be managed under clear rules and antitrust protocols. We will continue to work within these rules as we progress towards day one of the new industrial business. Additionally, we expect to leverage this opportunity to further improve our climate business to better serve our customers and unlock value for shareholders with a singular focus on reducing the world's energy intensity and greenhouse gas emissions. We are building on an incredibly strong foundation with great businesses, engaged and talented people, and a distinctive winning culture and core values. As I said at the beginning, we remain excited about the prospects of creating a premier industrial company as well as a leading pure play climate technologies company. On another note, given the outsized transport order growth in 2018, we often get questions on the road about our order outlook. As we look at the fourth quarter, I'll remind you that we booked a large commercial order worth approximately $200 million in Q4 of last year. As we discussed when we booked this order, the revenues are expected to be recognized over the course of approximately three and a half years. Excluding this large order, we have tough comps in the rest of the business where enterprise organic bookings were up approximately 11% and climate segment organic bookings were up approximately 13%. Please go to slide number 16. As we highlighted earlier, we continue to execute well in an evolving landscape. All in, our full year adjusted earnings per share guidance remains unchanged at approximately $6.40. Our enterprise revenues and margin guidance also remains unchanged. With our continued strong climate segment revenue growth led by global HVAC, we now anticipate full-year organic revenues to grow between approximately 7% and 7.5%, a full point higher than our original guidance. Our industrial segment revenues have been impacted by soft short-cycle investment spending. We now anticipate industrial organic revenue to be flat to up 0.5% for the year, as we expect short-cycle softness to persist in the fourth quarter. Our guidance for both our climate segment and our industrial segment margin rates remain unchanged, although we do anticipate delivering towards the high end of the climate range and towards the low end of the industrial range. We are increasing full-year restructuring cost guidance to approximately $0.30 per from 25 cents, primarily related to additional footprint optimization efforts. We have a couple of elements of guidance we also recommend tweaking, including reduced corporate spending to less than $240 million and a lower expected effective tax rate of approximately 20% to 21%. And with that, I'll turn the call back over to Mike.

Thanks, Sue. Please go to slide 17. In summary, we're effectively managing the global landscape as it evolves to deliver our 2019 guidance for top-tier revenue growth, EPS growth, and free cash flow in 2019. Looking forward, we believe the company is extremely well positioned to deliver strong shareholder returns over the next several years. Fundamentally, our strategy remains at the nexus of environmental sustainability and impact. Today, 15% of the world's carbon emissions come from heating and cooling buildings, And by 2030, it's estimated that 25% will derive from these sources. Transport refrigeration creates another 80 million metric tons of CO2 emissions annually, which can be eliminated through electrification over time. Earlier this year, we announced our 2030 ESG commitments, which included a commitment to reduce our customer carbon footprint by one gigaton of CO2 through our HVAC and transport refrigeration products and services. We believe this is the largest customer climate commitment made by any B2B company, and our math shows that this reduction could equate to 2% of the world's total emissions. For size and scale, it's equivalent to the annual emissions of Italy, France, and the UK combined. At the Climate Summit last month, we also introduced the same challenge to like-minded companies. We are bending the global warming curve by changing the way the world heats and cools buildings and moves refrigerated cargo. New technology we've developed can reduce up to 99% of the emissions that come from heating and cooling a commercial building. This doesn't include the substantial environmental benefit of increasing system energy efficiency through optimized system designs, advanced controls, and data analytics, ongoing system monitoring, and service and maintenance. These comprehensive solutions can also dramatically reduce power generation at the source and energy storage requirements. We're continually working to innovate in this way to electrify heating, electrify diesel engines used to cool trucks and trailers that transport perishable goods, and to reduce the energy intensity and greenhouse gas emissions in residential and commercial buildings. Our 2030 ESG commitments also included addressing a host of other important issues. We continue to transform our supply chain and operations to have a restorative impact on the environment, including achieving carbon neutral operations and giving back more water than we use in water-stressed areas. We are committed to increasing opportunity for all, strengthening economic mobility, and bolstering the quality of life of our people. Additionally, we're committed to gender parity in leadership roles, a workforce reflective of our community populations, maintaining livable market competitive wages, and broadening community access to cooling comfort and healthy foods. We've been investing heavily for years to build franchise brands and to advance our leadership market positions to enable consistent, profitable growth. We have an experienced management team and a high-performing culture that instills operational excellence into everything we do. We remain committed to dynamic and balanced deployment of capital, and we have a strong track record of deploying excess cash, to deliver top-tier shareholder returns over the years. Lastly, we're extremely excited about the proposed transaction and the strategic combination of our industrial segment with Gardner Denver. Combining two of the premier complementary industrial companies offers the opportunity to drive significant innovation and growth with meaningful revenue and cost synergies supported by secular growth trends and diverse end-market exposure. We're also excited about creating the premier pure play HVAC and transport refrigeration company with our existing climate segment businesses. We have a tremendous opportunity to leverage a simplified business model and design and sharpen our sustainability focus in our investments. Our climate businesses have clearly differentiated performance, and we see significant opportunity as a pure play built in this performance for our employees, customers, and shareholders. And with that, Sue and I will be happy to take your questions. Operator?

Ladies and gentlemen, to ask a question, please press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Steve Tusa with J.P. Morgan. Your line is open.

Hey, guys. Good morning. Morning, Steve. Good morning. I don't usually suck up on these calls, but congrats to you guys for not getting over your ski tips after a good first half and, you know, staying conservative. It obviously is warranted in this environment, so kudos to you guys for that. On the businesses, Rezzy, you're saying contributed to kind of orders and revenue growth, so that means it was kind of revenues up, you know, greater than a high single digit and, you know, orders up around double digit. Is that, you know... Is that kind of the messaging there on Resi?

Yeah, Resi was strong, Steve. I agree with what you said. We typically don't think about residential bookings because residential bookings book in turn so quickly, but we did end the quarter with a low team's booking number. So to the extent you can read a little forward in the fourth quarter, I feel it's going to be fairly strong again.

I would also say, Steve, as you think about that, our residential business, in addition to having you know, good revenues in the third quarter also had, you know, some tough comparisons to the third quarter of last year where the revenues were also very high.

Yeah, clearly you guys are taking some of this share that was lost by Lennox. What are the mechanics of kind of holding on to those customers, and do you feel like that's now yours to lose, or as they kind of try and come back after that, there's a risk that that fades?

Yeah, Steve, I would just say we're just executing our own strategy here. So this is, you know, building great stuff, having great distribution, you know, working through all the technical and digital work that we've been working on now for a couple of years. So this is just really executing against our own strategy more than it is anything else.

Okay, and then just a quick one on the details on the productivity and other inflation. Even X, the corporate kind of benefits there, It looks pretty solid at, like, up 50 basis points. I mean, it was up 80 basis points reported. And anything specific to call out there? And is that, you know, kind of the benefits of recent restructuring? And is that something that, you know, you guys can pull lever on in the future if things get, you know, a little bit weaker on your revenues?

I'll let Sue Conley here in a second, Steve. But one thing I'd say would be on the corporate side, we've worked really hard at reducing corporate costs and thought about this over years. It passed a year and a half, two years now, in putting the same lean tools toward benchmarking and executing against cost reductions there. So I'm happy to see that that's actually flowing through. And then, Sue, do you have any other comments?

Yeah, I think when you think about the productivity in general, Steve, you're absolutely right. Some of the productivity in operations comes from normal productivity projects that we have on any given year, but it also comes from some of the restructuring that we've done over the past couple of years. And on the corporate side, to Mike's point, we've worked really hard at decreasing the functional spending over time. We know we've been successful at that in that we've leveled out the spending as well as have offset any inflation that comes into the corporate arena. And just in case anyone is thinking about, you know, the less than $240 million, the fourth quarter is when all, you know, different accruals and other things get trued up. So we didn't want to get ahead of ourselves on what that looked like. But all in all, a really good productivity quarter for the entire company. Okay, great. Thanks a lot.

Your next question comes from Jeff Sprague with Vertical Research. Your line is open.

Good morning. Maybe to pick up on that thread a little bit, should we view what we're seeing in corporate costs here kind of a running start on the stranded costs? And could you update us on, you know, what your view there is and how that should play out maybe over the next couple quarters?

Yeah, Jeff, we've done a lot of work on the blueprinting to this point about where we think the opportunity is for all of ClimateCo across all the cost structure, whether that be at corporate or what's in the segments. Also, rethinking what should be in corporate and what should be in the segments. But with that being said, there's probably 10 specific ideas we have kind of going forward into 2020 that we're beginning to execute on as it relates to entire cost structure. And so, yes, you can think about this as getting a running start on 2020.

And then just, you know, the order and revenue performance, certainly impressive. I'll echo that. How are you feeling about backlogs now, Mike? I mean, you know, did you have notable backlog depletion in this quarter? I think the commercial HVAC franchise overall was at something like 21% backlog growth last quarter, if I recall correctly. Just your visibility in Q4, I'm sure, is very buttoned up, but how much further around the corner can you look?

Yeah, pipelines look very strong coming in. Backlogs look still very strong. Jeff, I'd have to go back and look at the 21. You're talking about Q2 versus Q1. I'd have to go back and give you a number, Q2 to Q3, but my guess is we didn't deplete much of the backlog there. It was a strong-looking quarter again for us. So that all feels good. Even in the industrial compressor business, we've had backlog build on engineered order compressors, backlog build on oil-free rotary, backlog on services. So there's goodness built up, I think, in the backlog going forward. The only place we saw a reduction in backlog would have been in Thermo King. That's fundamentally just a weakening. Europe. from the last view we had in quarter two. And then also just some summer cancellations that occurred, but backlog there is still above where it was this year at last time. It's just a little bit less than it was last time we spoke at the end of last quarter.

And just finally on TK, obviously your comments are around Europe weakness, but kind of all eyes are probably on kind of the ACT numbers into next year. I think you're trying to avoid 2020 outlook here today on the call, but How do you feel about your ability to kind of counteract, you know, kind of pressure in that part of the business potentially next year?

Yeah, I think the context to put it in, Jeff, would to say that on a pro forma basis, ClimateCo would have about 5% or less than 5% of its revenues associated with North American trailer, which is really what we're talking about here. And if you took the ACT numbers at face value, it would reflect something on the order of an 18% decline between the 49.9 units this year and next year's units in the 41 and change range. So if you think about that less than 5% revenue and 18%-ish drop, you end up with something less than one point of revenue headwind to the company. And I think that LATK has significant levers to pull with a lot of new launches and product innovation coming through in 2020. But I feel good about, you know, the HVAC businesses at large and the backlog that we're building there and what I still think is, you know, kind of early to mid, you know, in the North American institutional cycle as well. So I feel like without giving specific 2020 guidance, we've sized it. We think we've got plenty of levers to pull to have a good year in 2020. Great. Thank you.

Your next question comes from Scott Davis with Melius Research. Your line is open.

Good morning, guys.

Good morning, Scott. Good morning.

It seems like, and maybe I'm over-reading this, that ESG has become a pretty big theme for you guys almost increasingly every quarter. I guess what I'm wondering is how much does this narrow or widen the lens, I guess, when it comes to M&A once the deal is done? meaning are you more likely to stick to HVAC or think more broadly? Is ESG as a theme overall kind of, you know, afford you at least the mindset to think a little bit more broadly?

Well, I think you think about it as a funnel, really. You think about the enormity of the HVAC and transport refrigeration markets and businesses first. That's obviously what the go-forward company is very good at, and then you look at that in the context of, any innovation or idea that we would have that would make sense from a reducing energy intensity or reducing greenhouse gas emissions point of view is going to be additive to that. So I think you look at those in combination as opposed to independently.

Okay. I guess that kind of answers it, but I'll move on to the next one.

Scott, I'll just be really clear because I want to be clear on this. We've got plenty to do in our core space, and so We're not opening the lens here to think about a third leg of the stool from a sustainability perspective. We're building the company on its HVAC and refrigeration routes. And to the extent we find things that lower energy intensity and lower greenhouse gas emissions within that, that's sort of a double check for us.

Okay. That's more clear. Thanks, Mike. And just one of the things that's sometimes tough to analyze is the mix of non-res as you think about your order book, I mean, is there a mix change as far as complexity and, you know, size of projects and things like that that we should think about for 2020 or something in your backlog?

Yeah, the mix really wouldn't be size of projects. You know, the mixes that come into play here are going to be things like applied systems versus unitary systems, which, you know, applied carry a lower initial gross margin, but over the long haul we're pretty agnostic to the margins because service margins, really accrue to the applied business. And then as we're growing the HVAC business faster than the transport business, of course, the transport margins are higher than the HVAC business. So those are the general issues that we see. But as we look at the business regionally, you know, the EBITDAs of the three businesses regionally are fairly close. And so we're somewhat agnostic to where in the world the growth is, but certainly the actual product or systems or services can change the mix, you know, for us.

Okay, thank you.

Your next question comes from Julian Mitchell with Barclays. Your line is open.

Hi, good morning. Hey, just wanted to focus on the climate revenue guidance a little bit. So you took up the guide, I think, for the year just over a point organically for climate. Just wanted to confirm if that's mostly resi-related. and you took up your Rezzy market guide for the year, just when you're thinking over the next 18 months or what have you, any perspective you could provide on the longevity of the Rezzy replacement cycle in the U.S., understanding that Rezzy is only 15%, 20% or so of the climate piece?

Julian, we took up climate really based on just universal strength across the globe and pipeline bookings and backlog in general. So it would have been commercial and residential across the board. The point you made about residential going up, I think it might have been related to last quarter. I think we had a bit of a typo in the deck. We might have said low single-digit to mid-single-digit. We didn't mean to do that. It was always mid-single-digit. Zach, is that about right?

No. We actually put low single-digit in the deck. instead of low to mid single-digit, which is what we've always intended.

Yeah, okay. So we don't really feel different about RAS all year long as playing out the way that we thought it would. And then really the comment on the cycle, we've got over the years pretty good sources of data and analytics that are proprietary to what we use. And because our business is so dependent on replacement, it's well north of 80% replacement for us. We're watching that very carefully, but we don't see anything here in the near future that would change our view toward a strong 2020 in the residential business for us.

Thank you very much. And then just my second quick follow-up would be around just, you know, if you could give some more color on the climate business in Asia. You know, it seems quite choppy, some of the construction trends there. You've got some tough comps. but you do have the benefits, I guess, of a lot of share gains from that distribution build-out you did a couple of years ago. So maybe just give us some context as to how you see growth there in your non-res climate business in Asia and anything on competitive discipline as well.

Yeah, I think that we're still seeing Asia in general and China specifically to your question. It's been a good market over the long run. You're seeing a change within China around end markets themselves. And so if you think about the three largest markets in Asia, the retail, leisure, and office, all three of those markets are down significantly. Retail is down, I'm talking about the market, down about 15%. Leisure down about 11%. Office about 6.5%. Those are big markets that are down. Interestingly, industrial markets are up. That's good for us. And things like education and transportation are up double digit, even though they're smaller markets. But those are the markets that we wanted to focus on from an applied perspective as being longer cycle, but core to the economy, core to the five-year plan in China. So we will continue to, I think, see good markets there and continue to see benefits of the direct strategy that we put in place in China.

Great. Thank you.

Your next question comes from Nigel Coe with Wolf Research. Your line is open.

Thanks. Good morning. Morning, Nigel. So, hey, I just want to go back to the productivity bucket and the 80 base points. How did that land between the two segments? I know you've been restructuring in both segments, so I'm just curious whether it was heavier in one versus the other. And then maybe just touch on the industrial business. What's changed since? 2016, where we saw a lot of deleverage in that business. And I know that was partly due to the fact you just acquired Cameron. But what's changed today versus three or four years ago to kind of hold in margins a lot better through a tropical environment?

Productivity was about equal between both segments. There's nothing remarkable that we're seeing really there. Inflation would have been higher on the climate side, so the net would have been a little bit stronger toward industrial net productivity. If you think about total productivity over non-material productivity, industrial would have been a little bit stronger. And there's been really good progress over the years. Just congratulate all our leaders in the industrial space. Todd's done a very nice job specifically in the compression technology business around looking at some of his footprint there. And we've essentially gone from a number of larger compressor plants down to a smaller number and have executed that without missing a hitch. And so there's very strong market work there. I would tell you within the club car business, they're doing an outstanding job and have grown this consumer vehicle into a meaningful part of the business. And every time we sell a consumer vehicle versus a Gulf Fleet vehicle, we mix up in terms of the margin. pleased with what's happening in our tool and material handling business, and even material handling in particular has moved back to the black after pretty strong declines over the years in oil and gas. And then our fluid management and PFS business really had a record Q3 for them, and so we're proud of what's happening there. Coming out of private equity, it's always a challenge to improve margins, but the team managed to improve margins in Q3, so Just across the board, good performance. And to us, it's a test of the resilience that we talk about in stress testing our business to make sure that when we do see negative revenue growth, that the leverage can be maintained inside of our gross margins. And we get that question a lot from investors. And so it's important to point out that when we see this and we have leverage inside that sort of 30% margin number, it's indicative of the fact that I think we're executing well against the plans.

Great. Thanks, Mike. That's good detail. And then just on the, you know, you pointed out in the slides, you know, that big $200 million project you booked in 4Q. What's the outlook for, number one, the funnel for commercial globally? Maybe just touch on that. But specifically, you know, these large mega projects, because I'm assuming in a zero net world, we'll see a lot more of these large projects, maybe rip and replace type projects. So maybe just touch on that, please.

Yeah, it's almost normal now for us to see large projects in the pipeline. It's difficult to predict when they close and what they look like when they're complete. We've got a number in the backlog. I would say not as large as that, but maybe collectively some of the larger projects would total that. So, yeah, we are seeing more of that. It is more of a sort of a base business for us at this point in time in in terms of our ability to execute against that, and we're set up to do that. So we've invested heavily in that business, and we do have a pipeline of larger projects sitting in that backlog. Great. Thank you.

Your next question comes from John Walsh with Credit Suisse. Your line is open. Hi.

Good morning. Good morning, John. I was wondering if you could talk a little bit about what you saw in service for both the climate business and the industrial business as well, a little more granularity around those growth rates.

Yeah, I mean, service for both has been a strategy for both. I mean, so there's nothing, you know, new in terms of our focus on the services business there at all. Service has, for us, been something that's grown kind of in the high single-digit range, particularly in the climate business over the last decade or so. That continues to clip along at about that level consistently as we're going forward. And then, as you've seen in the industrial segment from the reports we did here, that we continue to see good service growth there, differentiated service growth there to the mix. maybe a little bit less than what we've seen in climate over time. You know, but again, it's been a healthy, you know, mid to higher single-digit growth in industrial services over time. And really when we're talking about industrial services, it's really in our compressor technology business, and that's generally going to be based off our larger centrifugal and engineered order or our larger oil-free compressors, you know, as opposed to some of the book-in-turn smaller compressors. which don't have the same sort of service opportunity.

Great. Thank you. And then, you know, going back to kind of the M&A question, I mean, I think a lot of time we focus on the larger deals, but you did get this smaller deal done here in September. And I was just kind of curious, you know, what kind of made this Arctic Chiller Company an interesting property for Ingersoll? Was it something on the technology side? Was it something to do with where their service and sales reps were located? Any color around these smaller kind of singles that are out there to do in the industry would be helpful.

Well, I appreciate you actually raising that. We've done about 18 or so of those in the last few years. A lot of them are sort of that size, maybe a little bit smaller, but Typically, it's going to be a technology that we think is novel, it's innovative, it's not part of the portfolio today. It may come with a channel, it may not. But generally speaking, if we can take an innovative product and then move it through the dedicated trained commercial channel, it's a home run for us. In other cases, there's also a strategy to maintain a second channel through independent reps. And that's an important element where we might go to market train for some of the portfolio, and in this case, Arctic Chiller for another part of the portfolio. So that multi-channel strategy can work for some of this as well. This is just a novel idea around a modular, smaller Chiller design for modular small applications. And it just adds to our portfolio in that regard.

Great. Appreciate the color. Thank you.

Your next question comes from Andrew Obin with Bank of America. Marilyn, your line is open.

Good morning.

Hi, Andrew.

Hey, just going back to slide 10. If you look at volume leverage, any way you can decompose it between climate and industrial? And specifically what I'm trying to get at, you cited applied impacting volume leverage at climate, and I'm just trying to figure out how bad it was and when does it go away. Thank you.

So, Andrew, I think as you're looking at volume in total, I think that volume that you're talking about, the volume leverage is going to come out of the climate segment, which is, you know, what we were talking about with the markets a little flatter on the industrial side. That isn't going to be the piece of it. And as we were, you know, going through the different areas, you know, in constructing the slide, what we wanted to look at was not only what it was contributing and then the comments around mix that we've given throughout, you know, the commentary with that being more to the applied side than to the unitary side. But it was more on the climate side than industrial.

Yeah, and Andrew, on that, I mean, I'm looking and I'm seeing volume kind of flowing through pretty much at the 25% level. Yeah. For climate, it was the mix that kind of pulled that back a little bit from there. And if I go to the deleverage, you know, the organic side of the deleverage and industrial, it deleverated about the gross margins of the business, hurt a little bit on mix. But, again, you know, this is where the productivity and, you know, managing that productivity equation and price helped that out quite a bit.

That makes sense. And just a follow-up question. You know, I know institutional market is quite important to you. You seem to be constructive. If you look at construction put in place data, institutional markets, you know, education, healthcare seems to be mixed at best. So what gives you confidence that this market continues to grow into the year end and into 2020? Thank you.

Well, thank you. What I always say is when you look at put in place, you really only get about half the visible market, and the other half of the visible market is the market that you go out and create demand with by, you know, putting offers to customers that would reduce their energy intensity or improve operations in their buildings. And so notwithstanding what you said, what I would tell you that in quarter three, from a vertical market perspective, the strength we saw was in higher education and in health care. We saw that and continue to see that going into the fourth quarter and in 2020 just by virtue of the pipeline that we're chasing. Commercial and industrial, we saw strength there in energy, food, beverage, and interestingly, even in retail, which gets to be national accounts and some of the brick and mortar out there. So that was, again, really strong for us as well. But we're seeing a very good pipeline going forward in these markets and that put in place data really tells only about half the story, not always indicative of what we're seeing in the marketplace.

And do you guys track bond issuance in those markets? Do they tell you anything in terms of visibility?

Yeah, well, they do. That's a very long leading indicator toward visibility in the marketplace. Generally speaking, when we know that a school district is going to vote or applying for bonds, We know generally then what they're trying to do or construct with those bonds. And so we're doing some preliminary work with schools as they're going out for bonds to get estimates for what things might cost and sort of what it might take from an operational basis to maintain those facilities. Then, of course, it's predicated on that bond actually passing. And then once that bond passes, it can go through a fairly traditional cycle of detailed models and designs all the way through procurement. So, again, it's a very early indicator on a bond. But generally speaking, if we know a school district or hospital is going for a bond vote, you know, we're going to be working with that customer to understand, you know, what the scope of the project might look like.

Your next question comes from Nicole DuPlace with Deutsche Bank. Your line is open.

Yeah, thanks. Good morning.

Good morning.

So I just want to start on the climate margins just to take that a step further. So understanding that you guys did 25% incrementals on volume growth, the 4Q margin assumption seems to embed a bit of a stronger performance versus 3Q. Is that all accountable or attributable to, you know, the mixed headwind going away, or are you anticipating stronger incrementals on volumes as well?

Nicole, just to be clear, this is Nicole on the line, right? Yeah. Okay, good. I wasn't sure, first of all. So, are you talking about quarter four climate leverage specifically?

Exactly.

Yes.

So, what's your view on that?

Well, so as you look at the volume leverage in Q4, you know, it is slightly stronger than it is in Q3, but again, you know, the environment is roughly going to be the same as what we were seeing in Q3. So, in other words, you know, growth in all of the end markets, a probably, you know, same, you know, slight towards applied versus unitary, but there really isn't a huge amount of change that comes out of the volume leverage in Q4, you know, but again, All of our businesses are going to continue to grow in Q4, residential, the commercial businesses, et cetera.

When you look at total leverage, though, for quarter four, Sue's exactly right on the volume piece of it. What I would tell you is the mix will hurt us a little bit more there. We think about more applied, less transport. We would expect less price than we would have in Q3 sequentially just because we're kind of lapping. price there again. So, you know, I would think that will manage the full year for the enterprise to the same 25% we talked about. But I would expect that quarter four will look a lot like quarter three for climate, probably not any better.

Okay, got it. That's really helpful. Thanks, Mike and Sue. And then You brought up price-cost. It seems to me that because you're lapping tougher pricing comps in 4Q, price-cost impact to margins probably comes down a little bit, but thoughts on that and then any early thoughts into 2020 just specifically on the price-cost front?

So if you think about Q4, I think the back half of 2019 is similar. So I think you'll see about the same thing in Q4 that you saw in Q3. And as I think about 2020, so I'm going to give you an answer and it's not going to be, you know, what you want, which is what our guide is. But when I think about 2020 and I think about tier one materials, steel, copper, aluminum should all be on the surface deflationary. So in a good spot, we see the spot prices coming down. We're seeing it in results. and that should be a really nice tailwind, if you will, going into 2020. The however is that as we look at this, we want to watch this play out over the upcoming months because we just do not know what the tariffs and all of those pieces are going to mean to 2020. So in other words, you could have deflation on, you know, those base materials and you could be offset by tariffs. You could have a change in the tariffs and that's just something that we're not comfortable with trying to give that outlook on. So I can tell you what I see on spot prices and in what we're doing on, you know, early buys of material going into 2020, but we'll just watch the environment and then as we get closer to 2020, give you a guide on what we think it looks like at that point in time.

And, Nicole, I'd say that there's been so much, as you know, volatility around news and announcements coming out around tariffs that, unfortunately, we've gotten pretty good at being able to react to it. It takes us about two days to get from an announcement or a change to having that flow through and understand from a gross perspective what the impact is. And it takes us maybe a week from that point in time to understand what we think we can do from a net perspective around mitigating some of that. And therefore, then we know at that point in time, probably a week or so later, what we need to do from a pricing perspective. And it's so volatile that I think we're comfortable with our ability to react and change and understand and push sort of pricing through and mitigate what we can, that at this point in time, we're not trying to guess where things go in 2020 there.

Thanks, guys. This was really helpful.

Your next question comes from Josh Pokrowinski with Morgan Stanley. Your line is open.

Hi, good morning, guys. Hi, Josh. Mike, just to follow up on, I think, a couple questions, trying to get at maybe kind of the shift in climate over time toward more sustainability and energy efficiency. It seems like a lot of your competitors talk more about selling boxes and you guys are talking more about selling solutions. Can you give us a sense for how that mix has evolved in terms of, you know, just kind of straightaway product, you know, sold through traditional channels versus something that is this more kind of comprehensive, you know, sustainability path?

Yeah, I think two things have happened. I mean, one is that obviously the world is looking at regulations differently around greenhouse gas emissions, understanding the impact of refrigeration systems on the environment. That's one. Two, as these systems become greener, if you don't do anything to the fundamental underlying system, the refrigerants tend to be less energy efficient. So you end up using more power to generate the same level of cooling or heating in the system. And so from a system level, it's really making sure that you can reduce the energy intensity while using next-generation refrigerants. And so there's a lot of innovation that goes into that. It also feeds right into how we think about the need to have a direct, very high-quality sales force out there, typically engineers or professional engineers, selling to professional engineers and our customers in the commercial space. And that model exists for us all over the world because these are complex tradeoffs. And then as you think about 30-year lives on many of these systems, Any innovation you have, any advantage you have, and what the cost of maintaining those systems will be can be a very meaningful sort of kicker to total cost of ownership. And so it's just the way we go to market. It's our model. And when we think about creating demand, it was the earlier question about put in place, and I said about half of it is put in place and half of it is going out and creating demand. The half that we go out and create demand with are looking for those kinds of customers that that understand this technically and are wanting to do something about it and may have systems of an age or variety where there's a particular opportunity to go have a high return on invested capital. And so it's just a more sophisticated sale and way to market, and that's what we train people to do. I mean, we train them technically, and then we train them financially around how to go make the case.

Got it. So it's really all the mix is shifted toward this. It's kind of getting away from, hey, you need a box for the top of your strip mall, and we'll sell you one.

Well, it's really, over time, you try to move away from responding to quotes to creating specifications, creating opportunities, and creating your own demand. And that is the control element of what we do, even in a downturn, as opposed to sitting back waiting for something to be built. and somebody asking you for a price, there's plenty to do in the world today to go out and create an opportunity for return on investment for somebody. The other thing, too, is in a downturn, and I've said this very often, we fully expect both our service business and our performance contracting business to increase because you have to maintain or extend asset life. And if you can no longer extend the asset life, we've got a way of paying for these assets through the energy savings that we're willing to guarantee. as part of the asset swap.

Okay, thanks for that.

Thank you.

There are no further questions coming up at this time. I'll turn the call back over to Zach Nagel for closing remarks.

Thank you, Operator. I'd like to thank everyone for joining today's call. I apologize to anyone who was not able to get a question asked in the queue. However, Shane and I will be available all day today and obviously in the coming days and weeks to answer any questions that you may have And we encourage you to call, and we look forward to seeing you on the road soon. Thank you.

This concludes today's conference call. You may now disconnect.