Ingersoll Rand Inc.

Good morning, ladies and gentlemen, and welcome to the Ingersoll Rand second quarter 2022 earnings call. Our host for today's call is Matthew Fort, 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. Fort. You may begin, sir.

Thank you, and welcome to the Ingersoll Rand 2022 Second Quarter Earnings Call. I'm Matthew Ford, Vice President of Investor Relations, and joining me this morning are Vicente Rinal, 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. 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 in this call. Please review the forward-looking statements on slide two for more details. In addition, in today's remarks, we'll 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. 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&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.

Thanks, Matthew, and good morning to everyone. Moving to slide three, 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 to profitable growth and a strong marketing profile. In addition, I am also very happy to welcome Katherine Freitag as our new chief information officer. Both appointments demonstrate the deep bench of talent that we continue to develop at Ingersoll Running. 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 microenvironment. Our performance in the second quarter and here today exemplifies how our employees think and act like owners. Demand remains very strong as we sit here today. And when we see the supply chain risk and geopolitical and macroeconomic uncertainties continue 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 to our capital allocation strategy that is very focused on inorganic growth through Bolton acquisitions, and today we're highlighting three new acquisitions that are very well aligned with our stated M&A strategy and will enhance the quality of our portfolio. Starting on slide four, staying true to our five strategic imperatives where operate sustainably is at the center, we continue to align our portfolio to sustainable high growth and markets supported by global megatrends. There are four points I would like to briefly highlight on this page. First is that we have a simple two-prong approach of growing sustainably and operating sustainably. Second, 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 2030 targets. Third, 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 double B rating to a double A rating in less than two and a half years. 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 22nd, where we will provide a comprehensive update on our current efforts around sustainability. Moving to slide five, 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 are combined with our own patented cold plasma technology to produce nanobubbles that contain a high concentration of oxygen. 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 solution technology. Through the utilization of the Ingus O'Brien 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 PST segment, and we continue to increase our investments in R&D to drive future organic growth opportunities like this. Turning to slide six. We're also very pleased to highlight the most recent inorganic investment, which remain our top priority from a capital allocation perspective. Our M&A funnel remains very healthy. And as of the end of Q2 of 2022, the funnel remains over five times larger than it was in Q2 of 2020. Earlier this week, we announced the signing of three Bolton acquisitions, which are well aligned with our strategic and financial criteria. In addition, These three companies have grown on an aggregate of more than 20% CAGR over the past three years. Let me quickly walk through the sign deals. First, Holtec, which is a leading provider of onsite systems that generate high-purity nitrogen gas. This is a great example of a Bolton acquisition that extends our addressable market to very close adjacencies within the ICS 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. Second is Hanye, which is a manufacturer of dryer technology. that has served as a long-term OEM partner of our ICS Asia Pacific business. Hanye brings differentiated and patented technology to our China compressor business. Both Holtec and Hanye are great examples of expanding our solutions and offerings in the broader compressor ecosystem to better serve our customer needs. And finally, HydroProcast, an India-based manufacturer of progressive gravity pumps and retrofit spare parts. HydroProcast generates more than 80% of its revenue through the sale of aftermarket parts and serves as a complementary addition to the recent CPEX acquisition to further penetrate the growing market in India. We continue to be very prudent in our sourcing and execution of M&A deals, 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 Bolton acquisitions to announce in the second half of the year, as shown by the fact that we have eight additional deals under LOI. As a result, we're confident on being able to reaffirm our stated target of 400 to 500 basis points of annualized growth coming from M&A. I will now turn the presentation over to Kavik to provide an update on our Q2 financial performance.

Thanks, Vicente. Moving to slide seven, we continue to be encouraged by the performance of the company in Q2, which 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 million commitment in cost synergies from the merger. As we've indicated many times, we have a funnel that stands in excess of $350 million, and we are ready to take incremental actions if warranted by macroeconomic conditions and market activity. Total company orders and revenue increased 10% and 13% year-over-year respectively, driven by strong double-digit organic orders growth in ITS and low single-digit organic growth in PST orders. The company delivered second quarter adjusted EBITDA $335 million, a 15% year-over-year improvement, and adjusted EBITDA margins of 23.3%, a 50 basis point year-over-year improvement, and 60 basis point improvement sequentially from Q1. Free cash flow for the quarter was $165 million despite ongoing headwinds from inventory due to the global supply chain as well as the need to support backlog. Total liquidity of $2.4 billion at quarter end was down approximately $700 million 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 eight, for the total company, Q2 orders grew 15% and revenue increased 18%, both on the FX adjusted basis. 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 Solutions innovation highlighted by Vicente and the impact of China lockdowns in two PST facilities. When adjusted to exclude the impact with M&A completed in 2021, PST margins declined by 190 basis points. 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 team despite ongoing inflationary headwinds. Finally, corporate costs came in at $35 million 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 54 cents 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, Free cash flow for the quarter was $165 million despite a $92 million increase in inventory to support backlog. CapEx during the quarter totaled $21 million. 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 $2.4 billion based on approximately $1.3 billion of cash and $1.1 billion of availability on our revolving credit facility. Liquidity decreased by $700 million in the quarter, which included deploying $621 million to debt repayment, $153 million to share repurchases, and $8 million to our dividend payment. As Vicente mentioned, M&A remains our top priority for our capital allocation. Our funnel remains robust and active, and we would expect M&A to be our primary usage of cash here in the second half of the year. 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 structure, we took a number of actions within the quarter. First, we paid down the entirety of our Euro term loan of $621 million. The debt pay down is consistent with our financial policies to prudently manage our gross 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. I will now turn the call back to Vicente to discuss our segments.

Thanks, Vic. Turning to slide 11, our industrial technologies and service segment delivers 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. It is also important to know that on a two-year stack, the ITS segment organic orders grew more than 50%, which is a higher rate than the Q1 2022 two-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 effects, 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. In mainland Europe, down low single digits due primarily to FX headwinds. And a further look into our leading indicators like demand generation leads shows stable growth in mainland Europe. Despite yearly two 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. Moving next to the power tools and lifting, the power tools and lifting team delivers 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. This technology is a perfect example of how we're continuing to address our customers' sustainability needs and goals by driving productivity through improved efficiency and reduced energy costs, decreasing their scope one and scope two 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 $78 million, which was up 9% year-over-year with incremental margins of 11%. Adjusted EBITDA margin was 26.8, down 390 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, where the other largest discrete driver has nearly 60 basis points given the impact to two China facilities in the PSC segment. Organic orders grew off 2% year over year, as future 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 two-year stack, organic orders were up 22%. It is also important to note that in Q1 of 2022, the two-year Oregon stack was approximately 19%, again showing some sequential acceleration of demand into Q2. Since the investor's 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 PSE. 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 at or below 25% EBITDA margin, with a 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 the three examples. The first example is CPEX. It illustrates how we plan to improve businesses that are in the less than 25% EBITDA margin bucket. As you recall, we acquired CPEX in September 2021, which had mid-teens EBITDA margin at the time of the acquisition and has already improved to the low 20s in less than two quarters. The next two examples point out to how we can continue to improve businesses that already have some very high EBITDA margins. First, Air Dimensions, which was another recently acquired company in Q4 of 2021, which in less than two quarters has gone from mid-50s EBITDA margin to low-60s EBITDA margin. And then there is our legacy Garner Denver medical segment, which we now call our Thomas Business. This is a core business where we have shown 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 a strong runway on margin expansion across the entire PST portfolio, and we will use IRX to ensure proper prioritization of action and nimble execution. 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 raise comes entirely from our IPS segment. 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 billion to $1.425 billion. 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. 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 slide six 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 Grand is in a very strong position. We delivered strong results in the first half of 2022, including record second quarter performance that was better than our expectations. 2022 is poised to be a strong year, despite known challenges and dynamic market conditions. We'll continue to remain agile and leverage IRX across every facet of our business to deliver on our commitments. To our 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 a high return on capital as we continue our track record of market performance.

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

If you would like to ask a question, please press star 1 on your telephone keypad now. You'll be placed into the queue in the order received. Please be prepared to ask your question when prompted. Once again, if you have a question, please press star one on your phone now. And our first question comes from Michael Halloran. Hey, good morning, everyone.

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

Yeah, Mike, I think one of the most important, I'll say, leading indicators for us is what 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 acceleration in some areas and markets and regions. 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.

Thanks for that. And then good caller 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?

Sure, Mike. I mean, I'll say that I'm very excited about what we see in the pipeline. I mean, very solid funnel. You saw the three transactions that are highly strategic. I mean, great growing companies, good technologies, 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 the other eight that we have in the LOI, I'll say similar to what we have been doing over the past kind of 12 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.

Thanks for that, Vicente. Appreciate it. Yeah, thank you, Mike.

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

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 weighting between third and fourth quarter, are we thinking the third quarter is maybe a sort of high 20s share of full year EBITDA? Just trying to understand the margin ramp. And then by segment, you know, any color you could give us on how much the margins step up into the back half is split between ITS versus PST.

Yeah, Julian, hey, 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 you asked about the phasing of EBITDA and Q3. Yeah, you're actually right. You know, 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.

Yeah, and maybe, Julian, 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 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 as some kind of continued movement in terms of the merger-related productivity savings. So think about it. It's already action that you could call it that we have, so to speak, in the back or already action. And then from a PST perspective, I think when you look at the data 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. And as we go into the second half, you know, 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&A synergy realization for the deals that we closed in the second half of 2021. And also for the PST is kind of some of these non-repeat China lockdown volume myths and absorption-related issues. So, again, it feels like fairly doable, and the team is executing to all those actions that we need to get done.

That's very helpful, thank you. And then just my follow-up would be around the ITNS EMEA orders progression, you know, how comfortable you feel with that and the demand outlook in that ITS, you know, 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?

Yeah, you know, Julian, from an ITS, Emiya, 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% headline impact. So, yeah, I mean, FX, but even with that, the team continues to outperform pretty well and confident on the execution with what the team continues to outlay 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 third quarter that should be relatively about the same to what we saw in the second quarter. And then basically after that, we should be kind of clearing the goal, I mean, in the fourth quarter.

Thanks very much. Thank you, Julian.

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

Thanks. Good morning, everyone. Just to put a final point on that third quarter statement, Vic, is that, I mean, my dumb math would get me to, 375 million of EBITDA. Is that in the right zone of where you see things?

Yeah, Nigel, I think that may be a little on the higher side. You know, if you were to use kind of a mid, I'm going to say mid to, you know, mid-plus, you know, 20% 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, so like 350, 360. Okay, that's really helpful. Thanks. And then on the PSP side, you know, we've talked about the margins a fair bit. You called out the COVID order headwinds. And I'm wondering, you know, when do we start to lap that impact? I think there's four points to orders. And, you know, how is that filtering through to revenues and margins? Are we seeing a headwind there as well?

Yeah, hey, Nigel, so we'll see one more quarter here in the third quarter of the same kind of COVID hit related one time from last year. And so what we see in the third quarter should be fairly similar to what we saw here in the second quarter from an audit and a revenue perspective.

Great. Okay, I'll leave it there, guys. Thanks a lot. Thank you.

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

Thanks. Good morning, guys.

Morning, Joe.

A couple of quick ones for me. Just trying to understand, I think with a lot of our companies, how the fact that base metal pricing is starting to deflate and how that ultimately impacts the P&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 to versus potentially

give back and what happens do you think to your margins if you do see some deflation from from a cost input perspective yeah joe i'll say that uh uh the way the way we think about it is that we're we're not uh we have not historically given out any pricing back and and the reason being all the price increases that we have done even this year and last year have been list price increases and 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, you know, five to eight years later. So it's kind of difficult to compare that kind of price-to-price perspective. I mean, clearly, it's 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. And so as we think and we look forward, yeah, I mean, we're pretty excited 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, you know, 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, yeah, I mean, we see that that could be a great margin expansion for us on an ongoing basis.

That's great to hear, Desente. And maybe just, I know we 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 four buckets, you know, M&A, growth, China, and then other, and you think about 3Q, maybe just talk me through the buckets and how those buckets change in the third quarter. I'm assuming that, you know, your PST margins are maybe down modestly in 3Q on a year-over-year basis?

Yeah, Joe, I'll take that one. So if we kind of think about the three buckets, the way I probably describe it is, you know, first starting with the biggest one, the impact of M&A. First and foremost, we do start to lap the M&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 lapse that, you know, and clearly with some of the higher synergy expectation that we expect to see, you know, that will start falling off. So, again, we would expect to see the impact of M&A start to dramatically reduce here in Q3, given that, you know, we only had a one-month impact last year. Or, sorry, one-month impact this year in terms of the 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 and exiting June, our China facilities, particularly in PST, were operating right back on track, and we don't have any expectations of any concerns here in Q3. Okay. In terms of the investments for growth, yes, that definitely will still, you know, be part of the equation. You know, I think it'll be, you know, you should expect to be dramatically different in terms of Q3. You know, a lot of these are areas like, for example, our hydrogen business and the ion solutions business that was highlighted in the deck. And, you know, those will continue. These are, you know, great innovations, things that we're really excited about, ones that we continue to, you know, invest in and execute on, you know, frankly, since last year, even through this year. So, again, I think that's how the three 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.

Super helpful. Thanks, guys. Thank you, Joe.

As a reminder, if you do have a question, please press star 1 on your telephone keypad now. And our next question comes from Rob Wertheimer. Your line is open.

Hey, thanks, and good morning, everybody.

Good morning, Rob.

My question is actually going to be on innovation. And the cold hard plasma is something, it sounds very interesting, I don't know 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, you know, any metrics you want to share on pacing change and so forth. And then breakthrough innovation is maybe slightly different. I don't know the, you know, 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.

Yeah, Rob, 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 its self-contained unit, not only the ability of creating this infection, but create the ability of accelerated oxygenation in the water, which is kind of particularly very, very important for hydroculture markets and hydrophonics markets and things like that. So I think it's going to be really, 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, it speaks volumes to some of the things that we've been wanting to do, which is kind of a combination of several Ingersoll-run technologies, such as compressors and pumps, into additive technology that can actually create a very unique solution. And again, here's 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, you know, from an ICS perspective, and we kind of gave a bit of a highlight that innovation accelerated dramatically uh when when the combination of the two companies and and we continue to do a lot of that work around you know global product summits that we have with the teams and uh so i think it's a very exciting piece you know which is uh fairly recently here a couple weeks ago we had our uh strategic plan review with the teams and one of the core characteristics of uh of the review in in every business it was around intellectual property and ip and patented 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've 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, you know, differentiation in energy efficiency. So, a pretty unique model that we leverage IRX all in its own to drive the process. And, you know, I would say that this ion solution, the cold plasma, was one great example. Acquire some IP, develop the IP, utilize IRX processes as a way to out-execute the, you know, 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.

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

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 to all these issues that we're seeing.

Yeah, I would say, you know, 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, yeah, 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 parts. So, yes, absolutely. We've seen productivity hits due to the inefficiencies on the supply chain. And I think, you know, 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 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 yeah, definitely some headwinds. So to your point, it's a very good point that as we go into maybe 2023 and beyond, we should see maybe the better efficiencies of productivity due to the ease of the supply chain being more stable.

Right. And obviously, that's exactly where I was going with this, 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 23. Absolutely.

Yeah, I would agree. 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, to get better into the second half of this year and then potentially, as Asante indicated earlier, if commodities start to deflate in the next year and given how we've deployed price, um we definitely see that as a potential tailwind into 2023. i think the other the other thing we should probably mention here is and you know you see it you saw it in the financials that clearly as a result of the supply chain obviously inventory continues to uh you know be at elevated levels and i think as supply chain alleviates here uh we obviously have a meaningful opportunity from a cash perspective in terms of uh in terms of deploying that that inventory so and again the good news is the backlog is there to do it for the back half of this year so again it's just matter of us continue to execute and seeing a little bit more normalization in the supply chain.

Super. Thank you. Our next question comes from Nicole de Vlaze.

Your line is open.

Yeah, thanks. Good morning, guys.

Good morning, Nicole.

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?

Yeah, I know, yeah. I figured that we'll get the follow-up for sure, yeah. 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, you know, we saw – we're starting to see more, I guess, release, so to speak, for some long-cycle projects. So we're seeing that, you know, 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, you know, energy transition related and or, you know, 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, you know, very exciting movement in the U.S., China, but even also in Europe. So I think it was fairly broad-based here, Nicole.

Thanks, Vicente. And Vic, maybe just to follow up on the comment you just made about free cash flow, 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 weighted based on your plans for reducing inventories?

Nicole, I'd say it's probably second half weighted is probably the best way to say it. You know, if you look, you know, last year's probably a good example. You know, typically we are seasonally more second half weighted. I would say that's probably a combination of two things. One, following the profitability of the company, as well as, you know, the typical movements in working capital. You know, I think in terms of this year, sure, you are going to see probably a stronger fourth 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. You kind of see that through the first half that we have built a meaningful amount of inventory, about a $200 million, I'd say, for the first half. headwind from a cash flow perspective. But despite that, we're actually quite pleased with generating $165 million of free cash flow still in the second quarter. 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.

Thanks, Dick.

I'll pass it on.

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

Morning, guys. Thanks for taking my question. Morning, Douglas.

So maybe just on the capital allocation front, a lot of good color around, obviously, the three 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, you know, how you're thinking about your appetite for larger deals, you know, especially given maybe some increased noise in the macro backdrop.

Yeah, I'll say, Vlad, you know, when you look at our funnel, 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 is nothing around those billion-plus acquisitions And not because there might not be out there, 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.

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&S growth. So can you just talk about you know, what's really changed in the environment since 1Q? I mean, investors are more focused on, you know, potential slowdown and worried about the macro, but you're seeing organic growth, you know, accelerate. So can you just talk about the drivers and how you think about, you know, the sustainability of that growth trajectory beyond the back half here? Sure.

So Vlad, I'll say that, you know, maybe to keep it more or less kind of simplistic in nature is that, You know, 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 ITS or PST. So, again, we, and those are actions that we have taken that is already built already in the backlog. So, it's basically shipping the product and realizing that higher price realization that gives you that increase in organic, as well as also, as Vic said, that, you know, price cost margin that will continue to get better in the second half. And to the volume, organic volume is then in terms of the, just again, supply chain constraints getting released and be able to accelerate some of the shipments from being able to deliver to what customers want. So again, it's better price realization and better supply chain kind of coming to a better movement here for us that allows the factories to produce the products.

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

We have a question from Nathan Jones. Your line is open. Good morning, everyone. Good morning, Nathan.

I wanted to start off with a question about the long cycle project, Vicente. You talked about some of those getting released and helping to drive the order book. I think by the time those projects get to ordering products from Ingersoll Rand, they're likely to go ahead regardless of the macro backdrop. Can you talk about any information or insight you might have on some of those larger, longer cycle projects that 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 you know, customers reconsidering or delaying kind of moving forward with earlier stage projects like that?

I'll say, you know, to be honest, 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 would 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.

Thanks. Maybe for Vic, 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.

Yeah, 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 to, 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 cognizant of balancing, you know, further interest rate exposure by balancing our fixed to floating ratio, as you indicated. And so what we did was, you know, I'd say three distinct things or three to four distinct things in the quarter. One, we did pay off the full amount of the Euro denominated term loan, which was in dollar terms, $621 million. Then we executed 1 billion Euros USD to Euro cross-currency swaps, three-year term, and 50% of that swapped to fixed, 50% swapped to floating. And then the final piece is we executed a billion dollars of U.S. dollar interest rate caps capped at 4% on the base interest rate. So, again, we've meaningfully changed the fixed to floating ratio here in the context of you know, where we were, you know, 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 debt towers right now are all out to 2027. So that gives us, you know, some time here to continue to both evaluate but execute and change that structure. And, you know, 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 a centric and clearly the funnel continues to support that and maybe just the bottom line what's the quarterly run rate for interest expense uh yeah you'll probably be um you know i'd say closer to the you know the high 20s to uh you know in the in the in the back half of the year on average roughly speaking it's probably good from an interest perspective thanks very much thanks

As a reminder for those who joined the call late, if you do have a question, please press star 1 on your telephone keypad now. And we have a question from Joe O'Day. Your line is open.

Hi, good morning. I wanted to ask on the M&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 45% 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 here?

Yeah, Joe, I think the best way to think about this is maybe two pieces. One, our commitment and what we still are reaffirming here today is the ability to execute 400 to 500 basic points on an annualized basis of inorganic growth. So let me take it in two pieces. You can see in the guidance, we still are committed to about $225 million 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 first quarter of a business called York. So that's really what's driving the $225 million. 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 you know, those deals as well as ones we just announced, again, we would expect to get to 400 to 500 basis points on an annualized basis. So, you know, 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, you know, 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&A impact to 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 three deals announced here earlier this week, they're technically not in guidance yet and they won't be until we actually close the deals.

Understood. And then circling back on the ITS Asia pack orders and upload 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?

Yeah, 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 lot of triangulation. And, yes, I mean, according to our teams, we continue to outperform China. 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 technology that we have around batches 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 IT 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 move pretty quickly to create applications to those areas where they're seeing kind of the good areas of growth momentum. So I think this is something that I would say still is 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, the team has done a phenomenal job just executing to that strategic aspect.

Got it. Thanks very much. Thank you, Joe.

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

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 2022. I mean, in terms of performance and 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 while leveraging IRX is the essential piece to our continued momentum. 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 Stevenson and Michael Stubbefield 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, I just want to say thank you for your continued support and look forward to speaking with many of you here. So thank you.

This concludes today's conference call. Thank you for attending.