Ingersoll Rand Inc.

Hello, everyone, and welcome to Ingersoll Rand Q3 2022 Earnings Conference Call. My name is Emily, and I'll be coordinating your call today. At the end of the presentation, you will have the opportunity to ask a question by pressing Start, followed by the number 1 on your telephone keypads. I will now turn the call over to our host, Matthew Fort with Ingersoll Rand. Please go ahead, Matthew.

Thank you, and welcome to the Ingersoll Rand 2022 Third Quarter Earnings Call. I'm Matthew Fort, 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 be referencing these during the call. Both are available on the investor relations section of our website. In addition, a replay of this conference call will be available later today. Before I start, I want to remind everyone that certain statements on this call are forward-looking in nature and are subject to the risks and uncertainties discussed in our previous SEC filings. which you should read in conjunction with the information provided on this call. Please review the forward-looking statements on slide two for more details. In addition, in today's remarks, we will refer to certain non-GAAP financial measures. You can find a reconciliation of these measures to the most comparable measure calculated and presented in accordance with GAAP in our slide presentation and in our earnings release, both of which are available on the investor relations section of our website. 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 the sender.

Thanks, Matthew, and good morning to all. I would like to begin with a big thank you to our employees worldwide for their hard work in helping us deliver another record quarter in Q3. You consistently exemplify our purpose and think and act like owners to deliver on our customer needs. Every day, I am impressed with how you're leveraging our IRX process to outperform in a continuously challenging environment. Our performance this quarter and year to date reinforces the impact we have as owners of Ingersoll Randall. And now let's review how we accomplished these results on slide three. Our achievement is reflected in the numbers and also in our commitment to lead sustainably. We continue to positioning those around for long-term value creation through industry-leading innovation that offers intrinsically sustainable benefits to our customers. Through Q3, demand remains strong. And while microeconomic, geopolitical, and supply chain uncertainties continue to be a concern, we remain focused on what we can control while leveraging our strong balance sheet and operational mindset to execute on our commitments. Remaining agile in today's environment is critical, and you will see today how we continue to accelerate organic growth through demand generation and product execution. In addition, we remain committed to our capital allocation strategy, which is focused on inorganic growth through bolt-on acquisitions. Today, we're highlighting six new companies we have recently acquired or have under contract that will strengthen our position in core categories and broaden our exposure to high-growth, sustainable end markets. Turning to slide four, today we will discuss four critical elements of our compounded model to demonstrate how we stay focused on controlling what we can control. Moving to slide five, we have some exciting news to share. We recently earned a score of 81 on the S&P Global Corporate Sustainability Assessment. As of October 21st, this score puts us at number one in North America, number four in the world and in the 99th percentile within our industry, which is very impressive. And think about it. Less than three years ago, we were not even showing on the list, and today we are number one in our industry in North America. We continue to align our portfolio to sustainable high growth and markets supported by megatrends. In September, we hosted our second annual sustainability call where we introduce our enhanced strategic imperative, Lead Sustainably, which is based on a simple two-pronged approach of grow sustainably and operate sustainably. On this slide, I'll spend a minute highlighting two examples from our broad portfolio that help improve energy efficiency and reduce water consumption. We believe that within the US alone, there are over $1.3 billion in cost savings opportunities for compressed air systems. And that number is likely five times greater globally. The energy recovery unit shown here is an innovative device that captures up to 94% of the heat generated during air compression and uses it to warm water that can be used in oil processes or for space heating, with a payback period for our customers of less than one year on average. Our impact on water conservation occurs in multiple ways, but perhaps the most compelling is our products that eliminate the need for water usage in critical applications. The Runtec Turbo Blower technology is a perfect example. This blower technology is used by leading pulp and paper manufacturers, and it replaces an alternative technology that requires a fresh water supply. Our existing InstaBase around the world is currently saving 7.5 billion gallons of water a year. And we estimate that over 50 billion gallons of water per year could be potentially saved with the full adoption of our Runtek technology globally. To put that into perspective, that's more than three times the amount of bottled water consumed in the United States annually. Within our own facilities, Operating sustainably is an integral part of our business. We focus on reducing electricity and water consumption to drive zero greenhouse gas emissions. Our commitment to operating sustainably delivers value for our stakeholders and our planet, creates a sense of purpose and inspiration for our employees, and has a positive impact on the communities in which we operate. This commitment also makes Ingersoll Grant a supplier of choice for our customers. Together, we're building a better future and planet by leading sustainable actions within our business, with our suppliers, and in our communities. Turning to slide six, let us demonstrate two simple examples on how we continue to control what we can control to deliver organic growth. On the left, we have an example of demand generation execution in Europe, which clearly has been a challenging market. In Q1, at the start of the Russia-Ukraine war, we saw a downward trend of marketing-qualified leads, or MQLs. The demand generation team immediately jumped into action, leveraging IRX to invert that trend through channel campaigns focused on high-growth sustainable markets, vertical-specific and energy-efficient related webinars, and utilizing trend data to remain agile and revise all targeted campaigns. As a result of these actions, we saw a 60% increase in MQL, which is our primary leading indicator for orders. And as you can see from our results, orders in mainland Europe continue to remain healthy and grew in the low single-digit excluding effects for our compressor portfolio in IPS. On the right is an example of an outstanding product line execution in China. Prior to the merger, Garner Denver had a solid compressor portfolio for the China market. but did not have the right sales structure or operational footprint. Post-merger and leveraging IRX, the team refreshed the program, integrating the best practices from both IR and GED. Through the new product development process, they improved efficiency by 5% to 10% and also improved the cost structure of the compressor portfolio through utilization of ITV. With those improvements in efficiency and cost structure, we focused on fast-growing small to medium-sized customers and expanded the Garner Denver channel over 200% separate from the legacy IR channel. The end result is triple-digit growth in revenue and unit volume in a highly competitive market. Turning to slide seven, since our Q2 earnings call, we announced the signing of six Bolton acquisitions that enable us to increase value across ecosystems by expanding our core mission-critical flow creation technologies while accelerating our addressable market with close adjacencies. So let me quickly walk you through these deals. First, AirMax, which is a leading full-service provider of air compressors and compressed air system services based in France. This is an example of a strategic channel expansion for our ITS segment, which will leverage AirMax strong end-user relationship and technician network to convert competitive products and support aftermarket growth. Second is Pedro Hill, a leading Spanish manufacturer of blower and vacuum systems. This acquisition strengthens our position in core blower and vacuum categories in high-growth sustainable markets, including water and wastewater. Next is Everest, which is a leading Indian manufacturer of blower and vacuum systems. Everest significantly broadens our presence in the key high-growth market of India. These three acquisitions are strongly aligned with our strategy and increase our product portfolio in core technologies or enabling expansion into closed adjacencies. Continuing on page 8, moving from left to right of the page, these are great examples of closed adjacencies with immediate synergies. The FPX Flow air treatment business is a leading manufacturer of desiccants and refrigerator dryers, filtration systems, and purifiers for compressed air. These products are highly complementary to our portfolio since more than 75% of compressors need one of these air treatment solutions, and in addition, they generate strong recurrent aftermarket business. Next, Dosatron International, which is a UAS leader in water-powered flow solutions, and IIoT for hydroponics and agricultural markets, which improves our capabilities in several high-growth, sustainable end markets through depreciated digital controls and IIoT solutions. And finally, Westwood Technical, which is a highly experienced control instrumentation and IIoT specialist with technology that is complementary to our YZ system program. Westwood enhances our IIoT platform including innovative low-power wide area networking technology. We expect the team to integrate these acquisitions at the regional level by utilizing IRX and our proven model of integration excellence that you have seen in prior acquisitions. Our M&A funnel remains strong, and as of today, the funnel still remains over five times larger than it was in Q3 of 2020. I will now turn the presentation over to Vic to provide update on our Q3 financial performance.

Thanks, Vicente. On slide nine, we continue to be encouraged by the performance of the company in Q3 with a strong balance of commercial and operational execution fueled by IRX despite ongoing macroeconomic uncertainty. We remain on track to deliver on our $300 million commitment and cost synergies from the merger. And as we have 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 14% year over year respectively. We saw strong double digit organic revenue growth in both ITS and PST at 19% and 15% respectively. Overall, we post a strong book to bill of 1.09 turns for the quarter. and we remain encouraged by the strength of our backlog, which is up over 40% year-over-year. The company delivered third quarter adjusted EBITDA of $376 million, a 20% year-over-year improvement, and adjusted EBITDA margins of 24.8%, a 110 basis point year-over-year improvement, and a 160 basis point improvement sequentially from Q2. Free cash flow for the quarter was $253 million, despite ongoing headwinds from inventory due to global supply chain challenges, as well as the need to support backlog. And total liquidity of $2.6 billion at quarter end was up approximately $200 million sequentially. Our net leverage continues to improve and is at 1.0 turns, which is 0.1 turns better than the prior quarter. Turning to slide 10, for the total company, Q3 orders grew 18% and revenue increased 22%, both on an FX-adjusted basis. Total company adjusted EBITDA increased 20% from the prior year, and the ITS segment margin increased 70 basis points, while the PST segment margin declined 60 basis points, driven primarily by the impact of prior year acquisitions, as well as the impact of prior year COVID-19 related demand. When adjusted to exclude the impact of M&A completed in 2021, PST adjusted EBITDA margin actually increased by 60 basis points. And we did see a significant sequential increase in PSTs adjusted EBITDA margins, which were up 230 basis points versus Q2. And now PST margins are generally back in line with where we have seen them historically at approximately 30%. It's important to note that both segments remain price-cost positive in terms of dollars, which speaks to the nimble actions of our teams despite ongoing inflationary headwinds. And finally, corporate costs came in at $30 million for the quarter. Adjusted EPS for the quarter was up 9% to 62 cents per share. The tax rate for the quarter was 21.7%, and we anticipate the full year being in the low 20s as well. Moving to the next slide, free cash flow for the quarter was $253 million, despite $69 million of inventory headwinds, primarily to support backlog. CapEx during the quarter totaled $22 million, and leverage for the quarter was 1.0 turns, which was an 0.1 turn sequential improvement. Total liquidity now stands at $2.6 billion based on approximately $1.5 billion of cash and $1.1 billion of availability on our revolving credit facility. Cash outflows for the quarter include $4 million for share repurchases and $8 million to our dividend payment. M&A remains our top priority for capital allocation, and we continue to expect M&A to be our primary usage of cash as we look forward. I will now turn the call back to Descente to discuss our segment performance.

Thanks, Vic. On slide 12, our industrial technologies and services segment delivered strong year-over-year organic revenue growth of 19%, split evenly between price and volume. Adjusted EBITDA rose 15% year-over-year, with an adjusted EBITDA margin of 26.2%, up 70 basis points from prior year, with an incremental margin of 32%. We also deliver sequential margin expansion of 80 basis points from Q2 to Q3. Organic orders were up 16% with a strong book-to-bill of 1.13 turns. And note that on a two-year stack, the ITS segment organic orders grew approximately 50%, which is in line with a Q2 2022 two-year stack, meaning that thus far we continue to see strong demand for our products. Moving to the individual product categories, each of the figures exclude the negative impact of FX, which was a 7% headwind across the total segment on both orders and revenue. Starting with compressors, we saw orders up in the high double digits. And a further breakdown shows orders for oil-free products grew 20%, and oil-lubricated products grew in the mid-teens. The Americas team delivers solid performance. with orders in North America up high 20s, while Latin America was up mid 30s. In mainland Europe, orders remained strong with growth in the low single digits, while India and the Middle East were up high double digits. The Asia Pacific team delivered orders growth in the high single digits, driven by low single digit growth in China and low 30s percent growth across the rest of Asia Pacific. In vacuum and blower, orders were up low 20s on a global basis. The global power tools and lifting team continues their strong performance with orders for the total business growing in the high double digits. Moving to the sustainable innovation and action portion of the slide, we're highlighting the relaunch of our Buffalo, New York facility. The reopening of this site has not only localized manufacturing and reduced customer lead times, but it has also expanded our global capacity for air and gas centrifugal products in high-growth, sustainable markets, such as clean energy. Doing a large part of restoring activities, orders are up over 500% in the Americas, with over $40 million booked since our May 2022 launch. And this is a real, tangible, and very inspirational example of our employees thinking and acting like owners. Turning to slide 13, revenue in the precision and science technology segment grew 15% organically split evenly between price and volume. Additionally, the PST team delivered adjusted EBITDA of $92 million, which was up 22% year-over-year with incremental margins of 27%. Adjusted EBITDA margin was 29.1%, down 60 basis points year-over-year. As illustrated in the table on the bottom left side of the page, the decline year-over-year in adjusted EBITDA margin is driven by the impact of prior year acquisitions at 120 basis points and the impact of prior year COVID-19 related demand at 60 basis points. However, sequential adjusted EBITDA margin significantly improved by 230 basis points due to operational execution and price cost performance. Organic orders were up 3% year-over-year, as Q3 comps were impacted by headwinds from prior year COVID-related demand, primarily in the Thomas business. Adjusting for the COVID-related orders, normalized organic orders were up approximately 8%. On a two-year stack, organic orders are up 27%, which is higher than a two-year stack from Q2. From our PST, sustainable innovation in action, we're highlighting air dimensions. This recently acquired business is a market leader in diaphragm vacuum pumps serving mission-critical environmental applications in sustainable end markets such as clean energy. Since the Q4 of 2021 acquisition, the team has installed and leveraged IRX to accelerate investments in new product development and launch a higher-pressure offering, securing orders from four major OEMs and system integrators. As a result, the business is seeing revenue growth of low double digits and has improved adjusted EBITDA margin from the mid-50s to low 60s in less than three quarters post-acquisition. This is a great example of how we leverage our compounded model through the power of IRX to achieve double-digit earnings growth. Moving to slide 14, in terms of 2022 guidance, given the ongoing strength in commercial and operational performance, we are raising our organic revenue guidance from the total company to 12% to 14%, a 100 basis point increase from prior guidance based on both our ITS and PST segments. The organic growth increase is offset by the negative impact of FX, which is expected to now contribute headwinds of approximately 6% compared to a headwind of 5% in the prior guidance. For the full year, we are reaffirming our 2022 revenue guidance at 11% to 13% total growth. We're also raising our adjusted EBITDA guidance at the midpoint by tightening the range to between $1.4 billion and $1.425 billion. Important to note that this guidance includes nearly $20 million of adjusted EBITDA headwinds from FX when compared to our prior guidance. Due to investments in inventory to meet growing demand, we expect free cash flow conversion to adjusted net income to be approximately 90% for the year. Even with this change, free cash flow margins are expected to be in the mid-teens. And we expect free cash flow conversion to return back to 100% as we think about 2023 and beyond. We anticipate our adjusted tax rate to be in the low 20s and capex to be approximately 2% of revenue. Interest expense is estimated to be approximately $35 million in the fourth quarter. Our M&A guidance does include the acquisitions of Hanye, Holtec, Hydroprocaf, Westwood Tech, Pedohill, Dosatron, and Airmax. However, overall M&A revenue guidance for the year remains flat to prior guidance due to the impact of FX, specifically on previously acquired businesses with CPEX and Maximus seeing the largest effect. Turning to slide 15, as we wrap up today's call, I want to reiterate that Ingersoll Brand is in a strong position. We deliver strong results in the first three quarters of 2022, but our full year outlook remains optimistic. We're keeping a close eye on the dynamic market conditions while we remain agile and prepared for any challenges that may come. To ensure consistent delivery of our commitments, we will continue to leverage IRX across every facet of our business. To our employees, I want to again thank you for your ongoing engagement and for making thoughtful, action-oriented decisions like the owners you are. This continues to draw our ability to make life better for our customers, our planet, and our stockholders. It is also exciting that our most recent survey on employee engagement continues to show improvement, which demonstrates the rapid changes we continue to drive are very welcomed by our employees. Our balance sheet is strong and with our discipline and comprehensive capital allocation strategy, we remain resilient and have the capacity to deploy capital to investments with the highest return as we continue our track record of market outperformance. With that, I will turn the call back to the operator and open for Q&A.

Thank you. If you would like to ask a question, you may do so now by pressing start followed by the number one on your telephone keypad. When preparing to ask your question, please ensure that your device and your microphone are unmuted locally. And if you change your mind and would like to be withdrawn from the queue, please press start followed by two. We'll just take a brief pause and allow the queue to fill. Our first question today comes from Mike Halloran with Baird. Please go ahead, Mike. Your line is open.

Good morning, everyone. So two questions here. First question, you know, obviously the orders trends are really healthy and pretty impressive considering the backdrop here. Maybe just talk a little about the volume trends you saw through the quarter, anything notable, any areas of weakness. And when you look at those leading indicators that you talked to, you know, any signs of concern in there, or do you think there's just a lot going on that, is unique to Ingersoll Rand that allows you to be able to continue a pretty healthy clip going forward on the order side?

Yeah, Mike, I'll say nothing that I will classify as major significance up or down. I mean, very good, you know, stable, robust across the portfolio, the regions, the segments. You know, clearly, as we kind of highlighted here on the earnings call, it's a lot of that has to do with controlling what we can control and clearly our demand generation. It's a great example here that we're showing some proof points in terms of how that is helping us, you know, overcome any market dynamics that we see out there. Clearly, aftermarket continues and services continue to be a very important piece of our equation. And then, you know, so I think it's just continual, the teams driving the initiative that we have in place.

And, you know, I heard Vic's comments about, you know, if things change, you have the ability to leverage into some of those synergies to drive some upside to the range. You know, and I know Vicente, you've got a... history of being able to act quickly if the environment changes. And so I guess what I'm just wondering is what kinds of things are you guys looking for to be able to pull that trigger in a more real-time basis?

Yeah, Mike, as you can expect, you know, we're quick and pretty agile and nimble in taking action. And a lot of that has to do with the proper planning that we have in place. So we already have, you know, several downplay scenario playbooks that we have with the teams that, as we cannot look at the demand and we see that order patterns, if those materialize in terms of reduction or decrease, we will definitely take immediate action. So I think it's just one of those that we continue to look at the leading indicators, the MQL, the order rates, and we're ready to pull the trigger. I mean, if you can think about it, one example of this is that over the past couple of years, as we integrated the two large companies, Garnet Denver and Ingersoll Rand, during a period of, in the middle of pandemic, You know, we didn't do much on footprint, and footprint could be another area of continuing expanding our synergy creation here from the merger of the two companies.

Appreciate that.

Thanks. Thank you.

Our next question comes from Julian Mitchell with Barclays.

Please go ahead, Julian.

Hi, good morning. Maybe just a first question on the very short term. I know you get asked this hundreds of times in the last few months, but help us understand that fourth quarter EBITDA ramp one more time. I think it implies sequentially sales are down slightly, and then EBITDA is up about $20 million sequentially there. even with a wider sort of corporate cost. So maybe just help us understand between the two segments how those earnings are moving up sequentially.

Yeah, Julian, I think the way to think about it sequentially, you know, think about revenue to be kind of fairly, you know, on an absolute dollar basis consistent, maybe slightly up Q4 compared to Q3. And this implies kind of on a year-over-year, the organic growth is going to be on the top end of the organic growth guidance, kind of mid-teens growth versus what you saw here in the third quarter, fairly similar, slightly above. But FX continued to be a headwind of an additional 100 to 150 basis points, and M&A roughly 200 basis points lower than Q3 as some of the M&A falls off And we move through the fourth quarter. So when you put all this together, kind of comparing to the total company from an EBITDA perspective, and this is fairly similar, I would say, in the segment level, is that would you continue to see improved price realization Q3 to Q4, given the actions that we have already taken and inflation staying flat, I mean, relatively flat to Q2 exit level. So again, we expect to see a moderate improvement as we go quarter to quarter. M&A synergy realization for the deals we closed in the second half of 2021, particularly PST. We'll continue to see some acceleration on that as we kind of move ahead. And also don't forget that we still have, you know, roughly in the year we had about roughly $50 million of the merger-related synergies that tend to correlate to volume. So again, we'll see some of that here in the fourth quarter. So those are kind of the three core variables that allows us to To your point, with a prudent revenue being roughly consistent Q3 to Q4, we still see improvement in the EBITDA, even though we're getting a big headwind on the FX. So, again, it just speaks loudly to what the teams continue to execute really well, despite a lot of headwinds that we continue to see.

That's very helpful. Thank you. And then maybe just my quick follow-up. There's a massive good color on ITNS orders and sales by region. Maybe then to focus on PST, how you're thinking about the sort of organic orders trajectory there? They were up. kind of low single digit for a couple of quarters in a row, understood the COVID headwinds. So maybe how do we think about orders, you know, next few quarters in PST play out?

Sure, Julian. You know, Seneca, you said it well in terms of kind of reflecting here in the Q3 and Q2 ex-COVID impacts that we saw from these kind of large orders in the 2021, not happening now. When you exclude that, PST in the Q3 was up 8%, which we view as relatively healthy and in line with our stated investor day targets of growing PST in the mid-single-digit-plus range. As we continue to move forward over the next few quarters, we expect that the teams will continue to deliver in that kind of range as we move forward.

And the COVID headwind kind of drops out as we enter 23.

Yes, that's right. Great. Thank you. I mean, there's a, yeah, it was mostly noted Q2 and Q3, you know, a little bit here in the fourth quarter, but more, I mean, less significant. And obviously as you're going to 2023, there's definitely nothing.

Perfect. Thank you. Thank you.

Our next question comes from Joe Ritchie with Goldman Sachs. Please go ahead, Joe.

Thanks. Good morning, guys.

Morning, Joe. Morning, Joe.

So just starting off, I guess, you know, Vicente, thinking about ITS, you know, the order strength has been notable, you know, throughout the year. I guess it might be too early to think about a 2023 framework. But I'm curious, do you have any preliminary thoughts on, you know, growth, particularly in ITS? And then also, you know, pricing has been very strong. Maybe some comments around the carry forward in pricing and how to think about that for 23.

Yeah, Joe. So as we think about 2023, and clearly we're not going to provide kind of detailed guidance here on this call on 2023, but a couple items to consider. Is that, you know, from a revenue perspective, I mean, we had a very strong book to book to build in Q3 over 1 and particularly much even stronger in the. And so again, we continue to build more backlog. We built more backlog in Q3 as to compare to the 2nd quarter, even though obviously we had increased revenue output. So heading into 2023, we're very pleased that we're going to have much more backlog than we have ever historically had. And I think a lot of that has to do with how we have continued to align to the mega trends that we spoke about around sustainability, digitization, that those are kind of gathering very good momentum. And it is then what will allow us, as we continue to move forward, perhaps continue to deliver or outdeliver the commitment that we said that the ITS segment can continue to grow at this kind of organically mid-single digit over the horizon and the period that we committed to. I mean, in terms of price, we said that even, you know, in any market, we can generate at least 1 to 2 percent of price regardless of the market conditions. Again, that's just because of the nature of our product being so mission critical. So as we kind of go into 2023, you expect that we'll definitely continue to generate some of that new price as well as carryover. There will definitely be plenty of carryover that will be much higher than the 1% to 2% of price. But I think the good thing is that as we think about 2023 is that inflation seems to be fairly stable or stabilizing, which when that starts turning more favorable or kind of inflation decreasing, we're holding the price, so expect that that continues to drive continued margin expansion, and that we, you know, we recognize that as we move forward, we'll continue to see also very good momentum on the integration of the M&As that we're doing here.

Got it. That's super helpful. And then if I, maybe one question for Vic. You saw that this quarter you guys had the $33 million LIFO adjustment. I think last year it happened in the fourth quarter. Can you just maybe just provide some context around the timing of the adjustments, like what to kind of expect? I guess maybe there aren't any surprises kind of like going forward in that regard.

Yeah, sure, Joe. I'll take that one real quick. So just kind of just high-level, first and foremost, you know, one, the LIFO adjustment, it's a non-cash adjustment. It's done, frankly, more so for book or really tax purposes. We do state our books each quarter on a FIFO basis, which we believe is, you know, is a more, you know, accurate assessment of our true operating performance. And, you know, as such, we do adjust out the LIFO reserve adjustment from our non-GAAP results. It's also worth noting, as you indicated, this is 100% consistent with our historic practice. You saw in Q4 2021, we did exactly the same thing. And in fact, the dollar impact was, interestingly enough, almost exactly the same amount. Now, with regards to the timing, you know, and I'd say really much more in line with, you know, accounting requirements, we do monitor materiality on a quarterly basis. to determine when the adjustment should be made. And obviously, it was deemed that just given, you know, the inflationary dynamics that we've seen, that it was appropriate to make that adjustment here in Q3 of 2022. So, again, you know, I would say nothing inconsistent with what you've seen historic. It's just the facts and circumstances here that have dictated that we take the adjustment here in Q3. And it's also worth noting, obviously, that Our guidance, the way we report all of our non-GAAP financial metrics, whether it be adjusted EPS or adjusted EBITDA, 100% consistent. So whether it's the adjusted EBITDA number you saw or the 62 cents of adjusted EPS, that excludes that impact, but that's 100% consistent with how we've guided and how we've historically reported.

Great. Thanks, guys. Thanks, Joe.

Our next question comes from Bastian Sasson-Morin with Wolf Research. Please go ahead, Bastian.

Hi, everyone.

So, congratulations on the quarter. I was curious, and I wanted to ask a follow-up question on the LIFO reserve. Maybe you could show a little bit more color on why it was so large, and are you seeing any ad backs on Q4, and if you tell us something about the future of inflation? Thank you.

Yeah, I'll keep it pretty short here. I mean, the LIFO reserve adjustment is obviously correlated to the inflationary levels that we have been seeing in the market. And as you would expect, given where inflation has continued to trend, whether it be last year or this year, we're obviously seeing the impact commensurate there. So, again, I would tell you it's reflective of the current operating environment that we're in. It's nothing, quite frankly, more than that. But I think that's quite frankly the easy, you know, direct answer there. and then you know i'll reiterate kind of what i've said before our practice with regards to stating our non-gap metrics is 100 consistent and um you know as such that's what you've seen us report uh whether it be whether it's our guidance or our actuals or our comparatives on a year-over-year basis great that's helpful and my follow-up question would be about orders and compressor so you had a low 30 order growth in america as well europe and china were more

middle single digits and high single digits. Could you maybe shed a little light on your marketing qualified lead and how do they stack up against software orders in Europe? And maybe if you could shed a little bit of light on what's the pipeline of MQL conversion order looks like. Thank you.

Yeah, in terms of the MQL, I mean, you saw on one of the slides, we provided a little bit of color in terms of that increase in MQLs that we saw particularly in Europe, again, too driven to the activities that the team have been doing. And as you saw, you know, over 60% increase in MQLs. It does take time to convert those leads. What we typically say is that it's anywhere between six to eight weeks to go from the marketing qualified lead to the sales qualified lead that kind of generates the order. And to your point, I mean, there's a percentage of conversion rate. We don't really actually talk about that externally because obviously we think that this whole system that we have is really, you know, strategic and proprietary to us, which is very exciting what we have been able to build here together internally. But But again, I think the exciting piece is that whether you look at it by region or by product line, MQLs continue to be stable, if not continue to look a bit upward momentum as we can all go into here in the fourth quarter.

Thank you.

That's helpful.

Our next question comes from Andy Kaplowitz with Citigroup. Please go ahead, Andy.

Hey, good morning, everyone. Morning, Andy. Andy. Vicente, it seems like a relatively difficult time to get M&A done given the volatility of the markets, but you've obviously been able to maintain or even step up your M&A activity. I know you mentioned your funnel is still five times larger. Could you talk about the sustainability of your recent M&A momentum? Obviously, you announced a somewhat larger deal pretty recently, so Just talk about sort of what you're seeing out there.

Sure. I'll say that we continue to see pretty good momentum and activity on the M&A. And again, I think we have said it before, which is that a lot of our M&A, call it 90% of that, it is sole source, meaning that we are proactively going to the owners and cultivate that relationship in order to execute the M&A at the right moment in time. And I think what you saw here in a lot of these deals is exactly that. I mean, think about even Everest, that vacuum and blower Indian manufacturer. I mean, that has been a relationship cultivation of over two years. And clearly now is the right time to move on and transition mutually from the ownership of the family to even also us. So I think we continue to leverage a lot of our processes. I mean, as you can imagine, we're utilizing IRX processes as a way to drive M&A through the funnel and increase the velocity. So I will say that we still see continued demand. We still see that there's a lot of companies that we're also walking away from. So in the same amount that you see deals that we're transacting, I mean, we're working away from a very, very large number of deals and transactions. So over 80 companies that we have said no to over the past kind of couple quarters. So that tells you a lot of the kind of velocity and movement that we see in the M&A funnel. But again, yes, we're excited that, as you said, you know, over five times the funnel size and still already –

eight lois on current currently on negotiations in addition to obviously the transactions that we have announced got and then vincente maybe give us a little more color regarding what you're seeing in china order girls looks like it maybe decelerated a bit in china in q3 versus q2 i think it was upload double digits for free last quarter and upload single digits this quarter What's your visibility like there? I know you've done a lot of work there. You know, the RMT has helped you. So what's your visibility there going into Q4 and into 2023?

Yeah, I would say, Andy, that we still see fairly stable demand. I mean, even as we kind of go here into the month of October, October on a year-over-year basis, actually, you know, from a percentage perspective, XFX even accelerated from the numbers that we posted here in Q3. So, again, we continue to see good stable demand. And I think, you know, important to note that, you know, Q3 of 2021, I mean, this is the time when China, we were seeing really, really like 50% type of growth numbers. So again, it's a bit of a tough comp, but still, even the team was able to deliver a two-year stack that is really impressive and see that continued momentum as we go here into the fourth quarter. And as you pointed out, a lot of that very important self-help, we show the example of compressors, but you can imagine that vacuums and blowers is very similar story that the team is driving and doing, localizing products, making it more in the market for the market, and then leveraging the commercial footprint to execute with the help of IRX.

Appreciate the color.

Thank you, Andy.

Our next question comes from Rod Wertmeyer with Mellius Research. Please go ahead, Rob.

Thanks, and good morning, everybody.

Morning, Rob.

So my question is really on Europe. You obviously used IRX to offset some choppiness in the European markets. And it's really just the fundamental question, again, about the rising need for energy efficiency in Europe as energy prices have gone way up versus the obvious potential hesitancy on spending CapEx. So aside from what you've done there, do you see customers coming to you with a need for energy efficiency? Do you see them being hesitant? How would you characterize the market?

Absolutely, Rob. That's definitely one of the core fundamental things that is definitely happening in Europe is that clearly natural gas prices, and, you know, you've seen a little bit of a drop here or dramatic drop in natural gas prices, but, you know, it takes time to digest that also through the system. But, yeah, long-term, yeah, I mean, we see that continue, you know, rising energy in Europe, but also in other places of the world as a way for us to drive that Return on that invested capital to be very, very palatable when you think about generating less than one year payback when you buy a compressor and not only quick payback, but also you're doing something good for the planet because you're saving the energy and helping these customers achieve their sustainability targets.

And so do you think that Europe is getting worse or better on, you know, on the underlying demand dynamics through the quarter and into 4Q? And I'll stop there. Thanks.

Yeah, Rob, in terms of what we saw in the third quarter, again, fairly stable, but the stability comes in really driven by, I would say, a good, you know, long cycle CapEx kind of getting released. And that is in the sense of, again, related to sustainability, relating to energy transition activities. A lot of things that we've been talking about in terms of getting ourselves aligned to these megatrends of sustainability and even digitization. I mean, the team continues to do a very good job on driving that service and aftermarket capability in Europe. And as we kind of look into here into October, again, we still see effects adjusted. positive growth in the month of October from the orders perspective.

In Europe particularly, to your question. Yeah, sure.

Our next question comes from Josh Poskowinski with Morgan Stanley.

Please go ahead, Josh.

Hey, good morning. This is Brandon on for Josh. Just two follow-ups on some of the questions that have already been asked. First, on the MQLs, when you turn to this MQL process in places like Europe where demand may be slowing, does that come with some sort of margin impact versus the more typical order process?

Hey, Brandon, you know, the cost of customer acquisition for MQL is really low. So I would say think about it as even perhaps it might be a margin accretion or margin improvement. Because we're not sending the sales guy to knock on doors, and we're doing all these kind of digitally. And so we're really increasing and enhancing the efficiency. So if anything else, I'll say that we, because we're more prone to specifically put products with a higher margin through the MQL process, is actually good news that you see a total average margin improvement.

Got it. And then just on M&A with all the deals recently, how are you guys thinking about synergies for 2023 and what's been announced?

Yeah, Brandon, I'll take that one. The way I would think about it here is, again, the framework with which we have done all these deals. And again, I'll talk about it kind of in totality. You've kind of seen very much in line with historic practice you know, the pre-synergy, adjust EBITDA, purchase multiple across effectively the suite of everything you've seen us do has kind of been in that low double digit type range. We typically are able to drive anywhere from some, you know, roughly two to four turns of EBITDA multiple purchase reduction as we think about a three-year out view. And so whether you want to look at it from a purchase multiple perspective and the ability to reduce that through synergies or alternately the ROIC kind of calculus where Everything we're doing is very much in line with kind of our stated return criteria, you know, mid-teens ROIC, then our, you know, cost of capital. So, again, double-digit type returns. That's the way I would probably describe all these. And, you know, as Vicente mentioned during the prepared comments, these are all core technologies or close adjacencies. They are technologies, businesses, companies we know very well. They are split nicely between the two segments, and interestingly enough, actually across the different geographies. which is great because the integration happens in the business. And, you know, I would tell you right now we don't see any reason why these won't be in line with the types of deals and the types of returns and the types of synergy profiles you've seen from our historic bolt-on acquisitions.

Our next question comes from the line of Nathan Jones with Stiefel. Please go ahead, Nathan.

Good morning, everyone. Good morning, Nathan. I'm going to ask a couple of questions. EMAX, the EMAX heat recovery device that you highlighted, you talked about that being 1.3 billion of potential cost savings for customers in the US, five times that globally at less than a one-year payback, which kind of implies that's more than a $5 billion revenue opportunity for Ingersoll Rand. Customers are typically looking for, you know, two years or less payback on those kinds of investments. What's the limiting factor to getting those out of there? Like, how do you view the rollout of something like that and the customer adoption for something like that? What do you have to do for education, marketing, those kinds of things to get that product out into the market?

Yeah, Nathan, I think I'll say that that is basically the... I call it limiting factor or not, but this is why we think and why we believe that demand generation in terms of digitally educating customers in a better way, more efficiently and more proactive is the way to go, even in the industrial market space that we are today. So I think it's just a matter of continuing to educate customers. Customers see that technologies like this, what can drive for them. Clearly, you hear a lot about whether heat pumps and other things in Europe We think this is also another avenue of technology that can really help a lot of companies save energy, not only in this case for how we do it on the heat recovery unit, but in many other applications. So again, it's just one of those that it's just all about educating customers and customers seeing that they can grab that activity and implement it in their businesses. So, but yeah, you can imagine that we're leveraging, as you can imagine, we're leveraging the demand generation team and a lot of our digital transformation activities towards educating customers on very unique innovations like this.

Then my follow-ups around the drying side of the business. I think it's pretty obvious you guys have decided that having the drying capability to go with compression is a strategic advantage for Ingersoll Rand with some of the acquisitions you've been making. Can you talk about why you think being able to supply both the drying and the compression is a strategic advantage and how you can leverage that in the marketplace.

Yeah, I'll say that in simple terms, the more you can actually optimize the total system versus optimizing or sub-optimizing multiple systems separately, then you're better off. Meaning if you have a compressor that is attached to a dryer and you can actually work in a way to really optimize the two at the same time, in an ongoing operating basis, that I think is a very winning proposition for us to drive that to the customer and then potentially create new revenue streams that could be very good for us. So again, it's just one of those that we believe that air treatments, whether you're drying it or whether you're really utilizing the air treatment as a way to generate nitrogen or oxygen, that point of use, it's a good thing for the customer, is a good thing for the planet. And it goes really well aligned with our just total holistic company strategy.

Do customers see the value in you having the dual capabilities?

Oh, yes. Yes. Yes, because then, again, when you sell it, you're talking to the customer about the best optimal solution between the two versus having the customer buy a compressor and then buying something else from someone else and the two of them have just not been optimized together. So, the better optimization, which then drives better.

Yep.

Those are all the questions we have for today.

So, I'll now hand back to Vicente for concluding remarks.

Yeah, thank you. I, you know, concluding my, I just want to say that, you know, you have seen, you know, our culture continues to be a very unique differentiation. and, you know, differentiation based on the performance that we're driving. And this is driven by our employees, which we pass on with a big thank you. I mean, our employees continue to be highly engaged and is driven by a lot of the activity that we do internally in the company, as well as these ownership mindset and thinking at 99 Corners, because all the employees are owners in the company. And we're very excited about what's ahead of us and continue to drive performance and be very transparent with all the investor community. So with that,

Thanks so much and look forward to seeing many of you as we go into the road. Thanks.

Thank you for joining us today. This concludes our conference call and you may now disconnect your lines.