Ingersoll Rand Q3 2022 Earnings Call Transcript

Presentation

[Operator]

Hello, everyone, and welcome to Ingersoll Rand's Q3 2022 Earnings Conference Call. My name is Emily and I'll be coordinating your call today. [Operator Instructions]. I will now turn the call over to our host, Matthew Fort with Ingersoll-Rand. Please go-ahead, Matthew.

[Matthew Fort, Vice President, Investor Relations at Ingersoll Rand]

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 Reynal, Chairman and CEO, and Vik Kini, 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 to keep to one question and one follow-up to allow time for other participants. At this time, I will turn the call over to Vicente.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

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 our customer's 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 Rand.

And now, let's review how we accomplish these results on Slide 3. Our achievement is reflected in the numbers and also in our commitment to lead sustainably. We continued to position Ingersoll Rand for long-term value-creation through industry-leading innovation that offers intrinsically sustainable benefits to our customers. Through Q3, demand remained strong. And while macroeconomic, geopolitical, and supply-chain uncertainties continue to be a concern, we remained 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 continued to accelerate organic growth through demand generation and product execution. In addition, we remained committed to our capital allocation strategy, which is focused on inorganic growth through bolt-ons 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 4, today we'll discuss four critical elements of our compounded model to demonstrate how we stay focused on controlling what we can control.

Moving to Slide 5, 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 21, 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 left, and today we are number one in our industry in North America.

We continued to align our portfolio to sustainable high-growth end markets, supported by mega-trends. In September, we hosted our second Annual Sustainability Call, where we introduced our enhanced strategic imperative lead sustainably, which is based on a simple two-pronged approach on grow sustainably and operate sustainably.

On this slide, I'll [Indecipherable] details of highlighting two examples from our broad core 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 system. 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 that to warm water that can be used in our processes or [Indecipherable], with a payback period for our customers of less than one year on average. Our impact on water conservation occurred in multiple ways, but perhaps the most compelling is our products that eliminate the need for water usage in critical applications.

The Runtech, 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 required a fresh water supply. Our existing installed base around the world is currently 7.5 billion gallons of water a year. And we estimate that over 15 billion gallons of water per year could be potentially saved with a full adoption of our Runtech technology globally. To put that into perspective, that's more than three times the amount of bottled water concern in the United States annually.

Within our own facilities, operate sustainably is an integral part of our business, whose focus is on reducing the electricity and water consumption to drive zero greenhouse gas emissions. Our commitment to operate 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 Rand the supplier of choice for our customers. Together, we are building a better future employment by leading sustainable actions within our business, with our suppliers, and in our communities.

In Slide 6, [Indecipherable] demonstrate, two simple examples on how we continued 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 and Ukraine war, we saw a downward trend of marketing qualified leads or MQL. The demand-generation team immediately jumped into action leveraging IRX to invert that trend through channel campaigns, focusing on high-growth sustainable markets. A vertical-specific and energy-efficient related webinars and utilizing trends there to remain agile and revised 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 continued to remain healthy and grew in the low-single digits, excluding effects for our compressor portfolio in ITS.

On the right, is an example of an outstanding product-line execution in China. Prior to the merger, Gardner 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 GD. Through the new product on process, they improve efficiency by 5% to 10% and also improve the cost structure of the compressor portfolio through the utilization of i2V. With those improvements in efficiency and cost structure, we focused on fast-growing small to medium-sized customers and expanded the Gardner 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 bolt-ons acquisitions that enables 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's strong End-User relationship and technician network to convert competitive products and support aftermarket growth. Second is better here, a leading Spanish manufacturer of a 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 a 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, who are enabling expansion into close adjacencies.

Continuing on page eight, moving from left to right of the page. These are great examples of close adjacencies with immediate synergies. The SPX Flow air treatment business is a leading manufacturer of desiccant and refrigerated 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 the US 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 in IIoT specialist with technology that is complementary to our YZ Systems product line. 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'll now turn the presentation over to Vik to provide update on our Q3 financial performance.

[Vikram Kini, Senior Vice President, Chief Financial Officer at Ingersoll Rand]

Thanks, Vicente. On slide nine, we continued 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 remained on track to deliver on our $300 million commitment in 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 posted a strong book to bill of 1.09 times for the quarter and we remained 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 margin 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 times which is 0.1 times 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 PST of adjusted EBITDA margins, which were up 230 basis points versus Q2, and now PST margins are generally back-in line with where we've 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 team 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 $0.62 per share. The tax-rate for the quarter was 21.7% and we anticipated 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 headwind primarily to support backlog. CapEx during the quarter totaled $22 million and leverage for the quarter was 1.0 times, which was an 0.1 times 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 included $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'll now turn the call back to Vicente to discuss our segment performance.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Thanks, Vik. 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 times. And note that on a two-year stack the ITS segment organic orders grew approximately 50%, which is in-line with the Q2 2022, two-year stack, meaning that at those parts, we continued to see strong demand for our products.

Moving to the individual product categories, each of the figures excludes the negative impact of FX, which was at 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 delivered a solid performance with orders in North America of 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 30% growth across the rest of Asia-Pacific. In vacuums and blowers, 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 in the 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 and [Indecipherable] in high-growth sustainable end markets such as clean energy. Due in a large part of Russian 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 Technologies 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 30% year-over-year, as Q3 counts were impacted by headwinds from prior year COVID-related demand primarily in the [Indecipherable] 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 the 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.

So 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 of post-acquisition. This is a great example of how we leveraged our compounding 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. 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 dollars. 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 anticipated 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, Hydro Prokav, Westwood, Pedro Gil, Dosatron, and Airmax. However, overall M&A revenue guidance for the year remains flat to prior guidance, due to the impact of FX, and specifically on previously acquired businesses with Seepex and Maximus seeing the largest effect.

Turning to slide 15, as we wrap up today's call, I want to reiterate that Ingersoll Rand is in a strong position. We delivered 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 prepare for any challenges that may come.

To ensure consistent delivery of our commitments, we'll 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 drive 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 continued to drive are very welcomed by our employees.

Our balance sheet is strong and with our disciplined and comprehensive capital allocation strategy, we remained 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'll turn the call back to the operator and open for Q&A.

Questions and Answers

[Operator]

Thank you. [Operator Instructions]. Our first question today comes from Mike Halloran with Baird. Please go ahead, Mike. Your line is open.

[Michael Halloran, Analyst at Robert W. Baird and Company]

Good morning, everyone.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Good morning, Mike Halloran.

[Michael Halloran, Analyst at Robert W. Baird and Company]

So, two questions here. First question, 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 in the areas of weakness? And when you look at those leading indicators that you talk to, any signs of concern 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 quiet going forward on the older side?

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Yeah, Mike. I'll say, nothing that would classify as a major significance up or down. I mean very good stable robust across the portfolio, the regions, and on the segments. Clearly as we kind of highlighted the year 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 overcome any market dynamics that we would [Indecipherable] clearly aftermarket continues and services continued to be a very important piece of our question and then -- so I think it just continues the teams driving the initiatives that we have in place.

[Michael Halloran, Analyst at Robert W. Baird and Company]

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

[Vikram Kini, Senior Vice President, Chief Financial Officer at Ingersoll Rand]

Yes, Mike. As you could expect, we were quick and pretty agile and nimble and taken action and a lot of that has to do with the proper planning that we have in place. So, we already have several downplayed scenario playbooks that we have with the team that as we kind of look at the demand and we see that order patterns if those materialized in terms of reduction or decrease, we'll definitely take immediate action.

So, I think it's just one of those that we continued 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 our two large companies, Gardner has been running Ingersoll Rand, during period of -- in the middle of a pandemic. We didn't do much on footprint and footprint could be another area of continued expansion -- expanding our synergy creation here from the merger with the company.

[Michael Halloran, Analyst at Robert W. Baird and Company]

I appreciate that. Thanks.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Thank you.

[Operator]

Our next question comes from Julian Mitchell with Barclays. Please go ahead, Julian.

[Julian Mitchell, Analyst at Barclays]

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

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Yeah, Julian. I think the way to think about it sequentially, you know think about revenue to be a kind of fairly on an absolute dollar basis, consistent maybe slightly up Q4 compared to Q3. And this implies a kind of on a year-over-year, the organic growth is going to be in the top end of the organic growth guidance, a 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 basis points to 150 basis points and M&A roughly 200 basis points lower than Q3 and some of the M&A falls off and we move through the fourth quarter.

So, when you put all these together kind of comparing to the total company from an EBITDA perspective and this is fairly similar, I would say in this --in the segment level is that we would -- 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 during Q2 exit levels, so again we expect to see a moderate improvement as we go quarter-to-quarter.

M&A synergy realization for the deals we close in the second half of 2021, in particular PST, we'll continue to see some acceleration on that and we kind of move ahead. And also don't forget that we still have roughly -- in the year, we had about roughly $50 million of the merger-related synergies that tend to correlate to volumes again. We'll see some of that here in the fourth quarter.

So those are kind of the three core variable that allows us to -- to your point with the prudent revenue being roughly consistent in 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 lovely to what the teams continued to execute really well despite the lot of headwinds that we continue to do.

[Julian Mitchell, Analyst at Barclays]

That's very helpful, thank you. And then maybe just my quick follow-up. There is a massive of good color on ITS orders and the sales by region, maybe tend to focus on PST. How you're thinking about the sort of organic orders trajectory there? They were kind of low single digits for a couple of quarters in a row, understood that the COVID headwind, so maybe how do we think about orders in the next few quarters in PST play-out?

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Sure, Julian. You said it well in terms of the kind of reflecting here in the Q3 and Q2, ex-COVID impacts that we saw from these kinds of large orders in the 2021, not happening now. When you exclude that, PST was 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 continued to move forward over the next few quarters, we expect that the teams will continue to deliver that kind of range as we move forward.

[Julian Mitchell, Analyst at Barclays]

Got it. And the COVID headwind kind of drops out as we enter 2023?

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Yes, that's, right.

[Julian Mitchell, Analyst at Barclays]

Great. Thank you.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

I mean there is a -- it was mostly not Q2 and Q3. 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.

[Julian Mitchell, Analyst at Barclays]

Perfect. Thank you.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Thank you.

[Operator]

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

[Joe Ritchie, Analyst at The Goldman Sachs Group]

Thanks, good morning, guys.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Good morning, Joe.

[Vikram Kini, Senior Vice President, Chief Financial Officer at Ingersoll Rand]

Good morning, Joe.

[Joe Ritchie, Analyst at The Goldman Sachs Group]

So, just starting off. I guess you [Indecipherable] thinking about ITS, the order strength has been notable 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 growth, particularly in ITS? And then also pricing has been very strong, maybe some comments around the carry-forward in pricing and how to think about that for 2023?

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Yes, Joe. So as we think about 2023 and clearly we're not going to provide any kind of detailed guidance here on this call on 2023, but a couple of items to consider is that, from a revenue perspective, I mean we had a very strong book to bill in Q3, over one, particularly much even stronger in the ITS and so again we continued to build more backlog. We built more backlog in Q3 as compared to the second 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 there a very good momentum. And it is then what will allow us, as we continued to move forward, perhaps continued to deliver or out-deliver the commitment that we said that the ITS segment can continue to grow at these kinds of organically mid-single digit over of the horizon in the period that we committed to.

I mean in terms of price, we said that even -- any market we can generate at least 1% to 2% of the price, regardless of the market conditions and 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 will definitely continue to generate some of that new price as well as carryover that will definitely be plenty of carryover, that will be much higher than that -- than the 1% to 2% of the price.

But I think the good thing that is -- that, as we, think about 2023 is that inflation seems to be fairly stable and stabilizing, which -- when that starts turning more favorable or kind of inflation decreasing, we're holding the price or expect that continued to drive, continued margin expansion and that we recognized that but as we move forward, we'll continue to see also very good momentum on the integration of the M&A that we're doing here.

[Joe Ritchie, Analyst at The Goldman Sachs Group]

Got it. That's super helpful and then if I maybe one question for Vik. We saw in this quarter you guys had $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 adjustment, like what kind of expect that -- Yes. I guess maybe that, there are any surprises, kind of like going-forward in that regard?

[Vikram Kini, Senior Vice President, Chief Financial Officer at Ingersoll Rand]

Yes, so, Joe. I'll take that one real quick. So just kind of just high-level first and foremost. One, the LIFO adjustment, it's a noncash adjustment, it's done frankly more so for a book are really tax purposes. We do state our books each quarter on a LIFO basis, which we believe is a more accurate assessment of our true operating performance and 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 almost exactly the same amount.

Now with regards to the timing, I'd say really much more in line with accounting requirements. We do monitor materiality on a quarterly basis to determine when the adjustments should be made and obviously, it was deemed that just given the inflationary dynamic that we see in that, it was appropriate to make that adjustment here in Q3 of 2022.

So again, 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 is 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, a 100% consistent. So whether it's the adjusted EBITDA number you saw or the $0.62 of adjusted EPS that excludes that impact but that's 100% consistent with how we've guided and how we've historically reported.

[Joe Ritchie, Analyst at The Goldman Sachs Group]

Great thanks guys.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Thanks, Joe.

[Operator]

Our next question comes from [Indecipherable] with Wolfe Research. Please go ahead, Bastien [Phonetic].

[Unidentified Participant, at Ingersoll Rand]

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

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Yes. I'll keep it pretty short here. I mean the LIFO reserve adjustment is obviously correlated to the inflationary levels that we've been seeing in the market and as you would expect given where inflation has continued to trend, whether it'd be last year or this year, we've obviously seen the impact commensurate there.

So again, I would tell you it's reflective of the current operating environment that we're in, it's not been quite frankly more than that but I think that's quite frankly the easy direct answer there and then I'll reiterate kind of what I've said before our practice with regards to stating our non-GAAP metrics is 100% consistent and as such that's what you've seen as a report, whether it'd be -- whether it's our guidance or actuals or our comparatives on a year-over-year basis.

[Unidentified Participant, at Ingersoll Rand]

Great, that's helpful. And then my follow-up question would be about orders in compressors. So you had a low 30% order growth in America, as well as in Europe and China where more middle single digits and high single digits. Could you maybe shed a little light on your margin-qualified leads and how do they stack up against [Indecipherable] orders in Europe and maybe if you could shed a little bit of light on what's the pipeline of MQL conversion orders looks like? Thank you.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Yes. 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 driven to the activities of the team have been doing. And as you saw over 60% increase in MQl, it does take time to convert those leads what we typically say is it's anywhere between six to eight weeks to grow from the marketing qualified lead to the sales qualified lead that kind of generates the order.

And to your point, I mean there is a percentage of conversion rate, we don't really actually talk about that externally because obviously, we think that these whole systems that we have is really strategic and proprietary to us, which is very exciting what we have been able to build here together internally. But again. I think the exciting piece is that whether you look at it by region or by product line, MQLs continued to be stable, if not continued to look a bit upward momentum as we can all go into here in the fourth quarter so.

[Joe Ritchie, Analyst at The Goldman Sachs Group]

Thank you, that's helpful.

[Operator]

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

[Andy Kaplowitz, Analyst at Citi Group]

Hey, good morning everyone.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Good morning, Andy.

[Andy Kaplowitz, Analyst at Citi Group]

Vincente, it seems like a relatively difficult time to get M&A done given the volatility in 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've announced some larger deal pretty recently, so just talk about sort of what you're seeing out there?

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Sure, Andy I'll say that, we continued 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 on the ownership of the family to even also us.

So, I think we continued 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 would say that we still see continued demand, we still see that there is a lot of companies that we're also walking away from. So in the same amount that you see deals that were transacting, I mean we're walking away from a very, very large number of deals and transactions, so over 80 companies that we have said no to over the past couple of quarters. So, you can -- 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 over five times the funnel size and still already eight LOIs on current -- currently on negotiation, in addition to obviously the transactions that we have announced.

[Andy Kaplowitz, Analyst at Citi Group]

Got it and then maybe give us some more color regarding what you're seeing in China, order growth looks like it, maybe decelerated a bit in China in Q3 versus Q2. I think it was up low double digits a pretty last quarter and up low-single digits this quarter, what's your visibility like there? I know you've done a lot of work there, the RMT has helped you. So what's your visibility there going into Q4 and into 2023?

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Yes. I will say, Andy, that we still see fairly stable demand. I mean even as we kind of go here into the month of October. October in a year-over-year basis, actually from a percentage perspective ex-FX even accelerated from the numbers that we posted here in Q3. So again, if we continue to see good stable demand and I think -- important to note that Q3 of 2021, I mean this is the time when China, we're seeing really 50% type of growth numbers. So again, it's a bit of a tough comp, but still, even the theme 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, we can imagine that vacuums and blowers is a very similar story but the team is driving and doing localizing products, making them more for in the market, for the market and then leveraging the commercial footprint to execute with the help of IRX.

[Andy Kaplowitz, Analyst at Citi Group]

I appreciate the color.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Thank you, Andy.

[Operator]

Our next question comes from Rob Wertheimer with Melius Research. Please go-ahead, Rob.

[Rob Wertheimer, Analyst at Melius Research]

Thanks, and good morning, everybody. We've-- 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 as in [Indecipherable] spending CapEx. So aside from what you've done there, do you see customers coming to you with the need for energy efficiency, do you see them being hesitant or how would you characterize the market?

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Absolutely, Rob. That's definitely one of the core fundamental things that are definitely happening in Europe is that, clear natural gas prices and you've seen a little bit of a drop here or dramatic drop natural gas prices, but it takes time to digest that also through the system. But yes, long-term, we see that continue 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 a 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.

[Rob Wertheimer, Analyst at Melius Research]

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

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Yes, 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 on loan cycle CapEx kind of getting released and that is in the center of -- again related to sustainability relating to energy transition activities and a lot of things we've been spoken about -- talking about in terms of getting ourselves aligned to these mega-trends or sustainability uneven and the decision, 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 the here into October, again we still see FX-adjusted positive growth in the month of October from an orders perspective, in Europe particularly to your question.

[Rob Wertheimer, Analyst at Melius Research]

Thank you. Yes, sure. Our next question comes from Josh Pokrzywinski with Morgan Stanley. Please go ahead, Josh.

[Josh Pokrzywinski, Analyst at Morgan Stanley]

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 MQL, 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?

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Hey, Brandon. 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, your 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 are 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.

[Josh Pokrzywinski, Analyst at Morgan Stanley]

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?

[Unidentified Speaker, at Ingersoll Rand]

Yes, Brian. 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 the uneven totality. You've kind of seen very much in-line with historic practice, the pre-synergy, adjusted EBITDA, purchase multiple across effectively the suite of R&D you've seen us do that's kind of been in that low-double-digit type range. We typically are able to drive anywhere from roughly 2 times to 4 times of EBITDA multiple purchase reductions, as we think about it three years 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 ultimately the ROIC kind of calculus, where everything we're doing is very much in-line with kind of our stated return criteria mid-teens ROIC, then our cost-of-capital so again double-digit type returns. That's the way I would probably describe all of these and you know as 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 not actually across the different geographies which is great because the integration happens in the business and. 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 profile as you've seen from our historic bolt-ons acquisitions.

[Operator]

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

[Nathan Jones, Analyst at Stifel Financial]

Good morning, everyone.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Good morning, Nathan.

[Nathan Jones, Analyst at Stifel Financial]

I'm going to ask a couple of questions on 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, thoughts on that globally at less than one-year payback, which kind of implies that more than a $5 billion revenue opportunity for Ingersoll Rand. Customers are typically looking for two years or less payback on those kinds of investments.

What's the limiting factor to getting those out there like how do you think -- how do you view the rollout at something like that in 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.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Hey, Nathan. I think I say that is basically the -- I call it limiting factor or not, but this is why we think and while we believe the 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 than we are today.

So, I think it's just a matter of continuing to educate customers, customer see that technologies like this what can drive for them clearly, you hear a lot about weather 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 implemented in their businesses. So, yes, you could 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.

[Nathan Jones, Analyst at Stifel Financial]

And then my follow-up around the drawing side of the business. I think it's pretty obvious you guys have decided that having the drawing 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 but both the drawing and the compression is a strategic advantage and how you can leverage that in the marketplace?

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Yes. I think that's -- 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. If you have a compressor that is attached to a driver 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 it's 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 design 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, it's a good thing for the planet and it goes really well-aligned with our just total holistic company strategy.

[Nathan Jones, Analyst at Stifel Financial]

The customers see the value in you having that dual capabilities?

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Well, yes because and then again you can -- when you said that you're talking to the customer about the best optimal solution between the two versus having the customer by 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.

[Nathan Jones, Analyst at Stifel Financial]

Yes.

[Operator]

There is no other questions we have for today. So I'll now hand back to the Vicente for concluding remarks.

[Vicente Reynal, Chairman, President and Chief Executive Officer at Ingersoll Rand]

Yes, thank you. I concluded my I just want to say that you have seen our culture continues to be a very unique differentiation. Differentiation is 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 continued to be highly engaged and it's driven by a lot of activity that we do internally in the company as well as this ownership mindset and I'm thinking a not in my 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.

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

• Matthew Fort, Vice President, Investor Relations
• Vicente Reynal, Chairman, President and Chief Executive Officer
• Vikram Kini, Senior Vice President, Chief Financial Officer
• Unidentified Speaker

Analysts

• Michael Halloran, Robert W. Baird and Company
• Julian Mitchell, Barclays PLC
• Joe Ritchie, The Goldman Sachs Group, Inc.
• Unidentified Participant
• Andy Kaplowitz, Citi Group
• Rob Wertheimer, Melius Research
• Josh Pokrzywinski, Morgan Stanley
• Nathan Jones, Stifel Financial