Ingersoll Rand Inc. (IR) Earnings Call Transcript & Summary

Good morning, everyone. And thanks for tuning in to day 2 of Deutsche Bank's Global Industrials & Materials Summit. Hope everyone is staying safe and healthy. For anyone that doesn't know me, I'm Nicole DeBlase. I'm the lead analyst covering the electrical equipment and multi-industry space at DB. Today, I'm joined by Vicente Reynal, CEO of Ingersoll Rand. Very pleased to have him join us for the conference. Prior to becoming CEO following the RMT between Gardner Denver and Ingersoll Rand's industrial business, Vicente served as CEO of Gardner Denver since 2016 after an 11-year career at Danaher. And Vik Kini also joins us. For those of you who don't know him, he heads up Investor Relations for Ingersoll Rand.

I think we're going to go ahead and dive right into the fireside chat today. [Operator Instructions] And with that, I'll go ahead and dive right into the first question. So Vicente, clearly COVID kit-driven demand declines are at the front of investors' minds. Can you give us a sense of what you saw across your various businesses into May? And I guess I think the expectation was that we would see improvement from a pretty deep trough in April throughout the rest of the quarter. So curious if you're starting to see that improvement in order activity.

Yes, Nicole. First of all, I'd say thank you for inviting us and exciting to be here with you this morning and with many of the investors here through the day today. So yes, I mean so what we saw -- as you remember a few weeks ago during our earnings call, we spoke about orders in April being down 20%; however, book-to-bill ratio being greater than 1, particularly driven by our precision and science as well as our industrial technology. And in the month of May, what we saw May so far is that very consistent with our expectations. I mean definitely there's slight uptick that we were expecting here to see sequentially as the economies and kind of the wave of the pandemic continued to move across the different regions. And beyond -- but still, what we will call out and say that beyond kind of the second quarter, just like many of us, I mean that we have kind of limited visibility. But -- so what we are doing is we continue to plan for market conditions that are comparable to what we're seeing right now. And this is where we feel that IRX is the right tool leading our teams to execute under all economic conditions. Currently, we have over 120, 130 IMPACT Daily Management rooms executing across the company every week. And here, the teams, they're focusing here day to day and week to week on an execution -- or controlling what we can control as you saw and accelerating synergies as well as adding more discretionary actions and definitely delivering some very good commercial initiatives across the company.

Got it. And maybe digging a little bit more into the trends that we're seeing. Is -- the improvement into May, it would seem to me like that would be pretty universal across all of your businesses, maybe with the exception of the upstream energy business. Is that how you would characterize it? And maybe are there pieces of the business where you're seeing the recovery come a bit faster than others?

No. I would definitely say the way you characterize it at the beginning, fairly consistent across the businesses. The upstream business, one that obviously still is what we call at that trough level, although we believe that April, in terms of when you think about number of fleets out in the market, it was maybe considered to be a bit of a trough. And we saw in the month of May, more fleets out in the market than what we saw in the month of April. It just takes time to see some of that. But I mean I think everything fairly consistent across most segments in terms of the recovery month over month.

Got it. That's helpful. Did you guys face significant supply chain disruptions on the back of COVID? And I guess if you did, are there certain businesses that have been more impacted than others?

Yes. We saw, and we mentioned this on the call, I mean we definitely saw some supply chain disruptions back in the first quarter in China. And then as the pandemic moved into the other regions, then we saw some in Europe and some in the U.S. I'll say all of that has mostly recovered now. And the most recent area that we called out as well, it was India. But we also saw that recovery here in the month of May as we predicted, we were going to see as economies -- the governmental restrictions will ease. And we're monitoring now Brazil, but so far, no major issues on the supply chain. So we don't expect supply chain to cause a material drag at this point in time and one that we're seeing some good recovery. And I think the other thing, the point I will make, Nicole, is that this is the benefit of the power of this combination of 2 companies that we've been able to leverage the supply chain from both companies and be able to be highly selective as to which suppliers we want to be partnering with. And as we see maybe some issues on one supplier that could be maybe for the legacy Gardner Denver, we could leverage what the legacy Ingersoll Rand brand supply chain had and then create a better synergy, not only on the price, but also on the supplies.

Got it. That makes sense. And I guess trying to think through what the world looks like post-COVID as economies begin to reopen in Europe and the U.S., I mean can you talk a little bit about new safety standards that you've been implementing in your businesses? And I guess -- or in your facilities? And I guess is there a risk that that's a drag on margins as we start to see a recovery just with the changes that you had to make in the way that you manufacture goods?

Yes. So we definitely -- we were pretty quick to move on implementing a lot of the safety standards about social distancing in the factories, temperature checking. For one thing of having a sizable business in China is that we definitely learned a lot of lessons on how to react pretty quickly. And that's why we were still able to keep a lot of our factories mostly open and operational. In terms of investments that are needed to maintain the new safety standards, I mean all of that, whatever implementation is in terms of re-laying out or reconfiguration, we have already done. We don't think that, that is a material drag at this point, so no material margin drag that we can see.

Okay. Understood. Maybe moving away from COVID and shifting into the integration process. So maybe you can just broadly comment on progress with the integration between Ingersoll Rand Industrial and what used to be Gardner Denver. And maybe hit on what surprised you so far, if anything, as you've worked through the early stages of integration.

Yes, Nicole. I mean I think it speaks -- it says a lot about the power of our culture, the processes that we have implemented and the talent and the teams when you think that we closed this major transaction in the middle of a pandemic, and still we were able to accelerate a lot of the structural costs out that we spoke about during the last call. In addition, to keep on creating this one company, one culture, we launched over 60 new IMPACT Daily Management rooms, all virtually, which are the core of our Ingersoll Rand execution excellence process. And a lot of these great acceleration of the synergies and good cadence of the integration goes back to how we approached the deal from May 2019, where we started to do a lot of cross-functional integration planning across both organizations utilizing IRX. And this allowed us to have a really good head start on the integration process, which has allowed us to accelerate the actions in the March time frame. So we think that COVID has been an accelerator in the sense that it had gotten us even more focused on what we need to bring these 2 companies together as one from an integration perspective. So processes like product summits, structural cost reductions, procurement, Innovate 2 Value or I2V planning have picked up even more momentum. And they are key aspects of the integration work that we have already started.

Got it. Definitely a bit of a silver lining with COVID reducing demand. I guess it's early days in the integration. So it was definitely encouraging to see that the funnel of opportunities is already $100 million larger than your committed $250 million in cost synergies. But I guess thinking about what's in that extra $100 million, do you think there's scope for that funnel to grow even more over time as you move deeper into the integration effort? Or would you say that the $350 million is becoming kind of like the best-case scenario for executing on synergies?

Yes. I mean I will say -- I will never go out as being kind of maxed out. I think our culture and -- of continuous improvement will naturally find always ways to push us to find more. And this is just who we are. That's kind of part of our culture. I'd say keep in mind also that we always spoke about cost synergies. And the $250 million and the other $100 million of the incremental funnel, they are around cost synergies, but that does not include growth synergies. So we see the growth synergies as a way to always find new opportunities here. So I continue to be very impressed with the team's ability to find new cost opportunities as well as growth. And I think leveraging the IRX tools to execute on it will lead us the appropriate way to maximize the performance here.

Got it. And then I'm glad you brought up the growth synergies. That was one thing that I definitely want to ask about since early in the process, it is pretty normal for companies not to quantify what the revenue synergies could be. Maybe can you talk a little bit about where -- early days, but where you could see like significant cross-selling opportunities, thinking about the 2 businesses coming together?

Yes. So I will give you a few kind of maybe examples here. I think for strategic reasons, we prefer not to quantify or kind of do a lot of commentary too much about it. But what I can see -- what I can say is that we see the growth synergies as a multidimension approach with multiple levers. And so let me give you kind of 3 that come to mind. Within the industrial technology segment, the go-to market, I mean we spoke a lot about multichannel and multibrand. And our multichannel is a big area where we're focused. We have a very strong channel through both direct and distribution which we can leverage for the appropriate technologies. In terms of technologies and brands, we have greater scope. An example here is the compressors. Gardner Denver, we were very focused on what I'd like to refer to as kind of the small to medium compressors -- small to medium horsepower compressors, while Ingersoll Rand was really more on the medium to large horsepower compressors. And this is very true for oil-lubricated and oil-free compressors, and all of these with some premium and iconic brands that are highly recognizable in the market. So again, great cross-selling and cross-branding through a multichannel could really lead to some good growth synergy. And the one that we're really excited about, too, as well is this adjacent market expansion that with the creation of the precision and science platform, is very exciting. We -- as you know, we combined our medical business from the Gardner Denver side with the Precision Flow System business and -- that Ingersoll Rand had. And this is allowing us to increase the share of wallet at customers and penetrate better some of the end markets that we find kind of highly attractive.

Got it. That's helpful. And maybe you could elaborate on that a bit more, Vicente. I was -- I'm not totally clear on the synergies that exist between the fluid management platform and the medical platform. Can you elaborate on that a little bit?

Sure. Yes. So if you -- I think if you think about it from a technology perspective and not to go into a very good detailed level, technology like diaphragm pump technology where the Ingersoll Rand team had a very good solid technology with ARO. And then on our medical devices, we had a miniaturized diaphragm pump technology that we were leveraging that into medical applications. So now you're combining actually 2 technology teams that when the technology per se is fairly similar in nature but now the applicability into different end markets, it's actually kind of quite unique. So we're leveraging a lot of the lessons learned from both teams in terms of this technology. Then when you think about the channel and you think about how we sell some of these specialized pumps through distribution, a very unique distribution channel in the U.S. and -- which is actually a new initiative that we launched in the Medical business not too long ago, but now we're leveraging what the very unique channel that Milton Roy and the Haskel brands have in the U.S. So we're now taking a very specialized channel that is very used to be able to sell these very high-end niche technologies, and then now putting in some of these kind of medical, very highly specialized pump technology into these very specialized channels that we didn't have access before. So again, it's a combination of, first example, a little bit of a technology, and then not only creating a better scope and broad base of technologies, but also then leveraging the channel that, in this case, the legacy Ingersoll Rand team has. That is a very highly specialized channel that, in our Medical business, we did not have. And it would...

Sorry. I didn't mean to cut you off. Go ahead.

No, no, no. Go ahead. Go ahead, Nicole. Yes.

Yes. I was just going to say, that's really interesting. I think a lot of people kind of appreciate the cross-selling opportunities that exist within compressors, but that's something that's definitely not as well understood. So maybe we can think a little bit about aftermarket. I think another piece of the benefits of combining these 2 businesses is the opportunity to grow the aftermarket piece of total sales over time. Maybe just think about as you've combined the 2 businesses, where do total aftermarket sales stand today as a percent of the portfolio? And I guess what would be kind of the thinking of where this could go over time?

Yes, Nicole. I mean this is definitely a very exciting piece of the portfolio. And today, in the company, we are roughly at 40% of the total company revenue is aftermarket. And so we see opportunities across all segments, and let me tell you why. And if I start with the biggest, largest segment, industrial technology, for the most part in this segment here, we combined the legacy Gardner Denver industrial segment and the legacy Ingersoll Rand, what -- it used to be called CTS, the compression technology and services. If you think -- you put in perspective, the legacy Gardner Denver was lagging Ingersoll Rand. I mean Gardner Denver was at roughly 35% aftermarket, while CTS was already at 50%. So -- and our largest peer in the same -- in this kind of same market has the same range as what CTS is today. So clearly, the industrial technology here is the biggest opportunity probably in 2 main areas. First of all is kind of improving the aftermarket connectivity from the legacy Gardner Denver side and leveraging the aspects of the channel that Ingersoll Rand has brought as a means to accelerate that. And a great example is how to use the Ingersoll Rand direct channel to better serve more technical pieces of the equipment of Gardner Denver side like, for example, oil-free. And the second piece here is continuing to optimize the aftermarket on the Ingersoll Rand side to get healthier profitability on large aftermarket base. Because if you remember, even though we had a much lower aftermarket as a percentage of sales for legacy Garner Denver, the profitability for the industrial segment on legacy Gardner Denver, much higher than what we are finding here in the compression technology. So again, opportunity not only from a growth, but also from a margin perspective. The second segment is this -- the precision and science that today sits roughly kind of mid-teens, 15%. But one thing that we like to think about this is that many of the pumps that we have in this segment are kind of like-to-like -- like-for-like replacement. So having said that, we see opportunities here, although not as large as what we see on the industrial technology. If I talk about the specialty vehicle, last year it was at roughly 26%, so again a pretty good foundational for us to continue to improve. And the focus historically was not on this side of the business. The segment historically, this specialty vehicle business, even though at 26%, which is parts and services, was not the focus historically. But we know that accessories, parts and aftermarket can be a great revenue stream, and we're exploring how to accelerate that. And a great way on how we were able to do that is with the high pressure that today is mostly aftermarket at roughly 90%. But not too long ago basically, as we have said in past reports and the Investor Day, this segment used to be basically a pure OE or equipment provider and not focused on the aftermarket. So again, we were able to transform that to 90%. And a lot of good lessons learned on that one as to very applicable to specialty vehicles and potentially even also precision and science.

Got it. That's a really helpful overview of how aftermarket could become a bigger piece of the business. I guess a few more on just like the total strategy, and then we'll delve into the businesses again a bit. How do you think about the new Ingersoll Rand's portfolio? Is there going to be a process as you move through this integration to evaluate which businesses are core versus noncore over time?

Yes. Yes, Nicole. And -- but I will say that, as you said, over time. I mean today we continue to be very focused on integration and enhancing the value of all the businesses. For example, I mean most recently, last week, we were doing a review with the specialty vehicle team. And the IRX tool is helping them with a more distinct execution focus to all kind of continued growth momentum. Or even in the tool business, the power tool business, we're very focused on margin expansion, even in what it is a very tough environment for them. And so when we created the RMT, we did it strategically in a way that we could carve out some of the businesses to help increase the flexibility if the time comes to evaluating the portfolios. So with that, we are not tied to any timing for the 3 businesses of specialty vehicles, power tools or high-pressure solutions.

Okay. Understood. And I mean I have this question from investors a few times. If you look across those businesses, are there any areas where like you'd have a high-tax basis, where that could potentially preclude you from making any portfolio moves?

No. I think in terms of tax basis, that has not been materially changed due to a transaction. I mean the assets of note don't have a high tax basis. So that is definitely an area of consideration, Nicole. Yes.

Okay. Got it. And then I guess I had a question come in from an investor with respect to free cash, so let's go ahead and do that one. It is, "What's the right way to think about normalized free cash flow once we're through the period of integration cost?" And maybe however you want to define that, Vicente, whether it's conversion or percent of sales.

Yes, Nicole. So we like to think that we can be at definitely 100% over net income, greater than 100% of our net income. And that's something that -- I mean we know that today, there's a lot of movement. That's why we have been very explicit about just the absolute dollar of the cash. But over time, having a metric around that, being greater than 100% of our net income is definitely what we're working towards, too.

Okay. Understood. That makes sense. And I mean while we're on the topic of cash, how would you think about capital allocation in the current environment kind of dovetailing with the amount of leverage you have on the balance sheet today? Is M&A an option that's on the table? Or is it let's get through the integration? Clearly, the economy is pretty choppy, so you're kind of in a holding pattern right now.

Yes. So I think M&A is an option, but only on bolt-on M&A and only on those segments that we definitely see a lot of good focus such as, for example, the Precision and Science Technologies segment, where even though I gave you some examples on this kind of growth synergies that we see on integration, not a lot of cost rationalization like the way we're doing on the industrial technology. So the teams are very focused on organic and inorganic growth momentum. But in terms of the overall capital allocation, I mean we view it the same way of what we were doing back with Garner Denver, which was basically, number one, prudent debt paydown to manage leverage, then bolt-on M&AS and then internal investments, particularly around any organic investments that we could do here internally.

Okay. That's clear. Maybe digging into -- we have a few minutes left here, maybe 10 minutes or so. So let's go ahead and look at some of these questions around the businesses. So over time, as you look at the margin trajectory within the ITS (sic) [ IT&S ] segment, I think this is where a lot of the synergies are coming through. But I guess, is there any structural reason why you can't close the margin gap between your biggest competitor in the industry over time?

That is definitely our plan. And maybe kind of one thing that I'll say here, Nicole, is that I think many times, it's good to look a little bit at the history to reflect on to what can be achieved. And if you recall, the industrial segment at Gardner Denver when I joined in 2015, it was mid-teens EBITDA. And last year, in 2019, we finished at 22% EBITDA in the fourth quarter with a continued path towards our goal of what we wanted to be at mid-20s. So the IR industrial segment, and more specifically the CTS, it's a similar EBITDA percentage as to what Gardner Denver industrials was back in 2015. So I guess in comparison here with our biggest peer in the industry, there's definitely some areas that are differences today, but you see that we're starting to take some very meaningful actions to start tightening that gap. The cost actions are clearly starting to see that and reflect that, first, with the structural cost-outs that we announced. And now we have a lot of opportunity ahead of us on procurement, I2V, footprint. But we also see good areas on the commercial side as we just kind of here briefly talked about whether -- or equipment but also margin accretive of aftermarket. So something that before, I'll say it was also very different in the industrials of Gardner Denver is that as we spoke about aftermarket in the mid-30s and versus the peer in the low to mid-40s. And now here with the combination, having more scale, more opportunities to leverage the channel to better -- get better connectivity through the aftermarket and technologies that we have, again, it's another way for us to be able to get some margin expansion and accretion.

Okay. Got it. That's really helpful. And I mean maybe sticking with ITS for a second. I know at the beginning of this call, we kind of characterized things that you are seeing kind of across the businesses improved May versus April. I know you talked about on the 1Q earnings call, you gave some data points around compressor utilization. Is there any update during May? And I guess maybe it's just that you are seeing an improvement in compressor utilization, but I just wanted to confirm that.

Yes. So we're definitely seeing -- I mean April continued to be consistent to what we articulated during the earnings calls. And when we look at the data, we see the data by the regions. We see improvements across the regions as they continue to open the economies. And I will characterize that the utilization is kind of steady improvement, not a B shape in any form yet. And so -- but yes, so -- but some continuous, steady improvement.

Okay. Got it. And then on -- in the PST segment, you guys saw high single-digit growth in legacy medical orders during the first quarter. How do we think about how that comes through from a revenue perspective? Like what's the cadence of when that high single-digit growth in order activity starts to show in organic revenue growth?

Yes. So we expect to see these kind of large frame orders to ship mostly over Q2 and Q3 and maybe early part of Q4. And that's kind of -- and just to put in perspective, the medical business is roughly about 1/3 of that entire segment, so that kind of gives you hopefully a perspective here.

It does, yes. And then specialty vehicles, if we looked prior to COVID, the segment was actually seeing very robust growth. Can you maybe elaborate on the drivers of this? And whether in a post-COVID world, do you think we can get back to kind of similar levels of growth that we were seeing before all of this happened?

Yes. So I think the team here has done a pretty good job on diversifying from golf into other markets like connectivity and customer and now we're -- applications. And now we're obviously applying some of that. We certainly see that -- sorry, one second -- customers -- I mean consumers. So we certainly want the business to grow back to those levels. I mean I think the one thing to keep in mind here in the short term, in the second quarter, is that Q2 of 2019 will definitely be a very -- well, Q2 of this year will definitely be a very tough comp for multiple reasons. Clearly COVID, but more pronounced, it was a growth of the business that the business saw in Q2 of 2019 due to back then some supply issues they had in the first quarter of '19 that delayed shipments into Q2 of '19. But here over the long term, we definitely expect that as mobility and the conversion from gas engines to electric engines, even on these specialty vehicles, whether it is on consumers, whether it is to kind of the last-mile utility vehicles as well as the software solutions around connectivity, that hopefully all those levers pull together and execute well. We'll continue to see some good growth momentum in the business as well as better margin accretion as those product lines are with a better margin than -- that historically golf didn't have.

Okay. Perfect. Got it. That's clear. And we're within the last 5 minutes. And I think we -- you're not going to escape completely without talking about energy. But I think it's encouraging that, hey, like it took until the last 5 minutes of the presentation to talk about it. This is moving direction in the right direction. But I guess I think investors understand the downside potential within the High Pressure Solutions business pretty well and the upstream piece. But I guess what are your thoughts on midstream and downstream, given what we've seen in oil prices recently?

Yes. Sure. So as a reference, as you know, our mid- and downstream businesses are now within the industrial technology segment. And we did that as those businesses really kind of behave more like the industrials from a cycle perspective, but also from an aftermarket kind of perspective, too, as well. And the midstream, midstream for us is a rather -- it's a very small business. I mean it's less than $100 million, while downstream is much larger with a good portion of long-cycle projects. And we typically want to get the projects booked in the first half of the year in order to get those shipments out in the second half. And Q1 largely behaved the way we expected. We continue to see solid funnel of projects with some getting closure here, particularly in the more kind of niche end markets like wastewater treatment and other kind of non-oil and gas applications. And we do see from another perspective, some delays due to COVID, but things picking up again as the teams are able to meet with these engineering firms and customers.

Got it. That's clear. Okay. And I guess thinking about the upstream business, is there a certain crude price level where you think about HPS revenue potentially starts to stabilize? Or is that the wrong way to kind of think about like where we go from here?

Yes. So crude has an implication. But I mean for us, it's really more about the intensity, so the -- and the utilization because that's what drives the large aftermarket business that we have in this business. So the metric that we look at is the number of fleets that are active in the market. And during the earnings call, we said that we expected the number of fleets to kind of trough in April. And so far, we believe that April has been the bottom. You have seen some news about OPEC+, and we're watching that carefully because it seems like the production cut extensions and kind of -- so basically creating better sustainability and -- in the market, which I think is actually good clearly for long-term side of the business. So -- but I think even though we see some stabilization and some trough in the market, our teams continue to operate based on assuming that market conditions do not get better. So I think it's just one of those that -- where we -- the teams continue to work even in these tough economic environments by taking cost actions and being ready for when the market pickup will come.

Okay. Got it. That makes sense. And then final question for you, Vicente, I want to kind of end on a more positive note. As we move past this downturn into recovery mode, how would you think about underlying incremental margins for the new Ingersoll Rand? And I guess when we think about how to model this properly, is it fair to take normal incrementals and just layer synergies on top of that? I would love to get your perspective.

Sure. Great question, Nicole. So in the past, we said that normal incrementals are typically in the 30% to 40% range depending on the business. And as we layer in the synergies, we should see better than that. However, we also want to take a very prudent view as we do expect that there will be some investments back into the business for growth and as we move forward as well as some of the short-term actions that we're taking now to protect the business, like furloughs, merit deferrals and so on, will come back into the cost structure as the market recovers. So yes, I mean layering some, but I mean again, we want to take a very prudent view on how we use incrementals to be able to continue to reinvest back on growth.

Got it. That makes a ton of sense. Okay. Well, I think we're out of time, so we'll go ahead and wrap it up there. Vicente, thank you so much for participating in the conference today and the fireside chat. I really enjoyed our conversation. And Vik, same to you. Thank you so much for being here today.

Thank you, Nicole. A pleasure, and thank you for the invitation. Thank you.

Of course. Thanks, everyone, for listening as well.