Earnings Call Transcript - IR Q2 2024

Operator, Operator

Good morning. My name is Briana, and I will be your conference operator today. I would like to welcome everyone to the Ingersoll Rand Second Quarter 2024 Earnings Call. Please note that this call is being recorded. I will now turn the call over to Matthew Fort, Vice President of Investor Relations. You may begin your conference.

Matthew Fort, Vice President of Investor Relations

Thank you, and welcome to the Ingersoll Rand 2024 Second 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 discuss 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 we start, I want to remind everyone that certain statements on this call are forward-looking in nature and are subject to the risks and uncertainties discussed in our previous SEC filings. Please review the forward-looking statements on Slide 2 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 on 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 review our company and segment financial highlights and provide an update to our 2024 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 will turn the call over to Vicente.

Vicente Reynal, Chairman and CEO

Thanks, Matthew, and good morning to all. I would like to begin by thanking and acknowledging our employees for their hard work, dedication, and continuing to think and act like owners, helping us to deliver another record quarter in Q2. Starting on Slide 3. Despite the challenging macroeconomic environment, our team delivered another record quarter, demonstrating the continued strength of our execution engine, IRX. We remain nimble and are prepared to pivot as market conditions change. And based on our solid performance, we are once again raising our 2024 full-year guidance. Turning to Slide 4. Our economic growth engine describes how we deliver durable compounding results. We remain committed to our strategy and, over the cycle, delivering our long-term Investor Day targets as outlined on this page. IRX is our competitive differentiator. Combined with our unique ownership mindset, we expect to continue to deliver long-term value creation. With that in mind, I would like to provide a brief update on our growth initiatives. On Slide 5, let me start with our inorganic growth initiatives. We're pleased to highlight three recently closed transactions, which together are expected to achieve an average of mid-teens ROIC by year three. Let me quickly walk you through these deals. First, CAPS, which is a leading provider of complete air and power generation services. This is a great example of strategic channel expansion, giving us access to a large install base, strong end-user relationships, and a robust technician network. Next is Fruitland, which expands our technology with low-flow applications. And lastly, we have Del Pumps, a mission-critical, high-margin pumping solution across high-growth sustainable end markets in India. On the bottom of the page, I'd like to highlight that with the closure of these transactions, along with the closure of ILC Dover within the quarter, we have already far exceeded our annualized inorganic revenue target of 400 to 500 basis points, setting us up well for a good start in 2025. In addition, the funnel continues to grow and stay very active, with deals mostly bolt-on in size. On our prior earnings call, we mentioned that we also had a couple of $1 billion purchase price deals in the funnel. During the second quarter, we decided to walk away from one of these larger transactions. This proved that we continue to remain very disciplined in our approach to M&A and committed to long-term shareholder value creation through effective capital allocation. We expect more bolt-on deals to be announced later in the year, further exceeding our annualized inorganic revenue targets. Turning to Slide 6. On this slide, I want to take a minute to walk you through why we're so excited about the ILC Dover acquisition and dive deep into the biopharma business, which accounts for approximately half of the total business. With exposure to high-growth therapies like GLP-1 and ADCs, this business is well-positioned to deliver double-digit growth in 2024 and beyond. The performance in biopharma is much better than the current market and speaks to the niche and unique nature of the product solutions and offerings we have. Let's start with GLP-1 or glucagon-like peptide-1 therapies, which are used in the treatment of type-2 diabetes and weight management. With the projected annual market growth rate of 20% to 30% over the next five years, GLP-1 manufacturers are rapidly expanding their capacity to meet both the current and growing market demand. We have deep and long-lasting relationships with our customers, where our proprietary single-use technology is already qualified in their production process, becoming an integral part of the validated bill of materials for GLP-1 production. As our customers expand capacity, either within their own facilities or CMO, our products are all required inputs for these new production lines to minimize validation time lines, start-up costs, and risks. Moving on to ADC or antibody-drug conjugates, which are used primarily in cancer treatment therapies. This market is expected to grow double digits annually over the next five years, driven by the efficacy of the technology. There have been several new ADC approvals in recent years with a robust drug development pipeline for this type of therapy. Our patented containment technology is proven to perform better than both clean-in-place and single-use alternatives. We continue to see customers convert their existing production lines and install new capacity leveraging our single-use containment technology. I will now turn the presentation to Vik to provide an update on the Q2 financial performance.

Vikram Kini, Chief Financial Officer

Thanks, Vicente. Starting on Slide 7. Despite the increasingly challenged macroeconomic environment, we delivered solid results in Q2 through a balance of commercial and operational execution fueled by IRX. Total company organic orders declined 1%, finishing largely in line with expectations. We saw strong sequential orders growth of 5% for the total company with the book-to-bill of 1.0x. Consistent with our guidance, book-to-bill finished above 1 in the first half at 1.0x. This provides us with a healthy backlog to execute in the back half of the year and gives us conviction in delivering our full year 2024 revenue guidance. Organic revenue was up 1% for the quarter and up 13% on a two-year stack. The company delivered second quarter adjusted EBITDA of $495 million, a 16% year-over-year improvement and adjusted EBITDA margins of 27.4%, a 220 basis point year-over-year improvement, driven predominantly through gross margin expansion, partially offset by investments for growth in SG&A. Adjusted earnings per share was $0.83 for the quarter, which is up 22% compared to the prior year. This marks six consecutive quarters of double-digit EPS growth and 12 out of the last 14 quarters of double-digit EPS growth beginning with Q1 of 2021. Free cash flow for the quarter was $283 million, and total liquidity was $3.7 billion, with $1.1 billion of cash on hand at quarter end. Our net leverage was 2.0 turns, which is up 1 turn versus the prior year. This increase is primarily driven by the $2.325 billion acquisition of ILC Dover. For the full year, we do anticipate net leverage finishing at approximately 1.5 turns. Turning to Slide 8. For the total company, on an FX-adjusted basis, Q2 orders were up 5% and revenue increased 8%. Total company adjusted EBITDA increased 16% from the prior year. The ITS segment margin increased 230 basis points, while the PST segment margin increased 110 basis points year-over-year. Overall, Ingersoll Rand expanded adjusted EBITDA margins by 220 basis points. Corporate costs came in at $44 million for the quarter, largely in line with expectations. And finally, adjusted EPS for the quarter was up 22% year-over-year to $0.83 per share, including an adjusted tax rate for the quarter of 21.3%. On the next slide, free cash flow for the quarter was $283 million, including CapEx, which totaled $22 million. Total company liquidity now stands at $3.7 billion based on approximately $1.1 billion of cash and $2.6 billion of availability on our revolving credit facility. Leverage for the quarter was 2.0 turns, which is a 1 turn increase year-over-year. As noted earlier, this increase was driven primarily by the purchase of ILC Dover, which was funded through $2 billion in bonds and $325 million in cash. Specifically, within the quarter, cash outflows included $2.6 billion overall deployed to M&A as well as $71 million returned to shareholders through $63 million in share repurchases and $8 million for our dividend payment. Our capital allocation strategy remains unchanged with M&A being our top priority and we continue to expect M&A to be our primary use of cash as we look ahead. On Slide 10, I'd like to take a minute to highlight the transformation of our debt portfolio. This transformation has been underway for several years, and I'm pleased to say that we now have a fully investment-grade structure. Also important to note that within the quarter, we received a 1-notch upgrade from each of the 3 rating agencies, which you can see highlighted on the right side of the page, further solidifying our investment-grade status. In terms of the overall capital structure, in May, we issued $3.3 billion of unsecured investment-grade bonds. The proceeds of the bond issuance were used to repay $1.23 billion of our legacy secured term loans, and $2 billion was used to partially fund the acquisition of ILC Dover, with the remainder retained for general purposes. In addition, we took the opportunity to increase the size of our revolver from $2 billion to $2.6 billion, which further provides flexibility to execute on our strategic initiatives. As a result of this debt portfolio transformation, we now have a fixed-to-floating ratio of 84% fixed and 16% floating, and extended our weighted average maturity on our overall debt from 6 years to 10 years. Our new capital structure is designed to facilitate our long-term capital allocation strategy, and we remain committed to maintaining our investment-grade status. Finally, our 2024 gross interest expense outlook is now approximately $215 million. On an annualized basis, we expect gross interest to be approximately $260 million as we move into 2025. I will now turn the call back to Vicente to discuss our segment results.

Vicente Reynal, Chairman and CEO

Thanks, Vik. Moving to Slide 11. Our Industrial Technologies and Service segment delivered solid year-over-year revenue growth of 6% on top of approximately 20% growth in Q2 of last year. Adjusted EBITDA margins were 29.7%, up 230 basis points from the prior year, which was driven primarily by gross margin expansion. Book-to-bill was one-to-one, with organic orders down 2.6%, which was largely in line with expectations. Important to note that we saw sequential order growth of 5% which were primarily driven by compressors. Moving to the program highlights. Compressor orders were up low single digits while still comparing to a low double-digit growth in Q2 of 2023. It's good to note that we saw positive order growth across the Americas, EMEIA, and Asia Pacific, excluding China. Compressor revenue was up mid-single digits in the quarter, which we view as still healthy after mid-teens growth in Q2 of 2023. Industrial banking orders were up low single digits and revenue was up mid-teens. For innovation in action, we're highlighting Elmo Rietschle's new high-speed blower technology, which was recently launched in Europe. This patented oil-free technology offers a 60% reduction in energy consumption compared to traditional blower technology, enabling productivity for the customer and reducing total cost of ownership by up to 50%. Turning to Slide 12. The PST segment achieved 6% organic order growth and delivered adjusted EBITDA of approximately $103 million with a margin of 30.3%. It is encouraging to see that the legacy Ingersoll Rand Life Science business saw organic order growth of 8%. In addition, short cycle orders in the PST segment remained positive with book and ship orders up mid-single digits year-over-year. We see organic order growth stabilizing, and we remain positive about the underlying health of the PST business, and it remains on track to meet our long-term Investor Day growth commitments. For our PST innovation in action, we're highlighting an extremely innovative technology within the legacy Ingersoll Rand Life Science business. Combining multiple technologies across different brands, we have developed a product offering in micro-fluidics to create a customized liquid handling automated system for biotech R&D labs as well as the production of personalized therapeutics. This innovative technology drives up to 50% productivity compared to existing processes in a market that is expected to grow approximately 20% through 2027. On the next slide, I would like to spend a minute discussing the current market trends as we always get a lot of questions about our leading indicators. A key leading indicator of our short-to-medium cycle business is marketing qualified leads or MQLs. As illustrated on the top chart, our MQL continues to grow. In Q2, we saw organic MQLs up 13% year-over-year. As for the longer-cycle component of our portfolio, one key indicator we look at is the funnel activity for engineered-to-order compressor systems. We remain encouraged as the funnel activities are up 27% in the first half year-over-year. While the leading indicators have been encouraging, we have seen an elongation in the decision-making process with the prolonging of the time to convert an MQL to another. The feedback we hear contains multiple reasons. But some of the most often cited are customer site readiness and too many concurrent projects impacting EPC engineering capacity. Having said this, this situation is encouraging as we look to 2025. Switching back to 2024 expectations, from a regional perspective, the Americas is on pace to deliver mid-single-digit organic revenue growth. EMEIA remains stable, and we see very good pockets of growth, primarily in the emerging markets of India and the Middle East. Asia Pacific, and specifically China, is a key driver of the reduction in our organic growth guidance. Moving next to inorganic growth. We're anticipating approximately $270 million of incremental revenue from our recently acquired M&A. ILC Dover is the largest driver, contributing approximately $220 million of revenue in 2024. The biopharma business, as highlighted earlier in the deck, remains strong and on track to deliver double-digit growth. However, we do anticipate that the Aerospace & Defense revenue to be down approximately $30 million versus our initial expectations. This is driven by lower-than-expected activity levels in our space business, predominantly related to the next-generation spacesuit, which is often referred to as xEVAS. As we move to Slide 14, given the solid performance in the first half, our recently acquired M&A, and our expectation of continued operational execution fueled by IRX, we are once again raising our 2024 guidance. The company revenue is expected to grow overall between 6% to 8%, which is up 200 basis points versus our initial guidance. As discussed on the previous slide, we anticipate positive organic growth in the range of 0% to 2%. The reduction in the range versus our prior guidance is largely attributable to lower organic growth expectations, specifically in China. FX is now expected to be a 1% headwind for the full year, which is down approximately 100 basis points compared to our previous guidance. M&A is projected to contribute approximately $440 million, which reflects all completed and closed M&A transactions as of July 31, 2024. Corporate costs are planned at $170 million and will be incurred relatively evenly per quarter for the balance of the year. Total adjusted EBITDA for the company is expected to be in the range of $2.01 billion and $2.06 billion, which is up approximately 14% year-over-year at the midpoint. Adjusted EPS is projected to be within the range of $3.27 and $3.37, which is up 2% versus prior guidance and approximately 12% year-over-year at the midpoint. On the bottom right-hand side of the page, we have included a 2024 full-year guidance bridge, showing the changes in our latest guidance compared to our previous guidance provided in May. As you can see, the primary driver of adjusted EPS growth is associated with operational execution, partially offset by increases in the net impact from interest and FX. We're also seeing a $0.02 improvement in our adjusted EPS as compared to our previous guidance from an improvement in our full-year adjusted tax rate. Gross interest expense is now expected to be approximately $250 million, and net interest expense will be approximately $170 million and will be incurred relatively evenly per quarter for the balance of the year. The adjusted tax rate is expected to finish in the year between 22% and 23%. No changes have been made to our guidance on CapEx spend as a percentage of revenue, free cash flow to adjusted net income curvation, or share count, all remain in line with our previous guidance. Finally, as we turn to Slide 15, I'm very pleased with how our teams continue to execute despite overall market conditions. We continue to deliver record results and our updated guidance is reflective of our first half performance and ongoing momentum. With our most recent guidance, we continue to expect to deliver results above our long-term Investor Day targets. Based on the midpoint of our 2024 full-year guidance, the four-year CAGR for organic revenue growth will be approximately 10%. We believe this continues to show durable outperformance over the cycle. That in combination with our inorganic growth, robust margin expansion, and execution of IRX, we expect to deliver a four-year CAGR in excess of 25% for adjusted EPS. To our employees, I want to thank you for the strong results thus far showing the impact each of you have as owners of the company. Thank you for your resilience, hard work, and focused attention. We believe the power of IRX, combined with our ownership mindset and leading portfolios, strengthens the durability of our company while delivering long-term value to shareholders. With that, I will turn the call back to the operator to open the call for Q&A.

Operator, Operator

Our first question comes from the line of Mike Halloran with Baird.

Mike Halloran, Analyst

So let's start with the change in the second half organic assumptions. If I look at how the second quarter progressed, it feels generally consistent with what you were talking about on the top line coming into the quarter. The book-to-bill, orders down a little bit. Revenue levels came in at a reasonable level, all else equal. I certainly understand the commentary about a little longer to close on some of these transactions and pushouts of the orders, as well as the China piece. So twofold question. One, was there something about July that you saw that maybe changed that trajectory? And two, could you parse out some of the underlying things you're seeing from a demand environment, excluding some of the project pushouts, and if there's any changes elsewhere beyond just the China comments?

Vicente Reynal, Chairman and CEO

Yes. No, thank you, Mike. I mean I think you framed it up actually quite well. So the answer to your first question is definitely no. I mean, nothing that we saw in July that gives us the concern regarding the change in kind of how we think about it. I think also, as you said, I mean, I think things kind of are operating in the first half exactly as we expected. You saw that we even saw some very good sequential improvement Q1 to Q2 orders improving 5% and actually improving on both segments, not only the ITS but also in PST. But kind of when we think about the guidance, and also you can see that in the second half, we do anticipate still organic revenue growth to be positive with a very good phase-in between revenue and EBITDA, similar to prior years, which obviously implies that we'll continue to see some kind of good improvement here sequentially. But in terms of the guidance, I think the reduction is really predominantly driven by China. Again, although we also were encouraged by what we saw improvements Q1 to Q2 in China, which was positive. And we're also encouraged by kind of what we hear from our teams in terms of the level of activity in the month of July, driven by these new programs in place of replacing equipment that the government is putting out together in the market. We feel that we're taking the approach to be prudent and not necessarily see that the market materially changes in the second half in China and kind of keep it stable from here onwards. I will also say kind of in terms of any other changes in terms of market dynamics. I mean, not necessarily, we were very transparent here in terms of leading indicators that we always talk about, which is MQLs and funnel acceleration, just to show that market activity continues to be actually pretty good. I think is this elongation in what we call the velocity of converting some of those either formal or MQLs through the process, it seems to be kind of a little bit more elongated. Could that be driven by elections or could that be driven by geopolitical and obviously, what we hear about EPC capacity constraints and site readiness. There's a little bit of a few different points. I think, in our view, what we wanted to do is just kind of be more prudent as we go here into the second half. And again, based on these good visibility that we see on leading indicators, feeling good about how this could play out as we head into 2025.

Mike Halloran, Analyst

That makes sense. And does that change how you guys were articulating the book-to-bill and order cadence from last quarter? If I remember correctly, it was orders slightly negative front half, but positive back half and then the inverse on the book-to-bill. Is that still the way to think about it? Or do these pushouts shift some of those numbers?

Vicente Reynal, Chairman and CEO

No, that's exactly the way to think about it, Mike, spot on. Yes.

Operator, Operator

Our next question comes from the line of Julian Mitchell with Barclays.

Julian Mitchell, Analyst

Maybe Vicente, it seems like China was the pivot point on the organic guide. So maybe a little bit more color there. You mentioned the teams on the ground sound more optimistic, but maybe just put some numbers around it, sort of remind us, I guess, total China revenue exposure of Ingersoll Rand and then what were organic sales in China down in the first half of the year? And what does the midpoint of the guide embed for second half revenue trends year-on-year in China, please?

Vikram Kini, Chief Financial Officer

Yes. Julian, this is Vik. I'll begin and then let Vicente add some details. Regarding the first part of your question, it aligns with our historical statements, and it's important to highlight that this is consistent across both segments, ITS and PST. Total APAC makes up approximately 20% of our revenue, with China accounting for the majority, likely in the high teens percentage. To provide some rough figures for growth expectations, I'll concentrate on revenue. In the first half, total APAC revenue, primarily driven by China, is down by low double digits. It's worth noting that the comparisons for the first half of the year are significant. Moving into the second half, as Vicente mentioned, we anticipate stability and some sequential improvement from the first to the second half. Year-over-year, we expect to be relatively flat. This stability from the first half to the second half, combined with somewhat easier comparisons in the back half of the year, especially in China, is important to consider.

Vicente Reynal, Chairman and CEO

The other thing to add there, and I think in terms of some of the color that we see is that if you were to even exclude some of these kind of large, long-cycle projects, China order is kind of that core business, which excludes this long cycle, is still performing actually quite well.

Julian Mitchell, Analyst

And then just my quick follow-up. Just within the second half guidance as we think about seasonality. I realize there's some distortions sequentially into Q3 because of the acquisitions that closed in early June. But when we think about sort of third versus fourth quarter in your guide, are we thinking kind of Q3 is, I don't know, 25%, 26% of the year's EPS? And then revenue-wise, you kind of have just under $1.9 billion in Q3 and maybe just over $1.9 billion in Q4. Is that the way to think about it?

Vikram Kini, Chief Financial Officer

Yes. So, I think you're close enough around it, and I think that's probably the right way to think about it. So interesting enough, I'd say the seasonal phasing, whether it be on the revenue side or on the earnings side, not dramatically different than what you've seen in prior year, slightly more weighted towards the back half than the front half. That is correct.

Operator, Operator

Our next question comes from the line of Jeff Sprague with Vertical Research Partners.

Jeff Sprague, Analyst

Vicente, can you drill in a little bit more on kind of PST in general, but kind of biopharma markets in particular? It does sound like you're seeing and feeling kind of the turn in those markets. But just kind of speak to what's going on in the channel or the channels cleared, what the outlook for maybe the remainder of the year is there.

Vicente Reynal, Chairman and CEO

Yes, definitely. Jeff, let me break this down into a few key points. Firstly, let's discuss the legacy Ingersoll Rand Life Science and medical business. As you observed, we had very strong momentum in Q2 with impressive growth of 8%, which is quite encouraging. We've seen some significant wins as we continue to showcase our innovations. The team is gaining valuable experience in personalized medicine, especially in the area of cancer treatment, which is promising. Additionally, we are now two months into the acquisition of ILC Dover within biopharma, and the team remains optimistic about what they are observing. We're seeing sustained positive momentum there as well. As mentioned in our prepared remarks, we still anticipate that this business will achieve double-digit growth this year. This underlines the effectiveness of our product innovation and the specialized nature of our technology, as we focus on specific end markets that are experiencing external growth.

Jeff Sprague, Analyst

And then maybe just shifting, maybe this is total Ingersoll Rand, maybe biases a little bit more towards industrial tech. But what's going on with kind of service, service attachment? Is it growing here? How does it look into the back half?

Vicente Reynal, Chairman and CEO

Yes. Great, Jeff. Thank you for asking the question. I think we continue to be very excited about all the actions that we're doing around the care packages and the service attachment. As a matter of fact, even this week right now here, we have a team getting together to talk about the continuation of taking service activities to the next level. So we continue to be very encouraged with what we're seeing and whether it is with just regular service attachment, but also Ecoplant as Ecoplant continues to see some progression. And you saw that we also acquired a company called CAPS in Australia, and that's ready to give us better channel and better access with a larger footprint on service. So service continues to be a very high priority for all of us as we move forward.

Operator, Operator

Our next question comes from the line of Rob Wertheimer with Melius Research.

Rob Wertheimer, Analyst

My question is about gross margin. It was impressive this quarter. Could you discuss price costs a bit, along with price and competitive dynamics, and how you're gaining or losing market share? Also, when you have a higher gross margin, it allows for more spending. I'm curious about how you manage that and what that increased spending entails.

Vicente Reynal, Chairman and CEO

Yes, Rob, that's a great question. I'm very pleased to see the expansion in gross margin, largely driven by the execution of various initiatives, including I2V, as well as the growth in our recurring revenue streams that we mentioned earlier. This has contributed to a significant increase in our gross margin, which in turn has positively impacted our EBITDA margin. We are definitely making investments in areas such as demand generation, research and development, and other necessary fields, including sales force activities and service technicians, to maintain our growth in recurring revenue. Vik, would you like to add your thoughts on the price-cost dynamics?

Vikram Kini, Chief Financial Officer

Yes. On the price cost side of the equation, so specifically in the quarter, price was approximately 2.5% across the entire enterprise, fairly comparable between the two segments. And then from an inflationary perspective, I'd say the commentary is very similar to what we saw in Q1. I'd say the direct material side, it kind of continues to move sideways. So not a lot of what I would say, headwinds on a year-over-year basis, but kind of sideways. And then I'd say on the labor side, relatively normal course. So again, continue to see good pricing momentum from the organization, good translation to the bottom line, and you see that reflected in the gross margin profile, along with some of the other initiatives that Vicente spoke to.

Rob Wertheimer, Analyst

Got it. And then just a minor follow-up. Just pricing looking forward, roughly the same. And what does the new normal and price feel like now? Is it going forward as far as you can see or two or three years? Or any commentary? And I'll stop.

Vikram Kini, Chief Financial Officer

Yes. Just to keep it relatively simple. I think we've said that pricing will kind of return to, I'd say, a little bit more of the norm that you've seen historically, which is probably around that 1% to 2% gross pricing levels, or net pricing level, I should say. And if you think about where we're headed in the back half, I think that's kind of where we should be. We were still benefiting from a little bit of some of the carryover pricing actions from last year here in the first half. But we would expect between 1% to 2% is probably a good indicative range for the back half of 2024 as well as expectations for '25 onwards.

Operator, Operator

Our next question comes from the line of Joe Ritchie with Goldman Sachs.

Joe Ritchie, Analyst

Vicente, can we double-click on that commentary around the MQLs and the plays that you're seeing? I'm just curious, like, obviously, there's a lot of activity, particularly happening in the U.S. with mega project activity. And I'm just wondering if that's just a function of, look, these projects have started, but you guys aren't really seeing the orders as quickly at this point, but they're on the come because projects have broken ground. Just any other color you could give us around that would be helpful.

Vicente Reynal, Chairman and CEO

Yes, Joe, that's a good question. On that slide, we attempted to distinguish between the short to medium cycle and the long cycle. The mega projects tend to fall more into the long cycle category, where we continue to see an increase in our pipeline. However, there is an ongoing delay, as some EPCs have a backlog of two to three years, which hinders the timely release of these large projects into orders. That’s why we mentioned that looking ahead, particularly around 2025, there are many projects that, once released, could generate better momentum for us. Regarding the short to medium cycle, we previously commented on PST. The short cycle business has been performing well, showing mid-single digit growth even in the second quarter. We also wanted to highlight that MQL is experiencing double-digit growth year-over-year. While this level of growth doesn't directly translate into orders—since we're not seeing double-digit orders—it is a positive sign of our market activity and how effectively we're penetrating new accounts and customer bases. This serves as a promising leading indicator of our ongoing performance.

Joe Ritchie, Analyst

Got it. That's super helpful, Vicente. And then my other question, like, look, to take this a variety of different ways, but congrats on shoring up the balance sheet from a leverage standpoint and from a debt standpoint. I know how important M&A is for you guys going forward and how it has been a great value creator for you. It is interesting to see you take down the aerospace and defense number for the year by $30 million. I know that's a small number. And I think that, that's the part of the piece that came out of the ILC Dover acquisition that you just completed. So I guess the question is, as you're kind of thinking through these acquisitions and there might be pieces of these acquired companies that you buy that will have inherent volatility. How are you thinking about managing that going forward as you look through your evaluation process?

Vicente Reynal, Chairman and CEO

Yes, that's a great question. We are very excited about ILC Dover and its business, especially considering that approximately 75% of our total business in ILC Dover is focused on Life Sciences, which includes a strong mix of biopharma and medical device components. We’ve also mentioned that aerospace serves as more of an optional area for us. While it offers valuable insights and opportunities to learn, our main focus remains on Life Sciences. As we continue to advance and gain a deeper understanding of the business, we will strategically emphasize different areas based on what we discover. Historically, we have been good at making selective choices regarding our investments or focusing more heavily on certain sectors, and our strategic goal with ILC Dover is to enhance our presence in the Life Sciences segment.

Operator, Operator

Our next question comes from the line of Andy Kaplowitz with Citi.

Andy Kaplowitz, Analyst

In the center, Vik, you started out essentially flat in terms of organic revenue growth in the first half of '24. So I think in order to hit the midpoint of your guide, now you need to grow the high end of that 0% to 2% for the second half. So we know you have easier comps, but do you need to see any incremental acceleration in your short-cycle businesses to achieve that midpoint? Are you basically just assuming more status quo in terms of short-cycle markets now remaining somewhat constrained in long-cycle markets contributing more growth?

Vikram Kini, Chief Financial Officer

Yes. Andy, this is Vik. I think the way you've described it is correct. So just to calibrate the numbers, I think you're right, 1% to 2% organic growth in the back half of the year is probably the right way to think about it system-wide. I think in terms of the components and the moving pieces, yes, I think what we would say here is relative stability, no dramatic, let's just call it, hockey stick improvement or anything of that nature in the back half implied. Obviously, we've taken down the China expectations, which is effectively the preponderance of what changed the organic growth guide. So I think now it's execution of the backlog. You know that we typically do have a little bit of seasonality in the business where the second half is stronger than the first half; that's no different this year. And I think the other factors you mentioned here are largely accurate. So I think we feel comfortable with the guidance as provided.

Andy Kaplowitz, Analyst

That's helpful. And then maybe can you talk about what happened to PST adjusted EBITDA margin in Q2? I mean, it's down sequentially despite significantly higher revenue. I think we recognize there's a fair amount of acquisition-related revenue in there. But I thought ILC Dover was coming in at accretive margins in the segment. Are there acquisition margins or something else that happened in the quarter?

Vikram Kini, Chief Financial Officer

Yes, Andy, so just to address the second part of your question first, we did have one month of ILC Dover results in Q2. And I'd say largely in line with expectations both from a top line and bottom line and profitability perspective. I think, generally speaking here, about 30.8% EBITDA margins to about 30.3%. I wouldn't attribute that to anything more than just some of the normal course revenue mix and things of that nature from the balance of the business. Nothing that I think you should read into any further than that as we think, frankly, going forward here into the back half of the year, those numbers are closer trending sequentially better from Q2 and into Q3, and then Q3 to Q4, absolutely. So I don't think anything has changed in our context as far as that getting to a mid-30s EBITDA margin profile over the next few years in line with our Investor Day targets for PST. So nothing has really changed in that respect.

Operator, Operator

Our next question comes from the line of Stephen Volkmann with Jefferies.

Stephen Volkmann, Analyst

Most of my questions are answered. But I'm curious to go back to your kind of indicators, the MQL and the funnel activity. You must track kind of win rates or conversion or something over time as well. Any changes to note there?

Vicente Reynal, Chairman and CEO

Yes, we do. And no changes on that. I think the change has been basically more because we also track the velocity of those kind of projects or orders through the funnel, and that is basically what I would say has maybe changed and then the reason why we call it that elongation. But in terms of win rates and all that, no change in that.

Stephen Volkmann, Analyst

Okay. And then I'm curious about this CAPS acquisition. I'm not sure if I'm reading this right, but this sounds like you're actually providing power and air to customers, which is kind of a different kind of service, I think, than most of the rest of what you do. Does this open up sort of a new area where you can be more of a power-by-the-hour type supplier across a bigger addressable market?

Vicente Reynal, Chairman and CEO

Yes, Steve. I would say they are primarily a compressor distributor. They do have a small power segment in their business, and interestingly, they have supplied power for various applications, including data centers. This is an interesting area for us to explore, and we have some chiller technology with Friulair that we are looking into. We are definitely learning a lot in this aspect. Regarding air services, we have programs already established in Australia with our legacy Ingersoll Rand business, often referred to as air over the fence. We are very excited about the CAPS acquisition, as it greatly expands our footprint in Australia and connects us to a strong customer base, in addition to the solid revenue base we already have with Ingersoll Rand.

Operator, Operator

Our next question comes from the line of Nigel Coe with Wolfe Research.

Nigel Coe, Analyst

Yes, we've got a lot of ground already. I just want to make sure that we've got the second half book-to-bill sort of lined up here. I think in response to Mark's question, I think you talked about the inverse of the first half. So are we talking about sort of like a high 0.9, maybe like close to 1x book-to-bill in the back half, or ITS? And obviously, that would suggest orders up mid- to high single digits. So I just want to make sure that's the message. And what do we see getting better here? Do we see China improving? Are we expecting some of these larger projects that start breaking free? Because it sounds like the EPC project bundle is not really breaking until 2025. So just want to just try and dial into that comment.

Vicente Reynal, Chairman and CEO

Yes, certainly, Nigel. The book-to-bill ratio is expected to be less than 1 in the second half, which aligns with our usual pattern. We indicated a 1-to-1 ratio in the first half, but it will be below 1 in the second half. In terms of numbers, Q3 and Q4 will show low single-digit year-over-year changes. While we don't typically provide guidance on orders, you can make some rough calculations based on this information. Regarding your second question, the EPC and large projects are still relevant for the second half. The decision-making process is taking longer than expected, and we are factoring that into our assessments. These projects are ongoing, and they may be completed in the second half or potentially extend into 2025. We see this as a strong indication of the market opportunities that will eventually return to us.

Nigel Coe, Analyst

Okay. So low single-digit growth in the second half of the year, okay. That's helpful. And obviously, China is the issue here. I had battery EV as maybe 15% or so of the China business. I want to make sure that's still the sort of the right zone there. And just thinking about your verticals across the globe. I mean, we are seeing some noisy trends in food and beverage. So I'm just curious if you're seeing stable trends in food and beverage or whether there's some noise there as well.

Vikram Kini, Chief Financial Officer

Yes. Nigel, on the first part, we don't typically talk about kind of like end markets, let's just call it, designations within our specific regions, but I think it's fair to say that EV battery, solar were two meaningful end markets in terms of the order and revenue contribution in 2023. I'd still say they are active markets, but just, frankly, obviously, not at the same level as what you've seen in prior year. And Vicente, I'll let you comment on the food and beverage.

Vicente Reynal, Chairman and CEO

Yes. Food and beverage, I mean, nothing of note to be honest here, Nigel. I mean, I think food and beverage will continue to sell based on just as we always do in terms of sustainability, whether it is return on investment based on energy savings, the ability to be able to provide service agreements. So a good combination of all and it's about prioritizing the spend in those facilities. And as long as we show a great return on investment, which we are with our technologies and our solutions, we can get that into us.

Nigel Coe, Analyst

And just to clarify, Vicente, the low single digit, that's organic, not reported, right?

Vicente Reynal, Chairman and CEO

That's right. That's exactly right, yes.

Operator, Operator

Our next question comes from the line of Joe O'Dea with Wells Fargo.

Joseph O'Dea, Analyst

So I also wanted to ask on some of the site readiness and EPC dynamics you're talking about. And just your evaluation on why that's emerging now. It doesn't seem like the demand environment has changed all that much. I'm not sure if this is more of a reflection of kind of mega project funnel, but just what you've seen over the course of the past two or three quarters such that this would be emerging as a challenge now. And then as it relates to the guide and expectations in the back half of the year, does that embed kind of any expectation that some of these sort of projects move forward, that the EPC capacity eases? Or if any of that happens, should we think about that as more of an upside?

Vicente Reynal, Chairman and CEO

Yes. I'll take the first one and let Vik kind of talk about the second one. As you know, and I think you said it and someone said it as well. I mean, there's been a lot of megaprojects approved for the past few years. But not all those orders and revenue have been seen from those projects. And so there's definitely bottlenecks throughout the process. And what we hear is basically that customer site readiness due to labor but also that EPC capacity. I made an example about an EPC in Europe that currently has something like 2.5 years of backlog in orders that they got to push through the process. And what we're saying here is that it seems to bring to light, but potentially having a good 2025 as some of those projects get released, and perhaps hear some as well here in the second half. Second question, Vik?

Vikram Kini, Chief Financial Officer

Yes. I think, Joe, in terms of the second half, is there anything directly embedded? No. I think this is a simple answer. Obviously, our second half includes execution on existing backlog. Obviously, there's a component of longer-cycle projects like you've seen in prior years. To the degree, as Vicente said, some of the solutions up or things like that, great. I would view that as potential maybe some orders. But remember, most of these are 6- to 18-month lead time type projects. So the reality is those will not convert to revenue until 2025 or later.

Joseph O'Dea, Analyst

Got it. Yes. No, makes sense, comments helpful. And then also just in terms of China, is it right that, that China kind of played out as expected, more or less in the first half of the year? So the guidance adjustment would be more reflective of the second half of the year, a little softer than anticipated. And if so, it seems like it's more kind of stable in China first half to second half. And so what did you think might get a little bit better at this point in time doesn't seem like it's going to play out that way?

Vicente Reynal, Chairman and CEO

So I'll say that China definitely played out very well in terms of what we kind of saw in the first half. I will say that even in some regards, slightly better because we saw that Q1 to Q2 sequential improvement in orders in China, which we were surprised to see and the team building some backlog. We just decided that based on everything that we can see coming out of China and whether geopolitical elections and all of that kind of put together, we decided to be more prudent and kind of put China more as being stable here in the second half versus seeing any material improvement from here onwards.

Operator, Operator

Our next question comes from the line of Nicole DeBlase with Deutsche Bank.

Nicole DeBlase, Analyst

We've had a lot of discussion around the large project activity in ITS. I guess can you talk a little bit about what you guys saw on the short cycle part of the business from an order perspective throughout the quarter?

Vicente Reynal, Chairman and CEO

Nicole, one important data point we've discussed is the short cycle growth on the PST side, which was in the mid-single digits for Q2. This is a positive development. Looking at the ITS side across all regions, except for China, we've seen strong momentum as well. Specifically, we noted that our compressor orders increased in the second quarter, largely driven by the short to medium cycle demand.

Operator, Operator

Our final question comes from the line of David Raso with Evercore ISI.

David Raso, Analyst

I have a couple of quick points. I apologize if I missed it amidst all the earnings reports this morning. You mentioned deciding to walk away from one of the larger transactions. Could you share more details about that? Was it strictly a decision based on price, or was there something related to the markets? I'd like to understand better why you chose to walk away, as it could help us learn more about your approach to other larger deals in the future.

Vicente Reynal, Chairman and CEO

Yes. Good question there, David. I think the reason for that is that, first of all, I say this is a transaction that we cultivated for the past kind of three years. So we've been kind of watching them on the sidelines and learning a lot about them. And this transaction, I would say, fell really more into the adjacent category as compared to our core offering of compressor blower and vacuum. But yes, I mean, I think, ultimately, it was all about valuation. I mean we continue to be highly disciplined. And we assume very well know, we tend to do a lot of our ROI analysis around the line, so things that we can control and how do we view that business on areas that we can control versus extrapolating on revenue activity that we tend to discount heavily. So I will say that, ultimately, that led to a performance that we've decided that it was just not the right timing for us.

David Raso, Analyst

I have a follow-up question. The new ILC with PST is expected to reach a run rate of about $1.7 billion. I believe around $700 million will come from the Life Science segment, while the remaining $1 billion will be from Precision Tech. Given the overall segment margin of approximately 31% this year, can you explain the difference in margins between Precision Tech and Life Sciences?

Vikram Kini, Chief Financial Officer

Yes, David, interesting enough. Yes, quite comparable to each other. I wouldn't tell you there's a meaningful mix differential between the two. Both are playing in and around that, I'd say, segment average profile. So actually quite comparable.

Operator, Operator

This will conclude our question-and-answer session. I will now turn the call back over to Vicente for closing remarks.

Vicente Reynal, Chairman and CEO

Thank you, Briana. I'll just say thank you for your level of interest, and I appreciate all the questions and all the participants that I know many of our employees are actually listening to the call and to those that are listening to the call, I'd just say thank you again for another great quarter's performance. And let's get out of here now to execute again here in the second half of the year. With that, thank you very much, and have a good day.

Operator, Operator

This will conclude today's conference call. Thank you all for your participation. You may now disconnect.