Good morning, ladies and gentlemen, and welcome to the Ingersoll Rand second quarter 2022 earnings call. Our host for today's call is Matthew Fort, Vice President of Investor Relations. At this time, all participants will be in a listen-only mode. Later, we will conduct a question- and- answer session. I would now like to turn the call over to your host. Mr. Fort, you may begin, sir.
Thank you, and welcome to the Ingersoll Rand 2022 second quarter earnings call. I'm Matthew Fort, Vice President of Investor Relations. 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 reference these during the call. Both are available on the investor relations section of our website, www.irco.com. In addition, a replay of this conference call will be available later today. Before we start, I want to remind everyone that certain statements on this call are forward-looking in nature and are subject to the risks and uncertainties discussed in our previous SEC filings, which you should read in conjunction with the information provided on this call. Please review the forward-looking statements on slide two for more details. In addition, in today's remarks, we will refer to certain non-GAAP financial measures.
You can find a reconciliation of these measures to the most comparable measure calculated and presented in accordance with GAAP in our slide presentation and in our earnings release, both of which are available on the investor relations section of our website. On today's call, we will provide a strategy update, review our company and segment financial highlights, and provide an update to 2022 guidance. For today's Q&A session, we ask that each caller keep to one question and one follow-up to allow time for other participants. At this time, I'll turn the call over to Vicente.
Thanks, Matthew, and good morning to everyone. Moving to slide three, I would like to start by welcoming Matthew to his new role as the head of investor relations after several successful years leading our power tools and lifting business as a finance leader, and helping to return the business to profitable growth and a strong margin profile. In addition, I am also very happy to welcome Kathryn Freytag as our new Chief Information Officer. Both appointments demonstrate the deep bench of talent that we continue to develop at Ingersoll Rand. I would also like to say thank you to our employees worldwide for exemplifying our purpose through an ownership mindset and entrepreneurial spirit and delivering on our customer's needs. Our teams continue to impress me on how we're leveraging our own IRX process to outperform in the most challenging macro environments.
Our performance in the second quarter and year- to- date exemplifies how our employees think and act like owners. Demand remains very strong as we sit here today. While we see the supply chain risk and geopolitical and macroeconomic uncertainties continue to be a concern, we stay focused on what we can control while leveraging our strong balance sheet and operational mindset to deliver on our 2022 commitments and beyond. We also remain very agile in this environment, and you will see today how we continue to accelerate organic investments for growth around innovation and demand generation. We also remain committed to our capital allocation strategy that is very focused on inorganic growth through bolt-on acquisitions. Today, we're highlighting three new acquisitions that are very well aligned with our stated M&A strategy and will enhance the quality of our portfolio.
Starting on slide four, staying true to our five strategic imperatives where operating sustainably is at the center, we continue to align our portfolio to sustainable high growth end markets supported by global mega trends. There are four points I would like to briefly highlight on this page. First is that we have a simple two-pronged approach of growing sustainably and operating sustainably. Second, we released our 2021 sustainability report in June, highlighting our progress across all aspects of our sustainability journey and how we continue to remain on track to hit our 2030 targets. Third, our efforts have resulted in another upgrade from MSCI to AA from A, which puts us in the upper quartile of our peer group.
It is also worth noting that we now have moved from a double B rating to a double A rating in less than two and a half years. This recent upgrade was done before the release of our 2021 sustainability report. We will be watching carefully, and we will expect to see continued positive momentum in our ratings from the other sustainability rating agencies. Last, I want to remind everyone to save the date for our annual sustainability webcast on September 22nd, where we will provide a comprehensive update on our current efforts around sustainability. Moving to slide five, we want to highlight today an exciting innovation, which is a testament to our commitment to sustainability and organic growth through differentiated technology. Later this year, we will officially launch this first-of-its-kind water treatment system called Ion Solutions.
This is a very compact solution in a box where a small compressor and liquid pump technology from Ingersoll Rand are combined with our own patented cold plasma technology to produce nanobubbles that contain a high concentration of oxygen. This innovation allows for chemical-free disinfection and enhanced oxygenation of water. You can see some of the incredible benefits this technology produces on the slide, including higher disinfection efficacy and increased oxygen concentration, all while delivering and driving a lower total cost of ownership and footprint. We're officially launching this product later this year for indoor farming as well as water disinfection applications, and we will continue to expand our reach into other high-growth, sustainable end markets like medical, food, and pharma. What excites me even more is the speed in which the team has moved to develop and commercialize the Ion Solutions technology.
Through the utilization of the Ingersoll Rand Execution Excellence, or IRX, the team moved from the acquisition of the technology and IP behind Ion Solutions to the launch of the product in less than 15 months. In addition, the development was self-funded within the PST segment, and we continue to increase our investments in R&D to drive future organic growth opportunities like this. Turning to slide 6, we're also very pleased to highlight the most recent inorganic investment, which remained our top priority from a capital allocation perspective. Our M&A funnel remains very healthy, and as of the end of Q2 of 2022, the funnel remains over 5 times larger than it was in Q2 of 2020. Earlier this week, we announced the signing of three bolt-on acquisitions, which are well-aligned with our strategic and financial criteria.
In addition, these three companies have grown on an aggregate at more than 20% CAGR over the past three years. Let me quickly walk through the signed deals. First, Holtec, which is a leading provider of on-site systems that generate high-purity nitrogen gas. This is a great example of a bolt-on acquisition that extends our addressable market to very close adjacencies within the ICS business. In this case, the nitrogen generation can be connected to a compressor and produce nitrogen on-site. There are huge benefits for this, including the elimination of large nitrogen storage tanks at a customer site, which typically also require frequent refilling via trucks. In addition, the purity and quality of the gas can be much better controlled on-site with a drastic reduction in cost.
Secondly is Hanye, which is a manufacturer of dryer technology that has served as a long-term OEM partner of our ICS Asia Pacific business. Hanye brings differentiated and patented technology to our China compressor business. Both Holtec and Hanye are great examples of expanding our solutions and offerings in the broader compressor ecosystem to better serve our customers' needs. Finally, Hydro Prokav, an India-based manufacturer of progressive cavity pumps and retrofit spare parts. Hydro Prokav generates more than 80% of its revenues through the sale of aftermarket parts and serves as a complementary addition to the recent Seepex acquisition to further penetrate the growing market in India. We continue to be very prudent in our sourcing and execution of M&A deals, as illustrated by the single-digit aggregate pre-synergy adjusted EBITDA purchase multiples for these three deals.
In addition, we expect to have several more bolt-on acquisitions to announce in the second half of the year, as shown by the fact that we have eight additional deals under LOI. As a result, we're confident on being able to reaffirm our stated target of 400-500 basis points of annualized growth coming from M&A. I will now turn the presentation over to Vic to provide an update on our Q2 financial performance.
Thanks, Vicente. Moving to slide seven, we continue to be encouraged by the performance of the company in Q2. We saw a strong balance of commercial and operational execution fueled by IRX, demonstrating our ability to operate in a very agile manner in the current environment. We remain on track to deliver on our $300 million commitment in cost synergies from the merger. In addition, 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 13% year-over-year, respectively, driven by strong double-digit organic orders growth in ITS and low single-digit organic growth in PST orders.
The company delivered second quarter adjusted EBITDA of $335 million, a 15% year-over-year improvement, and adjusted EBITDA margins of 23.3%, a 50 basis points year-over-year improvement and 60 basis points improvement sequentially from Q1. Free cash flow for the quarter was $165 million despite ongoing headwinds from inventory due to the global supply chain as well as the need to support backlog. Total liquidity of $2.4 billion at quarter end was down approximately $700 million from prior quarter, driven primarily by the execution of our capital structure strategy, which we will discuss shortly. Our net leverage is 1.1 turns, a slight improvement of 0.1 turns from prior quarter.
Turning to slide eight, for the total company, Q2 orders grew 15%, and revenue increased 18%, both on an FX-adjusted basis. Overall, we posted a strong book-to-bill of 1.11 turns for the quarter. We remain encouraged by the strength of our backlog, which is up over 40% from last year. Total company adjusted EBITDA increased 15% from the prior year. ITS segment margin increased 70 basis points, while the PST segment margin declined 390 basis points, driven by the impact of prior year acquisitions as well as the impact of investments for growth, such as the Ion Solutions innovation highlighted by Vicente- and the impact of China lockdowns in two PST facilities. When adjusted to exclude the impact of M&A completed in 2021, PST margins declined by 190 basis points.
It's important to note that both segments did remain price- cost positive in terms of dollars in the second quarter, which speaks to the nimble actions of our teams despite ongoing inflationary headwinds. Corporate costs came in at $35 million for the quarter, down year-over-year primarily due to lower incentive compensation costs and general cost savings and prudency offsetting incremental investments we made in the area of demand generation and IT. Adjusted EPS for the quarter was up 17% to $0.54 per share. The tax rate for the quarter was 23%, and we anticipate the full- year being approximately the same. Moving on to the next slide, free cash flow for the quarter was $165 million, despite a $92 million increase in inventory to support backlog. CapEx during the quarter totaled $21 million.
Leverage for the quarter was 1.1 turns, which was a 0.1-turn improvement versus the prior quarter. Total company liquidity now stands at $2.4 billion, based on approximately $1.3 billion of cash and $1.1 billion of availability on our revolving credit facility. Liquidity decreased by $700 million in the quarter, which included deploying $621 million to debt repayment, $153 million to share repurchases, and $8 million to our dividend payment. As Vicente mentioned, M&A remains our top priority for our capital allocation. Our funnel remains robust and active, and we would expect M&A to be our primary usage of cash here in the second half of the year.
On slide ten, we show in more detail the strategic changes we have made to our capital structure. In an effort to create a flexible and efficient capital structure, we took a number of actions within the quarter. First, we paid down the entirety of our euro term loan of $621 million. The debt pay down is consistent with our financial policy to prudently manage our gross debt and our commitment towards achieving investment-grade credit ratings. We also executed a combination of interest rate swaps, cross-currency swaps, and interest rate caps to better balance our fixed to floating interest rate ratio and our currency mix of our debt. In addition, strong cash generation of the business, along with a strong balance sheet, enables us to execute on our growth strategy across all economic conditions.
I will now turn the call back to Vicente to discuss our segments.
Thanks, Vic. Turning to slide 11, our Industrial Technologies and Services segment delivered strong organic revenue growth of 14%, including approximately 8% price and 6% volume growth year-over-year. Adjusted EBITDA rose 13% year-over-year with an adjusted EBITDA margin of 25.4%, up 70 basis points from prior year, with an incremental margin of 32%. Organic orders grew 11% with a strong book-to-bill of 1.11x. It is also important to know that on a two-year stack, the ITS segment organic orders grew more than 50%, which is a higher rate than the Q1 2022 two-year stack of approximately 40%, meaning that thus far, we continue to see accelerated demand for our products.
If we move to the individual product categories, each of the below figures includes the negative impact of FX, which you can see was about 5% headwind across the total segment. Starting with compressors, we saw orders up in the high single- digits. A further breakdown shows orders for oil-free products grew in the high teens, and oil-lubricated products grew in the low single- digits. The Americas team delivered solid performance with orders in North America up approximately 10%, while Latin America was up low- 20s. In mainland Europe, down low single- digits due primarily to FX headwinds. At a further look into our leading indicators like, demand generation leads, shows stable growth in mainland Europe. Despite nearly two months of lockdowns in Shanghai, China, the Asia Pacific team delivered orders in the mid-teens.
This was driven by low double-digit growth in China and mid-20s growth across the rest of Asia Pacific. In vacuums and blowers, orders were down low single- digits on a global basis, driven mainly by FX we spoke about before and also a tough comp given we saw mid-40s growth in orders during Q2 of 2021. Moving next to the power tools and lifting. The power tools and lifting team delivered a strong performance, with orders for the business up approximately 20%. This marks their largest quarter for orders since Q1 of 2015. Looking at the sustainable innovation in action portion of the slide, we're highlighting our next- generation oil-free compressor. With a patented aerodynamic impeller design, this innovative centrifugal compressor is approximately 15% more efficient than the oil-free rotary compressor it will typically replace.
This technology is a perfect example of how we're continuing to address our customers' sustainability needs and goals by driving productivity through improved efficiency and reduced energy costs, decreasing their scope one and scope two greenhouse gas emissions. Moving to slide twelve, revenue in the Precision and Science Technologies segment grew 6% organically. Additionally, the PST team delivered adjusted EBITDA of $78 million, which was up 9% year-over-year, with incremental margins of 11%. Adjusted EBITDA margin was 26.8%, down 390 basis points year-over-year. As illustrated on the table in the bottom left side of the page, the decline in adjusted EBITDA margin is driven primarily by the impact of prior year acquisitions, which drove 200 basis points of the decline.
In addition, the impact of investments for growth, such as our hydrogen business and the Ion Solutions product line that drove 80 basis points of decline, and China lockdowns, were the other largest discrete driver at nearly 60 basis points, given the impact to two China facilities in the PST segment. Organic orders grew 2% year-over-year as Q2 comps were challenging due to the prior year COVID-related demand, primarily in the Thomas Medical business. Adjusting for the COVID and the one-time large non-repeating orders, normalized organic orders were up approximately 9%. On a two-year stack, organic orders were up 22%. It is also important to note that in Q1 of 2022, the two-year organic stack was approximately 19%, again, showing some sequential acceleration of demand into Q2.
Since the Investors Day in November, one of the key questions we have been asked is how we expect to achieve the mid-30s EBITDA margin profile for PST. On the bottom right-hand side of the page, I want to illustrate why we continue to believe a mid-30s margin is achievable, and we remain committed to delivering that in the medium term. As you can see, 25% of the portfolio is already above 35% EBITDA margins, with another 40% of the portfolio that is around 30% margin. That leaves us with a few targeted businesses that are at or below 25% EBITDA margin, with the vast majority related to new acquisitions and early-stage innovations.
We believe we have a significant opportunity for margin expansion across the entire portfolio, and we have a proven track record of margin expansion in both newly acquired assets and within our core business. Let me point out the three examples. The first example is Seepex. It illustrates how we plan to improve businesses that are in the less than 25% EBITDA margin bucket. As you recall, we acquired Seepex in September 2021, which had mid-teens EBITDA margin at the time of the acquisition and has already improved to the low- 20s in less than two quarters. The next two examples point out to how we can continue to improve businesses that already have some very high EBITDA margins.
First, Earth Dimension, which was another recently acquired company in Q4 of 2021, which in less than two quarters has gone from mid-50s EBITDA margin to low-60s EBITDA margin. Then there is our legacy Gardner Denver medical segment, which we now call our Thomas business. This is a core business where we have shown an ability to grow its EBITDA margin from the high-20s in 2018 to the low-30s by 2021, and where it remains today. Overall, we continue to see a strong runway on margin expansion across the entire PST portfolio, and we will use IRX to ensure proper prioritization of actions and nimble execution. Moving to slide 13, once again, we're raising our full-year guidance.
We're raising our organic growth guidance for the total company to 11%-13%, which is a 300 basis point increase from our prior guidance. The raise comes entirely from our ITS segment. The organic growth increase is offset by the negative impact of FX. FX is expected to now contribute headwinds of approximately 5% versus a headwind of 2% in prior guidance. This leads to a full- year 2022 revenue guidance at 11%-13% total growth. We're also raising the adjusted EBITDA guidance to a range of $1.395 billion-$1.425 billion. We continue to expect free cash flow conversion to adjusted net income to be greater than or equal to 100%.
We anticipate our adjusted tax rate to be in the low- 20s and CapEx to be approximately 2% of revenue. Although we don't provide quarterly guidance, the best way to think about the back- half revenue and EBITDA phasing is that the distribution between Q3 and Q4 is similar to what we saw in prior year. We expect pricing to improve slightly from the first half to the second half as we continue to work through backlog, and we do expect the price-cost spread to improve in the second half of the year. As a reminder, the new acquisitions mentioned on slide six are not included in this guidance as the transactions have not closed. Turning to slide 14, as we wrap up today's call, I want to reiterate that Ingersoll Rand is in a very strong position-
We delivered strong results in the first half of 2022, including record second quarter performance that was better than our expectations. 2022 is poised to be a strong year despite known challenges and dynamic market conditions. We will continue to remain agile and leverage IRX across every facet of our business to deliver on our commitments. To our employees, I want to again thank you for your continued engagement and making thoughtful, action-oriented decisions like the owners that you are. This engagement continues to drive the accomplishment of our mission to make life better for our customers, the environment, and shareholders. Our balance sheet is very strong, and with our discipline and comprehensive capital allocation strategy, we remain resilient to have the capacity to deploy capital to investments with the highest return on capital as we continue our track record of market performance.
With that, I will turn the call back to the operator and open for Q&A.
If you would like to ask a question, please press star one on your telephone keypad now. You'll be placed into the queue in the order received. Please be prepared to ask your question when prompted. Once again, if you have a question, please press star one on your phone now. Our first question comes from Michael Halloran. Your line is open.
Hey. Hey, good morning, everyone.
Good morning, Mike.
Good morning, Mike.
A couple of questions here. First question, you know, Vicente, you talked about constructive or positive leading indicators that give you confidence in the demand through remainder of the year, at least. Maybe you could just dig into that a little bit more, you know, quoting customer conversations and what some of those leading indicators are that are making you feel that level of confidence.
Yeah, Mike, I think one of the most important, I'll say, leading indicators for us is what we have spoken in the past about demand generation, qualified leads, which, as you know, we have a very unique marketing engine to be able to grab a lot of good new customers. As we saw through the quarter, we continue to see pretty good stability on the marketing qualified leads that the team is generating. As we kind of move into July, we actually even saw acceleration in some areas and some end markets and regions. That's kinda what gives us confidence. As we look into the order momentum into July, also pretty strong, continue to be fairly strong.
Thanks for that. Good color on the capital deployment side of things. On the OIs and what you're seeing in the pipeline, could you give a little more context to size of the transactions and if there's any change to the type of things you're pursuing at this point?
Sure, Mike. I mean, I'll say that we're very excited about what we see in the pipeline. I mean, very solid funnel. You saw that the three transactions that are highly strategic, I mean, great growing companies, good technologies, addressing expanding the addressable markets. I mean, it kind of hits all the marks, and even also with the financial criteria. As we look forward to the other eight that we have in the LOI, I'll say similar to what we have been doing over the past kind of 12 to 18 months, which kind of bolt-on tuck-in in nature, great returns, good growing companies, elevating the portfolio of the company and ones that we see can be highly strategic for us to continue accelerating the growth.
Thanks for that, Vicente. Appreciate it.
Yeah. Thank you, Mike.
We have a question from Julian Mitchell. Your line is open.
Thanks. Good morning. Maybe just wanted to try and understand the sort of second half, you know, EBITDA outlook a little bit more clearly. When we're thinking about the sort of weighting between third and fourth quarter, are we thinking the third quarter is maybe a sort of, you know, high-20s share of full- year EBITDA? Just trying to understand the margin ramp. By segment, you know, any color you could give us on how much the margins step up into the back-half is split between ITS versus PST.
Yeah. Julian, hey. This is Vik. I'll take the first part of your question, and I'll let Vicente answer the second. I think in terms of your first question, in terms of, I think you asked about the phasing of EBITDA in Q3. Yeah, you're actually right. You know, I'd say mid- to high 20% in terms of the phasing. And what we would probably say, and very consistent to actually what we've been saying all year, is that the phasing throughout the year in terms of the quarters is actually very similar to what you saw last year in terms of the phasing in terms of the Q3, Q4 weighting of EBITDA. So that's probably a good proxy to use.
Yeah. Maybe Julian, in terms of the segments, I mean, if you think about it, kind of first half to second half, which is the way sometimes we like to look at it, is that, think about ITS, you know, flow through in the first half was approximately in the 30s. As we get closer to the 40s for the second half, and that's gonna be driven primarily through a better pricing realization that we already have action, as well as, some kind of continued movement in terms of the merger- related productivity savings that. Think about it. It's already actions that you could call it that we have, so to speak, in the bag or already actioned.
From a PST, I think when you look at the data, again, same thing. First half to second half, flow through in the first half was kind of in the low- 20s, with an EBITDA margin generating in the first half in the high- 20s, kind of 28% range. As we go into the second half, you know, our EBITDA margin should expect to grow closer to the 30s, which leads to that incremental flow through of the 50s. Again, when you think about the big pieces, it's fairly similar in terms of better price realization given the actions that we have taken. For the PST segment, it's a lot around the M&A synergy realization for the deals that we closed in the second half of 2021.
Also for the PST is kind of some of these non-repeat China lockdown volume miss and absorption related issues. Again, it feels like fairly doable and the team is executing to all those actions that we need to get done.
That's very helpful. Thank you. Just my follow-up would be around the ITS EMEA orders progression. You know, how comfortable do you feel with that and the demand outlook in that ITS, you know, compressor piece? I realize the orders numbers you put up are including FX and so stripping that out, it's a little bit healthier, but are you seeing any change in demand on that piece? And then PST, how long does that kind of COVID headwind last?
Yeah. You know, Julian, from an ITS EMEA, no change in dynamic as we see even here with our leading indicators, as you very well pointed out. I mean, the Q2 pretty well affected by the FX, and that's why when you can even see it, Q1 to Q2 sequentially, I mean FX, Euro alone was like a 5%-6% headwind impact. Yeah, I mean, FX, but even with that, the team continues to outperform pretty well and confident on the execution with what the team continues to lay out in the coming quarters.
From a PST perspective, in terms of COVID, you're gonna see one more kind of meaningful comp here in the third quarter that should be relatively about the same as what we saw in the second quarter. Basically, after that, we should be kind of clearing the goal, I mean, in the fourth quarter.
Thanks very much.
Thank you, Julian.
Our next question comes from Nigel Coe. Your line is open.
Thanks. Good morning, everyone. Just to put a final point on that third quarter phasing, Vik. Is that, I mean, my dumb math would get me to $375 million of EBITDA. Is that in the right zone of where you see things?
Yeah, Nigel, I think that may be a little on the higher side. You know, if you were to use kind of a mid, I'm gonna say mid to mid- plus 20% phasing in in Q3, I think you'd be in the right zone. That may be a little on the high side, but you're not dramatically that far off.
Okay. Like 3.50, 3.60. Okay. That's really helpful. Thanks. On the PST side, you know, we've talked about the margins a fair bit. You called out the COVID order headwinds, and I'm wondering, you know, when do we start to lap that impact? I think it's four points to orders and, you know, how is that filtering through to revenues and margins? Are we seeing a headwind there as well?
Yeah. Hey, Nigel. We'll see one more quarter here in the third quarter of the same kind of COVID headwind-related one-time from last year. What we usually see in the third quarter should be fairly similar to what we saw here in the second quarter from an orders and revenue perspective.
Great. Okay, I'll leave it there, guys. Thanks a lot.
Great. Thank you.
Our next question comes from Joe Ritchie. Your line is open.
Thanks. Good morning, guys.
Morning, Joe.
A couple of quick ones for me. Just trying to understand, I think with a lot of our companies, like how this, the fact that like base metal pricing is starting to deflate and how that ultimately impacts the P&L, you know, out in 2023. I'd love to hear some thoughts just around, you know, how much of the pricing will do you think you're gonna be able to hold on to versus potentially give back? What happens do you think to your margins if you do see some deflation from a cost input perspective?
Yeah, Joe, I'll say that the way we think about it is that we have not historically given out any pricing back. The reason being, all the price increases that we have done, even this year and last year, have been list price increases. The way to think about it, too as well, our customers, they don't buy the same type of product every month. I mean, they buy a compressor now, and they just probably buy another one, you know, five to eight years later. It's kind of difficult to compare that kind of price to price perspective.
I mean, clearly against the market, they do, but that's why we want to continue to create that, highly innovative solutions and differentiated technology that will allow us to command that premium price. As we think and we look forward, yeah, I mean, we're pretty excited that you're starting to see some of these kind of base commodities kind of dramatically reduce. What we have here in a forecast for ourselves, and we told the teams here for the second half is, you know, assume inflation stays constant and, kind of work on what you can control, which is price, and execution, and productivity.
As we go into 2023 and we get a better visibility of what that deflation could happen, yeah, I mean, we see that that could be a great margin expansion for us on an ongoing basis.
That's great to hear, Vicente. Maybe just, I know we've talked a little bit about the PST margins. I liked the walk that you guys did on slide 12, the year-over-year walk. If you take a look at those four buckets, you know, M&A, growth, China, and then other, and you think about 3Q, how—like, maybe just talk me through like the buckets and how those buckets change in the third quarter. I'm assuming that, you know, your PST margins are maybe down modestly in 3Q on a year-over-year basis.
Yeah, Joe, I'll take that one. If we kinda think about the three buckets, the way I probably describe it is, you know, first starting with the biggest one, the impact of M&A. First and foremost, we do start to lap the M&A. Obviously, the biggest drivers in there were coming from Q3 of last year's acquisitions, particularly Seepex being the biggest one, and we've highlighted that one a few times. Obviously, as we lap that, you know, and clearly with some of the, you know, the higher synergy expectation that we expect to see, you know, that'll start falling off.
Again, we would expect to see the impact of M&A start to dramatically reduce here in Q3, given that you know, we only had a one-time impact this year in terms of the timing of when we purchased it. The impact of China's lockdowns, we really wouldn't expect to see that repeat at all. Obviously, that was a very you know, nuanced in Q2. The good news here is you know, exiting really through June and exiting June, our China facilities particularly in PST, we're operating right back on track, and we don't have any expectations of any concerns here in Q3. In terms of the investments for growth, yes, that definitely will still you know, be part of the equation.
I think it'll be, you know, you should expect it to be dramatically different in terms of Q3. You know, a lot of these are areas like, for example, our hydrogen business and the Ion Solutions business that was highlighted in the deck. You know, those will continue. These are, you know, great innovations, things that we're really excited about and ones that we continue to, you know, invest in and execute on, you know, frankly, since last year, even through this year. I think that's how the three major buckets play themselves out. As Vicente indicated here, the price cost spread will continue to get better for PST, not just in Q3, but also in Q4.
Super helpful. Thanks, guys.
Thank you, Joe.
As a reminder, if you do have a question, please press star one on your telephone keypad now. Our next question comes from Rob Wertheimer. Your line is open.
Hi. Thanks, and good morning, everybody.
Morning, Rob.
My question is actually gonna be on innovation, and the cold plasma is something it sounds very interesting and how differentiated it is, and really just wanted to see if you could review your innovation sort of process changes that have gone on and, you know, any metrics you wanna share on pacing and change and so forth. Then, breakthrough innovation is maybe slightly different. I don't know the, you know, oil-free is a known industry thing. I'm not sure if this is evidence of a different program that's been ongoing, or whether it's kind of a lucky, you know, a lucky opportunity, or if it's a more widespread effort. Thank you.
Yeah, Rob, you know, solid, very intriguing questions. I'll say that the innovation on the cold plasma technology, it is highly differentiated and pretty unique. Actually, if you go out there in the market, and we'll be able to talk more about it, is the only one that has all in its own, in its self-contained unit, not only the ability to create disinfection, but to create the ability to accelerated oxygenation in the water, which is kind of particularly very, very important for horticulture markets and hydroponics markets and things like that. I think it's gonna be really, really strong. We have built a very strong IP around it, and so we have a very big barrier in terms of IP protection around that.
Again, speaks volumes to some of the things that we've been wanting to do, which is kind of a combination of several Ingersoll Rand technologies, such as compressors and pumps into additive technology that can actually create a very unique solution. Again, here is just one great example. In terms of how we think about innovation, kind of, the cadence of innovation, we spoke, I think it was back at the investor conference, how, you know, from an ITS perspective, and we kind of gave a bit of a highlight that innovation accelerated dramatically, when the combination of the two companies. We continue to do a lot of that work around, you know, global product summits that we have with the teams. I think it's a very exciting piece.
You know, we just fairly recently here, a couple of weeks ago, we had our strategic plan review with the teams, and one of the core characteristics of the review in every business, it was around intellectual property and IP and patented technology because we believe that we have unique technology that can be application-driven and protect that as a, as a protective IP. In regards to that breakthrough technology, and particularly to the centrifugal, I think it's just one example where again, you take kind of a core technology such as centrifugal compression that it is very unique for oil-free products, and in this case, oil-free compression. Again, we've created some IP protection around the aerodynamics of the product inside and how the airflow moves inside.
Again, we feel that that allows us to create, you know, differentiation in energy efficiency. A pretty unique model that we leverage IRX all in its own to drive the process. You know, I would say that this Ion solution, the cold plasma, was one great example. Acquire some IP, develop the IP, utilize IRX processes as a way to out-execute the, you know, the product, and in less than 15 months, we went from concept to launch of a product, which is pretty impressive.
Great. Thank you.
Thank you.
We have a question from Stephen Volkmann. Your line is open.
Hey, good morning, guys. I just wanted to ask about kind of what you're seeing in terms of the supply chain and sort of the productivity impact of that. I'm just trying to figure out if there's been any kind of margin headwind due to you know, all these issues that we're seeing.
Yeah, I would say, you know, Stephen, absolutely margin headwind, because if you think about it, we don't have all the components at the right time at the right place. Yeah, that creates the factories to do heroics in terms of reconfiguring and try to, you know, maybe pre-build a piece of the compressor, put it on the side, and then wait for the part. Yes, absolutely. We've seen productivity hits due to the inefficiencies on the supply chain. I think, you know, one thing we'll say is that we still see supply chain constraints and issues. I don't think that everything is perfect.
I mean, I think what our teams are doing with the utilization of the IRX and the processes is incredible, from the perspective that they're able to outperform. I mean, and you saw that very clearly with the team in ITS in China that just basically outperformed dramatically to even some of the expectations that we had when they came back with the lockdown. But yeah, definitely some headwinds. To your point, it's a very good point that as we go into maybe 2023 and beyond, we should see maybe the better efficiencies of productivity due to the ease of the supply chain being more stable.
Right. Obviously, that's exactly where I was going with this because it feels like for 2023, demand will be whatever it is, but you should see some margin tailwinds from sort of normalization of supply chain at some point, presumably. Then maybe price cost also turns positive. Maybe it feels like incrementals could be pretty robust in 2023.
Absolutely.
Yeah. See, I would agree. I mean, I think the only thing to add to what you said there is, we're pretty encouraged that, you know, price cost actually has been. We've actually been positive the entire time from last year, even through the first half of this year. We do expect it obviously get better into the second half of this year. Then potentially, as Vicente indicated earlier, if commodities start to deflate in the next year and given how we deployed price, we definitely see that as a potential tailwind into 2023.
I think the other thing we should probably mention here is, you know, you see it, you saw it in the financials that clearly as a result of the supply chain, obviously inventory continues to, you know, be at elevated levels. I think as supply chain alleviates here, we obviously have a meaningful opportunity from a cash perspective in terms of deploying that inventory. The good news is the backlog is there to do it for the back-half of this year. Again, it's just a matter of us continuing to execute and seeing a little bit more normalization in the supply chain.
Super. Thank you.
Yes. Thank you, Steve.
Our next question comes from Nicole DeBlase. Your line is open.
Yeah, thanks. Good morning, guys.
Morning, Nicole.
Hey, Nicole.
Just maybe going back to the comment you made about July orders, Vicente. Like, you mentioned some acceleration in certain regions and markets. Can you elaborate a little bit on where you guys saw things improve?
Yeah. No, yeah. I figured that we'll get the follow-up for sure. Yeah. I think, Nicole, it was to be honest, it was fairly broad-based, if I were to categorize it. I'll say that, you know, we saw. We're starting to see more, I guess release, so to speak, for some long cycle projects. So we're seeing that, you know, some of these kind of large projects that have been in the pipeline, and there's been a lot of conversations, they're getting released, and we're seeing some good momentum on that. Some of these are, you know, energy transition related and/or, you know, expansion of capacities and also in some cases onshore in the U.S. as well.
We're seeing some good momentum on that perspective. To be honest, it was fairly global from a global perspective across all regions and you know very exciting movement in the US, China, but even also in Europe. I think it was fairly broad-based here, Nicole.
Thanks, Vicente. Vik, maybe just to follow up on the comment you just made about free cash flow. Can you talk a little bit about the path you see in the second half to get to the 100%+ conversion? Like, is this very Q4 weighted based on your plans for reducing inventory?
Nicole, I'd say it's probably second half weighted is probably the best way to say it. You know, if you look, you know, last year is probably a good example. You know, typically we are seasonally more second half weighted. I would say that's probably a combination of two things. One, following the profitability of the company as well as, you know, the typical movements in in working capital. You know, I think in terms of this year, sure, you are going to see probably a stronger fourth quarter comparatively speaking. Yes, a lot of that is also predicated on the working capital, let's call it continued rightsizing, which inventory obviously being the biggest piece.
You kind of see that through the first half that we have built a meaningful amount of inventory, about a $200 million, I'd say, for the first half, headwind from a cash flow perspective. Despite that, we're actually quite pleased with generating $165 million of free cash flow still in the second quarter. Again, pretty pleased with the execution of the team despite what I would call a working capital headwind. You know, the good news here is we have the backlog and you know, the path to be able to execute and free up that cash.
Thanks, Vic. I'll pass it on.
Thank you, Nicole.
Our next question comes from Vlad Bystricky. Your line is open.
Morning, guys. Thanks for taking my question.
Morning, Vlad.
Vlad.
Maybe just on the capital allocation front, a lot of good color around obviously the three deals you've announced and then the additional LOIs on the bolt-ons. But can you talk about just given how leverage has come down, you know, how you're thinking about your appetite for larger deals, you know, especially given maybe some increased noise in the macro backdrop?
I'll say, Vlad, you know, when you look at our funnel, I think the funnel characteristics that we have are still fairly bolt-on in nature. I'll definitely speak in terms of what we see today in the funnel is nothing around those $1 billion-plus acquisitions. Not because there might not be out there, but because we're being very focused more on these kind of more bolt-on in nature deals that can be highly accretive to us.
Okay. That's really helpful, Vicente. Thanks. Maybe just going back to the organic growth outlook here. You took your organic growth outlook up on stronger ITS growth. Can you just talk about you know what's really changed in the environment since 1Q? I mean, investors are more focused on, you know, potential slowdown and worried about the macro, but you're seeing organic growth, you know, accelerate. Can you just talk about the drivers and how you think about, you know, the sustainability of that growth trajectory beyond the back- half here?
Sure. So Vlad, I'll say that, you know, maybe to keep it more or less kind of simplistic in nature, is that, you know, we're seeing definitely better price acceleration and realization. You saw how sequentially Q1 to Q2, we improved price. I mean, almost 200 basis points in terms of price, whether ITS or PST. Again, those are actions that we have taken that is already built in the backlog. So it's basically shipping the product and realizing that higher price realization that gives you that increase in organic. As well as also, as Vic said, that, you know, price cost margin amplitude that will continue to get better in the second half.
To the volume, organic volume is then in terms of the just again supply chain constraints getting released and be able to accelerate some of the shipments from being able to deliver to what customers want. Again, it's better price realization and better supply chain kind of coming to a better operating gear for us that allows the factories to produce a product.
Great. That's helpful, Vicente. Nice momentum. Thanks.
Thank you. Thank you, Vlad.
We have a question from Nathan Jones. Your line is open.
Good morning, everyone.
Morning, Nathan.
I wanted to start off with a question about the long- cycle projects, Vicente. You talked about some of those getting released and helping to drive the order book. I think, you know, by the time those projects get to ordering products from Ingersoll Rand, they're likely to go ahead regardless of the macro backdrop. Can you talk about any, you know, any information or insight you might have on some of those larger, longer cycle projects that might have been in the planning stages that maybe customers are reconsidering with higher interest rates, macro uncertainty, or anything like that? Have you heard anything about, you know, customers reconsidering or delaying kind of moving forward with earlier- stage projects like that?
I'll say, listen, you know, to be honest, it's an interesting question, but I would say that nothing that we see dramatically customers just putting a big pause and rethinking. I think on the contrary, I would say that because of current energy prices being so high and the fact that our technologies allow us to drive these energy efficiency and improvements, we're seeing customers making the acceleration of, "Let's just get it done here now," because they see energy prices to be high for the longer or kind of medium to longer period of time of perspective. So I think that again, this cost- benefit equation that we have with our products and solutions and how our teams are positioning that from a total cost of ownership to the customer that equates to, you know, a better carbon footprint for our customers.
It is actually seeing some good momentum on getting projects even more through the accelerated pipeline, in my view.
Thanks. Maybe for Vic on the capital structure swaps, caps, can you talk about, you know, any detail you can give us on notional value, how it impacts the interest expense here in the short- term, and what the plans are for maybe you know putting actual fixed debt in place over the next couple of years here? Just any details you can give us on your intentions with the capital structure.
Yeah, sure. Let me, maybe just for completeness here, I'll kind of just summarize kind of what we did here. You know, we did a number of things here in the second quarter to, I'd say, execute on our, on our capital structure strategy. It's important to note that, you know, ensuring that we're on our continued path to an investment-grade credit rating. We obviously want to make sure that we're cognizant of balancing, you know, further interest rate exposure, by balancing our fixed- to- floating ratio, as you indicate. What we did was, you know, I'd say three distinct things or, you know, three to four distinct things in the quarter.
One, we did pay off the full amount of the euro-denominated term loan, which was in dollar terms, $621 million. We executed EUR 1 billion of USD-to-euro cross-currency swaps, three-year term, and 50% of that swapped to fixed, 50% swapped to floating. The final piece is we executed $1 billion of U.S. dollar interest rate caps, capped at 4% on the base interest rate. Again, we've meaningfully changed, I'd say, a fixed-to-floating ratio here in the context of, you know, where we were, you know, exiting Q1, for example, to where we are now exiting Q2.
I think in the context of your kind of second part of your question, yes, I mean, I think this is just a step in the consistent evolution of our capital structure. As indicated here, we do continue to see a path to investment-grade credit rating, at which point in time, clearly, we would expect the nature of our capital structure to continue to evolve and change, at which point we'll probably go into more of a fixed rate structure at that point in time. The good news here is the maturities of our debt towers right now are all out to 2027. So that gives us, you know, some time here to continue to both evaluate but execute and change that structure.
You know, I think the good news here is we still have a considerable amount of flexibility as well as coupled with the strong free cash flow, as well as with the, I'd say, the amount of cash and liquidity we have exiting Q2. It gives us, I'd say, a lot of flexibility to continue to execute on our capital allocation strategy, which you heard from Vicente, obviously, will continue to be very M&A-centric. Clearly, the funnel continues to support that.
Maybe just the bottom line, what's the quarterly run rate for interest expense?
Yeah. You'll probably be, you know, I'd say closer to the, you know, the high- 20s to, you know, in the back-half of the year on average, roughly speaking.
Thank you.
It's probably a good number just from an interest expense perspective.
Thanks very much.
Great, Nathan Jones.
As a reminder for those who joined the call late, if you do have a question, please press star one on your telephone keypad now. We have a question from Joe O'Dea. Your line is open.
Hi. Good morning.
Good morning.
Actually I wanted to ask on the M&A contribution to growth based on the deals this quarter and then based on what you have under LOI. When you think about the framework of the 4%-5% annual target and given kind of, you know, what's in motion right now, you know, what kind of a contribution you think that's setting up for next year? Are we looking at something better than that based on the number of deals that we're looking at here?
Yeah, Joe, I think the best way to think about this is maybe two pieces. You know, one, our commitment and what we still are reaffirming here today is the ability to execute 400-500 basis points on an annualized basis of inorganic growth. So let me take it in two pieces. You can see in the guidance, we still are committed to about $225 million of in-year impact. Now, the reality is that's largely coming from the deals that you saw already announced primarily in the second half of the last year, as well as you'll see, remember we did one small bolt-on in the first quarter of a business called Jorc. So that's really what's driving the $225 million.
The three deals that were announced earlier this week, they are actually not in guidance yet because they have not been closed. We expect them all to close in the second half of the year. You know, based on what Vicente indicated, the LOIs and what's in the funnel, again, the annualized impact of those deals as well as ones we just announced, again, we would expect to get to 400-500 basis points on an annualized basis.
You know, we actually see that whether you wanna look at the in-year impact of revenue, the annualized impact of what we expect to be able to purchase this year, all of those, you know, lead to the 400-500 basis points, whichever way you wanna look at it, which is actually setting us up nicely here if I'd say the M&A impact to revenue as we go into 2023. I think Joe, depending on how you wanna look at it actually probably leads to the same answer, but just wanna make sure we understand that the three deals announced here earlier this week, they're technically not in guidance yet, and they won't be until we actually close the deals.
Understood. Circling back on the ITS Asia Pac orders and up low double digits China, mid-20s, rest of Asia. Can you talk a little bit about, I mean, the degree to which, you know, you have insight into outperformance in the market, you know, some of what's driving the growth that you're seeing in the region there?
Yeah, Joe. I mean, according to the teams, and there's actually not a third-party report in Asia Pacific or in China, but you can do a lot of triangulation. Yes, I mean, according to our teams, we continue to outperform what we see in terms of our peers, from a compressor perspective, I'd say. I think also the teams continue to leverage really well the technologies that we have around vacuums and blowers, and really expanding that penetration in the market where our market share is today fairly small. We have a very big, great opportunity to accelerate that.
The last piece I'll say, Joe, is that our team in the Asia-Pacific, the ITS team has been incredibly agile in terms of being able to take the technology that we have in our kind of palette of all technologies, compressors as well as the vacuums, and really move pretty quickly to create applications to those areas where they're seeing kind of the good areas of growth momentum.
I think this is something that I would say still is kind of not that well understood externally, but the fact that we have these kind of great technologies that you can make them applicable to the end markets and to the growth trends that you have. It is something that is unique to what we have in our portfolio, and that has been pretty well executed by our team here in Asia Pacific and in other regions. Particularly China, our team has done a phenomenal job just executing to that strategic aspect.
Got it. Thanks very much.
Thank you, Joe.
We have no further questions in the queue at this time. I will turn the call back over to Mr. Reynal.
Thank you, Paul. I'd like to say a few things here at the end. I just wanna say that I'm very proud, and we're all very proud of the work our teams have done over the second quarter and the first half of 2022. I mean, in terms of performance and navigating in this challenging macro environment, you can see that Ingersoll Rand continues to be very financially strong, operationally fit, and our business is quite resilient. More important, our culture of agility and ownership, and while leveraging IRX, is the essential piece to our continued momentum. We importantly wanna highlight that we continue to build a stronger team for long-lasting performance. With that, we're super excited about the announcements of Mark Stevenson and Michael Stubblefield to the board adding them to the board.
I know both will add incredible value as we continue to transform our company. Wih that, just wanna say thank you for your continued support and look forward to speaking with many of you here soon. Thank you.
This concludes today's conference call. Thank you for attending.