Trane Technologies Plc quarterly report, Q3 FY2019

Business context and reporting period

Ingersoll-Rand plc (now known as Trane Technologies) filed this unaudited Form 10-Q for the quarter ended September 30, 2019. The company reported two segments: Climate, comprising HVAC and transport refrigeration, and Industrial, comprising industrial products and services. Unless stated otherwise, amounts are in U.S. dollars.

Financial performance and liquidity

• Q3 revenue rose 7.8%; higher volume/product mix, acquisitions and pricing contributed, partly offset by unfavorable currency. Q3 operating income rose 6.2%, but margin declined 0.3 percentage points.
• For the first nine months, revenue rose 5.7% and operating income rose 8.3%; margin improved 0.3 percentage points. Continuing-operations earnings attributable to shareholders decreased slightly.
• Q3 Climate revenue increased 7.2% and segment operating margin improved to 16.8% from 16.5%. Industrial revenue increased 10.2%, including acquisition contribution, while its margin declined to 13.3% from 14.0%.
• Continuing operating cash flow for the first nine months was $1,089.8 million, versus $946.4 million. Capital expenditures were $186.2 million; acquisitions and equity-method investments used $1,536.8 million. Continuing operating cash flow less capital expenditures was $903.6 million, a derived figure.
• Cash was $830.9 million at September 30, 2019, compared with $903.4 million at December 31, 2018. Total debt was $5,572.4 million, up from $4,091.3 million; debt-to-total-capital increased to 43.4% from 36.7%. The company had no commercial paper outstanding and $2.0 billion of revolving credit commitments unused.
• Working capital changes used $472.2 million of cash in the first nine months, primarily reflecting seasonal inventory growth and higher receivables as sales increased.

Material changes, outlook and notable items

• Proposed separation: The company planned to spin off its Industrial businesses and combine them with Gardner Denver in a Reverse Morris Trust transaction, expected to close by early 2020 subject to shareholder, regulatory and other customary conditions. ClimateCo was to receive $1.9 billion in cash funded by new debt assumed by Gardner Denver. Existing Ingersoll-Rand shareholders were expected to own 50.1% of IndustrialCo. Management expected $150–$200 million of separation costs.
• Acquisition and debt: The company acquired Precision Flow Systems on May 15 for approximately $1.46 billion, funded through senior-note issuance. It issued $1.5 billion of senior notes in March 2019. Q3 operating margin was affected by separation costs, investment and restructuring spending, and acquisition-related inventory step-up and backlog amortization.
• Management outlook: Management said economic conditions had moderated and global Industrial markets had weakened, while HVAC equipment, replacement, services and aftermarket demand remained healthy. It expected growth in both segments in 2019, supported by productivity initiatives, product launches and cost programs. Management expected liquidity sources to cover operating and capital needs for at least the next 12 months.
• Capital returns: The company repurchased approximately $500 million of shares in the first nine months, leaving about $1.0 billion under its authorization. It expected to maintain the current quarterly dividend through 2020 and then resume dividend increases in line with earnings growth from 2021 onward.
• Taxes and discontinued operations: The nine-month effective tax rate was 20.1%, versus 12.5% in 2018; the prior-year rate benefited from tax-law measurement-period adjustments. Q3 discontinued operations contributed $24.4 million after tax, including gains associated with settlements of asbestos insurance coverage litigation.
• Contingencies: At September 30, asbestos-related liabilities were $562.5 million and probable insurance-recovery assets were $299.6 million. Management cautioned that actual claims and recoveries could differ significantly from estimates. Environmental reserves were $42.5 million. The company stated that pending legal matters were not expected to have a material adverse effect, while recognizing estimation and litigation uncertainties.
• The company adopted lease accounting ASC 842 on January 1, 2019, recording a $521 million right-of-use asset and related lease liability with no retained-earnings impact. Lease liabilities totaled $563.7 million at September 30.

Important facts for investors to verify

• Progress, approvals, final terms, timing and costs of the proposed Industrial separation and Gardner Denver combination.
• Whether revenue growth and margin performance persist, particularly the differing Climate and Industrial trends and the impact of moderating industrial markets and foreign exchange.
• Debt, interest expense and leverage after the acquisition financing, including maturities, refinancing needs and the planned $1.9 billion separation-related payment.
• Cash conversion and working-capital trends, given the cash tied up in receivables and inventories and the scale of acquisition spending.
• Future asbestos claim volumes, insurance recoverability and settlement outcomes, along with environmental and other legal contingencies.
• The effect of discontinued-operation settlements and tax-rate changes on reported earnings; Q3 net income includes a material benefit from discontinued operations, while continuing earnings declined year over year.