ITT Inc. (NYSE:ITT) Q2 2023 Earnings Call Transcript

ITT Inc. (NYSE:ITT) Q2 2023 Earnings Call Transcript August 4, 2023

Operator: Welcome to ITT’s 2023 Second Quarter Conference Call. Today is Thursday, August 3, 2023. Today’s call is being recorded and will be available for replay beginning at 12:00 p.m. ET. [Operator Instructions]. It is now my pleasure to turn the floor over to Mark Macaluso, Vice President of Investor Relations and Global Communications. You may now begin.

Mark Macaluso: Thank you, Ellen. Good morning. Joining me here in Stamford this morning are Luca Savi, ITT’s Chief Executive Officer and President; and Emmanuel Caprais, Chief Financial Officer. Today’s call will cover ITT’s financial results for the 3-month period ending July 1, 2023, which we announced this morning. Before we begin, please refer to Slide 2 of today’s presentation available on our website, where we note that today’s comments will include forward-looking statements that are based on our current expectations. Actual results may differ materially due to several risks and uncertainties, including those described in our 2022 annual report on Form 10-K and other recent SEC filings. Except or otherwise noted, the second quarter results we present this morning will be compared to the second quarter 2022 and include non-GAAP financial measures.

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The reconciliation of such measures to the most comparable GAAP figures are detailed in our press release and in the appendix of our presentation, both of which are available on our website. With that, it’s now my pleasure to turn the call over to Luca, who will begin on Slide 3.

Luca Savi: Thank you, Mark, and good morning. I would like to begin, as I always do, by thanking our employees around the world who work hard every day to ensure we deliver on our commitments to all our stakeholders and to our shareholders and customers for their ongoing support and investment in ITT. Last quarter, the ITT story was about growth and execution. And in Q2, the story is again growth and execution with a significant step-up and record results on many fronts. Our order growth rate accelerated. We expanded our margin, especially in Industrial Process and Motion Technologies, and our teams generated significantly higher cash and we deployed it. Let me share some of the highlights. 12% organic revenue growth, 280 basis points of segment margin expansion, 36% EPS growth and more than $120 million improvement in free cash flow since Q1.

And on top of that, orders, up 13% organically and 6% sequentially. Now let’s get into the details. On growth. Industrial Process delivered a 23% revenue increase and the 15% organic orders growth with another record quarter driven by projects and aftermarket. On aftermarket, our daily order rates in parts and service remain at historically high levels, and we are realizing further pricing. On projects, orders grew 41% despite a tough prior year comparison. This includes a significant pumps award on an LNG project for one of the world’s most prestigious engineering firms. Green project orders are up more than 100% in Q2 and year-to-date are already more than double the amount for all of 2022. Additionally, our Bornemann Twin-Screw and multiphase pump technologies are capturing share.

For example, Bornemann was recently awarding content on one of the world’s largest decarbonization project in Australia that produces roughly 16 million tons of LNG per year. When I was at our Bornemann site in Germany, I saw firsthand how the team’s outstanding project management capabilities are driving market share gains. IP is quickly developing best-in-class project management with strong leaders and rigor across the organization. With IP outperformance ramping, I’m pleased to announce that Fernando Roland has joined ITT as President of Industrial Process, succeeding Dave Steblein who retired early this year after 30 very successful years of service to Goulds Pumps and ITT. With more than 2 decades of senior leadership experience at large multinational companies, Fernando has the expertise to help grow our premier flow business and enhance IP’s differentiation.

Fernando, welcome to ITT. Continuing with growth. Motion Technologies grew revenue 10% organically, driven by Friction OE outperformance, which in Q2 was nearly 500 basis points. This quarter, we won content on 67 new electrified vehicle platforms with premier auto OEMs, including Tesla, BYD, Porsche, Polisher and , BMW. Stepping back from the quarter for a moment. One of the unique aspects about Friction is the team’s ability to serve our customers by anticipating their challenges and developing solutions to meet their needs. With each market disruption, Friction found ways to differentiate and accelerate our market share gains. It happened with copper-free brake pads. It’s happening with the EV transition. And the next opportunity is the eventual rollout of Euro 7 Emission Regulations.

The Friction team has been proactively developing Euro 7 compliant products in partnership with our customers ahead of the expected rollout. As you might remember, in 2022, our ITT Ventures Fund invested in WECODUR, a German company specializing in highly customized rotor-coating technology. Today, together with WECODUR, we are developing low-emission breaking technology to help our customers achieve EURO 7 compliance, 2 years before regulation are expected to be enacted. We expect this will drive further market share gains once again. Lastly, on growth. Connect and Control Technologies delivered record orders in the quarter, growing 7% organically versus prior year. Aerospace components grew 25%, fueled by increased commercial aero and defense demand in North America.

And despite the challenges in distribution, Connectors orders grew 2% year-over-year and 24% sequentially, with a strong performance with our North American OEM customers in Commercial Aero and Defense. Well-done Art and the entire Connectors team. On execution, we grew IP margin more than 600 basis points, driven by volume, pricing and shop floor productivity, eclipsing our long-term target of 20% for the fourth straight quarter. And we delivered this margin performance while continuing to invest in the business. Our team is increasing IPs manufacturing capabilities and advancing the lean transformation in Seneca Falls, and we now expect to have 5 one-piece flow lines running next month. We’re also progressing with the foundry closure, which will provide additional cost benefits beginning in 2024.

In MT, margin improved 150 basis points to 16% and 120 basis points sequentially as we anticipated. With the progress in 2023, we believe MT will return to roughly 18% margin in 2024 as destocking in the auto aftermarket abates. Moving to capital deployment. On M&A, we didn’t waste any time getting to work with our recent acquisition. The Connectors and Micro-Mode teams are working together to execute on the commercial synergies and grow the pipeline. The teams are sharing customer opportunities, exploring new ways to package our products and expand distribution. We believe Micro-Mode differentiated miniature and high-frequency design capabilities will enhance ITT’s product portfolio and customer base and provide further entry into attractive defense and space markets.

Feedback from our customers has been positive, and this is leading to other commercial opportunities for our Connectors business. Beyond M&A, we also paid down over $60 million of outstanding commercial paper and repurchased $60 million of ITT shares year-to-date, including $30 million in Q2. Next, to our outlook. With outperformance through the first half, a large profitable backlog and our order acceleration, today, we are raising the midpoint of our full year EPS guidance by $0.25. We have confidence in our ability to deliver over $5 of EPS or 14% growth for the year. Notably, the high end of our previous range now becomes the low end of the new guidance, thanks to the performance in MT and IP. Cash generation ramped considerably since Q1, with plenty of room still to grow on a path to nearly $400 million of free cash flow in 2023.

With our exposure to growing end markets, including auto, energy, air and defense and the backlog of more than $1.2 billion, ITT is in a strong position entering Q3. I’m incredibly proud of the team’s accomplishments this quarter and we are ready to conquer what lies ahead. Now I would like to share with you another growth opportunity for ITT. In June, I joined a Friction team for a groundbreaking ceremony at MT’s facility in Termoli, Italy to announce a EUR 50 million investment, that will position ITT to quickly gain share in the underserved and profitable high-performance vehicle segment. The investment comprises a new facility, upgraded production equipment and an expansion of our fast prototyping, testing and R&D capabilities. We are also installing solar panels that we expect will provide more than 20% of the entire Termoli-size electricity needs, demonstrating Friction’s ongoing commitment to sustainability.

This opportunity was largely driven by feedback from customers about their need for a responsive, high-quality and high-performing partner. We have earned that trust by understanding their needs, delivering highly customized solutions and performing. And today, they are trusting us again to deliver the same quality for their most prestigious platforms. This is a win-win. Our customers will benefit from having a trusted and known partner that they know will deliver and expect the returns for ITT are attractive. Congratulations to Luca Martinotto, Friction, and the entire Termoli team, you have earned this investment. Let me now turn the call over to Emmanuel to discuss our Q2 results and full year outlook in more detail.

Emmanuel Caprais: Thank you, Luca. Let’s begin on Slide 5. We continue to see strong top line growth in both Industrial Process and Motion Technologies. In IP, project grew over 100%, while baseline pumps and aftermarket grew mid-teens. In MT, Friction’s perfect on-time delivery performance drove double-digit revenue growth. As I indicated at a conference in June, Friction’s outperformance ramped this quarter. We also saw strong volume and pricing growth in KONI and Axtone, thanks to share gains in rail. . In CCT, the growth in our aero components business largely offset declines in industrial connectors associated with continued destocking in distribution, especially in Europe. The team is addressing the dynamics of strong demand, coupled with a challenged supply chain in commercial aerospace by reducing our internal lead types.

Moving to our margin performance. Our incremental margin this quarter was nearly 40%, and 50% in IP. This is driven by over 300 basis points from volume and price and over 200 basis points of productivity, which collectively outpaced cost inflation and unfavorable foreign currency impacts. Motion Technologies delivered a strong sequential and year-over-year improvement. This will continue as productivity ramps and commodity inflation eases further. Finally, this quarter, we divested a small product line in CCT and incurred acquisition expenses related to Micro-Mode, which drove a net $5 million gain or $0.05 of EPS. This amounted to 50 basis points of margin improvement that will not repeat. On adjusted EPS, Q2 showed another big step-up in performance.

The 36% growth is largely the result of strong operational performance, pricing realization that is now outpacing cost inflation. Finally, on cash, another impressive performance, both year-over-year and compared to Q1. Free cash flow margin was almost 15% this quarter. The $145 million increase in free cash flow year-to-date came from a combination of higher operating income and improved inventory management. What’s even more encouraging are the benefits that are still to come from further optimization of working capital. We also continued to repurchase ITT shares while reducing interest expense from Q1 given our strong cash generation. With this quarter’s performance, we have line of sight to nearly $400 million of free cash flow for the year.

Let’s now turn to Slide 6 to look at the EPS drivers in Q2. We delivered high-quality results in Q2 we’re growing operating income through share gains, pricing and productivity. In fact, the operating income growth rate was almost triple our revenue growth rate this quarter. Pricing is outpacing cost inflation. We overcame large and unfavorable year-over-year foreign currency impacts, and we are making strategic investments in new and emerging technologies to sustain our differentiation over the long term. All of this will help to deliver this high level of performance for many years to come. Let’s turn to Slide 7 to discuss the full year outlook. The positive demand we saw through the first part of Q2 continued and even ramped at the end of the quarter.

The result is a large and profitable backlog that provides greater visibility into the second half of 2023. In IP, our project margin in backlog expanded over 200 basis points year-to-date as we continue to drive project management excellence. In CCT, Orders in North America are growing sequentially, thanks to OEM share gains offsetting the fact that our distributors are continuing to work through elevated levels of inventory. With all this considered, we expect to be solidly at the midpoint of our current organic revenue guidance range of 6% to 8%. On margin, IP has far exceeded our expectations for several quarters. This and the improved performance in MT are driving our 4-year segment margin outlook to over 18% at the midpoint. We see signs of easing inflation and are progressing on our lean transformation.

With a $0.25 increase to our EPS midpoint to $5.05 we now expect growth of 11% to 16%, firmly above our long-term target. Looking ahead briefly to the third quarter, we expect low to mid-single-digit organic growth led by Industrial Process. Segment margin should be roughly flat sequentially with continued improvement in Motion Technologies. Earnings should be up mid-single digits year-over-year. Finally, our effective tax rate remained at approximately 21%. Let me turn the call back to Luca on Slide 8 to wrap up.

Luca Savi: Thank you, Emmanuel. A few points to reiterate before our Q&A. First, Growth. We are positioned in attractive and growing end markets, and we are outperforming. Second, the team’s execution in these end markets has been outstanding. They are fighting still challenging supply chain conditions, removing bottlenecks and finding new ways to deploy lean processes. And before you ask, let me assure you, we will have new long-term margin targets for industrial process in the not-too-distant future, given its current performance. It has been 1 year since we established a long-term segment margin target for ITT of 20%. And at 18.7% in Q2, we are already well on our way to achieving our target. Third, we’re not losing sight of the long term.

We’re investing today in innovation, product development and capacity to support growth in pump projects, in electrified vehicles, in the high-performance vehicle market, and in aero and defense. Our teams have been working throughout the summer on their long-term strategic plan. And I’m sure that we will deliver on them as we have done so far. We’ve been improving our balance sheet for several years now, which enabled us to go on offense. We are deploying capital while cultivating a strong M&A pipeline and investing in our business organically. Lastly, we raised our full year guidance to over $5 of EPS at the midpoint. ITT is entering a new stepped up level of performance. Thank you for your time today and your interest in ITT. Ellen, please open the line for questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question comes from Damian Karas.

Damian Karas: Congrats on the quarter. Luca, I was hoping maybe you can share some more.

Luca Savi: Thank you.

Damian Karas: Absolutely. Maybe you could share some more color on what you’re seeing across IP. I know you guys had expected some short-cycle pressures in the back half. What are you seeing on the short cycle side? And maybe if you could also just speak to the project funnel?

Luca Savi: Sure. Thank you, Damian. So when we’re talking about the orders overall, the orders are very positive, as you see, 15% growth. And if you look at the full picture, we are in a kind of, I will call it, reinforcing cycle. The revenue is up 23%. But the orders are very healthy with a book-to-bill of 1.2. So our backlog goes up to record level. But also the funnel is up sequentially year-over-year. So overall, a very good level of demand. Now let’s go specifically on the short cycle. On the short cycle, the orders will stay at elevated level. So the growth rate decelerated. But just to give you an example, parts were very strong. Parts grew 14% in the quarter, 7% was price, but 7% was volume. And when you look at the July orders, the July orders are still solid and growing year-over-year. And as I said, project is still healthy across the board, across the different regions.

Damian Karas: Terrific. And then maybe switching to margins. Obviously, you’ve seen some really nice expansion year-to-date and you called out the 39% incrementals in the second quarter. It looks to me like the guidance suggests just a good bit lower incremental. If my math is correct, maybe like 15% to 20% in the back half. So if you could maybe just talk about your margin expectations from here, any factors that might be leading to a little bit less uplift? And I guess, just more generally, like how should we be thinking about the incrementals for your business?

Emmanuel Caprais: Yes. Thanks, Damian. So we expect segment margin to be generally in line with Q2 for Q3 and Q4. And here, it’s important to keep in mind that MT continues to improve sequentially while IP will probably settle between 21% and 22%. I think it’s important also to remember that last year in the second half, there are a few one-off positives that impacted mostly IP and that will need to lap in the second half. So overall, I think it’s fair, a little bit of deceleration of incrementals in the second half, but still very, very healthy.

Operator: Our next question comes from Jeff Hammond from KeyBanc Capital Markets.

Jeff Hammond: Just wanted to really get an update on the destocking progress in industrial connectors in Europe automotive. I think you pointed out some better orders in connectors and looked like the orders were pretty good in MT as well. So I’m just wondering if those issues are starting to resolve themselves ahead of plan or still thinking it kind of runs through the year?

Luca Savi: Thanks, Jeff. Now when you look at the aftermarket in Motion Technologies, the aftermarket is still destocking. So the situation there has not changed. So the destocking probably will continue for all of 2023. This is when it comes to Automotive. When you look at Connectors. Connectors had a very good quarter in terms of orders and it was a record as a matter of fact. I think that we are still facing destocking, particularly in Europe, like Emmanuel was sharing in the prepared remarks. What the team has been able to do is to perform incredibly well on the orders with OEM. And also they worked very hard in the distribution here in North America to enlarge the product portfolio that we put through distribution. And this has led also to a very good orders intake in Distribution North America in Q2.

Jeff Hammond: Okay. And then this $0.05 gain, is that in CCT? And am I thinking about that the right way?

Emmanuel Caprais: Yes. This is in CCT. This is a small product line, roughly $3 million of sales annually that we decided to sell to focus really on the core business of CCT.

Jeff Hammond: Okay. So — but if you take out that $5 million gain, the margins were pretty low there. So maybe just what’s going on with the underlying margins in CCT.

Emmanuel Caprais: Yes, yes, you’re right, Jeff. So CCT has had a little bit of an issue in Europe, dealing with low levels of demand and adjustment of the cost base. So we — now we’re happy to report that as of June, really the second part of June and also what we saw in July, we’re back on track, and we’re back to the previous levels of performance. So we feel pretty confident that CCT is going to be higher than 17% in the back half of the year.

Operator: Our next question comes from Joe Ritchie from Goldman Sachs.