ITT Inc. (NYSE:ITT) Q1 2023 Earnings Call Transcript May 6, 2023

Operator: Welcome to the ITT’s 2023 First Quarter Conference Call. Today is Thursday, May 4, 2023. Today’s call is being recorded and will be available for a replay beginning at 12 p.m. ET [Operator Instructions]. It’s now my pleasure to turn the floor over to Mark Macaluso, Vice President, Investor Relations and Global Communications. You may begin.

Mark Macaluso: Thank you, Elliot, and good morning. Joining me here 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 three month period ending April 1, 2023, which we announced this morning. Before we begin, please refer to Slide 2 of today’s presentation 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 first quarter results we present this morning will be compared to the first quarter of 2022 and include non-GAAP financial measures.

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. It is now my pleasure to turn the call over to Luca, who will begin on Slide 3.

Luca Savi: Thank you, Mark, and good morning. As always, I would like to begin by thanking our shareholders and our customers for their continued support and investment in ITT. And again, I also want to recognize our employees around the world. It is thanks to your efforts that we were able to deliver such a strong first quarter. If there is one thing about ITT’s Q1 results, I would like you to remember, is our performance on both growth and execution. We delivered solid start to 2023 on all accounts, 10% organic revenue growth, leading to ITT’s highest quarterly revenue ever, 7% organic orders growth, 150 basis points of segment margin expansion, 21% EPS growth, and a more than $60 million improvement in free cash flow. We also signed a strategic aftermarket agreement in Friction with our partner Continental, repurchased $30 million of ITT shares and deployed $80 million towards the acquisition of Micro-Mode in May.

Now let’s get into the details. On growth, Industrial Process orders grew 22% as a result of continued share gains. We generated significant commercial momentum in the green energy space with large project awards and market share gains related to decarbonization. Project orders in IP grew an outstanding 54%, while on the short cycle, orders for aftermarket baseline pumps and valves grew 13%. The orders momentum drove IP’s revenue growth above 25% this quarter and added to an already large and most importantly, profitable backlog entering Q2. In Motion Technologies, we won 41 electrified vehicle platforms awards with leading OEMs, including BYD in China and Ford and [Chrysler] in North America. Continuing with electrification, orders in our EV connector business grew over 15% and with sales growth eclipsing 20% as electrification investments continue.

Moving to execution. Once again, Industrial Process led the way with 850 basis points of margin expansion to end above 21% for the third consecutive quarter. We are continuing to push on shop floor improvements and the lean out of IP’s manufacturing size, accelerating strategic pricing actions across the short cycle portfolio and driving increased profitability on pump projects in backlog. Together with the ITT leadership team, I spent time at our Seneca Falls campus, and reviewed our progress on the new lean layout. When it is completed in Q3, every single pump will be built using one-piece flow process. By eliminating excess movements, we will accelerate throughput, reduce lead time and improve our on-time delivery. We are on a journey of continuous improvement, and we have no finish line.

Also this quarter, I finally returned to China and spent time with our Wuxi team. We reviewed the investments that were made on the shaft floor and plans for the future. You may remember that our Wuxi employees achieved amazing feats last year by operating in isolation throughout the pandemic and working through a mass infection wave in December, all while adding new capacity and maintaining 99% on-time delivery. As Wuxi plant continues to gain market share, especially in EVs, we’re adding 2 new production lines and increasing capacity beyond what we initially thought was achievable. It was wonderful to be in person with such a high-performance team to discuss the vision for the new plant layout and how it will support EV growth in the region.

We are making similar growth investments in IP, which I saw firsthand. Saudi Arabia had a perfect on-time delivery performance and impressive orders growth last year. This is why we are expanding their testing capabilities. In India, a market with great opportunity, we’re also expanding our design center to support growth in the region. And in Germany, Bornemann is gaining share in decarbonization projects, which is driving the further expansion of its testing center. All of these sites have earned the right for investment. We also executed on cash and capital deployment. Free cash flow is rebounding with a $62 million increase versus prior year. This is a continuation of the positive trend we saw last quarter. And in the coming quarters, as supply chain disruptions begin to subside and we free up working capital, we expect cash generation will continue to ramp.

We also repurchased $30 million of ITT shares and paid down roughly $70 million of outstanding commercial paper. Finally, yesterday, we announced the acquisition of specialty connectors manufacturer, Micro-Mode for approximately $80 million. Micro-Mode has held a leading position in defense and space connectors for more than 30 years and brings a complementary technology portfolio to our profitable North America connectors platform. Each quarter, I like to highlight the progress ITT is making with our sustainability investments. As you hopefully saw last month, we announced a $25 million investment in green energy and sustainable projects, including solar panel installations and other energy efficiency initiatives. Together, these installations will reduce ITT’s CO2 emissions by more than 6,000 tons annually once completed.

Moving to our 2023 outlook. We are raising the midpoint of our adjusted EPS range by $0.05 after a strong first quarter. We have renewed confidence in our ability to deliver the midpoint of our updated guidance range due to a more than $1 billion backlog and exposure to growing aero, auto and energy markets. In Q1, we delivered growth and execution, double-digit organic revenue and EPS growth, 150 basis points of segment margin expansion, and an over $60 million increase in free cash flow. So now let me share some of our commercial wins this quarter on Slide 4. In March, we signed a 10-year $1 billion agreement with Continental to supply aftermarket brake pads in Europe. Our Friction team consistently provides the highest level of quality and service for our auto customers, and this helped us secure this important partnership.

Under the contract, Motion Technologies will continue to provide copper-free brake pads for ATE, Continental’s premium brake pad brand. Additionally, Continental will market and sell highly trusted brake pads from Galfer, an ITT brand, to help expand our aftermarket presence in Europe. The agreement contains improved volume incentives that will likely elevate the total value of the agreement to over $1 billion over the 10-year term. It also preserves ITT’s ability to expand our aftermarket business in China. Congratulations to Vincenzo and the Friction team on this exciting next chapter. We’re delighted to continue serving Continental and help them win in the car aftermarket. In Industrial Process, our Bornemann twin screw pumps are leading the way on large-scale green projects, thanks to their multiphase boosting technology.

In Q1, we were awarded anti-flaring projects at 2 oil and gas sites in Nigeria. Thanks to our Bornemann pump, our customer will eliminate roughly 350,000 tons of CO2 per year and avoid environmental fines. In early April, we won another decarbonization project at the largest LNG field in Australia and 1 of the largest sites in the world. This carbon capture project, the largest in the world, is expected to reduce CO2 emissions by 100 million tons over the system’s lifetime. I want to thank [Yaron] and the entire Bornemann team for developing these opportunities, establishing an incredible customer intimacy and working hard to share the value of our Bornemann pumps with our customers. The technology of our Bornemann pumps plays and will continue to play a pivotal role in the decarbonization of the energy industry.

Decarbonization is good for ITT. Let’s turn to Slide 5 to discuss the Micro-Mode acquisition. Yesterday, we announced the acquisition of Micro-Mode Products for approximately $80 million, and the company is now part of CCT. The effective purchase multiple was approximately 11x EBITDA, and we expect it will improve from here as the value creation accelerates. Micro-Mode is a leading designer and manufacturer of high-bandwidth radio frequency connectors for harsh applications in radar, satellite and smart defense systems. Micro-Mode’s connectors are the product of choice of mission-critical applications, and they’ve been qualified on space programs for more than 30 years. With this acquisition, ITT gains further entry into niche defense and space markets with significant long-term potential as this is a total addressable market of approximately $4 billion.

Micro-Mode customers love their performance, their responsiveness and attention to their needs, like Habonim, our recent valve acquisition, which has been a great success, Micro-Mode has strong, long-lasting intimacy with its customers. Mike, Gerald, Brian and the entire Micro-Mode team, welcome to ITT. I look forward to growing our business together. With that, I turn the call over to Emmanuel to discuss our first quarter results in more detail.

Emmanuel Caprais: Thank you, Luca, and good morning. Let’s begin on Slide 6. We generated 10% organic sales growth, led by IP at 25% and a strong double-digit performance by CCT. In IP, our book-to-bill was 1.23 this quarter, all the more impressive, given our 25% organic revenue growth. We are seeing outgrowth in projects with significant awards this quarter and continuing into April, and our aftermarket orders were up 19%. In CCT, we continue to drive top line growth on the strength of the commercial aero recovery. As a result of this and our strong position on key platforms, Controls grew 15%, Connectors grew 6% despite the deceleration in the industrial market. More on this when we discuss our 2023 outlook. Finally, in MT, pricing actions and share gains in Friction OE offset lower volumes in the aftermarket.

As a result, as we highlighted last quarter, there is a continued inventory correction occurring in the European car aftermarket, partially due to improved lead times and indirect impacts from the war in Ukraine. We initially believed this would be a 1 quarter headwind, but we now expect it will continue into the second half of the year. In rail, we saw mid-single-digit revenue growth as the KONI and Axtone businesses continue to execute and gain share. This is also the last quarter we will see a year-over-year headwind in Axtone related to the war in Ukraine. Nevertheless, Axtone delivered 11% growth in orders in Q1 to fully overcome the loss of its Russia business. And they continue to invest for future growth with the development of the digital automated coupler technology ahead of its European deployment in rail freight in 2025.

More to come in upcoming quarters. For all of ITT, pricing contributed roughly half of the 10 points of organic sales growth this quarter. We are strengthening pricing actions through deployment of a value-based pricing model across the organization. On profitability, margin expansion was driven by an outstanding performance in IP. Its margins expanded over 800 basis points to 21.3%. Notably, CCT also expanded margins by an impressive 80 basis points. Overall, segment’s incremental margin was a solid 33% in Q1. I want to take a minute to discuss the outperformance in Industrial Process in a bit more detail. First, we’re generating strong volume growth and demand across the projects, spare parts and service businesses. Second, we’re making good progress in pricing.

In Q1, pricing actions drove approximately 25% of IP’s top line growth. And with the efficiency improvements Luca mentioned, the Seneca Falls team is creating best-in-class processes that are increasing throughput and will support volume growth from share gains. Back to ITT. In Q1, our productivity drove nearly 300 basis points of margin improvement, which partially offset nearly 450 basis points of cost inflation despite some initial relief in commodities. Foreign currency was approximately 50 basis points headwind this quarter, mainly driven by the cost of our hedge instruments. Growth in EPS exceeded 20% in Q1, mainly driven by operations and pricing. Finally, on cash flow, we drove a strong improvement versus a weak Q1 last year, thanks to higher net income and a lower working capital impact.

We will generate higher cash flow from the unwinding of inventory as our teams improve working capital. However, challenges in the supply chain, particularly with our suppliers in aerospace, continued to weigh on working capital. We also paid down $70 million of outstanding commercial paper given our strong cash generation, which will reduce interest expense over time. We continue to invest organically in our business through capacity expansions in Friction, lean improvements in IP and green energy investments, which collectively drove $29 million of CapEx for the quarter. All in, a strong start to 2023 that gives us renewed confidence in delivering the midpoint of our updated 2023 EPS outlook. Let’s now turn to Slide 7 to have a look at the Q1 earnings drivers.

As you see here, we’re driving strong volume growth and productivity. Pricing actions are offsetting cost inflation, although we’re still seeing persistent inflation in labor and energy. The acquisition of Habonim and share repurchases each contributed $0.03. We deployed capital to share repurchases in the amount of $30 million in Q1 given the share price pullback. I also want to point out that we overcame $0.06 of negative impact from foreign currency, $0.03 from higher interest rates and roughly $0.02 of lost earnings from our Russia business. As you can see on Slide 8, we’re increasing the low end of the range by $0.10, thanks to the strong start of the year. And as a result, our EPS guidance is up $0.05 at the midpoint. We are continuing to gain share in Friction on both EVs and ICEs as well as in pump projects.

Our ending backlog grew nearly $70 million this quarter and remains at over $1 billion despite a 10% revenue increase in Q1. On the short-cycle portion of our business, we see two different dynamics. On one hand, demand for parts, service and valves in IP continues to be strong, and we expect this to last for the next quarter or two. On the other hand, deceleration of demand for the aftermarket brake pads and industrial connectors will likely persist into the second half. We’re closely monitoring the demand patterns and mitigating the slowdown in connectors with pricing actions and cost reductions. Regarding the acquisition, we expect that the impact of Micro-Mode’s incremental earnings will be negligible this year. We do not see any other notable changes for outlook for sales, segment margin or free cash flow.

Revenue growth will be driven by a combination of share gains and conversion of our backlog, but tempered by slowing short-cycle demand. For the second quarter, we expect high single-digit organic sales growth led by Industrial Process with strong demand expected across projects and aftermarket. In MT, sales are expected to grow in the mid-single-digit range, thanks to both Friction OE and rail, partially offset by continued decline in the car aftermarket. CCT’s revenue growth is expected to be slightly down in Q2 with the slowdown in industrial connectors outpacing the growth in commercial aerospace and defense. Segment operating margin is projected to be up between 100 and 150 basis points year-over-year. Both IP and MT will see strong year-over-year margin expansion and MT should improve sequentially in Q2.

We expect that CCT margin will be approximately flat year-over-year given the anticipated revenue decline. As a result, adjusted EPS will grow roughly 20% in Q2 and essentially be in line with the first quarter. Our tax rate remains at 21%, and interest expense will remain at an elevated level. Let me now turn the call back to Luca on Slide 9.

Luca Savi: Thanks, Emmanuel. Before we move to the best part of the call, the Q&A, just a few points. This quarter, we focused on growth and execution in everything we did, and we delivered a strong performance, through increased orders, project awards and large green energy wins we delivered on growth. Through our cash performance, capital deployment and operational improvements, we delivered on execution. The awards and share gains we’re bringing home and our execution give us the confidence to deliver on our long-term target, 6% top line growth, 20% segment margin, 10% plus EPS growth and 12% free cash flow margin. We are proud of our performance this quarter and never satisfied. So our journey continues. I would like to thank all our stakeholders for their continued support of ITT. It has been my pleasure speaking with you all this morning. Elliot, please open the line for questions.

Q&A Session

Operator: [Operator Instructions] Our first question today comes from Jeff Hammond from KeyBanc Capital Markets.

Operator: Our next question comes from Scott Davis from Melius Research.

Operator: Our next question comes from Vlad Bystricky from Citigroup.

Operator: Our next question comes from Mike Halloran with Baird.

Operator: Our next question comes from Damian Karas with UBS.

Operator: Our next question comes from Nathan Jones with Stifel.

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

Operator: Our next question comes from Matt Summerville from D.A. Davidson.

Operator: Our next question comes from Bryan Blair with Oppenheimer.

Operator: Our last question comes from Michael Anastasiou with TD Cowen.

Operator: This does conclude today’s teleconference. Please disconnect your lines at this time, and have a wonderful day.