Welcome to ITT's 2023 Third Quarter Conference Call. Today is Thursday, November 2, 2023. Today's call is being recorded and will be available for replay beginning at 12 p.m. Eastern Time. At this time, all participants are placed in a listen-only mode and the floor will be open to your question following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Mark Macaluso, Vice President, Investor Relations and Global Communications. You may begin.

Thank you, Lisa, and good morning. Joining me 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 three-month period ending September 30, 2023, which we announced this morning. Before we begin, please refer to Slide 2 of the 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 where otherwise noted, the third quarter results we present this morning will be compared to the third quarter of 2022 and include certain 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. With that, it's now my pleasure to turn the call over to Luca, who will begin on Slide 3.

Thank you, Mark, and good morning. Before we begin, I would like to share how shocked we all are at ITT about the terrorist attack in Israel on October 7. We strongly condemn these terrorist attacks. Israel is a special place to us given the presence of our colleagues working at our Habonim valves business headquartered in the northeast part of the country. I was fortunate to spend time with Ilan and the team in August, and I was humbled by their capabilities, their strong work ethic and their commitment to ITT and their customers. Obviously, all their lives were impacted by these tragic events. We'll stay in close contact with our Israeli colleagues there as the safety of our people and their families is always our primary concern. It is our hope that peace is restored in the region. Now to our latest results. The main theme of this call is a step up in performance, a step up in execution and a step up in capital deployment. We're converting ITT's $1.2 billion backlog. At 19.4%, we are making significant progress towards our 20% long-term segment margin target. We are delivering new levels of earnings with a record EPS this quarter and expected for the full year. Last but not least, we expect over $400 million of free cash flow. And on capital deployment, we are accelerating. Yesterday, we announced the signing of a $400 million strategic acquisition in flow with the addition of Svanehøj. Now let's get into the details. On execution, in Industrial Process, we continue to see strength in projects and aftermarket. Our pump projects, parts and service businesses all grew revenue double digits organically in the third quarter, demonstrating our prowess in gaining share and emerging as a leader in profitability in flow. Still, there…

Thank you, Luca, and good morning. Starting with revenue. Industrial Process once again led the way this quarter with 11% growth on the strength of the aftermarket, driven by both volume and price and project shipments. IP is also growing its backlog, which is up 18% year-to-date, with project orders up 29%, including green projects which are already up 160% versus all of 2022. CCT growth was primarily driven by a more than 20% increase in aerospace components and defense, underpinned by macro trends in these markets. Notably, we also generated 9% sequential growth in Connectors due to share gains in OE and SKU expansion with distributors in the U.S., more than offsetting weaker European distribution. Motion Technologies' growth was driven by friction OE at 7% and higher pricing in KONI, Axtone and Wolverine. This was mostly offset by timing in the friction aftermarket driven by distribution inventory reduction. Looking ahead, we expect our auto aftermarket business to be flat in Q4 and to start growing again in 2024. Rounding out the ITT top line. Core volume growth contributed 300 basis points, while pricing actions contributed 200 basis points. The pricing was most prominent in the IP aftermarket and aero in CCT. Aero OE contracts is an area where we are dedicating more energy as more long-term agreements are coming up for renewal in 2024. Moving to margin. We improved in Q3 due to a combination of profitable growth and pricing actions. Volume and price contributed over 200 basis points, while our net productivity actions drove 150 basis points of expansion, more than offsetting the impact of foreign exchange and investments. Specifically, we continue to invest in sales and operations planning to augment the Lean improvements in IP and CCT. The impact of stronger organic growth and improved margins drove…

Thanks, Emmanuel. Before we move to Q&A, I'd like to share a few closing thoughts about our execution and accelerated capital deployment. First, we continue to outperform in some of the world's fastest-growing end markets, and we are finding new avenues to differentiate, whether with groundbreaking innovations or new areas for growth. Second, we are well on our way to reaching the 20% long-term segment margin target that we set just last year. Industrial Process led the charge beginning at the end of last year and eclipsed their long-term target for five straight quarters. Third, because of the momentum we've built, we raised our outlook for revenue, margin, earnings and free cash flow. And with a double-digit increase in our backlog expected by the end of this year, we are confident that ITT will continue to grow in 2024. This is our third straight quarter of raising EPS guidance, and our progress towards our long-term margin target is accelerating. Finally, we are also accelerating capital deployment. We are acquiring Svanehøj to grow our flow portfolio, and we continue to evaluate other high-quality targets in flow and Connectors to put our strong balance sheet to use. Additionally, our new $1 billion share repurchase program gives us flexibility in allocating capital effectively. We have reached another new stepped-up level of performance for ITT. Thank you for joining us today and for your continued interest in ITT. Lisa, please open the line for questions.

Thank you. [Operator Instructions] And our first question will be coming from Michael Halloran of Baird.

So first, can we talk about the IP side of things, what you're seeing from a fundamental order trajectory perspective? And maybe you could parse that out a little bit by the end-market applications here, energy, the short-cycle general industrial, chem businesses, mining and any of the other -- or any other end markets you think I missed there?

Sure. Let me start and then, Emmanuel, you can build on that one. So when we look at the orders, the orders in Q3 declined 2%. You have short cycle that was flat year-over-year, and the project, there was a decline. Now having said that, there was a lot of timing that shifted from the quarter to October. And what I can tell you, that looking at the orders in October, they are considerably strong year-over-year. The short-cycle orders in October are up, and our rate is higher than what has been in Q3. And the projects in October are more than 40% higher year-over-year because some of the projects shifted. So that is the picture on the orders, and the funnel is still very, very healthy.

Yes. And by end market, just to add a little bit more color, we see a slowdown in chemical, but our general industrial markets are really strong. We continue to gain share there. And then if you look at the funnel, I would say the funnel is also very strong. As Luca was mentioning, year-over-year, our project funnel is up 16%. Versus the beginning of the year, it's up almost 10%. And this is driven by really energy, chemical, general industrial. So pretty good picture from a project standpoint also.

Great. Really appreciate that. And then follow-up is, maybe, Luca, you could give some thoughts on how you see the auto market tracking and any thoughts on the 2024 build rates on a global basis. You always give really good color there. Certainly appreciate Emmanuel's comments on the sequential improvement on the aftermarket side going into next year, but any other color would be great.

Sure. Thank you, Mike. When we look at the market, the market was up in Q3 a good 3.8%. The production was up in Europe, was up in North America despite the strike, whereas in Q3, it was flat in China. But then when you look -- and this was after a first half which was already very good. So when you look at the full year for 2023, we expect the market to be up roughly 7%, so mid-single digit; Europe, up low double digit; North America, mid-single digit; and also China, mid-single digits. So China was able to surprise us in 2023 as we forecast it to be flat for the year. So -- and on top of this market, as you know, we continue to outperform. The outperformance was very good. It was roughly 800 basis points in Q3 and accelerating. So year-to-date, roughly 400 basis points of outperformance. When you look at that -- so 2023, you are probably thinking about roughly 88 million vehicles produced when -- 88 million, 89 million. When you look at 2024, it's still a little bit too early to tell, but probably it's going to be a low single-digit growth, what we are considering right now. The aftermarket, which was the second part of your question, it's going to be flat in Q4 year-over-year. Q3 was a tough quarter in terms of comparison versus 2022. And we expect it to grow again, based on what the customers are telling us in Europe, in 2024.

And our next question today will be coming from Damian Karas of UBS.

Congrats on the deal. So maybe a higher-level question on MT and friction because there has been a lot of noise out there in the automotive world. Obviously, the strikes in the U.S., pushing back of a lot of these EV production schedules; OEM price wars in China. I'm just curious, Luca, how are you seeing all of this affecting your business? And just on the MT margin front, is that path to 19-plus -- 19%-plus, do you kind of see that sooner or later?

Okay. So let me address the last part of the question first. The long-term target for Motion Technologies is 20%. This has not changed, and we have a clear path to get there. You can see our margin already up sequentially year-over-year to 17%. This will keep on improving. We will be able to eat 18% in -- some time in 2024. Now going back to some of the dynamics that you shared, the strike. The strike was really immaterial for us. Probably what was the hit was a couple of million dollars in terms of revenue, so really immaterial. When you look at the EV production, sure, when you're listening, particularly in the North American market, you may see some slowing down in terms of the adoption and maybe investment from the OEMs. But this is really, I would say, a North American dynamic. The electrification is really going full speed when you look at Europe and North -- and China. And by the way, Damian, we are really targeting all electrified vehicles. You're talking about AV, you're talking about hybrid, you're talking about IC, and we are winning across the board. So we are also very successful in defending all our platforms that we are in, in the internal combustion engine. That is on the EV. When it comes to China, I'm glad that you are mentioning China because China is a great story for us. When you look at our China business, $300 million, 80% of that is friction. We are winning. It's a great, good operation, good financially. Let me give you a couple of examples. When you're talking about financially, this is a plant that is only producing OE, no aftermarket. Still, it's the most profitable plant for friction in the world. When you look at operations, in Q3, we had roughly 40 PV, 40 process validations every month. This is when you run your PPA for the SOP for the start of production. When you do that, you have a lot of interruption. You have a lot of disruption in production. Despite all of that, the fantastic Chinese team delivered 99.93% of on-time delivery. And this is why the Chinese keep on awarding us the platforms. Today, at the end of September, they've already reached 90% of their full year award target. And we are winning with the winners. More than 60% of what we are producing is for the Chinese OEM. So it's a great story there, too.

Great. And I know I'm going to botch the name of this, but on the Svanehøj deal, any color you can give on EPS accretion? And if my math is correct, it looks like it may be slightly dilutive to IP margins. Just curious if there's any synergies with Habonim or the rest of the pumps business.

Thanks, Damian. So yes, so we're very happy with our ability to secure that deal with -- to buy Svanehøj. It's a great business, gives us entry into cryogenic technology. We're very, very excited. If you think about accretion, from an EPS accretion standpoint, Svanehøj will be accretive in 2024. Keep in mind that this is a business that has a lot of long-term backlog. So there will be a negative impact on -- in terms of intangible depreciation in 2024. But overall, very, very strong business. As Luca mentioned, a very strong management team. So we're excited about that. In terms of margin, you're right. It's going to be -- from an EBITDA margin standpoint, it's going to be slightly dilutive to IP, but there are many opportunities. As we mentioned, this is a business with end markets that are in growth for multi years. And so we expect that to be reflected in the growth rate of this business in the years to come. And then the team has identified significant opportunities from a cost synergy standpoint. We visited in August their facilities. They're in great shape, but we think that we can help them become even more efficient.

Our next question will be coming from Andrew Obin of Bank of America.

You have Sabrina Abrams on for Andrew Obin. Yes, the gross margin expansion in the quarter is really impressive. And I think some of your peer -- as is the price/cost spread. And I think some of your peers have been talking about price/cost peaking here in 3Q or in 4Q and the spread narrowing in 4Q. Just wanted to ask, like how sustainable are these levels? And any thoughts on -- around whether it can hold?

Yes. Thank you, Sabrina. And I think you pointed out a really good stat. Our gross margin, indeed, has been on a path of increase year after year and also within the year 2023. We started the year with a little bit more than 33%. We're now at 34%, and we expect in Q4 to continuously improve on top of that. So what's really good about our operating margin improvement, both segment and EBIT, is that it's underpinned by a strong gross margin improvement as well. From a pricing standpoint, I think 2023 has been really strong from a pricing. I mean we're going to probably finish the year at ITT level with a little less than $100 million of pricing that we recovered. This is less than what we recovered in 2022, but keep in mind that it's obviously incremental. But I would say with commodity cost as a tailwind, we created an even bigger spread from a price/cost standpoint. And then on a quarterly standpoint, so thinking about Q3, Q4, maybe 2024, for sure, it's stepping -- it's going to step down in the second half, and that's logical, right? So the third and fourth quarter will have less price benefits year-over-year, but on an absolute basis, this is a really large contributor to our margin expansion story in 2023 and in 2024. And then going forward, we expect IP and CCT to be price-takers as we differentiate even more on our value proposition.

Great. And then looking at the backlog commentary, it sort of suggests having somewhere around 35% backlog coverage next year based on '24 consensus versus maybe somewhere around 30% last year. Could you guys provide some color on that coverage relative to history? And any timing on when you expect backlog to return to historical levels? Or do you think we remain elevated going forward?

Yes. So the backlog has kept on growing. And as we mentioned, in IP, for instance, year-over-year, the backlog is up 11%, so more than double digits. And we expect to finish the year with also a backlog increasing versus 2022. So I think in IP, today, we are at a lot higher level of coverage than we have usually, which is very, very positive. The backlog story is also very good in CCT, where we're growing backlog. And since the beginning of the year, we added almost $30 million of backlog in CCT, obviously driven by aerospace and defense. The coverage there is much higher than it is typically for our aerospace components business. And also what's really good is that it's -- there's a lot of long-term backlog, so into '25 and '26.

If I can add a point there, Sabrina, is that, particularly when you look at IP, both the projects and the short-cycle backlog are up year-over-year versus the beginning of the year. At the end of the year, we will be up 16%, which will feed the growth in 2024. And last but not least is the profitability of the backlog. Now when we look at the profitability that the backlog has, it's roughly 200 basis points better than what it was at the beginning of the year.

Our next question will come from Vlad Bystricky of Citigroup.

Congratulations on a nice quarter and the deal announcement there. So maybe just following up on that commentary around IP and the orders sort of reacceleration you're seeing into early October -- or into October here. Can you talk about how you're thinking about the potential for that business to continue maintaining positive organic growth overall over the next couple of quarters as comps get notably more difficult?

Sure. I think that all of that is linked to the performance and the continuous improvement that we're pushing through Lean and the reduction of lead times when it comes to the short cycle. So it's very important to continue to execute on the project side of the business. And because we are executing in a rigorous and good manner, this improves the customer loyalty and the customer giving us more opportunities and more win when we're bidding. So that is on one side. When you look at the projects, and the green project in particular, we are also using some differentiation from a technical point of view. If you look at our multiphase pumping technology with our Bornemann Pumps, this is something that enables us to win with Chevron, with some of our customers for their green projects, be it in carbon capture, be it in eliminating flaring. So all of those will continue to feed organic growth. And also, we are working with some customers where our market share is not so high to improve index, let's say, call it MT style.

Great. That's helpful color, Luca, and just really nice performance from IP. Maybe just shifting to CCT. The Connectors' weakness obviously isn't new on the channel destock. But can you just give us more color on whether the weakness you're seeing there is still really mainly channel destock-driven or whether you're seeing signs of incremental end market or sell-out weakening?

Okay. No, the weakness is mainly distribution and it's mainly European. It's linked. A little bit of a weakness probably in Asia Pacific on the Connectors side of the business, but this is very localized. As a matter of fact, when you look at our Connector business in North America has been very successful with great orders on the OEM, and those are nice long-term orders that will keep on feeding the revenue. But also with the SKU expansion that Emmanuel was talking in the prepared remarks, we were able also to have very good distribution orders when it comes to North America. And all of that have been able to offset some of the weakness that we had in Europe.

Yes. And so if we look at our Connectors orders, they were up 3% this quarter. And for the full year, we expect them to be roughly flat. And a lot of the strength is coming obviously from aerospace, defense that are way up in the double digits, and energy also. Energy has been a good story for us. So I think that it's true that we are seeing weakness in European distribution. But I think the strength of our portfolio and the commercial actions we're taking are able to nicely offset that weakness and still in Q3 come out with growth in terms of orders.

Our next question will come from Joe Ritchie of Goldman Sachs.

Maybe just hitting on that last point that Vlad brought up on the Connectors business. So how much is the European Connectors business down -- how much was it down this quarter? Because obviously, that's probably going to create a pretty easy comp for you guys as we head into 2024.

This quarter, Connectors was down in the low double digits, and this is mostly driven by industrial. So we expect that probably in terms of the destocking, we're going to be nearing the end of that destocking. And then sometime in 2024, we'll see an improvement.

And Emmanuel, is that better than where you were last quarter on the connectors side, specifically in Europe for the industrial connectors side?

I'm not so sure because also you have to think about in Europe some seasonality in Q3 with August. So it may not be the case.

Okay. All right. No, that's helpful. And then I guess just a longer-term question. The -- just the Industrial Process margins continue to surprise to the upside. I know that you guys are continually focused on continuous improvement as you kind of think through 2024 and margin expansion potentially for this business. Can you maybe just talk about some of the levers and how you're thinking about this business longer term?

Sure. I think that when it comes -- of course, when it comes to IP, we will have to share with you guys our new long-term target, which we will do sometime next year. When we look at this business, there is investment that needs to be made, some that we are making right now. We are investing both in S&OP process so that we really have stronger fundamentals in the long term. But some of the levers that you have on the other side is, for instance, the closing of the foundry. We're making progress on the closing of the foundry. We've closed already one line. We will finish the closing by Q1 2024, and this will allow us to be more cost-competitive in our products as well as reduce some of our lead times. Leverage on the purchasing side, on the supply chain, this is one of the other levers. The VA/VE, we continue our value analysis, value engineering of all the family of products. And then I would say, the continuous reduction in terms of our cost structure. I would say these are the levers that we have in our hands today, Joe.

Our next question will be coming from Jeff Hammond of KeyBanc Capital Markets. Our next question will be coming from Bryan Blair of Oppenheimer.

You've highlighted green energy transition momentum in IP seems to be quite strong. Bornemann wins some Habonim applications now Svanehøj, hopefully, I'm pronouncing that correctly. What is the current scale of that, I guess, aggregated revenue stream for green energy or energy transition for IP? And where should we expect that to go over time?

Yes. So we are really excited by this because we really were able to create a new leg for IP. That is really disassociated with -- from any consideration on the price -- on the actual price of energy because it's really driven by regulation. Today, our green projects year-to-date is a little bit more than $80 million. And then so if you think about the way this number has evolved, in 2022, it was around $20 million. So really strong growth that is really driven by the technology differentiation we have in our Bornemann product line, but also, as you were mentioning, Habonim with their play in hydrogen. So very happy with that growth, and that's a market potential that it represents.

I appreciate the detail. And just to level set on the auto aftermarket. You mentioned flattish Q4. So that stabilization is encouraging. Where do you expect, with that outlook, full year organic sales decline to shake out? And if we were to just kind of snap the line on destocking impact and have that lap year-on-year, what kind of growth would that imply for 2024?

So when you look at 2023, the total aftermarket will be probably down for the full year 6%; 5% would be the OES; and roughly 10% the independent aftermarket. That is for the full year of 2023. And I think that out of that base, we will start growing again in 2024. When it comes to exactly the growth for 2024 now, it's a little bit early to tell, I would say.

Our next question will be coming from Nathan Jones of Stifel.

I'll just -- I'll follow up on Bryan's question there on the aftermarket. You said 5% down OES and 10% down independent aftermarket. Do you have a view on what of that is inventory destocking versus what of that is actual softer end-market demand?

It's mostly inventory destocking. The aftermarket is pretty stable in Europe. I think it's up 2% to 3%. And so it's mostly our specific customer, which had been ordering a lot last year, and that is working through that excess inventory they have.

Got it. That's helpful. You guys had previously talked about wanting to expand the pump business into Europe and the two acquisitions that you've done, they have done that. Does that continue to be a priority for you? What are the other areas of priority strategically for capital deployment into M&A?

When you look at the categories for the M&A, it's really -- you're talking about the flow and you're talking about the Connectors business. And you have a little bit of rail. And if you look at the acquisitions -- the two acquisitions we made this year, it's really Micro-Mode on the Connectors side and now Svanehøj in flows.

But I wouldn't say -- like the European region, I wouldn't say this is a cut that we look at specifically when we look at M&A. We really look at companies that are high quality, that have an ability to differentiate from the competition. And that's what we saw with Habonim. And coincidently, that's what we saw also with Svanehøj. It's also easier for us to -- being European, to get to know the business there and to see and to connect with the people. So we use that for sure. But I wouldn't say that Europe is a priority for our M&A target.

No, that's right.

I would have thought this Svanehøj business would be definitely more focused on growth and probably less focused on cost synergies. Can you talk about the cost synergies that are there and whether this is more of a don't break what's going on there already in terms of taking cost out and focus more on growth?

You're spot on, Nathan. And I think that when one of the things that we really liked about Svanehøj is the team, is Søren, Johnny, the management team, very competent. They know their market. They know their customers very well. They've got a differentiated service, differentiated products and leadership position. So it's a growth play more than cost synergies. So definitely, that's the case in industry in attractive markets. So it's cryogenic pumps, which is adding to our portfolio. And that probably would be another lever for growth for our goods, parts and our pumps business traditionally over here, it's marine, where there's going to be investment in terms of green in the future. And while you talk about the energy transition and alternative fuels being ammonia, Svanehøj would be a great player in that. So this is really what we like, the growth opportunities and the team. And for sure, they know what they do. And we are very happy with that.

Just any color on what you expect the growth rate to be over the next few years for them?

So we expect that for the next several years -- so at least for the first four to five years, it's going to be low double digits and then after that, high single digits.

Our last question will be coming from Jeff Hammond of KeyBanc Capital Markets.

So it doesn't sound like we can get -- we can talk to Jeff. So I think we can close the call.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day.

Thank you.