Welcome to ITT's 2024 First Quarter Conference Call. Today is Thursday, May 2, 2024. Today's call is being recorded and will be available for replay beginning at 12:00 p.m. Eastern Time. [Operator Instructions]. It is now my pleasure to turn the floor to Mark Macaluso, Vice President, Investor Relations and Global Communications. Please, you may begin.

Thank you, Victor, and good morning. Joining me this morning in Stamford 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 March 30, 2024, 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 2023 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 2023 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. ITT had a very good and active start to the year. We grew revenue, margin and EPS above expectations, closed Svanehøj acquisition, invested to sustain our differentiation and continue to gain share with new, profitable awards. We also reached an important milestone on our multiyear safety journey. Because of our unrelenting focus on safety, we delivered a 40% year-over-year reduction in recordable incidents, leading to an injury frequency rate of 0.5, approaching best-in-class performance. Our plants are safer and more efficient every day. So for the results you delivered and for your focus on safety, I want to thank all ITT-ers a heartfelt thank you. Now on to the results. In Q1, we built on 2023 momentum in orders, revenue, margin and EPS and all of our businesses contributed to this performance. Here are the highlights: 7% organic orders growth or 13% in total, nearly $1 billion in order leading to a book-to-bill of 1.07, 9% organic revenue growth or 14% total surpassing $900 million of sales in the quarter for the very first time. 120 basis points of adjusted operating margin expansion to 17% with all businesses making significant progress on our long-term targets. And although we no longer report total segment margin, on that basis, we will be just 100 basis points shy of our 2026 long-term target. As a result of all of this, we drove over 20% adjusted EPS growth to another new level of earnings for ITT. Now the details, on orders CCT led the way with 23% growth, fueled by record aerospace orders and recovering demand in connectors. The connectors performance was encouraging after the business managed through a year of distributor destocking. MT grew 11% with strong growth in rail. Friction also won 47 new hybrid and…

Thank you, Luca, and good morning. Beginning with revenue. We generated 9% organic sales growth with all segments contributing. Volume drove most of the growth this quarter. IT projects were up 64%. CCT, Aerospace and Defense components were up 21% and Friction OE was up 12% with an outperformance well above the historical 800 basis point average. Svanehøj added 5% -- 5 points to the total revenue growth. And I also want to reemphasize that its orders were up over 30% compared to the [ prior year ]. On profitability, margin expansion was primarily driven by MT, which grew more than 300 basis points to surpass 18% faster than we anticipated. Excluding M&A, IP's margin was up 140 basis points. This was driven in part by over 200 basis points of margin expansion on projects, as we continue to improve execution. Collectively, our businesses drove 60 basis points of productivity, which more than offset 40 basis points of strategic investments related to new Friction product formulations and product redesigns in IP and CCT. On earnings, adjusted EPS growth of 21% was driven by volume, price and productivity. In addition, we absorbed higher interest expense and a slightly higher effective tax rate. Finally, on cash after generating $430 million for all of 2023, this quarter, we grew our free cash flow by 2% versus prior year, driven by increased profit. We continue to see significant opportunities for stronger cash generation as inventory and AR to improve. All in, a strong start to 2024 that gives us confidence in delivering the midpoint of our new EPS outlook. Let's move to Slide 6 to review the EPS bridge for Q1. Adjusted EPS grew 21% for the quarter to a record $1.42. Strong volume growth and higher price drove $0.23 of operating leverage, while…

Thank you, Emmanuel. Before I wrap up, I want to reemphasize a few points Emmanuel made on M&A. Historically, we created value through growing organically and expanding our margins. And why this will continue? Now we also expect to drive further value inorganically as we continue to build the M&A muscle. In the past few years, we added experienced deal makers to our leadership team and strengthen our M&A teams in the business. As a result, we have stronger capabilities and our success in this area is growing as evidenced by the 3 acquisitions in the last 2 years. Among these was Habonim, which expanded our valves business by more than 50%, generated more than 100% cash conversion in 2023 and exceeded our expectations in all metrics, adding $0.08 of EPS in year 1. And while it's too early for Svanehøj, the initial size are encouraging. We continue investing in our capabilities and expect to accelerate the pace of M&A in a disciplined manner. And as Emmanuel said, it all starts with a strategic fit. Now let me wrap up with a few points before Q&A. Q1 was another milestone quarter for ITT, and as a result, we raised our sales, margin and EPS guidance. Our businesses are outperforming their end markets, be it Energy, Transportation or Air and Defense, generating nearly $1 billion of orders and a book-to-bill above 1, leading to a record $1.5 billion backlog. We have many opportunities still to create value organically and with our strong financial position, we are working to compound this growth with enhanced M&A performance. As always, it has been a pleasure speaking with you today. Thank you for joining. Victor, please open the line for Q&A.

[Operator Instructions] Our first question will come from the line of Joe Giordano from TD Callon.

So on MT, I mean, the margins there were really good. I'm guessing like higher than maybe you thought in 1Q, I see in the slides you're talking about full year kind of being roughly similar than you did in 1Q. Can you kind of just frame that with -- you got new platforms ramping and you have -- where are you with price? Like how much of that full year guide? It feels kind of conservative in light of what you've put up in the 1Q. So maybe just walk us through the puts and takes there.

Sure. Thank you, Joe. So first of all, we are very happy with the performance that MT put in Q1, more than 80%. Now I think that we are working on consolidating this for the full year, Joe. Now when it comes to the dynamic of the price cost, as you can see, the price cost for the full year will be roughly neutral, when it comes to Motion Technologies and will be roughly neutral for ITT as well. Of course, there are a lot of programs that we won, and therefore, there is a lot of SOP and a lot of process validation that are happening in the line. And while this will help in the future, sometimes it's also impacting the efficiency in the line.

Perfect. And can you maybe, on CCT, on connector specifically, just what's going on here with you guys on the order side, it just seems very different than what we're seeing at others. I mean it goes on our end market by end market. But generally, 1 of the only markets we see doing well right now are Aerospace and Connectors and like IT with data centers, so where are you seeing this kind of strength? And how kind of company-specific is this to ITT?

Sure. When it comes to the orders of CCT, they were at the record line and specifically on the connectors at roughly [ $122 million ] total, they were a record high as well. The growth there were Aero for sure, was up, Defense was up, but also industrial orders were up. The only orders where we saw some declines were actually in the EV connectors. Now if you want to look at also in another dimension of the Connectors between the OEMs and distribution, we had good growth both on the OEM side and on the distribution side. This was probably the highest order on record for connectors that we had. Having said that, it's just 1 quarter.

And our next question will come from the line of Jeff Hammond from KeyBanc Capital.

So yes, I want to stay with the orders. So clearly impressive orders in MT. I'm just wondering a little more color in terms of what's inflecting there. And how much is just the aftermarket kind of through the destock and growth? And then just on CCT, any lumpiness in any of that orders, particularly on the Aero side? I know that can change quarter-to-quarter.

I would say when you look at the orders picture, Jeff, Q1 orders are definitely 1 of the highlights of the quarter. For total ITT, a record, almost $1 billion. And when you look at each value center is a good picture in each and every 1 and in the business in there. In Motion Technologies, don't forget about rail. Rail was -- is a good market right now, and then the business is outperforming tremendously, both in Europe and in China. The Friction award, I mean those 47 awards also in EV and hybrid, we are already in terms of the award that more than 40% of the total full year target. And we don't tend to give easy target, Jeff. On CCT, the highest orders on record when it comes to distribution connectors, the highest on the components obviously pushed from the Defense. When you're talking about Aero, and for sure, there are news out there in terms of some of the production coming down, we are keeping an eye on the production rate of some of our customers. So far in talking to our customers, things have not changed, but we're keeping an eye. And last on IP, the short cycle performed very well as well with 1% growth year-over-year and 9% growth sequentially. So overall, a very good picture on orders.

Okay. Great. And then appreciate the slide on capital allocation. Just wondering as we look a year or 2 out, what do you think the kind of optimal balance sheet leverage is? And do you think you have a pipeline that can support getting there over a couple of year period?

Yes, Jeff. So definitely, we're very happy with the health of our balance sheet. We have almost no debt. We have worked really hard to make it the way it is today. When you think about the prospects from an M&A standpoint, clearly, as I discussed, we created a lot of value organically, both from a top line and a margin standpoint. Thanks to those organic investments. In fact, if you look at our margin expansion, it was 350 basis points since 2019. And obviously, we will continue with that. But as I said, we're accelerating on M&A. We -- Luca had mentioned that we've been building the muscle on M&A. We have built a talented and experienced team. We have a clear and effective strategy. And so as a result, we've been able to really build a rich and actionable pipeline of targets. We have today a pipeline of like serious targets of more than 10. The average revenue size of each company is around $200 million to $250 million. And I think our goal internally, obviously, doing it in a disciplined manner, as Luca mentioned, is to try to deploy roughly $500 million to $700 million on average each year to get -- to really to get to grow ITT inorganically. Our targets are still flowing connectors. That hasn't changed. And so -- yes, so we're patiently building our execution on M&A.

Our next question will come from the line of Mike Halloran from Baird.

So a couple here. Following up on the order side, MT specifically, maybe just talk about the auto piece and how you're thinking about production on a full year basis and just inventory levels in the channel.

Sure. Thanks, Mike. So when you look at the quarter, the quarter worldwide was declining roughly 0.8%. And it was a little bit different than what expected. In terms of Europe was much weaker. Europe was down 2.5%, whereas China was surprisingly up more than 4%. And I'm talking about car production here, of course. And North America was up low single digits. So when we look at the full year, Mike, we are expecting Europe to be down low-single-digits. We expect China -- actually, the projection on China is better than at the beginning of the year. We expect it to be up low-single-digit, whereas North America up low-single-digit as well. Overall, the production for 2024, we expect roughly around 90 million vehicles. On all of this, as you know, we outperformed, and the outperformance was amazing in Q1 -- a quarter. And I want to mention 2 data points. One is China that despite the market growing 4.4%, I mean, our business grew 38%, an outstanding performance there. And Europe, even though the market declined, the business not only outperformed, but was able to grow year-over-year. So an exceptional performance from the Friction team.

Appreciate that. And then on the IP side of things, maybe just talk about underlying dynamics there, specifically 2 areas. One, what you're seeing on the short cycle chemical side of the business, general industrial side of the business, any trend changes either way there as well as how Svanehøj is doing as far as the organic business goes and kind of the momentum you're seeing there?

Sure. Let me talk about the digital cycle, maybe the market. I'll leave it for Emmanuel. When you look at the short cycle orders, as I said, they were up 1% year-over-year, and that was mainly thanks to valves and service. When you look at sequentially, they were up 9%. And that 9% is mainly only volume. And all the components of the short cycle in the quarter were up sequentially, baseline parts, service and [ BATS ]. And all of that is really volume. If you look at that show cycle orders is probably the second highest ever when we look at the million of dollars that we recorded per week. Now when it comes to market, I would say that -- I don't know, if you want to say it -- I would say that we see some weakness probably on the chemical side, but the general industrial was strong. Now -- and on a geographical basis, I would say the strength is mainly on the -- in North America.

And I would just add, even when we look at our funnel, a lot of activity coming from the Middle East, really strong oil and gas, chemical, mining prospects for orders. So very, very healthy market for the moment for IP, and you see it in the book-to-bill. Our book-to-bill was 106. I think Mike, you had also a question on Svanehøj. And so just to give you a little bit of update on this, so we closed Q1 in line with expectations, both on sales and income. And as Luca mentioned on top of that, we had really strong orders. They registered 30% growth on orders. And so when you think about the strategic fit, they continue to ring true. They are a market leader. They're a very, very active player in energy transition. And we continue to see that they built -- they continue to build long-term backlog. So we're booking orders well into 2025 now. The integration also is progressing really well. So all this is reinforcing our strategic rationale. And then finally, I would say they already started generating cash, which is always good.

Our next question will come from the line of Scott Davis from Melius Research.

Congrats on the start to the year, and it's been fun to watch you guys kick some tail over the last few years. So anyway, you've been very generous on the M&A commentary, but I'm just kind of curious, we've been talking about flow in particular, consolidating for 2 decades now, and there hasn't been a lot of consolidation. What has been the main barrier to perhaps maybe some of the transactions not occurring already? Is it more just a function of timing? Is it price? Is it that a lot of these things are niche assets and there just hasn't been much of an appetite? I'm just kind of curious more big picture than anything else. Luca, you're working on this, why we haven't seen more consolidation already.

Yes, sure. I think that it's a good question. I'm not so sure I do have the question -- the answer, Scott. In this very fragmented market, there are plenty of opportunities. I think probably sometimes is people tend to play in the courtyard that they know, and therefore, they've -- they haven't made the proper acquisition, but there is also a lot of things to do in cleaning your house -- in putting your house in order first. So I think that when I look at many companies in flow, probably the performance is not up to where it's supposed to be before starting M&A. If you're asking me, for example, Scott, 5 years ago, it would have been very difficult to be bullish on acquisition in IP. It's a different story now.

Okay. That's helpful. And guys, just a cleanup item, are rail margins higher than auto? Or are they pretty similar?

So when you look at KONI business, rail margin are clearly on par a little higher than our friction business. And then when you look at Axtone, Axtone is in the low teens. And the reason for this is because we still -- we're still driving pricing to offset the cost inflation. And the cost inflation has been really taking longer than expected because we had such a long backlog. So we have good line of sight to bring Axtone to the mid- to high-teens this year. But I would say rail margins, especially in KONI are trending really well.

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

Let's just maybe focusing the first question on IP. So the projects business up 64%, but you still saw margins north of 20%, that's pretty incredible, just given historically what the mix has been on that business and what the margins have been on that business. Can you just kind of mark-to-market the margins that you're seeing on the project business? And then there's an update that you can give us on the foundry closure that occurred last year and whether you're starting to reap those benefits as well?

Sure. Well spotted Joe, I think that despite the big headwinds of mix, the margin improved more than 140 basis points on an organic basis, on a like-for-like. And the reason is really the result of the selectivity that we had in other acquisition -- and the good project execution and the rigor that we have. Just -- and that we expect this to continue, Joe. I think that we are not done here. So just to give you an example, the backlog that today we have in our project business is a very healthy margin. And on a year-over-year basis, it's up 300 basis points. So this will continue the improvement of margin in IP on an organic basis. That is for the project and that we got continue, both in acquisition as well as in execution. Now when you think about the foundry, the foundry we were -- is closed. So we've been able to close it successfully. We now -- we have been able to reduce our headcount in the Seneca Falls because of the closing the foundry, improve our safety performance and also improve the quality of the castings that today we are getting either from low-cost region or also from North America and Mexico. So it has gone well and completed.

That's super helpful and great to hear. And then, I guess, maybe just continuing on the margin front, and other question earlier on Motion Tech and obviously, the strong incremental margins this quarter. Just help us kind of understand maybe the trajectory of the margins from here? Do we move higher off of the 18.2% number? And what does that look like for the rest of the year?

Yes. Thanks, Joe. So you're right, incrementals were super strong in Motion Technologies over 60% in the first quarter. We expect a similar number for the rest of the year as well. So we're very excited with the performance. There was a lot of work that was done from a pricing standpoint, from a managing the commodity cost as well and trying to book in advance steel prices, for instance, and taking advantage of the reduction that we've been seeing towards the end of last year and at the beginning of this year. If you think about from a margin standpoint, I think we can confidently say that we expect Motion Tech improve sequentially its margin quarter-after-quarter, but I would say, remain still within that 18% range, right, for the full year. So as Luca said, we're going to work on sustaining that higher level of margin. This is a business that not very long ago was lower than -- much lower than this. And what we want to do is to make sure that we're able to deliver on a consistent basis, a higher level of profitability.

And our next question will come from the line of Damian Karas from UBS.

Apologies, I'm joining the call a little bit late here, so sorry if rehashing anything you've already discussed. But I thought maybe you could just give us a little bit of a walk across the globe for your auto business. Any updates on kind of how you're feeling about the OE side in each region as well as European aftermarket?

Maybe I'll start with the European aftermarket, Emmanuel. So when you look at the market, Damian, the market was down in Q1. I'm talking about production, roughly 0.8%. We expect the market to be flat for the full year overall at 90 million vehicles produced was a little bit of different picture from the beginning -- what we expected at the beginning. In terms of Europe, was worse, was down 2.5% in Q1, and we are expecting Europe to be down low-single-digit in -- for the full year. China, which was expected to be flat, was actually up 4.4%, which tells you something about the resilience of the market. And we expect to be up for the full year low-single-digit. So this is great news. And then North America was up low-single-digit, and it will be up low-single-digit also for the full year. In each and every 1 of this region, we outperformed quite well. Europe, despite the decline of the market, we actually grew. And China, we grew 38%. So an incredible outperformance. We won an incredible number of awards already in Q1. When it comes to the aftermarket, Emmanuel?

So on the aftermarket, we continue to see a little bit the same pattern we saw in Q4, where we are showing increased revenue for aftermarket. So revenue growth in Q1 versus prior year, modest, plus 3% for our Friction business. But we continue to monitor really closely. We think that we're done with destocking and we continue to monitor the end customer demand.

That's very helpful. And then the Svanehøj order is up 30%, really stood out. Would you say that Svanehøj outperforming your expectations, since you acquired the company? And maybe if you could just -- any color that you can share on that part of the business would be appreciated.

Sure. So keep in mind, Damian, that we said that for the next 5 years, this company should be able to deliver low double-digit in terms of revenue growth. So obviously, that implies significant growth from an order standpoint, especially because this is a long-term business. So there's a lot of long-term backlog. That being said, we weren't expecting as much as 30% year-over-year order growth for Q1. So it's only 1 quarter. So we take it for what it is, but we're very happy. I think it really demonstrates the leadership that they have. I think then from a financial standpoint, Luca mentioned that it was really a good business, really delivered revenue and income in line with our expectations. Cash, as I mentioned, was very positive. So if you think about it, this is a roughly 20% -- currently 20% EBITDA business. They delivered that in Q1, and we expect that they will deliver that for the full year as well. So yes, a lot of really good positive things, but it's just the beginning.

Our next question will come from the line of Vladimir Bystricky from Citigroup.

So I wanted to ask you guys about the rail strength that you're seeing. Obviously, 37% rail orders growth in 1Q was quite strong. So can you talk about the duration or expected timing of delivery of these orders? And then also how you're thinking about potential lumpiness in rail orders going forward and whether you think you can sustained double-digit growth in orders in rail through the year?

So let's put some context around this. So as you know, there is massive government programs on rail in all 3 main regions, where we are. In Europe, we're around 60 billion of direct investment in improving rail, both in infrastructure and in cars. In the U.S., I think this number is around 50 billion. And in China, because ridership is back to prepandemic level, we know that the government is continuously investing as well. So we have a very favorable backdrop for our rail business. And we're seeing the early signs of the benefits of those government programs being executed. On top of that, we're gaining a lot of market share. So if you think about China, for instance, we are clearly the leader in high-speed train and there's a lot of investment that is happening right now for that market. So that's the context. Strong market, strong demand and then the outperformance. I think if you think about the way our rail business works is that we usually book orders that will deliver between 6 to 12 months later. So right now, we're continuously booking backlog that we will deliver in -- at the end of 2024 and then also at the beginning of 2025.

And if I can add to that, when you think about the reason that we like this market because 60% of this market in rail is aftermarket plan. And on top of that, you have an incredible amount of visibility. Some of the award that we're winning are going to last for the next 30 to 40 years. So it's a very good business to be in.

That's really helpful color. And clearly an exciting time for your rail business. Just separately on the capital allocation topic. That was a helpful slide. And you had mentioned on there that you regularly review the portfolio as well. So can you talk about whether we should be thinking about potential for any meaningful divestitures over time? Or just how you're thinking about the go-forward portfolio from here?

Sure. This is something that we do on a regular basis, Vlad. In terms of this is also what we started doing last year, right, when we were able to sell the [indiscernible] business in the first half of last year and matrix by the end of the year. So this is something that we have been doing more and more. Since Bartek came on board, we made our strategy crisp and very focused. We looked at a long term. And therefore, we are assessing that. So as we are adding more and more businesses through M&A in terms leaders in their market, close to core, critical components, technology and proprietary technology. It might well be that some other pieces of the business, we are not the rightful owner anymore. And that probably there will be underperforming parts of the business, I would say.

And our last question will come from Andrew Obin from Bank of America.

You have Sabrina Abrams on for Andrew. When we think about the margin cadence through the year, how should we think about the balance between productivity and reinvestment. And I think you have more capacity coming online. You have the Termoli plan. Should we think that reinvestment ramped sequentially through the year?

Yes. So thank you for the question. For us, productivity is 1 of the drivers that allows us to really drive reinvesting in the business. And that has been the story of a lot of our businesses. KONI was an underperforming asset. We drove operational improvement. And so we reinvested in modernizing the factories, invested in R&D. Same thing for IP. If you think about the [ VAV ] activity initiatives that we drove, those were possible because we started increasing profit tremendously. So when you think about this year, we expect to continue to drive productivity significantly through our businesses. In Q1, we -- productivity gave us 60 basis points of margin expansion. And we expect to continue to be able to do that. In terms of investments, the contribution or, let's say, the impact on the margin of investment, this quarter was around 40 basis points, and we expect also to be along those lines for the rest of the year. So we are driving productivity. We're driving pricing to offset a material impact and reinvest some of that to make sure that we're going to be able to drive long-term profitable growth.

And then a question on China and Friction OE, the share gains are really impressive and the outgrowth is really impressive. What is ITT doing that's driving such strong performance in this particular region? And what sort of visibility do you have in this market relative to Europe and the U.S.

Thanks, Sabrina, for asking this question. We got a special eye on China. Our China business is performing incredibly well. And when you look at our China business, roughly $350 million, 90% is Motion Technologies, which is made of rail and auto. So don't forget about rail because rail is big in China. It's a big market. It's growing, and we are outperforming the market. When it comes to auto, listen, the team has been performing exceptionally well, flawless execution. You have in Q1, an on-time delivery in China of 100%, quality less than 1 ppm. If you look in Q1, they had 50 start of production. So 50 new programs started production in Q1. Now not all of those will be successful, but think about that more than 100 process validations, which are future SOP. So when you look at all of this, think about the disruption that you have in the line. And despite all of that, the OE, the overall efficiency of the line is more than 90% and OTD of 100%. If you're a customer and you have a company that's performing like this for you, you tend to be loyal. And this is what we see. Thank you, Sabrina.

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