ITT Inc.

Welcome to ITT's 2020 second quarter conference call. Today is Friday, July 31st, 2020. Today's call is being recorded and will be available for replay beginning at 12 p.m. Eastern. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. If you should require operator assistance, please press star zero. We ask that you please pick up your handset to allow optimal sound quality. It is now my pleasure to turn the floor over to Emmanuel Capre, Group Chief Financial Officer. You may begin.

Good morning, and thank you, Maria. Welcome to ITT's second quarter 2020 earnings goal. This is Emmanuel Capre and on the line this morning are Lucas Savi, Chief Executive Officer and President, and Tom Scalera, Chief Financial Officer. Today's presentation, Press Release and Reconciliation of Non-GAAP Financial Measures to the Most Comparable GAAP Measure, can be found on our website at itt.com forward slash investors. Our adjusted non-GAAP results exclude certain non-operating and non-recurring items, including but not limited to asbestos, restructuring, asset impairment, acquisition-related items, and certain tax items. All adjustments in the quarter are detailed in the reconciliation. Before we begin, I'd like to provide a brief overview of our Q2 GAAP results compared to prior year. Q2 total revenue decreased 29% to $515 million. Segment operating income decreased 65% to $37 million, and EPS of 53 cents decreased 29%. Free cash flow increased 205% to $169 million. Please note that our remaining discussion will primarily focus on non-GAAP or adjusted measures unless otherwise indicated. Lastly, today's call will contain forward-looking statements that are subject to risk and uncertainties, including impacts from the COVID-19 pandemic. Actual results may vary materially. All such statements should be evaluated together with the safe harbor disclosures and the other risks and uncertainties that affect our business, including those disclosed in our SEC filings. Now let's turn to slide three, where Luca will take us through the key highlights.

Thank you, Emmanuel, and thank you all for being with us this morning. Despite the many challenges, and unique circumstances that you're dealing with at this time. I truly hope that everyone stays safe as we continue to adjust to the widespread repercussions of the COVID-19 pandemic. Before we start this call, I'd like to thank our customers and suppliers who have worked with us to ensure that we deliver our products safely and in a timely manner. I'm also very grateful to our shareholders for their support. And I want to give a heartfelt thank you to all our ITTs across the globe who continue to work relentlessly to serve our customers and shareholders in the most dedicated fashion and to take care of each other in challenging conditions. On our Q1 call, we highlighted our 2020 focus to strengthen ITTs' resilience and to drive aggressive cost actions while playing offense for the future. And this is exactly what we did in Q2. We delivered a 25% segment incremental margin. We accelerated and increased our cost and spend reduction actions to $160 million. We generated record-free cash flow of $169 million. We bolstered our liquidity to $1.4 billion, and we signed an LOI to acquire a niche European rail company. Building on this strong foundation, we will continue to drive operational execution that further reduces decremental margins while fueling future growth opportunities. We can only truly demonstrate our resilience through actions and results. This morning, we will share with you the actions we will keep on driving to strengthen the operational and financial performance as we continue to mitigate the COVID-19 impacts and reinforce the resilience at ITT. Today, we will also give our understanding of the market that we serve and our expectations for the balance of 2020. Before going into Q2 highlights, a word on safety. Safety is my top priority, and when I talk weekly with our facilities across the world, I'm energized by the accomplishments of our teams who diligently and effectively execute our health protocols. This enabled us to contain the global number of infections to fewer than 70. Now let's turn to our Q2 results. We focused on what we control and produced better results than expected. During the second quarter, ITT's resilience the resolve of our teams and our pivot to play offense were on full display. From a financial perspective, we deliver solid EPS of 57 cents, exceptional segment decremental margin of 25%, record-free cash flow of $169 million, representing a significant growth of 205% or $114 million. and segment working capital reduction of 210 basis points compared to prior year and 100 basis points compared to the first quarter. Operational excellence is a fundamental pillar of ITT's long-term success. And during the month of June, I was able to experience it firsthand over and over again when visiting our Seneca Falls plant and seven facilities in Europe. SFO operational improvements enabled industrial process to deliver a 13.7% adjusted operating margin. This is 120 basis point expansion versus prior year, despite a revenue decline of 17%. The 13.7% margin also represents an improvement of 240 basis points over Q1. We moved quickly to take out costs. and we are progressing nicely toward our long-term 15% plus margin target. IP continues to impress with strong operational execution, and as an example, the ANSI line at Seneca Falls achieved above 90% on-time delivery for the 10th consecutive month. Whilst in Europe, I was also pleased to see all the Kaizen projects we have underway to improve our operations. being an assembly line efficiency workshop in Coney of Berlin, or boosting output in Axton Stavola Vola in Poland. Last but not least, in Barge, our friction teams continue to improve our manufacturing processes by repurposing and driving the utilization of existing equipment. All across ITT, we drove high levels of operating efficiency at our manufacturing plants in Asia, Europe, Middle East, and the Americas. And lastly, this operational excellence combined with our speed in execution enabled us to accelerate and boost our cost reduction plan, adding 25 million of new actions that increased our target to $160 million. All of the operational excellence was possible because all our leaders kept our people safe through the adoption of rigorous health protocols. Thanks for this. On customer centricity, our teams passionately serve our customers and were created in satisfying increasingly demanding requirements, showing in actions, once again, that our customers are our priority. Let me elaborate. Momentum infliction OEM share gain continued. In the first half of 2020, we outperformed the global market and each of our main regions. And based on platforms ramping in the second half, we continue to expect to outperform global markets by 700 to 1,000 basis points this year. Our M ordering unit drew new business awards by 94% in the quarter. The improvement that Laurent and his team executed have put this business back on a growth trajectory. IP grew organic pump project orders by 22%. project orders were consistent with the level reached in the first quarter. As a result, our backlog at the end of Q2 was up 3% excluding foreign exchange compared to the beginning of 2020. The project order performance is an emerging sign of customers' recognition of IP's operational improvement and the innovation in our products. IP customers were also delighted By Seneca Falls, 95% plus baseline pumps delivery performance during Q2. This outstanding delivery performance pairs nicely with the rest of our U.S. facilities and our Korean and Saudi plans. Well done, IP. This level of execution mirrors the motion technologies playbook, where our friction business maintained 99% on-time delivery performance despite operating in areas hit hard by COVID-19. Lastly, on capital deployment, our effective capital deployment strategies consolidated and protected our outstanding liquidity position. This will enable us to continue to invest in future growth opportunities as we pivot to play more often. Today, we have $1.4 billion of available liquidity. and we have ample capital to fund all our operational needs and investments, and position us to take advantage of other strategic opportunities. And we continue to protect our cash position through daily and weekly cash reviews, and we added a record $169 million of free cash flow year-to-date. While we play offense for the future, we will continue to strictly control our capital expenditures. In Q2, We reduced capex by 25% compared to prior year, and are tracking to our $35 million reduction target for the full year. Our strong liquidity position enabled us to weather the present storm while we saw the seeds of future growth. We will continue to invest in smart and energy-efficient applications that will drive revenue growth in the long term. In 2020, The ITT SmartPAD is making new inroads in both aftermarket and OE customers. And at IP, we are currently testing a revolutionary energy-efficient power source for our pumps. Lastly, on capital deployment, we signed an LOI for a new niche rail acquisition as we continue to build out this long-term growth platform. All of these actions, executed with speed, helped us deliver the Q2 results provided on slide four. Segment operating income margin of 12.6% despite the revenue decline. We delivered this margin through strong operational execution and fast and decisive cost actions that produced segment decremental margin of 25% and an EBIT decremental margin of 20%. We achieved 52% corporate spend reduction versus prior year. EPS of 57 cents per share was ahead of our expectations and declined 35%, excluding unfavorable effects of 3 cents. And lastly, we generated $169 million of free cash flow year-to-date, representing a 205% improvement over the prior year. In summary, we delivered a solid second quarter in a difficult environment by executing decisive action early and with speed. Now, let me turn it over to Tom to discuss Q2 results by segment. Tom?

Thank you, Luca. Let's start on slide five with motion technologies. MT organic revenue declined 35% due to wide-ranging auto production shutdowns impacting our friction and Wolverine businesses. In the quarter, friction declined 42%. However, for the first half of 2020, friction outperformed each of our major OEM auto markets. In North America, we outperformed by 1,000 basis points. In Europe, we outperformed by 400 basis points. And in China, we outperformed by 1,600 basis points. As discussed during our Q1 call, we expected Q2 top line results to be impacted by unfavorable customer order phasing. Nonetheless, we continue to project 700 to 1,000 basis points of global OE outperformance for the full year as new platform awards enter the production phase in the second half. Wolverine declined 38% in the quarter, but was able to deliver 800 basis points of outperformance for the first half. And finally, Kony and Axstone revenue decreased 9% as solid Europe OE rail growth partially offset lower aftermarket revenue in North America and Asia. MT's adjusted segment operating income declined 57% to $24 million due to volume declines and unfavorable FX of $2 million. However, MT successfully contained detrimental margins to 27% due to increased manufacturing efficiency, proactive plant shutdowns, restructuring benefits, and aggressive discretionary cost actions. The 27% decremental margin improved sequentially and is also much lower than the decremental margins during the 2008-2009 recession, reflecting the true resilience of today's MT. MT delivered solid Q2 margins of 12.2%, mainly reflecting the volume decrease. Axone continued to expand margins, both compared to the prior year and to the first quarter, and Friction China almost returned to pre-COVID-19 margin levels. Continuing restructuring actions in the second half will further bolster MT's structural competitive advantages, which are the foundation for our continued market outperformance. And these reductions will also help to improve decremental margins in the second half. It is also worthy to note that MT improved working capital by 120 basis points and produced record operating cash flow. And lastly, from an award perspective, both Friction and Wolverine, continue to gain share with key Concord wins and new platform wins, both on conventional and electric vehicles. These awards continue to share gain momentum that will power MP's significant outperformance in the global auto markets we serve well into the future. Let's now turn to industrial process on slide six. IP delivered outstanding results considering the challenging environment. Organic revenue was down 17%. However, Margins expanded 120 basis points compared to the prior year and 240 basis points sequentially. The IP revenue decline was driven by lower project revenue due to large project shipments in the prior year. Short cycle revenue was up 4%, mostly driven by lower industrial valve activity that more than offset relatively flat aftermarket and baseline activity. Organic orders for the quarter declined 9% as 22% project growth driven by general industrial market share gains, was partially offset by reduced capital investments across major markets due to COVID-19. IP's backlog at the end of Q2 was up 3%, excluding foreign exchange, versus the beginning of 2020, providing solid visibility into the second half of 2020. Operating income declined 9% to $26 million, as George and the IP team confined decremental margins to a mere 6%. This is a major accomplishment driven by proactive measures taken in late Q3 of last year and rapid restructuring actions implemented in 2020. And as a result, IP segment operating margin grew 120 basis points to 13.7%. This operating margin performance was driven by mixed restructuring and sourcing benefits, continued strong project execution, price and government incentives, more than offsetting the impacts of volume declines and increased customer payment risks. Working capital improved 760 basis points as the IP and shared services teams were hard at work securing payments from customers and deleveraging the balance sheet thanks to significant inventory reductions that resulted in a 20% improvement in inventory terms versus the prior year. IP's resilience reflects the motion technology's business approach as global on-time performance and product portfolio redesign accentuate differentiation with customers. IP will continue to reduce costs in the second half as we implement new restructuring actions and execute on footprint optimization projects. Now let's turn to CCT on slide seven. CCT organic revenue declined 29% on the weakness across all major end markets. The steep reduction in air traffic lowered commercial air demand and caused a major slowdown in OE build rates that was further compounded by the specific challenges related to 737 MAX requalification. Industrial process business experienced a 7% decline as distribution inventory adjusted to lower levels of activity and medical connectors saw a surge in demand to accommodate COVID-19 patient care. Operating income declined 55% on the volume drop and margins declined to 11.1%. The primary drivers of the declines were volume impacts from COVID-19 and OE production weakness. These impacts were partially upset by strong productivity, restructuring action, government incentives, and lower material inflation. We expect volatile market conditions to persist for the balance of the year, affecting OE build rates at air framers. CCT's decremental margins of 35% improved sequentially from Q1 and reflect the aggressive restructuring actions executed by the business. CCT executed a footprint move in Q2 and will continue to drive product line transfers to lower cost regions and additional restructuring for the balance of 2020 as a part of the comprehensive operational reset designed to better align with current demand expectations. So now I'll turn it to Emmanuel, our future ITC CFO, for an update of our cost actions, liquidity, and balance of the year expectations starting on slide eight.

Thank you, Tom. As you can see here, in 2020, we are laser-focused on what we can control, and we implemented aggressive and largely structural cost actions in all of our businesses as well as at corporate at the onset of the pandemic to protect margins, and to produce strong free cash flow performance. In Q2, as a result of this focus, we increased our savings target of $260 million, exceeding the original guidance that we communicated during Q1. We have already executed a large portion of our restructuring plan, and the remaining actions will mostly take place in international regions in the second half. We are also detailing incremental actions across ITT as part of our increased cost target of $160 million. Specifically, we added annualized savings coming from our global industrial footprint optimization, mainly dealing with IP production facilities. We already announced one closure, and the relocation into a larger production site is scheduled for Q4 this year. we continue to prepare plans for additional consolidations. And our discretionary spending cuts were very impactful in Q2, and we will exceed our original target for the year. Finally, we reduced CAPEX by 25% in Q2 and continue to track to our overall target of 35 million reduction. We remain flexible on our CAPEX strategy and continue to focus the reduced capital allocation towards productivity and targeted growth projects. Overall, as a result of the great progress made to date and the decisive incremental actions we took, our 25% decremental margin in Q2 has significantly improved from Q1. And we now expect total segment decremental margin in 2020 to range between 22% and 28%. Now on slide 9. We ended the quarter with liquidity of $1.4 billion, which was significantly strengthened compared to Q1. Our balance sheet and liquidity position are key strengths of ITT, and this provides us the ability to effectively deploy capital when opportunity materialize and value creation targets are achievable. From a cash flow perspective, we continue our strict routines to monitor collections and other working capital improvements on a daily basis. We scored some good wins with customers, and our collections aim to help generate a record $169 million of free cash flow year-to-date. This represents an increase of 205% versus the prior year. We also collected significant past-year receivables early in July with key customers to continue our successful receivable harvesting actions. We optimized segment working capital by 210 basis points year over year, and we have more opportunities to further improve in the second half, especially regarding inventory at MT and TCT. However, we also expect demand to increase sequentially at MT and IP, which will start to weigh on our second half receivables. Based on this, we are now targeting a free cash flow margin of more than 11% for the four year, which is 160 basis points better than prior year. The next few quarters will continue to be unpredictable, even though the visibility has improved compared to 90 days ago. As a result, we will continue to suspend formal guidance until demand certainty improves. But let me provide some perspectives on how we see the year playing out for the balance of 2020. We expect gradual sequential improvement in the second half, but still expect high teen revenue year-over-year declines, mainly driven by CCT. Despite improving passenger air traffic in Q3, we do not see commercial aero production rates materially improving sequentially. However, we expect defense revenue to pick up compared to the first half on the back of improved project order intake. We expect auto production rates to improve sequentially, reflecting a market decline of approximately 25% for the four-year. We also reaffirm that our friction OE business will outperform this global market decline by 700 to 1,000 basis points for the four-year. Sequentially in Q3, we expect empty revenue to improve more than 20% versus Q2, with further improvements expected in Q4. This empty revenue growth, combined with our aggressive cost actions, will fuel solid sequential margin expansion in Q3 and Q4. We expect IP revenue to be consistent with Q2 levels in Q3 and show modest sequential growth in Q4. Finally, we expect corporate expenses in Q3 and Q4 to be similar to Q1. Overall, we have not integrated in our forecasts another global lockdown like we experienced in Q2. Even though we have seen improvements in June and July from CERN and markets, we expect the sequential recovery to be erratic because of COVID-19. We expect Q3 EPS to show mid-teens sequential improvement. The gradual improvement will come from cost actions combined with gradual market recoveries. We are now targeting segment decremental margins of 22% to 28% for the four-year. And finally, from a free cash flow standpoint, we're targeting more than 11% of free cash flow margin. Let me turn it back to Luca for his closing remarks.

Thanks, Emmanuel. Q2 has been a very demanding quarter, and I'm very proud of ITT's achievement when it comes to our customers. We serve them even better than before by assisting them in navigating this crisis. and delivering our products safely and on time, day after day. For our IT tiers, we kept our people safe by rigorously respecting health protocols. For our communities, the civil rights movements have been an inspiration to us all. At ITT, we reject racism. Racism has no place at ITT, full stop. We at ITT are upstanders and live by the principles of diversity, equity, and inclusion, and we're taking concrete actions to make ITT a better workplace. And for our shareholders, we deliver record-free cash flow and aggressively reduce costs to limit the impact of lower demand. We're already playing offense and using our strong competitive position to our advantage. We will continue to focus on what we control and drive operational excellence, customer centricity, and effective capital deployment. These are our value creation drivers. Before taking your questions, I would like to take a moment to acknowledge my colleague, Tom Scalera. As you are aware, Tom will be stepping down as ITT's Chief Financial Officer as of October. At this time, he and Emmanuel Capret, who will be succeeding him as ITT's next CFO, are working closely on the transition. You should know that it was Tom and I who recruited Emmanuel in 2012. This is when our partnership started. I want to express my deepest appreciation to Tom for all he has done for ITT, for our customers, our IT tiers, and, of course, our investors. Tom has been with ITT since 2006 and was named CFO in 2011 as we navigated the spin-off. Since that time, under Tom's leadership, among many others' accomplishments, ITT's market value tripled. I'm sure that many of you have gotten to know Tom professionally during his time with ITT. He has spent a lot of time with many of you in all of his roles here. By my calculations, Tom has made more than 50 quarterly earnings calls. Also, between conferences and other meetings, he has been part of more than 1,700 investor and analyst meetings during his tenure as CFO. That number is even higher when you consider all the interactions he had with many of you up until he became CFO. But for those of you lucky enough to have gotten to know Tom personally, you also know that he's not only a special finance leader, but a truly special person who cares about people and who always brings a fresh perspective. And he does it with a great sense of humor. I found this counsel and partnership during our time working together to be invaluable. When I was getting ready to start into my new role as CEO, ITT provided me some coaching on the higher side. Still, I can tell you today that the best coaching was in working day in and day out with Tom and listening to his perspective and absorbed from his experience. As he goes on to his next venture to focus on the charitable foundation he co-founded with his late wife, Rebecca, the Cancer Couch, I want to wish Tom the best of luck. And from my heart, thank you, Tom. Now, we are ready to take your questions. Maria?

Thank you. The floor is now open for questions. At this time, if you have a question or comment, please press star 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. Again, we do ask that while you pose your question, you pick up your handset to provide optimal sound quality. And thank you. Our first question coming from the line of Mike Halloran of Baird.

Good morning, everyone, and best of luck, Tom. Enjoyed working with you the last decade. It was a little mean of Luca to count all those earnings seasons and conference calls and everything. I tried my best not to do that myself, but it's been very enjoyable and best of luck. Thanks, Mike. Okay, so a couple questions here. First, on the motion side, certainly helpful with some of the sequential commentary, but maybe you could dig into the regions. You know, what you're seeing on a regional basis from a recovery perspective, what kind of production assumptions you guys are using at a high level for the back half of the year? on a regional basis. Obviously, the outperformance will be there, and it's always great to see, but a little bit more granularity on just what the end markets are doing would be great.

Sure. So, Mike, let me tell you about our view of the market. Now, as you know, when you look at IHS, IHS is projecting a global market decline for the full year roughly of 22%. heavier in Europe and North America and in the minus 13, something like that, for China. What we are projecting today is a little bit worse than IHS, but better than our previous forecast. We like to be a little bit more conservative because this helps us in adjusting our cost in a more aggressive way. But I can tell you that in the last three months, we have revised upwards our forecast for each of those regions, for Europe, China, and North America. The reason for that is, of course, what we have seen in China, AQ2 with a very good recovery and the growth roughly of 9%. You have to watch carefully if there was some pent-up demand there coming from Q1, and also in talking from our customers. So this is why we revised our forecast upwards from our view three months ago. Let me share a couple of more data points that might give you some more color. We do not have big concerns on programs. There might be delays, but we have not experienced any cancellation, and the majority of the programs are really starting maybe a little bit later. and maybe a little bit slower, but no major cancellation that we at ITT are experiencing. And then the last data point on the market, I would say, you know, we talked in the past, I shared with you that when we are looking daily at our order book, because we are tracking that on a daily basis, we look at what we call the variation factor. The variation factor is the variation that you get in your order book from the beginning of the month until when you close the month. And what we have seen is that the variation factor, which was huge, we showed a lot of volatility in the past, improved, continues to improve in China in Q2. We saw Europe and North America behaving in Q2 like China did at the beginning of Q1 and then in Q2. And then when we look at the July variation factor, it's almost at normal level. So all of these is good because this means less volatility, more stable market, and a supply chain that is more in control. So Q3 will see a substantial sequential growth over Q2.

That's super helpful. And then on the IP side, maybe help put the backlog commentary and the order commentary in context. You know, the strength, the general industrial side was surprising. You know, the overall orders were pretty reasonable relative to what the environment looks like. How does that inform how you're thinking about the next 12 months here? How do you think this backlog spins off? What's the ability to replenish as we sit here? Any kind of context around that would be helpful.

Sure. Thank you, Mike. So, when you look at the orders, right, the orders were down 9% year over year, roughly 10% sequentially. But you have two different stories within those orders. You've got the project side of the business, which was 22% positive year-over-year and flexed sequentially, while actually slightly positive, and the short cycle, which was minus 17%, with the baseline and parts around in the low 20s. So, when you look at this, what you see is also a backlog, which overall is up 3% year-to-date, Once again, the same thing in the backlog. You have the project backlog which has gone up since the beginning of the year, and the short cycle backlog that has gone down. So what you have, I'm sharing this because when you look, for instance, at some of these great improvement in margins that you see in IP despite the revenue decline, comes also from the mix. This has been a tailwind for our Q2. It would be more of a headwind when we move to Q3 and Q4 as, you know, the short cycle orders lower in Q2 because of the lockdown, which was supposed to be delivered in Q3. Of course, they're representing a headwind from a mixed perspective. When you look at the funnel, when you look at the funnel, I would say interesting enough, the North America funnel has grown year over year. has grown since the beginning of 2020, and it's also been growing since March 2020. So we see on the North America is a strong, strong funnel. And when you're talking about general industrial, you know that this is our bread and butter. This is really where in North America we are strong, both directly and also with our GDPWW, which is our distribution network, which is the envy of the industry. Where we have seen a little bit more challenges on the funnel, and probably you will expect that, is in the Middle East, which is our second largest geography. When you look at the Middle East funnel, that has gone down during Q2, and this is mainly because orders have been assigned, but what this means is that really the replenishment of the funnel is not as fast as it was in the past, and that's the region where that has gone a little bit slower. When you look at July, we see some positive sign, though, in July in terms of some opportunities coming into the funnel.

Great. Appreciate the call as always. It was super helpful. Thank you, Mike.

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

Thanks. Good morning, everyone. Morning, Joe. Hey, Joe. Tom, echo what everybody else has already said. It's just really great to work with you over the years, and thank you for all the help. Wishing you nothing but the best, and congratulations to Emmanuel as well.

Thanks, Joe.

Thank you, Joe. So maybe just starting out, I think I'm just going to focus my questions on really just the margins. And your comments on Mix, notwithstanding Luca on the IT business, you know, the result this quarter from a margin perspective was really, really good. And so I'm just thinking about, you know, kind of like that longer-term entitlement that we've talked about, you know, mid-team type entitlement. Do you feel like, you know, the progress that you guys are making is allowing you to hit that or is going to allow you to hit that number in a quicker way even despite this, you know, this backdrop that we're experiencing?

Yeah. Well, I think that the performance has been outstanding at IP, and I really applaud George, Dave, and the entire IP team for what they've done. A decline of 17% in revenue, an improvement of 120 basis points. You have to think about that improvement. We had a headwind of volume, which was roughly 500. I want just to give you a color to put in context. It had a volume of roughly 500 basis points, but we had a positive mix, which contributed roughly 340. The net productivity is 250 basis points, and that was good, because when you see this net productivity of 250, and it comes both from the productivity in operation, productivity in supply chain, and productivity in restructuring savings, All of these makes it, you know, a nice path to tracking towards our 15 plus margin. Now, when it comes to the timing, I would say I will still stick to our two years time to get to our 15 plus, and this will come In two ways, we will keep on having headwinds because of the COVID-19, the rapid demand. In the next couple of quarters, we will have headwinds in terms of the mix. But because of the extra actions that we are taking and the footprint action that we are taking and the continuous productivity, I believe that in the next couple of years, we will hit our 15-plus targets.

Okay, that's super helpful context, Luca. And then just staying on the margins for a second, maybe conversely just talking about CCT and the headwinds that that business is seeing from an end market perspective, how do you think about the path for that business from a margin standpoint as well and maybe talk specifically around some of the actions that you're taking to drive better profitability longer term?

Okay, when you look at the CCT, I like to think about CCT in the business in CCT, you have the aerospace, and we know, you know, you guys know better than anybody else in terms of what's happening out there, and it's practically lowered for longer. And then another part of the business, the connector business, the short cycle business, and this business will react fast if the recovery happens. So when we look at the aerospace, we have to be very aggressive on our cost structure, and we are aggressive on working capital. So this is where our restructuring action has been more impactful. If we think from a margin perspective, I would say probably more than 300 basis points improvement came from restructuring actions at CCT. But at the same time, we need to be ready to play offense also in CCTs. because of the short cycle. So because when we want, when the economy starts again, we want to jump on that surf and ride the wave. And with the connectors and with the short cycle business, we can do that. But really, it's a cost play addressing our cost structure and reducing our structural cost even further.

Yeah, Joe, if I could just build on what Luca's highlighting there. I think we're we're on a good trajectory with the connector business when markets do start to recover across the different end markets that we serve. I think we'll see a more immediate or shorter medium-term benefit in the margin profile of our connector business, which, as you know, has been gaining a lot of momentum prior to COVID-19. And I think the actions we're taking are going to give the connector portion of CCT even more upside when we're dropping incremental margin performance Certainly, the question on the duration of the segment target is around the aerospace and components out of the business, which right now is a little bit more in managed cost and wait and see until the top line becomes more certain in the future. But I think where we have the leverage and the torque and the momentum is probably more on the connector side of the portfolio, particularly if the market demand comes back. That's helpful, guys. Thank you so much.

Thanks, Joe.

Our next question comes from one of Damien Krause of UBS.

Hi. Good morning, everyone. And Tom, thank you for all of your help over the years.

You're welcome, Damien. Thank you.

I wanted to follow up on some of your comments on IP and specifically on the margins, you know, given, the various moving pieces there with the cost productivity actions and then sort of the order dynamics with the short cycle, but the higher project orders and obviously some timing around project delivery. What's the margin cadence that we should be thinking about for the second half in IP?

Yeah, I think, Damian, you know, one of the things... So, we mentioned that there's mixed pressure, you know, that we're going to be offsetting as we roll from Q2 into Q3. And fortunately, one of the offsets is the restructuring actions that we've been taking. And the incremental restructuring benefits we're expecting in Q3 is going to give us some nice offset to a less favorable mix as we progress through the quarter. So, you know, there's opportunity for us to outperform the prior year. from a margin perspective in Q3, but I think sequentially, you know, we're kind of a little bit too much mix to overcome, but I think we're going to be in the same zip code for the balance of the year from a margin perspective, you know, plus or minus 20, 30, 40 basis points from kind of where we jumped off Q2 based on mix and restructuring savings, but I think fortunately we do have a lot of momentum built up on our cost actions and the restructuring actions, and those will gain momentum as the year progresses.

And if I may add to what Tom said, because obviously when you look at the mix, the short cycle obviously is more profitable than the project. But one thing I can share with you is this beautiful chart of the profitability of our project backlog. And you can see this line, which for the last three years has constantly gone up. you know, year after year, and the backlog that we have at the end of Q2, the profitability of the backlog is the highest it's ever been for our project backlog, which is a good position to be in. That's really helpful.

And then switching over to MT, you know, it seems China is going to be leading you out of the recovery for the friction business. I was wondering if you could maybe just discuss how that business is progressing for you and how you're feeling about your market share objectives in the region. And, you know, also just wondering if you've seen any changes structurally in the market or any evolving competitive dynamics just kind of coming through the pandemic.

Okay. So when we look at China, we outperform the China market in the first six months by roughly 1,600 basis points. And when we look at our awards year-to-date, I'm very happy about the performance of the team in general, but specifically when we look at China, one-third of the awards that we had year-to-date in 2020 are actually in China. And one-third of the total awards are actually New Conquer and the platforms where we are not in. So I'm feeling positive about the trajectory of the market share gain momentum and because of these new awards, because of the Conqueror Awards. And when we look at the China performance in general also of the business, I would say even though the utilization of the machines, of our equipment is not even close to where it was supposed to be overall in the world, the efficiency that we have of these machines is already in the around 85%, and the labor productivity is already above 80. When you're not running a fully loaded factory, it's already a pretty good achievement. So I feel good about the market share gain, and I feel good about how China is performing from a P&S standpoint.

Okay, great. Thank you. I'll pass it along. Best of luck, guys.

Thank you, Damian. Our next question comes from the line of Matt Somerville of DA Davidson.

Thanks, and echo the same sentence, Tom. Best of luck. Thanks, Tom. With respect to CCT, I want to make sure I understand. Can you talk through kind of the organic cadence for that business in the back half of the year? With incoming order rates, I think, down 37, I'm curious as to whether organically that business gets worse before it gets better.

Yeah, Matt.

Go ahead, Emmanuel.

Sorry. So we don't expect significant improvement in terms of top line from CCT on a sequential basis because, you know, it's linked. As a reminder, 35% of our revenue there are aerospace. And we know that the passenger air traffic is not really going to improve sequentially, and probably OE build rates are not going to improve as well. So we don't expect a meaningful recovery. We expect year-over-year declines to be similar to what we've seen in Q2. And so, you know, as Lucas said, CCT for us is a, for the moment, is a focus on taking our cost and reducing as much as possible decremental margins so that we can benefit from really nice incremental margins when the business picks up. We think that for aerospace, you know, we're going to see a recovery that is probably similar to what we experienced after 9-11. It's probably going to take two to three years. And as Luca said, we have discrete opportunities to really repurpose some of our resources to projects mainly in defense some of their short-term opportunities to try to boost the top line in the meantime. I would say to finish that our connector business is very short cycle. So we've dipped pretty quickly into two. And so as the economic recovery happens even slowly, that business of connector is going to bring us a little bit of growth from a sequential standpoint.

Thank you. And just as a follow-up, what sort of P&L benefits should we expect to carry over into 21 when we think about incremental pluses from all the cost takeout you're doing this year? Thank you.

And, Matt, you mean for all the businesses, correct?

Correct.

Okay. So our $125 million plan – is an accumulation of several different actions. What we expect is that for 2020, a benefit of around $90 million of those actions. And then when you look at 2021, we expect around $100 million. And the reason for this increase is that you're going to see some of the discretionary cost actions that are going to come back in 2021 compared to 2020, but you're also going to see some restructuring benefits, and we're going to enjoy the four-year benefit from those actions. So 90 million roughly benefit in 2020, more or less 100 million in 2021. We expect, as I said, the majority of those cost actions will be structural. We expect some of them to come back. I think when you think about incrementals, you know, they're going to be larger than our decrementals, and we expect that they are going to be north of 35%. Great.

Thank you, guys.

Our next question comes from one of Jeff Hammond of KeyBank Capital Markets.

Hey, good morning, guys. Best of luck, Tom. Look forward to staying in touch.

Thanks, Jeff.

Just on... I guess back to MT, I'm just trying to better understand regionally how you're thinking about production and where you're maybe more different than IHS, and then just maybe speak to what you're seeing in terms of aftermarket trends.

Sure. Good morning, Jeff. I would say on IHS, we are definitely more conservative compared to IHS. across all the three regions, both in Europe, in China, and North America is spread across all three compared to them. So they're talking about a 21% decline. So they're thinking about roughly 69, 70 million vehicles produced in the year. We are more in the region of 65 million vehicles produced in the year. And this is spread, as I said, across all the three different regions. And what was the second part of your question, Jeff?

Just aftermarket. Aftermarket.

When we look at the aftermarket, we see Q2 was actually a worse deterioration compared to Q1. We saw Q2 roughly around minus 20%. And when we look, so this for the full year, we are around probably around between minus 15, minus 16%. And we expect this probably to continue for the full year in terms of this range. This is the feedback that actually got from one of our major aftermarket customers just the other day over the phone. This is what they are expecting. Okay.

And then just, I mean, I know, Emmanuel, you give some good color on CCT and like sequentially, but I'm just trying to, you know, the orders tend to be lumpy and they're pretty ugly and commercial and defense had to comp. But like, where do you think, you know, the commercial business is falling out in terms of kind of, you know, run rate declines and, you know, and then what's, you know, X kind of a lumpiness, what's kind of the outlook on the defense side?

So on the defense side, we have, you're right, the science is a little bit more lumpy. So what you have, if you look at the science, probably overall for the year, we will be, while the market is roughly flat, we will be around minus 7%. Now, the different first half and second half. We have a good second half comparing versus prior year, just because of the way that the program works. And whereas in the first half, we were on the negative side. When it comes to the change of the market, we are positive year over year, mid-single digit.

And same on the commercial?

So on the commercial, we think that for the four-year, we're going to be impacted by the lower build rates. So probably we're going to be around 50% in terms of revenue declines. for our commercial aerospace business. One thing that's to note here is that a portion of our business is linked to interiors. And so as airlines cut their discretionary spending on refurbishing the interiors, we are impacted disproportionately on this business. And that's why you see a little higher aerospace decline.

And what's the difference between you and the market for defense?

So we expect the market to be around flat for defense. And so as Lucas said, we're going to be down mid-single digit.

Is that just program timing or?

Yeah, you're right, Jeff. Defense is very programmatic for us. And so this is why we're seeing a second half that is stronger than what we've seen in the first half.

But it's just a question of program, Jeff.

Okay, great. Okay, Luca, good to see you back out on the road again.

Absolutely.

He's always traveling. And, Jeff, just to finish off on the industrial side of CCT, so I would say all of the industrial-facing parts of CCT are probably outperforming the markets that they serve. Obviously, there's a lot of different subcategories, but if you really look at it, aerospace market for CCT generally in line with – you know, different pressures across the commercial aerospace sector, but generally in line. Descent's a good second half, but probably facing a little bit more programmatics on a full-year basis, but a solid second half in descent. And then I would say the overall industrial portion of CPP, probably slightly ahead of the markets that we serve, just to give the full perspective for the year.

Okay, great. Thanks, guys. Thanks, Jeff.

Our next question comes from one of John H. of Gordon Haskett.

Thank you. Good morning, everybody. And, hey, Tom, I hope you get some nice parting gifts, maybe a new briefcase, huh? Sounds great. Old joke. Anyway, so you're welcome. You're welcome. It's okay. The old ones are the best ones. Hey, are you guys, maybe this is for Luca and Emmanuel, are you increasing your cost reduction targets because you're finding more opportunity or because the outlook has become more challenged than you thought versus last quarter?

So, let me address this and then, Emmanuel, you can deal on this one. I think that, you know, it's just part of the way of our operating. in terms of being proud but never satisfied, and ensure that you continue to build your world chest of opportunities. As a matter of fact, I would say, looking at how the market is evolving, I think that our biggest market, which is our biggest sector, which is motion technologies and automotive, we had the drop in Q2. and we expect, you know, sequential improvement in Q3 and in Q4 as the recovery happens. So that would be the answer. It's a question of way of operating and reaching our war chest, and this is it, really.

And specifically on the increase to $160 million, it is driven by some footprint actions, And here the footprint is mainly at IP, and we always had some of those plans, but we were wary not to disrupt the customer, so we were kind of really slow rolling those. And as demand has declined significantly, we have seen this as an opportunity to really accelerate our footprint operation, and we've announced a footprint consolidation at IP in Q2, and we'll continue to do so in the rest of the year for several other sites. And then additionally, you know, we were really aggressive in reducing discretionary costs, and then so we're benefiting from that in our increased targets of $160 million.

So it kind of dovetails in with that question. I mean, where would you guys say versus where we were at the beginning of last quarter, where would you say things are playing out better or worse versus your expectations in Denmark?

Okay, so when we look at, and let me give you also some color in terms of July, we think that we have seen China recover nicely on the automotive market. And we are seeing, you know, also when we look at the month of July, you know, what we call a variation factor, which is almost back to normal. So, I would say, in general, moisture technologies and the debt market is performing better than what we were expecting. This is also why we changed our forecast. It's not like what IHS is saying, but definitely better than what it was three months ago. And then when we look at also on the IP side, I'm encouraged by some of the things that I've seen in July when I look at, you know, we are always looking at some leading indicators. So we got a good picture on the project, but then when we look at the short cycle, we looked at daily rates for parts or weekly rates for baseline or service or valves. And I'm encouraged by the numbers that we have seen in July, which are a little bit better than our forecast.

What about oil and gas, Luca? I mean, you had talked about potential share gains. Is that industry? It's obviously a pretty tough spot right now. Is that industry playing out the way you had thought? And are you still on track to kind of put forward those share gains that you had talked about in the past?

I think we are. So when you look at oil and gas, you look at two parts of the business in oil and gas for ITT. So first of all, oil and gas in ITT represent roughly 10% of all ITT business. And we have the connector side of the business. that are playing only in the upstream, and we will outperform these markets. Upstream would probably be for the full year roughly minus 40, minus 50. We will be in the region of minus 20, and this is because of market share gain, particularly in the Middle East. Now, when we look at oil and gas for IP, we play in the downstream, upstream, as well as midstream, and we will be outperforming in that market as well. And what we saw there, we haven't seen really any project cancellation, John. We've seen some projects that get delayed, but our strategy on those delayed projects is really to win the engineering orders. And even if you don't get the full order of the project with engineering, you build the customer intimacy and you've got the foot in the door. In July, actually, we had a positive news on the oil and gas. It was an order that was put on hold during Q2. In July, it came back active, and we are starting talking again to the customer. So I would say confirming the market share gain. And that order was for in Kazakhstan.

Yeah, got it. Cool. Great. Thanks, and good luck, Tom. Thanks, John.

Our next question comes from the line of Brian Blair of Oppenheimer.

Good morning, guys. Tom, thank you for all your help over the years.

Absolutely, Brian. Thank you. Morning, Brian.

I was hoping you could break out the monthly sales rate for friction aftermarket in the quarter. I assume April was quite painful and then there was some degree of recovery to get to the down low 20s. You could also speak to the July sales rate, just trying to gauge the pace of sequential recovery.

Okay. So definitely there was an improvement. I mean, when you look at the quarter of Q2, obviously April was the – because also you think about it, our aftermarket is a European business. So what you see is that – April was definitely the worst. May was not much better, but May is when actually some of the lockdown became easier, and then you have a better situation during the month of June. July is still catching up. So that is the normal, I would say, the normal trend that you would expect with the ease of a lockdown in Europe. Okay, understood.

And you called out the rail M&A pipeline. It sounds like that build-out could accelerate a bit over the near term. Can you remind us of the run rate size of your Coney-Axton platform? And I know we tend to discuss entitlement ranges in terms of margin, but do you have a target in mind for the scale of the rail platform as you continue organic in M&A investments?

Sure. So when you look at the Coney Axton business, you're talking roughly about a $200 million, $200 to $210 million platform. And when we look at building a RAID platform, we're talking about in the long term to be a business of roughly $500, $600 million. When you look at this acquisition, this inorganic opportunity, it's a niche acquisition, so it's a small one. But it's a good, it's a well-run company that might enable us also to play a bigger role on the service side of rail. So that is a nice and neat addition. What we've been doing, Brian, is really cultivating this heavily. We have paused because of COVID, of course. We have reactivated recently because of the easing of the lockdown, but I would say it's a niche application and it's a bolt-on.

Okay. Appreciate all the color. And, again, if we think longer term for the rail platform, can that business structurally get to friction-type margins?

Yes, it can.

Okay. Excellent. Thank you. Thank you.

Our next question comes from one of Brett Linsky of Vertical Research.

Hey, good morning, everyone. Many thanks to Tom and congrats to Emmanuel. Thank you, Brett. Just first a point of clarification on the cost savings. Emmanuel, you indicated $90 million this year, $100 next year. I just want to make sure that $100 million is, in fact, incremental to the $90 million.

No, no, no, it's not. It's not. What's incremental is roughly the 10 million to go from 90 to 100. And the reason for this, you basically have restructuring actions that are carrying over and that give you an incremental benefit. And then you have some of the discretionary spending that is rolled back.

Got it. Okay. And then just on the balance sheet, obviously in great shape, the pension I know is frozen at 108%. Is there an opportunity to move that off balance sheet and then Just second on the asbestos, could you just provide a little more color on the Qualified Settlement Fund note in the slides and then strategically, you know, is there an opportunity to fully eliminate and remove that, you know, this year or next?

Yes. Thanks, Brad. Certainly a lot of momentum and positive elements to the balance sheet story that you're highlighting. So for sure, to start with pension at 108% funded, our plan is to terminate you know, the pension plan to move it off balance sheet to an insurance company. This is the U.S. pension plan specifically that we're referring to here. So that effort is in motion, and that is something that we are trying to accomplish by the end of the year for the U.S. plan. So that's in good shape, and we're progressing with a good team working on it. The QSF is basically, you know, that is – where we store all of our proceeds from settlements with our insurance providers. And the QSF continues to grow now. And basically, that's cash that we could use for many asbestos and the majority of our environmental spend that we have. So the good news about the QSF is no operating cash is going towards satisfying those legacy obligations. That money is already in our internal QSF fund, and when we have to make asbestos claims or environmental claims, we can use that cash to satisfy those claims, and that's going to give us really good coverage for the next, you know, roughly two years, potentially plus, around both asbestos and environmental cash outflows. And then lastly, continuing the momentum on asbestos, you know, we've driven that liability down. We've done a lot of things to structure it. you know, in a certain way so that if there is an opportunity, Brett, to find a counterparty or transaction, obviously, that could make sense. You know, there are options or examples out there of different ways to address this liability. And I would just, you know, highlight that we are constantly evaluating all of those and, you know, would look for an opportunity that might make sense. But in the meantime, we'll drive that net liability down, you know, 45, 50% as we have. We'll use our QSF cash to satisfy the obligations, which will maintain minimal draw on operating cash. And if we see a good strategy to do something in the future, we're certainly actively reviewing those on a constant basis.

Okay, great. Congrats on a good quarter and best of luck. Thank you. Thanks, Brad.

Our next question comes from one of Andrew Ogan of Bank of America.

Hi, good morning. This is Emily Xu on for Andrew Obin. I wanted to extend my thanks and best of luck to Tom and congrats to Emmanuel.

Thank you, Emily.

Just a question on supply chain. Did you adjust your sourcing at all in the quarter or, you know, move some production in region? And also, how did the Mexican facility function given that there were, extensive government mandated shutdowns.

Thanks. Okay. Thanks, Emily. So when it comes to supply chain, we had good savings in supply chain across all the different businesses in the region of roughly triple digit, more than 100 basis points improvement from a margin point of view. We had no major disruption on supply chain because of the shutdowns. We had our backup plan, particularly when you think about motion technology in terms of our suppliers, so we had built a kind of resiliency and some redundancy in the supply chain, but no major disruption on the supply chain. And when we had some hiccups because of maybe some suppliers coming, some casting coming from Asia, we've been able to work together with the customer to adjust the schedule. Now, going back to the second part of your question, which is Mexico, our Mexican operations in Nogales kept on operating across the quarter. We had several audits with the government, and in some cases were at 30%, at 50%, or 70% based on the situation that was in the state of Solano where Nogales is. When it comes to the Mexican facilities in Silao for motion technologies, We shut down that facility during the month of April and part of May, and that was mainly because of customer demand and customer demand only. They restarted, and we are operating it right now.

Okay, great. Very helpful. And then a follow-up question on MotionTech. Any outlook on autos into 2021, you know, in terms of maybe build rates, being revised up and with MotionTech's out performance could MotionTech be up in 2021? Thanks.

I would say when we look at what we see is obviously 2021 is going to be the focus is going to be higher than 2020 so the growth will continue but there is not going to go in 2021 to the level of 2019. I think that exactly where this growth is going to land is probably a little bit too early to tell. So there is growth that the trajectory is there, but it's probably a little bit too early to tell. But one thing that we can commit is that motion technology will continue to outperform the market.

Okay, good. Thank you very much.

Thank you.

Our next question comes from one of Joe Giordano of Callen.

Hey, guys. Good morning. And, you know, good to see you guys are finally upgrading the CFO job. It's been long due. No, Tom, I'm going to miss you, man. It was great working with you, buddy. Thanks. So, Luca, you mentioned the project profitability and IP in the backlog is the highest it's been in years. You know, just given some – virus flare-ups, and now there's kind of some confusion about what the pacing of opening up and things is going to look like. What's the risk of the longer stuff stays in backlog, what that does to the profitability?

Okay, so when you look at how the funnel and the backlog have evolved in the last six months, Joe, and the last six months, I would say, have been the worst And I expect the last six months to be the worst in this COVID-19 crisis because we didn't know when this is happening in Asia-Pacific. There was a major complete lockdown in Europe for more than a month and the same in North America. In all this environment, what we had is our backlog for our project actually went up 3% since the beginning of the year. And if we look at the funnel in the two main regions that we operate, North America and Middle East, the Middle East went down during the last quarter, even though in July it started replenishing up, and in North America it's actually gone up. So I would say, and added to that, I haven't seen any major cancellations, only some postponements and shifting to the right. I would say I don't see any major issues with the project side of the business. Now, if there are some changes on the contract, you know, usually there is some protection there in terms of the terms and conditions that you have with the contract, but we are not experiencing any of those at this moment, and this has probably been the most demanding quarter for the business due to

That's helpful there. And then I just wanted to ask one more on rail. Can you kind of just describe the landscape there? Like how regionalized are the companies that you're looking at as targets? Like if you're buying a business that's in one region, can you globalize that, or would you have to buy similar companies that do similar capabilities in different regions of the world? Are there big companies out there, or is it going to be a lot of kind of rolling up of smaller players? Kind of just go off on that a little bit.

Yeah, it's a little bit of a mix, Joe, in the sense that rail is very regional, and therefore you tend to have more small, medium companies that have a good foothold in the region. Sometimes it may be in a specific country. So this is the first thing in general. Then, of course, it depends on the product, because if you think about our business, Connie, We have our shock absorbers that go, you know, on the cars of the train in locomotives, high-speed trains, coach, and they are both on the GE locomotives here in the U.S. as well as in India as well as the locomotives in China. They are on the high-speed train from Siemens, Humber, Alstom, CRRC. So those products, for instance, are more global. So it depends. But generally, it's a very fragmented market with small and medium companies.

Thanks, guys. Thanks, Josh.

And ladies and gentlemen, that was our final question. I'd now like to turn the call back over to Tom for any additional or closing remarks.

Yes, thanks. Thanks, Miriam. Thanks, everyone. I just wanted to take a quick second, I know we ran long, to thank all of the analysts and investors. It's been my pleasure and my honor to... to get to know you and to work with you and to represent ITT and to help you understand, you know, and appreciate this company and all the potential that we have. And I've enjoyed the experience and the opportunity to get to know many of you very well over quite a long period. So I'll miss you all, and I just wanted to thank you. I want to thank my world-class team. And in particular, Michelle, my support that many of you know that they've all helped to make me much, much, much better than I am. Certainly want to thank Luca for all of his support and his incredibly kind words. And no, I did not script those for him. Those were from his heart and from his pen. So, I really appreciate his kind words. And lastly, to Emmanuel, you know, best of luck and congratulations. ITT is in great hands and we have a great balance sheet and a tremendous future and Emmanuel and Luca will certainly help us realize even greater value creation going forward. So thank you all and hopefully we can all connect at some other point in the future. With that, Maria, I think we're pretty well concluded.

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