ITT Inc.

Welcome to ITT's 2020 fourth quarter conference call. Today is Friday, February 19th, 2021. 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 Mark Micheluso, Vice President, Investor Relations. You may begin.

Thank you, Maria, and good morning. It is my pleasure to welcome you to ITT's fourth quarter 2020 earnings conference call. Joining me here this morning are Luca Savi, ITT's Chief Executive Officer and President, and Emmanuel Capre, Chief Financial Officer. Today's press release, presentation, and reconciliations of non-GAAP financial measures to the most comparable GAAP measure can be found on our website at itt.com forward slash investors. This call contains forward-looking statements that are subject to certain risks and uncertainties, including but not limited to impacts from the COVID-19 pandemic. Actual results may vary materially from the assumptions presented today. All such statements should be evaluated together with the safe harbor disclosures and the other risks and uncertainties that affect our business, including those discussed in our Form 10-K and other SEC filings. Except where otherwise noted, the information we present this morning will be based on adjusted non-GAAP figures. These results exclude certain non-operating and non-recurring items, including but not limited to asbestos-related charges, restructuring, asset impairment, acquisition related items, and certain tax items. All adjustments in the quarter and for the full year 2020 are detailed in the reconciliations in the appendix. Before we begin, I'd like to provide a brief overview of our fourth quarter gap results compared to prior year. Q4 revenue decreased 1.5% to $709 million. Segment operating income increased 11.6% to $120 million. and reporting earnings per share was a net loss of 16 cents. This is principally driven by a $137 million charge related to the successful termination of our U.S. pension plan and other items, including tax charges, totaling $17 million, partially offset by a $52 million asbestos insurance settlement benefit. With that, let me turn the call over to Luca, who will begin on slide three.

Thank you, Mark. And thank you all for being with us this morning. I truly hope that everyone is healthy and safe. Before I begin, I'd like to again thank all the IT tiers around the world who continue to work tirelessly during this pandemic to serve our customers and to take care of each other in these challenging times. I'm humbled by the way this team continues to respond to the crisis and want to express my sincere gratitude for all you have done. Your efforts to serve our customers and drive exceptional performance in a safe, fast, and productive manner are a testament to the commitment, perseverance, and your hard work. I would also like to welcome to ITT our new Vice President of Investor Relations, Mark Macalusa. Mark joined ITT in January of this year after a successful 13-year career at Honeywell and has hit the ground running. I'm happy and excited to have Mark on the ITT team to drive our global investor relations strategy. Welcome, Mark. As a result of our focus on the health of our people and our efforts, we delivered another strong performance in the fourth quarter. Early last year, we took some difficult and swift actions to respond to the pandemic. These actions ensured that ITT continued to outperform in 2020 and and will emerge stronger in 2021 as the economic environment recovers. And, as you will hear this morning, we have made tremendous progress on both fronts. Let me now highlight some key financial achievements for the quarter. We generated adjusted segment operating income growth of 8%, with margin expansion of 150 basis points on a 4% organic sales decline. and we improved our decremental margins every quarter in 2020. For the full year, our decremental margin was 22% at the low end of our range. As a result, we delivered adjusted earnings per share of $1.01, a sequential and as well as a year-over-year increase. We generated free cash flow of $102 million for Q4 and $372 million for full year. Throughout the year, we drove cash collections and optimized inventory whilst applying strict control over capital investments. This drove a free cash flow margin of 15% at the high end of our guidance that we increased just last quarter. On capital deployment, in 2020, we increased our dividend by 15%. We repurchased ITT shares totaling $73 million. and we increased our majority stake in our Wolverine China joint venture as we continue to expand our market share in Asia. Despite the restrictions posed by COVID, I was fortunate to safely visit many of our facilities around the globe, including in China, Europe, the Middle East, and across the US. As you know, I consider this fundamental to identifying and executing the many operational and commercial opportunities we at ITT have around the globe. In 2020, we reduced the number of recordable incidents by 25% and implemented safer workplace protocols globally. This is an important element in ensuring the health of our people, and it also contributed to a significant reduction in workers' compensation expense in the U.S. Safety is foundational for our operational excellence. and all of us should expect a continued reduction in incidents in the future. From a commercial perspective, sales infriction outpaced global auto production rates by more than 600 basis points for the full year. We increased market share by almost 400 basis points in North America, more than 200 basis points in China, and almost 100 basis points in Europe. And when it comes to EVs, we secured position on 42 new electric vehicle platforms during the year. In industrial process, we continue to execute on our footprint rationalization projects. We finalized our first consolidation in Europe this quarter and are progressing according to plan on our second project, this one in North America. We are making progress in sourcing efficiencies through aggressive negotiation and supplier rationalizations. As I noted before, I believe there are still many opportunities to improve our purchasing performance, as well as further lean out our operations. Industrial process delivered 15.1% adjusted segment operating margins this quarter. This is a milestone. Still in IP at the end of last year, I visited our Industrial Valves site in Emory, Mississippi. I was impressed with the order management process implemented by Angie and her team that has resulted in best-in-class on-time delivery performance and unparalleled service for our customers. This is also true from a project management performance standpoint, where IP continue to drive near-perfect execution and on-time delivery, whilst driving margin expansion for many of our large projects. In connect and control technologies, the order situation improved sequentially in the fourth quarter, and our book to build was above one, thanks to our industrial connectors. While CCTs and markets remain challenged, we are deploying the same operational excellence playbook that we successfully executed in MT and IP. We expect to reach pre-COVID margin levels at CCT in the next two to three years. Today, I'm also pleased to provide our outlook for 2021 that reflects all that we have done to strengthen our operations, our people, and our potential. We anticipate full-year organic sales growth of 2% to 4% driven by continued share gains in motion technologies, as well as the broader auto market recovery. We expect the rest of our markets to be flat to slightly down. We plan to expand adjusted segment margins by 130 to 180 basis points. The increased sales volume and the carryover impact of our 2020 cost actions, coupled with the strong productivity from 2021 initiatives, will generate adjusted earnings per share in a range of $3.45 to $3.75, which equates to 8% to 17% growth versus prior year. because of our strong free cash flow performance in 2020, we're well positioned to deploy capital in 2021. First, we will invest in our businesses with approximately 100 million of capital expenditures, up over 55% versus 2020. Second, we will aggressively and diligently pursue acquisitions in our core markets to effectively put our cash to work and build on our strong businesses. Third, we increased our dividend by 30% as announced this morning. This is our ninth consecutive dividend increase. And finally, we are planning to repurchase ITT shares totaling $50 to $100 million, reducing the full-year weighted average share count by approximately 1%. Let's turn to slide four to talk further about the fourth quarter and full-year results. From a top-line perspective, motion technologies delivered a strong performance, growing over 10% organically, driven by continued share gains and double-digit growth in auto in North America and China. This was offset by lower short-cycle demand in industrial process, as we anticipated, and the impact of commercial aerospace dynamics in CCT. Our focus on operational excellence is producing strong results. Motion technologies expanded margins over 400 basis points to 19.5%. Industrial process grew margin 90 basis points to 15.1% despite a 10% organic sales decline. The MT and IP performances more than offset connect and control technologies margin decline. For the full year, I'd like to point out a few highlights in addition to those that we have already discussed. First, working capital as a percentage of sales continues to decline, and we saw 70 basis points of improvement in 2020, excluding the impact of FX. Second, free cash flow increased 40% versus prior year, despite the challenges posed by the global pandemic. We hit the high end of our full year target for free cash flow margins, while also investing in the business through growth capex of more than $35 million for the year. Third, we continue to effectively manage our legacy liability profile. As I mentioned in our last earnings call, early in Q4, we successfully transferred our U.S. pension liability to a third party. This will reduce our administrative costs and end all future funding requirements for the plans. We also continue to successfully negotiate asbestos-related insurance settlements with our carriers. And we drove an increase in our insurance assets of $52 million in the fourth quarter and $100 million for the full year. As a result, our net asbestos liability that we recently brought to a full horizon valuation is now $487 million. Let's quickly turn to slide five to discuss a few wins and awards in our businesses that will shape 2021 and beyond. Years back, our friction team developed a strategy to penetrate the growing EV segment while continuing to gain share on conventional vehicle platforms. We focused our technical expertise in addressing tighter noise and vibration requirements while continuing to deliver a frictionless customer experience. In China, our EV Brakepad Development Center continues to effectively partner with our customers in the largest EV market in the world. And in 2020, we continue to see the results of our strategy by winning content on new electric vehicle platforms, including several platforms with the EV manufacturers. We also won both the front and rear axle for a new U.S. performance crossover vehicle. The strength of our friction technology continues to be on display as we assist automakers in significantly reducing braking distance of heavier vehicles. All of this is a testament to the innovation and engineering prowess behind our brake pad technology. In industrial process, Our redesign between bearing API pump has seen new orders increase over 50% this year. Our customers are benefiting from improved hydraulic efficiency and performance. We reduced lead times at the competitive price point. In Q3, we further expanded and improved our hydraulic pump offering and have an active funnel of potential orders already. Our new iAlert remote monitoring offers diagnostic capabilities and tailored solutions that predict customer equipment failure and improve asset uptime. Finally, in connect and control technologies, our Anodyne business is teaming with Bell Textron to produce passive vibration control technology for the 360 Invictus. The Invictus is Bell's competitive prototype to the US Future Attack Reconnaissance Aircraft, or the FARA program. Together with Bell, the Anodyne team is developing technology for use in a mission-critical defense application suitable for the FARA program. As we embark on 2021, we remain laser-focused on operational excellence and customer centricity. This has been the ITT playbook for the last four years. We continue to make significant progress, and we again show the benefits of this commitment in the results we delivered in Q4. We will continue to be good stewards of ITT, driving performance for our customers while searching for organic and inorganic opportunities to deploy capital and grow the business. Our effective and comprehensive capital deployment strategy with clear priorities on organic investment first and foremost, followed by close to core acquisitions, and then returns to shareholders will ensure that our cash is efficiently put to work. Let me now turn the call over to Emmanuel, who will take us through the segment results and provide more detail on Outlook for 2021.

Thank you, Luca, and good morning, everyone. Let me begin with motion technologies. Our Q4 organic growth of 10% was primarily driven by a strong performance in our friction OE business. We delivered 640 basis points of outperformance in 2020 on a global basis, further evidence that the MT machine continues to win in the marketplace. For the quarter, friction sales in North America were up 43%, and sales in China up 19%. while growth in our Wolverine business was over 12%, with strength in Europe and Asia-Pacific as we gained market share in both break shims and ceilings. Segment margins were incredibly strong again, expanding 410 basis points on incremental margins of 46%. This was mainly driven by higher volume and productivity that allowed us to continue to fund growth investments. We are very pleased with the pace and the strength of the recovery in MT as we head into 2021. For industrial process, sales were down as we anticipated with declines in short cycle due to pandemic-related impacts that affected our previous two quarters bookings. Our project business, which encompasses most of our oil and gas exposure in IP, saw declines in pump bookings as large projects continued to shift to the right. However, our short cycle orders in the quarter were up 1% driven by aftermarket demand. IP margins expanded 90 basis points on 7% decremental margins. The impact of the sales decline was almost entirely offset by productivity benefits, restructuring savings, and price. Also, as Luca mentioned, we continue to make significant headway in our purchasing performance, thanks to our long-term supplier rationalization strategy. Furthermore, IP's working capital as a percent of sales improved 590 basis points versus prior year, and we still see further opportunities to optimize inventory as we consolidate footprint and enhance materials planning. IP finished a quarter with less than 20% working capital as a percent of sales. Lastly, in connect and control technologies, we continue to see weak demand across all major end markets. Sales in aerospace and defense were down over 30%, driven by lower passenger traffic and lower build rates from airframers. The debookings we saw in aerospace in the second and third quarters declined sequentially in the fourth quarter to minimal levels. we expect that the sales weakness we saw this quarter in commercial aerospace will likely persist into the first half of 2021. Connected sales were down over 10%, mainly due to North America aerospace and defense. On a positive note, we are encouraged by the recovery in orders in defense and industrial connectors. These contributed to a book to bill of more than one in Q4. CCT margins, were impacted mostly by lower volumes, partially offset by an aggressive cost reduction plan. While this year was challenging for CCT, we are encouraged by the productivity, which was over 400 basis points this quarter and the four-year. I am now on slide seven to present a deeper look at the margin performance this quarter. I want to highlight two main points. First, we generated productivity of 230 basis points. For the full year, that number was over 300 basis points. This is the result of a multi-year approach to reduce ITT's cost structure by driving operational excellence across the enterprise and moving towards a leaner ITT in all three segments and at corporate. We have successfully executed this playbook at Motion Technologies, and we are in the early stages of the journey with industrial process. At CCT, we're still laying the foundation, and over time, we expect results similar to what we experienced in motion technology. The second key takeaway is on strategic investments. While we made necessary cuts to discretionary expense this year to manage through the pandemic, these did not come at the expense of growth investments. We continue to selectively fund the most promising growth initiatives in key markets, including in EVs globally, to ensure we continue to win in the marketplace as we did with our successful launch of copper-free brake pads several years back. Let's turn to slide eight to review the 2020 cost action results. For the four year, we achieved cost reduction savings in excess of $100 million, including $40 million in the fourth quarter. This came from a combination of headcount reductions, reduced executive and board compensation, and discretionary cost actions. We delivered approximately $65 million of structural reduction in fixed costs for the four-year, with the remainder comprising temporary savings, which will partially reverse in 2021. We are continuing to drive footprint optimization at both IP and CCT, while remaining diligent with strong cost control and accelerated sourcing performance. We expect that the carryover impact of actions in 2020 will generate approximately $10 to $15 million of additional savings in 2021. We also expect to fund and execute new footprint rationalization and cost reduction plans in addition to the normal productivity we will generate. As a result of these measures, our decremental margins improved every quarter since Q2, And we finished the year at 22% at the lower end of our target, given the strong performance in Q4. In 2021, we expect incremental margins north of 35% as volumes recover and we leverage our optimized cost structure. Keep in mind, this will vary from quarter to quarter based on our quarterly performance in 2020 and the mix among our businesses. Let's turn to slide nine to discuss our 2021 guidance. Our end markets are showing signs of recovery. Still, the four-year economic outlook remains somewhat uncertain at this time. We intend to remain flexible and manage our costs to coincide with the expected gradual recovery. Despite the ongoing disruption from the COVID pandemic, we see general economic conditions continuing to improve throughout 2021. particularly in the second half of the year. We expect total revenue will be up 5% to 7% versus 2020 and up 2% to 4% on an organic basis. The strong organic growth we see in friction stemming from continued share gains and the resurgence in auto will likely be offset by declines in industrial pumps as customer OPEX continues to be constrained and project activity remains weak. Notably, We expect sales in motion technologies in 2021 to get back to 2019 levels. In commercial aerospace, activity will slowly recover starting in the second half of 2021 as inventory levels normalize and passenger air traffic begins to recover. Defense should be relatively stable as the large order we won in the fourth quarter of last year will convert into revenue towards the end of 2021. Finally, in oil and gas, we expect modest growth from downstream activity improvement. However, the growth rate will be impacted by lower project bookings in 2020 as a result of the market downturn. We expect to see stronger growth in the Middle East and Asia Pacific in particular. We expect adjusted segment margins to expand by 150 basis points at the midpoint, driven by higher volumes, continued productivity, and the incremental benefits from structural reductions to our cost structure in 2020. All segments should deliver triple-digit margin expansion. We're guiding to adjusted earnings per share growth of 8% to 17%. This assumes an approximate 1% reduction in our four-year weighted average share count from repurchases and an effective tax rate of 21.5%. Free cash flow will be in a range of $270 to $300 million, and we expect free cash flow margin to be 10% to 12%. This is lower than the 15% delivered in 2020, as we expect to increase CAPEX spending, including $5 to $10 million of investment into green projects, and increase working capital dollars to support top-line growth. However, we expect working capital to continuously decline as a percent of sales over the long term. At these levels, adjusted free cash flow conversion will approximately be 100% aided in part by working capital optimization. On slide 10, we show the walk to our 2021 adjusted earnings per share guidance. The majority of our earnings growth will be generated by stronger volume and net productivity, partially offset by the reversal of temporary cost savings and the incremental investments for growth. The reversal of temporary cost savings is due to a combination of higher compensation costs, travel expense, and CARES Act benefits that will become a headwind to earnings in 2021. Foreign exchange is expected to contribute positively to earnings, and tax rate is expected to be slightly higher than 2020 at 21.5%, with a variance of 20 basis points around the mean depending on the jurisdictional mix of our income. Our planning rate currently implies a $0.02 EPS headwind. Lastly, as Luca highlighted, we expect to repurchase $50 to $100 million in ITT shares, which will generate a $0.01 to $0.03 tailwind. Before we wrap up, I also want to share some additional details on what we're seeing thus far in 2021 and what we expect in the first quarter. Year-to-date, we are on track. Our first quarter outlook assumes continued double-digit organic sales growth in motion technologies, offset by mid- to high-teens declines in both industrial process and connect and control. In industrial process, soft 2020 bookings will continue to weigh on revenue near-term, particularly in the chemical and oil and gas segments. Our short cycle business will decline due to customers maintaining tight operating expense controls and lower ending backlog. However, we expect that IP short cycle will improve sequentially in the second quarter and then grow in the second half of 2021. In CCT, the declines will be driven by weak commercial aero demand. This will be partially offset by growth in connectors given the strong beginning backlog after over 30% sequential order growth in Q4. The margin expansion will be driven by MTNIP given the higher order volumes and the cost actions executed in 2020. Despite progress, CCT's margin will be lower than last Q1, which was still largely unaffected by the pandemic. While there remains a fair amount of uncertainty in some of our end markets, we're confident in ITT's ability to continue to execute and outperform the competition, which will likely generate Q1 adjusted earnings per share growth of mid to high single digits versus prior. Let me pass it back to Luca for closing remarks.

Thanks, Emmanuel. Once more, I would like to thank ITTers, our customers, and all our other stakeholders for their support and commitment to ITT. I'm proud of the results we delivered in 2020. We focused on what we could control, acted quickly, and continued to invest in our businesses. Our motion technologies business is our springboard for growth. Friction continues to win in the marketplace with a focus on capturing share in the fast-growing EV segment. We are progressing in our transformation at both industrial process and connect and control technologies with a lot of runway. And finally, our financial health is strong entering 2021 with ample capacity to deploy capital. We intend to fund high return growth initiatives, aggressively and diligently pursue strategic acquisitions, pay a competitive dividend, and systematically reduce our share count whilst continuing to wind down our legacy liability exposure. We have clear priorities. We are aligned and purposely committed and accountable, and we are seeing the benefits of our rigor in our results. With that, Maria, could you please open the line for Q&A?

Thank you. The floor is now open for questions. At this time, if you have a question or comment, please press star one on your touch-tone 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. Please limit your questions to one question and one follow-up. Our first question comes from one of Jeff Hammond of KeyBank Capital.

Hey, good morning.

Morning, Jeff. Morning, Jeff.

So I guess on friction, can you just talk about what you see for outgrowth specifically versus the long-term trend and what your kind of IHS expectations underline that as well, or I guess your production versus IHS?

Sure. So as you've seen, we outperformed very well in Q4, and our outperformance for the full year was 640 basis points. And we outperformed every region to 300 basis points in Europe, more than 1,000 basis points in China, 1,700 basis points in North America for the full year. So we expect to continue to outperform the market in 2021 and to have a solid market and significant outperformance of the market. We have done that for the last nine years at an average of 900 basis points, and we will continue to do so in 2021. When you're talking about the IHS forecast for 2021, IHS is forecasting a growth of roughly 14%. So this means production that goes from the 74, 75 million vehicles this year to roughly 85%. As you know, Jeff, very well, we tend to be a little bit more conservative than IHS. So we're forecasting a 10% growth in 2021 and our outperformance on top of that. One thing to stress is that when you look at the production vehicles, the forecast is to get back to the 2019 level in production, probably in 2022, 2023. We think we will get there this year.

Okay, and then just on the incrementals, certainly very impressive, 35% plus, and despite still quite a bit of headwinds in IP and CCT, can you just talk about how much of the temp cost, I think you have $40 million in 2020, how much of that comes back? And then beyond just the carryover savings, how much additional restructuring savings do you expect to get to kind of support that incremental? Thanks. Absolutely, Jeff.

So we have achieved, executed $105 million of cost savings in 2020. And we expect that there is going to be a significant carryover impact in 2021, roughly something like $40 million. And then obviously there's going to be some reversal of temporary cost cuts such as executive compensation and other discretionary costs that are going to come back in the amount of 25 to 30 million. So net-net 10 to 15 million incremental savings in 2021 compared to 2020. Okay.

And then just to follow on that, it just seems like – Is there a big just productivity number that you're looking at over and above just the restructuring costs?

Yeah, absolutely. We expect to, in addition to those cost action benefits, we expect to execute on our natural and normal productivity that we get every year. And we're pretty strong on this. We had in the fourth quarter more than 200 basis points And that productivity is basically coming from sourcing activities, and we know we have a lot of opportunities in all three segments, short-flow productivity, as well as some VAV activities in IP. So, yeah, the pipeline of cost reduction and efficiencies for 2021 is pretty full.

Our next question comes from one of Scott Davis of Milius Research.

Hey, good morning, guys. Good morning, Scott. Hi, Scott. I think you mentioned 42 EV platforms that you got on. I don't know whether it's this quarter or this year, but what's the hit rate? Is that something you can put in percentage terms for us?

Yeah, it's very high, Scott, and it's higher than our current market share is. executed in the production. So this is very positive because this will feed us continuous market share gains in the year to come. And bear in mind that our market share today worldwide is roughly 26%, and we are much higher than that in our awards won in EV.

And just a quick one, Scott. our market share increased of UC versus prior year. And what was really interesting is that it increased in every region, even in Europe where we are in a more mature position.

Okay, good. And then, you know, you've got a pretty big CapEx increase and buyback that you mentioned. Is M&A kind of in the mix? I don't think you said anything in prepared remarks, but maybe you did. But if you can talk about that.

Yes, Scott, thanks for the question. Yes, it is. And this is why I stress the ample capital that we have. We have the ability to do everything that we said. We have the ability to put cash for our growth investment, and we are increasing to roughly $100 million of CapEx. Second, aggressively, but at the same time diligently and with rigor, pursue acquisitions. in close to core our businesses. And this goes across all the three value centers, all three businesses. And we are actively cultivating right now. And we also have the cash. We are fortunate to have the cash also to increase our dividend by 30% and commit to share repurchases. We want to get our cash to sweat, Scott.

Okay. Sounds encouraging. Well, good luck, guys. I'll pass it on. Thank you.

Thank you. Our next question comes from one of Nathan Jones of Stifel.

Good morning, everyone.

Hi, Nathan. Good morning, Nathan.

Just wanted to talk a little bit about inflation and price costs. We're obviously seeing steel prices here go up pretty steeply. And historically, that has caused, you know, a few issues on the margin side, particularly in MT, you know, where I understand a lot of your contracts there are fixed price so you can protect your intellectual property. Can you talk about what your expectations are for price cost there, particularly in MT, but also in IP?

Sure. So in terms of price cost, you know, in MT, we're in a situation where every year we have to give price to our customers. That's part of our contract. I would say, though, that we are able to negotiate with our customers so that the impact is usually less than the average for the market. For 2021, we expect similar pressure than we had in 2020. But we're going to have significant improvements coming from both net productivity. In MT, it'll be more than 150 basis points. And then from volume, obviously, as Luca mentioned. I think in general... In the other businesses, we're able to get price in IP and CCT, so that should be okay. From a cost standpoint, we are seeing increases in commodities, especially steel. And here there are a couple of things that we're doing. First, we obviously try to mention to our customers and negotiate with our customers because we have this increase in cost. The other thing also is we're driving a lot of supply chain savings, especially in the resourcing of some of our steel to China and to Turkey, which will help us reduce the cost of this commodity. Finally, we're also booking in advance steel. So right now we're booked until May. And so that will ensure that we are a little bit protected from the current increases.

Okay, thanks for that. I wanted to follow up with just some questions around your plans on footprint reduction supply chain. I know you've made some changes to the footprint and probably don't want to be too specific about the ones to come, but maybe any commentary on that. And also supply chain. I know you guys have talked about having far too many suppliers. Where are you in the process of rationalizing the number of suppliers and leveraging the amount of spend with each supplier?

Okay. Nathan, the footprint, we keep on progressing the footprint across all the three businesses. As you know, also in motion technologies because of the acquisition that we made a couple of years ago. So there are action on the footprint on that front. When it comes to CCT, we have action on the footprint of CCT as well. And also with the transfer of some product lines. And on IP, we successfully concluded that finish our first move in Europe with and we are progressing nicely on the one in North America, and there are more to come, another two or three that we are expecting to execute in 2021. When it comes to the supplier rationalizations, I would say we started well, but we are at the beginning. So I think that there are, as I said, there is runway there, and Nicola and his team are doing an excellent job already on the front.

Is there a specific target you have for supply chain savings maybe on an annual basis over the next few years?

Yeah, so we don't really disclose a number, but I would say this. In 2020, especially in IP, we reached the highest ever supply chain savings. And as Lucas said, we're just scratching the surface. So we're driving for sure in 2021 higher numbers that we have executed in IP in 2020. And we're also working to deploy the same methodology and the same tools in CCT and in MT.

Okay, thanks very much. I'll pass it on. Thank you, Nathan. Thanks, Neda.

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

Yes, good morning.

Good morning, Andrew. Good morning, Andrew.

So very interesting, you know, very robust increase in dividends. And I was just thinking, how should we think about that, you know, in terms of your capital allocation going forward and the dividend policy and what kind of signal are you trying to send us? I mean, clearly, I think Luca said that you feel very confident about your cash flow generation. But how do you prioritize dividends versus buybacks? How should we think about that balance? Thank you.

Okay, so let me start, and then, Emmanuel, you can build on that one. When it comes to capital deployment, the priorities are very clear. The money goes to organic investment first and foremost. This is where we know our business very well. We get the highest return. This is the best value creation for our shareholders and for all our stakeholders. Second, and if you think about it, in 2021, we are increasing that by roughly 60%. and 90% of that capex is really in growth, in innovation, and in productivity. Only 10% of that is really maintenance. Second, it goes into acquisitions, close to the core, and as I said, it's across all the different businesses. We are pursuing aggressively, but diligently, with rigor. We don't want to do anything stupid over here. And then third, Lastly is really return to our shareholders in dividend and share repurchases. And we are in the lucky position to have all the capital to do all of that. Emmanuel?

Yeah, and I think specifically on dividend, what was important for us was to maintain our yield of 1%. And so we can still put up a really good increase in terms of dividend and do that and then do $50 to $100 million in repurchases and do also the acquisitions that we need to do while investing in growth for the future. That's very helpful.

The second question on restructuring, and I know people have asked you about the numbers, but just philosophically, you were in a very unique position to have started restructuring into COVID, and our numbers indicate that you were among sort of top people in the sector in terms of taking the cost out through COVID. But I was just wondering, given that you had the head start, how has the plan evolved throughout COVID, and what sort of operational changes will you make at the other end of COVID, right? Because I'm sure COVID has changed the big thinking, right? So can you just Walk us through how has your thinking changed over the past 12 months as you've executed on your cost cutting. Thank you.

Okay. So let me start. And, Emmanuel, if you want to build on that one. Well, two sides, Andrew, on this one. One thing is the structural cost. COVID has helped us execute and challenge those fixed costs and making some of those fixed costs variable and reducing our cost structure, reducing our break-even points. And this is something that we are challenging the business to keep in mind all the time as we are recovering, as the economy is recovering. Now, when it comes on the direct labor, when it comes on the operational cost, it's really in trying to make it as flexible as possible. So in terms of if it is running the shift and maybe is using shift mechanism that are using the same workforce for a longer weekend. So flexibility and agility has been really the rule of the game on the direct cost.

And I think part of the efficiency, Andrew, is also for us to always look at the way we're organized and the way we're structured and our processes so that we can possibly do more with less. And so we have done, as you mentioned, a lot of work in 2020, and we'll continue to do that work, maybe not to that much of an extent, but we'll continue to do the same work in 2021 and beyond.

Yeah, thank you. Your cross-cutting was very, very impressive. Thank you. Thank you, Andrew.

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

Thank you. Good morning, everybody. Hi, John. Good morning, everyone. So I want to know, what are your oil and gas customers saying with respect to prospectively boosting E&P CapEx this year or even, say, next year, like in terms of their – given the rising price of oil. If I remember correctly, I don't think you have great visibility into that, but maybe there is some commentary you can add. And the other sort of part of that question is, you know, given the advent of federal fracking restrictions, does that really have any kind of material impact on spending plans for areas that touch you? So, like, how important, just to remind us, is fracking to ITT? I don't think it's that important, but I did want to kind of... If you could just give us a refresh on that, that would be very helpful. Thank you.

Sure, John. Thanks for the question. So when it comes to the visibility on the investments, we continue to see investments shifting to the second half of 2021. And also when we are looking at the funnel of the opportunities that we see coming up, we see that the funnel has increased in the last quarter in Q4 versus what we had at the end of October. And also when we close January, the funnel has increased in January over December. But that increase is not really coming from oil and gas. That increase is coming more from generally industrial and petrochemical. So we don't see the opportunities in the funnel coming. So, having said that, I can tell you that the activity is bubbling up. I was talking to Hamdi, Hamdi Salem, our head in the Middle East, and he was telling me that things seem to be moving over there, where we are making an investment actually in our facilities in enlarging our test stand over there. Going back to the second part of the question, which is the fracking, fracking is not an area where we are really playing. in terms of ITT, with the exception of our oil and gas connectors. But before COVID, we made an agreement with an oil producer for a solution with our twin screw pumps, our multi-phase pumping, an exclusive deal where they will be able, with our solution, to eliminate completely the flaring and this is an important initiative for the oil producer these days. You know the pressure that they are under the ESG.

Okay, so I think that answers that. And then out of curiosity, I don't know if I caught this, but kind of the impact of, say, the raw mats. Emmanuel, I know, touched on it a little bit. The raw mats and the component price increases. You kept your $10 million to $15 million, right? of restructuring net savings. I think you had mentioned that same number in 2021 last quarter. Is the messaging here that the raw mat price increases components that you're seeing, you're going to be able to more than adequately raise your own prices or, you know, you hedge. I know you do forward buying, that sort of thing. And therefore, it is not dragging of any consequence. And I apologize if you had already sort of mentioned that previously in the discussion.

So commodities is a drag, but it is offset by productivity and all the mitigation actions that we're taking, such as the booking and such as the resourcing to low-cost regions. We expect for the four-year to have a commodities impact of maybe 20 to 40 basis points in terms of margin. But as I said, we have strong productivity to mitigate that.

And on the price side, Emmanuel, are you able to slowly bleed in pricing or... modify your project terms or leverage some pass-through stuff that offset the 20 to 40 that's somehow somewhere else in the context of the guidance or, you know, the kind of the waterfall down?

Yeah, so in the case of IP on the short cycle, we're able to, yes, pass on that increase and mostly also in CCT. In the case of MT, it depends. We have some customers with which we have escalators, and it's probably 40% to 50% of our customers with which we have established contracts. And then it is a negotiation, and we intend to make sure that they recognize the fact that our costs are increasing because of commodity, and we'll just do that as a regular negotiation like we've been doing for several years.

Well, I guess with those copper-free pads, you don't have to worry about copper prices rising.

Yeah, that's a very interesting point because we have also been able to decrease our exposure to copper. And so I'll give you just a quick stat. In 2015, our copper-free content was 7%, and we're now to 50% of our brake pads that are copper-free. So that's also a way to mitigate from commodity inflation.

I'm heading out to buy those copper-free pads now. Thank you.

We'll be taking orders. Our next question comes from one of Joe Ritchie of Goldman Sachs.

Hey, good morning, guys, and welcome, welcome, Mark.

Good morning, Joe.

Good morning, Joe. Hi. So, just maybe my first question is touching on motion tech margins for a second. I know you guys have called out greater than 100 basis points of margin expansion in 21 for each of the segments. But, you know, the margins in 4Q were really strong. And I think you guys highlighted, you know, high volume productivity. So, I'm just curious. You know, is the fourth quarter maybe like a baseline for MT margins moving forward, or was there anything maybe kind of one-timish that helped the margins in the fourth quarter?

So there was not really anything that was one-timer in Q4. What you see in Joe is the fact that we really acted early on our fixed cost structure, and now that volume has increased. we were able to really benefit from that. And keep in mind that in Q4, volumes increased by 30% for motion tech in auto compared to Q3. So that's a really nice improvement, and we're able to really take advantage of that lower fixed cost structure that we have now. I wouldn't say that this is necessarily the baseline for 2021. But I think that we expect to show a triple-digit improvement in 2021 compared to 2020. Got it.

No, that makes sense, Emmanuel. I guess maybe asking it differently, if we did have similar scale, call it $350 million or so in revenues on a quarterly basis, is it reasonable then to assume, given the fixed cost leverage that you're getting, that the margin should be comparable to what you saw in 4K? No.

So I think that there definitely will have a leverage impact. Just keep in mind that some of the margin expansion, and especially gross margin expansion, we'd like to reinvest in some of our initiatives such as the SmartPAD, the EV brake pad in China. So we're definitely going to see a really large leverage and an improvement into our gross margins. but some of it is going to be compensated by some strategic initiatives.

I think if I can build on that one, it's exactly right. In 2020, we kept on investing in the business, but as you can see, in 2021, we will invest much more. So it's going to up roughly by 60%, and a lot of that is going to be in MT.

Got it. No, that makes sense. And maybe if I could sneak one longer-term question in. The penetration that you're seeing in EV is impressive and congratulations on that. I know that some of the questions that we get at times as it relates to the longer-term opportunity for you on the friction business is that shift to EV and whether that has any structural implications on your aftermarket business. So, Luca, maybe if you can elaborate now that you're seeing all these orders come through. I'm curious, how do you see that affecting your business longer term, and how are you guys involved in trying to set the standard for electric vehicle brake pads?

Sure. First of all, when you look at our aftermarket, you're talking about roughly 30% to 35% of our business is aftermarket, and the split in half between original equipment and independent aftermarket. is exclusively today the European. So that's just to contextualize it. Now, thinking about the impact of EV in the aftermarket, you have to think about all the car park and how impactful would that be in terms of time. And it will be... very little impact at least for the next 10, 13 years, Joe. Think about it. Our full electric vehicle last year was probably 2 million vehicles. They're projected to be at the high speed, roughly more than 10, 12 million vehicles in 2025, 2026. So think about how much they're going to get impactful in the car park. Did I answer your question, Joe?

Yeah, you did. Thank you very much and have a great weekend.

You too, Joe.

Take care, Joe.

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

Hi, good morning, Luca, Manuel, Mark.

Good morning, Damien. Ciao, Damien.

Ciao. Had a follow-up question on MT. Emmanuel, you mentioned that you are expecting double-digit growth in the first quarter, but there's a lot of news out there regarding some component shortages across the automotive supply chain. I was just wondering what kind of impact you'd expect for the business and how that might be weighing on your guidance for the year.

Yeah, so in Q1 of 2021, we don't expect really things to change compared to what we've seen in Q4. You know, Luca mentioned that we have a really strong order book. And so even with the shortages in electronics and other commodities, by the way, we're seeing still our order book that is still staying pretty strong. I think that right now in what we expect, we kind of limited the impact to Q1, maybe early Q2, and we expect things to improve in terms of electronics starting mid of Q2.

Now, if I can build on this one, Damien, we are in fact, first of all, the numbers that you have seen and we have communicated with you today are already taking into consideration these difficulties on the supply chain. You can imagine that the impact that we have from the supply chain is on two aspects. One is volume reduction that is already in the numbers. We are talking to our OEMs, to every single plant, looking at every single platform, and we are adjusting our scheduling accordingly. So that is impact number one. The second impact is, of course, because of all these changes that are much more right now, the plant are not running as efficient or as effectively as you can imagine. And for that reason, because you've got more changeovers, as an example. So supply chain is gonna be a challenge to manage in 2021 in automotive.

Okay, great. That's really helpful commentary. And Luca, you had also mentioned earlier, flaring gas and how IP's products are addressing that made me think a little bit about the current situation in Texas with the power outages and a lot of refineries and petrochem plants shut down. Just wondering if there's any potential impact to the business that we should be thinking about and, you know, wondering to what extent there actually could be some aftermarket business to be had as a result of that once those facilities come back online.

Yeah, Damien, this is Emmanuel. So we're seeing a little bit of impact in February in some of the deliveries. Some of our customers are not able to take some of the deliveries, but we think that we're going to be able to get that back in March. I think that similar to what had happened in Houston a couple years ago, If there are opportunities for parts in aftermarket, we'll jump on those and we'll make sure that our salespeople are at the forefront with our customers.

Okay, great. Thanks a lot.

Thanks, Damien.

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

Thanks. Good morning, guys.

Good morning, Brian. Good morning, Brian.

I was hoping we could drill down a little bit more on your motion tech growth outlook. If we account for friction OE momentum, even taking the more conservative stance on global production, the comps you have across the platform and FX talents, it seems like low double-digit growth is a bit conservative. I was hoping you could provide a little more color and maybe parse out what you're looking for in terms of growth by friction, OE, after markets, and then non-friction.

Okay. So just let me start, maybe Brian, and then Luca can add some color. So keep in mind that we are taking, we're not taking exactly the IHS number, as Luca mentioned. You know, IHS shows an improvement of 14% in 2021. We're taking a slightly lower number. So some of that may be that. And I think that IHS has been recognized to be a little bit optimistic at times. So I think that this is why we're a little bit more conservative on that front. I think that there is, like in 2020, there is a lot of volatility in the market. So I think that we are expecting a pretty strong quarter in Q1 for motion tech. And I think that we'll see if that maintains in the next quarters. We talked about the semiconductor difficulties and other commodities. So we'll just play it by ear. But I think that right now we expect motion technologies to post a really strong growth in 2021.

And following up on that, you were asking about the aftermarket as well, Brian. The aftermarket improves substantially in Q4. And in terms of expectation for the aftermarket in 2021, is to grow high single digit to low teens. That's the expectation for the aftermarket in 2021.

Okay, appreciate that. And you mentioned for CCT getting back to pre-COVID margin within two to three years. So if we rough that out to 450, 500 basis point lift versus the trough in 2020, how should we think about the splits between contribution from volume recovery and the self-help actions you have underway?

So for the moment, this is mostly going to be driven by productivity because we don't expect aerospace to come back before two to three years. So, you know, CCT, as we said from the beginning, was hit pretty heavily by aerospace. Aerospace represents more or less 25%. of CCT's revenue and also oil and gas. And as a result, we went really heavy in restructuring and cost cuts. And so I think that we think that there's more in the pipeline in addition to productivity. You know, when we worked the shop floor with Luca in October, we saw a lot of opportunities in Valencia, for instance. We have many opportunities also in some of our North American facilities. So mostly it's going to be productivity, and hopefully by the third year, we expect aerospace volume to start picking back up a little bit.

Got it. Thanks again.

And ladies and gentlemen, that was our final question. I'd like to turn the floor back over to Luca Savi.

Thank you, Maria. Just a couple of last words. During 2020, we had clear priorities. We focused on the health of our people, which enabled us to execute, deliver for our shareholders with an outstanding cash generation, and deliver for our customers, which translated in a winning share in several markets that we operate. So we won in the down. For 2021, the focus will be to win in the up. and we're executing flawlessly in the recovery. We keep on investing in growth, putting our cash to work, and having MT, as I said, as a springboard for growth. I want to thank you for joining this morning, and stay safe, and I really hope to see you soon.

And thank you, ladies and gentlemen. This does conclude today's call. You may disconnect your lines at this time, and have a wonderful day.