ITT Inc.

Welcome to ITT's 2021 Second Quarter Conference Call. Today is Friday, August 6, 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 0. We ask that you please pick up your handset to allow optimal sound quality. It is now my pleasure to turn the call over to Mr. Mark Macaluso, Vice President, Investor Relations. You may begin. Thank you, Christelle, and good morning.

It is my pleasure to welcome you to ITT's second quarter 2021 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 call will cover ITT's financial results for the three-month period ending July 3rd, announced yesterday evening. Today's remarks may contain forward-looking statements, including comments relating to company performance, strategic priorities, business mix, market conditions, and the effects of COVID-19 on ITT, which are subject to certain risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual results may vary materially due to, among other items, the factors described in our 2020 annual report on Form 10-K and other recent SEC filings. ITD is not under any and expressly disclaims any obligation to update forward-looking statements, whether as a result of new information, future events, or otherwise. Except where otherwise noted, the second quarter results we present this morning will be compared to the second quarter of prior year and based on non-GAAP financial measures. These adjusted 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 expected for the full year 2021 are detailed along with the reconciliation of such measures to the most comparable gap figures in our press release and presentation both of which are available on our website before we begin i'll provide a brief overview of our second quarter gap results revenue increased 34 percent to 692 million dollars Segment operating income increased 206% to $114 million, which equates to segment operating margin of 16.5%. Reported earnings per share decreased 15% to 45 cents, driven primarily by a $28 million after-tax loss on the divestiture of Intelco Management LLC, formerly a wholly owned subsidiary that holds legacy asbestos liabilities and related insurance assets. as well as prior year income tax benefits and increased corporate and environmental costs. With that, it's my pleasure to turn the call over to Luca, who will begin on slide number three.

Thank you, Mark, and good morning. I want to first thank you, our stakeholders, for your continued support and investment in ITT. I also want to thank the nearly 10,000 employees at ITT that continue to demonstrate the resilience that makes ITT a trusted partner for our customers and the communities in which we operate. We are all focused on ensuring ITT delivers on its commitments hour after hour, whilst taking care of each other, our families, and our customers. This has been a pivotal quarter for ITT. On July 1st, we divested the subsidiary that holds all of our legacy asbestos liabilities to a portfolio company of Warburg Pincus. Importantly, ITT is indemnified from any further responsibility for all pending and future legacy asbestos claims. This transaction follows the successful transfer of our U.S. pension liability in October 2020 and will allow us to focus more on growing the core business organically and through acquisitions. We are now beginning the next chapter in ITT's history. On the operational front, over the past few months, I've had the privilege of meeting our teams in person at our sites in Italy, California, the Netherlands, and the Northeast. I continue to be encouraged by the progress we are making, by the opportunities that remain, and by the commitment and the passion I see from our workforce. Before reviewing our results, let me talk a little bit about ITT's sustainability efforts. In the coming weeks, we will be releasing our 2021 sustainability report supplement, which will show our commitment to environmental, social, and governance initiatives. It is clear that while we've made significant progress in 2020, despite the impact of the pandemic, there is still more that we can do. Our employees' efforts during the pandemic to take care of each other and our customers have strengthened our resolve to continually improve our ESG practices, and this is what we will do. Some of our accomplishments, which you can soon read about it in the supplement, include a 25% reduction in greenhouse gas emissions and a 25% reduction in workplace incidents. Further, we maintain an A rating for our ESG profile as measured by MSCI, a recognized leader in global ESG assessment. Now, let's review our results for the second quarter, beginning with sales. Friction continued to outperform global auto production growth. In fact, the outperformance we drove this quarter was significantly above our historical average. The auto businesses in MT grew organic revenue nearly 80%, and MT's revenue exceeded pre-COVID levels from 2019 once again this quarter. More importantly, we continue to win key awards in both conventional vehicles and on new electric vehicle platforms, which will fuel future auto performance. This quarter, we were awarded content on 10 new electric vehicle platforms, seven of which were in China, and two on key strategic platforms in the growing North American market. We also continue to differentiate ourselves from the competition. In July, frictions at a ceramic prepet sold in the aftermarket were ranked the highest among five competitors according to EDAC, Europe's largest motoring association based in Germany. Our brake pads have been acknowledged for their outstanding safety and durability and received best-in-class ratings for wear resistance and braking distance. This is a testament to the supplier excellence and innovation of the friction team. Let's get back to the quarter. Building on the first quarter momentum, our connectors business in connect and control technologies grew sales by 17% organically. after 8% organic in Q1. We saw continued strength in the North American distribution channel, and sequentially, industrial connectors in Q2 grew 6% versus Q1 due to distribution strength worldwide. We also drove 8% organic revenue growth in industrial process, driven by strong pump project deliveries, which were up 52% organically in the quarter due to strength in the chemical and oil and gas markets. We achieved this by remaining focused on serving our customers and ensuring we commission their projects on time, despite significant supply chain disruptions. Turning to orders, I am energized by the growth our commercial teams generated this quarter across all three segments. In total, we drove 47% organic orders growth across ITT, with order levels surpassing 2019, positioning as well for the second half of the year and for 2022. First, Motion Technologies grew orders by 76% organically, driven mainly by auto. And we also saw a strong performance in rail, which grew over 20% organically. Second, in industrial process, orders were up 18% organically and up 7% sequentially, driven by continued recovery in our short cycle business, where orders grew 24% across parts, valves, and service. Our pump project orders were relatively flat year over year. However, we are increasingly confident that project activity in the funnel is strengthening. and we expect to successfully leverage this momentum in the second half. Finally, in CCT, orders were up 47% organically, driven largely by industrial connectors and aerospace components. As we mentioned last quarter, we saw some positive signs in commercial aerospace, which we expected would start to pick up in Q2, and we are seeing that momentum in orders today. From a profitability perspective, despite increasing pressure from commodity costs and supply chain disruptions, we delivered nearly 400 basis points of adjusted segment margin expansion, with triple-digit margin expansion in each segment. This was a result of the incredible growth in volumes I mentioned earlier and the team's ability to generate productivity net of inflation while successfully navigating challenging market conditions. This was aided in part by the actions we took in 2020 to reduce our structural costs. As a result of the revenue growth and margin expansion, ITT delivered adjusted earnings per share of 94 cents, growing 65% and surpassing our pre-COVID adjusted EPS levels in Q2 2019. Given the strong first outperformance, and our confidence in ITT's ability to outperform, we are again raising our outlook for 2021. We now anticipate organic revenue growth will be 8% to 10% for the year, a 300 basis point increase on both the low and high end of our already increased guidance from the first quarter. This will be driven by the strength in friction and short cycle orders growth in both IP and CCT. The increased sales volume and strong productivity expected in 2021 will generate adjusted earnings per share in the range of $3.90 to $4.05 at the high end, which equates to 22% to 27% growth versus prior year. This is an $0.08 improvement at the midpoint after a $0.30 increase after the first quarter, and this puts ITT on pace to comfortably surpass 2019 adjusted EPS despite significant inflationary pressure. Let's turn to slide four to talk further about the second quarter results. From a top-line perspective, motion technologies delivered a solid performance driven by strong growth in the OE business and continued share gains despite the global chip shortage and supply chain disruptions. our friction and Wolverine OE businesses grew over 60% organically. As I always do, this quarter I traveled to a number of our facilities, including our world-class friction plant in Bargia, Italy. Here, I saw the team's engineering expertise on full display, which will enable us to continue winning an outsized share of global EV platforms. Our continued investment in automation in all our plants and hour-by-hour management allows us to continually meet customer demand despite constantly changing production schedules. And we continue to invest in and develop new technologies to address the needs of a new and more environmentally friendly automotive braking system. In CCT, we drove nearly 19% organic revenue growth in industrial connectors, mainly through distribution, continuing the momentum we saw in the first quarter. Demand in commercial aerospace is increasing, exhibited by the nearly 70% growth in aerospace orders. The book to bill in CCT was an impressive 1.18 for the quarter, which positions us well for the future. Now, moving to operating margins. Our focus on operational excellence produced 250 basis points of expansion in Q2 at the ITT level and 390 basis points at the segment level. By segment, MT grew margin 660 basis points, connecting control 230 basis points with an incremental margin of 37%, and industrial process grew margin 100 basis points to nearly 15% once again. The strong performance was a combination of higher sales volume, commercial actions and productivity, offset by raw material inflation, an unfavorable mix given the growth in pump projects, and continued investments for growth, which are critical to sustain ITT's outperformance. Regarding raw materials inflation, the impact this quarter was approximately 240 basis points, which was higher than what we expected. And whilst we are deploying pricing actions with our customers based on current prices for material purchases for the remainder of 2021, we expect this phenomenon will have a significant impact in the second half. Free cash flow for the quarter, was impacted by the sale of our legacy asbestos liabilities. Excluding this one-time non-recurring item, adjusted free cash flow was $131 million. The decline compared to prior year was the result of higher operating income generation in the segment that was more than offset by strategic investments in working capital to support growing customer demand. Wrapping up, our ITTs around the world deliver another outstanding performance in Q2. Organic growth was strong across all three segments, and we converted the higher sales at good margins. We generated over 400 basis points of productivity while investing for future growth and successfully navigated challenging market conditions. And our nearly 50% organic growth in orders positioned ITT for a strong second half. Let me now turn the call over to Emmanuel on slide 5 to discuss the segment performance in more detail.

Thank you, Luca, and good morning. Motion Technologies Q2 organic revenue growth of 64% was primarily driven by strength in OTO. As you know, the second quarter of last year was down significantly due to the pandemic. Friction continued to outperform global auto production by a very wide margin. And from an operating standpoint, our OE business performed very well with 99% plus on-time performance. This was a key reason MT's revenue eclipsed pre-COVID levels in the second quarter of 2019 by 8%. The strong orders growth in MT this quarter was a combination of both auto and rail, where we continue to gain share. Segment margin expanded 660 basis points versus prior year to 18.8%, mainly due to higher volumes and productivity offset by the impact of higher raw material costs for steel, tin and copper. As we indicated last year, MT's margins declined sequentially in the second quarter given the increasing commodities pressure. However, MT delivered almost 30% incremental margin in spite of these headwinds. Wolverine sales growth was over 60% driven by OE shims in North America and Europe and in ceilings. While KONE grew by double digits organically, Margins in Wolverine, Coney, and Acton were all double digits in the quarter. For industrial process, revenue was up 8% organically. This was driven partially by easy prior comparison stemming from steep declines in project shipments, which resulted in over 50% revenue growth this quarter. We also saw minor short cycle declines driven by lower service sales and flag growth in baseline pumps due to the materials shortage. As we have indicated, given the order trends we see across IP, we continue to expect the short cycle businesses to accelerate in the second half. From an end market perspective, growth was spread across general industrial, oil and gas, and chemical markets. Turning to orders. IP grew 18% organically and 7% sequentially due to the short cycle, namely parts, valves, and service. Our daily order rates continue to be strong into the third quarter. Orders in all product categories except baseline pumps were above 2019 levels. And the month of June was our largest month of project orders since 2015. We believe these positions as well for the remainder of 2021. IP's margin expanded 100 basis points to 14.7% with an incremental margin of 24%. This was partially impacted by unfavorable mix given the higher proportion of project versus short cycle sales. We expect the mix to improve from here as short cycle continues to recover. Lastly, in connect and control technologies, we turned the corner with incremental margins of 37% this quarter. This was the result of continued volume leverage and strong productivity despite inflationary headwinds and continued declines in commercial aerospace. While OE production continues to improve, our largest aerospace customers are managing through elevated inventory levels on key platforms, which will delay a significant recovery in aero components demand until 2022. Similar to the rest of ITT, orders growth was incredibly strong, driven by our connector business with continued North American distribution strength and growth in aerospace OE and aftermarket. the book to bill was largely above one and backlog was up 16% compared to year end 2020, which again positioned us well heading into 2022. Before we move on, just a few additional comments on EPS for the quarter. As you can see on the Q2 adjusted EPS walk on slide 11, the year over year comparisons were negatively impacted by prior benefits related to environmental, temporary cost actions, and CARES Act credits. Partially offsetting these items was a roughly $0.03 benefit from foreign currency, consistent with our outlook, and a roughly $0.01 benefit from a lower-than-planned effective tax rate of 21.5%. Let's turn to slide 6 to discuss Tar asbestos liability sale further. On July 1st, ITT divested 100% of its equity of a subsidiary that holds legacy asbestos liabilities and related insurance assets to Delticus, a portfolio company of Warburg Pincus. At closing, ITT contributed $398 million in cash and Delticus contributed $60 million in cash to Intelco. As a result of the transaction, ITT removed all asbestos obligations, related insurance assets, and associated deferred tax assets from our consolidated balance sheet as of the second quarter. The benefits of this transaction include the indemnification for all legacy asbestos liabilities and stronger free cash flow generation in the absence of asbestos-related payments that we previously estimated at 20 to 30 million per year on average over the next 10 years prior to the divestiture. Additionally, the transaction frees up management time and resources to focus more on growing the core business and executing other more strategic initiatives, including ESG and M&A. Coupled with our successful US pension plan transfer executed in October 2020, we are well positioned to grow with a flexible balance sheet and without the risk and uncertainty of managing these legacy liabilities. Let's now turn to slide seven to discuss our end markets and the updates to our full year outlook. As we saw in Friction's results, global auto production is increasing, albeit constrained by the global semiconductor shortage which is causing inventory levels to remain low. And while we expect demand will remain strong throughout 2021, the impact of higher raw material prices will weigh on margins and adjusted EPS during the second half. The growth we're seeing in IEP orders is mainly in short cycle. On projects, however, we continue to expect that large project spend, particularly in oil and gas, will not fully recover until 2022. In the meantime, we're seeing continued momentum in weekly run rates in our short cycle businesses in industrial process and connectors, which we believe will drive organic revenue growth to a new range of 8% to 10% for the year. Our assumption regarding commercial aerospace is that a substantial recovery will not occur until early 2022, given the level of inventory at our largest OE customers. However, we see encouraging signs in orders as production levels continue to increase. Our outlook for adjusted segment margin remains at approximately 17.1% at the midpoint. We expect a pronounced impact from raw material inflation, mainly in motion technologies. However, Our teams are driving commercial actions and additional productivity to minimize the impact. We're planning for raw materials to remain at these elevated levels throughout 2021. As you will see on slide seven, our revised guidance assumes the incremental impact from this trend will be $0.09 at the high end for the remainder of 2021. Our revised adjusted EPS guidance reflects an $0.08 improvement at the midpoint of our range, eclipsing 2019 levels and our previous high end. The net impact of all other items is roughly $0.01 benefit to four-year adjusted EPS, including a slightly lower than planned effective tax rate. Foreign currency and other items will be a minor benefit compared to our previous guidance. and we continue to expect a 1% reduction in the weighted average share count given our share repurchases to date. Additionally, we're raising our adjusted free cash flow guidance by $5 million at the low and high ends of our previous range to reflect the higher operating income generated in the first half, offset by further working capital investments to support future growth. especially given the supply chain disruptions we are experiencing today. In summary, we are again raising our outlook for 2021 across sales, earnings, and free cash flow. And with this raise, we now expect to eclipse 2019 levels in terms of adjusted segment margin and adjusted earnings per share. Let's turn to slide eight, to quickly look at the components of our revised 2021 adjusted EPS guidance. As you can see, the majority of the improvement in adjusted earnings per share is operational in nature. The higher volumes will likely be partially offset by incremental headwinds from rising raw material costs, which we have already discussed. The remaining changes to our outlook are rather immaterial. Before I turn you back over to Luca, I want to share some details on what we're seeing thus far in the third quarter. From an end market perspective, the trends we saw in the second quarter have remained largely consistent throughout July. Auto and the short cycle businesses in IP continue to perform well, and CCT remains comfortably on path to recovery from both a sales and margin perspective. On the other hand, Our outlook reflects increased commodity pressure, and we do not see any near-term improvements related to the supply chain. Organic sales growth is expected to be in the mid-teens range, driven by growth across the portfolio and led by MT's strong performance. IP and CCT should both improve to approximately high single-digit organic growth, driven by short cycle. segment margin should be approximately flat sequentially to Q2 and above prior year even with the significant raw material headwinds we anticipate primarily in MT. This negative impact on MT's margin will largely be offset by margin improvements in CCT followed by industrial process. Despite the margin challenges in Q3, we still expect all three businesses to be up over 100 basis points for the four-year, which will eclipse ITT's segment margin for 2019. The combined impact of higher sales and strong productivity will drive adjusted earnings per share growth in the low to mid-teens. With that, let me pass it back to Luca for closing remarks.

Thanks, Emmanuel. ITT continues to execute on its strategic priorities to position the company for long-term success. The actions we took to eliminate our legacy as best as liabilities will allow our teams to drive better growth in the core and up our game in capital deployment. We are now even more laser-focused on growing ITT organically and through acquisitions, while funding high return growth investments given our capital flexibility and strengthen cash flow profile. We continue to outperform across all our businesses, and we see encouraging signs in our orders growth, which we position as well for the remainder of 2021, 2022, and beyond. And the segments continue to drive strong cash generation through increased income and effective working capital management. The second half of 2021 will be challenging, given the supply chain disruptions, commodities pressure, and emergence of COVID variants around the world. However, I'm confident in ITT's ability to navigate these headwinds effectively and drive growth and profitability while leveraging our optimized cost structure and doing it all in a safe, sustainable, and efficient manner. As ever, it has been my pleasure speaking with you all this morning, and we will happily take your questions now. Christelle, 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 1 on your touchtone phone. If for any reason your question has been answered, you may remove yourself from the queue by pressing the pound key. Again, we do ask that while you ask your question, you pick up your handset to provide optimal sound quality. Please limit your questions to one question and one follow-up. Thank you. Your first question is coming from Jeff Hammond, with KeyBank Capital Markets.

Hey, good morning, guys. Good morning, Jeff. Good morning, Jeff. Yeah, so I just want to get a better feel for sequential margins in the segments. It sounds like MT maybe is under a little bit more pressure, and then you get mixed benefits in the other two segments. Is that the right way to think about it?

So MT is being impacted by raw materials. And I think that if you look at between Q1 and what happened in Q2, there's definitely the impact of those raw materials inflation into Q2. And this is going to go in accelerating in Q3 and in Q4 also. And the difference we're going to see in the second half is we're going to see a ramp up of all the pricing and productivity actions that we're going to drive to compensate for those negative impacts.

Just on the pricing, where are you specifically pushing price?

When you look at price, we have a positive price of impact in IP and in CCT. This is where we have the distribution and this is where it's always been done also traditionally. A positive sign that we've seen in Q2 is also price has been neutral for motion technologies. And you know the dynamic in auto, and this is the first time ever that pricing has actually been neutral in motion technologies. Now, of course, we need to work harder to negotiate, to stay at the table and negotiate with all our OEM customers as the material cost base now is completely different level. So we are expecting to get pricing also at MT in the second half of the year.

Okay, great. And then just last one. If you look at the three-point raise in organic growth, would you say that's fairly balanced between the segments, or is that a heavier lean towards MT?

I would say that... Go ahead, Emmanuel, please.

I think, Jeff, it's pretty balanced across all segments. All segments are growing versus our previous expectations. And this is really good news. And, you know, as we discussed, short cycle has been really strong in terms of orders for IP and CCT. So I think that we're going to benefit from that. And then we continue to see really good momentum from an auto standpoint, even though volumes have been impacted by chip shortages.

And if I can add a point to that one, Jeff, and this is not only you see it, not only on the revenue, but if you look forward, you see it in the orders. So the orders are very good on the short cycle. We have good sign on the project as well. We have good sign on the connectors. We have good signs also now on the aero components and, of course, rail and auto. So these orders will feed it.

Okay, great. Appreciate it, guys. Thanks, Jeff. Thank you, Jeff.

Your next question is from Andrew Obin with Bank of America.

Yes, good morning. Hey, Andrew, how are you? Good morning, Andrew. Just a bigger picture question, right? You guys have been very good at sort of managing the downturn, managing the upturn. But given the inflationary pressures both on labor and inputs, Are you guys changing sort of a way you're thinking about approach to cost supply chain processes in a more structural way? Do you think what's happening is more permanent than nature? And if so, you know, how are you guys adjusting the organization? Because execution so far has been superb.

Okay. So let me tell you a little bit about what we're facing from a labor, from an input perspective. So when you look from a labor perspective, there is inflation that we are seeing, but we haven't really, we're not facing really any difficulties in terms of recruiting and finding the labor for our factories or for our businesses. So that's on the labor front. When you look at our inflation from a material point of view, we are really looking at the raw materials. The major impetus in MT, you're really looking at tin, copper, and steel. So there is a limited thing that you can do on this point. One thing that I would say is radically changing, Andrew, would be, one, you're working on your products. As you know, we're moving all our brake pads to copper-free, so eventually we will be copper-independent, and that would be a great feeling, I can tell you that. And also, the other thing is changing the mindset and ensuring that also in friction in most technologies, we go to the table and we work with our OEMs and our customers really to get price. We must get price in this condition, and this is a fundamental change. Did I answer your question, Andrew?

Sorry, I keep hitting the – I haven't learned how to use the mute button still. Yeah, the question was, are you making any adjustments to your supply chain in the view of sort of supply chain disruptions? But it actually sounds you guys are executing quite well, right? Is that a fair takeaway?

Absolutely right. Of course, as you can imagine, not only we're working with our commercial team on the sales front with our OEMs, but our supply chain team is working hour by hour for, of course, to find a new source. But today is particularly in terms of securing the supply because of all the disruption that we have on the supply chain, being one port or being with one supplier. So it's more the way that you're working, which is hour by hour, as we said in the prepared remarks, because this is exactly what's happening right now. Gotcha.

And just a little follow-up. You said something about aero industry having inventory. And I'm just trying to understand because I think some companies highlighted the fact that on defense side, there was some pull forward of activity last year as DOD kept supply chain sort of working in this bad downturn. But we've also heard some companies talk about the fact that air framers have pre-ordered some components last year to also sort of keep the supply chain, what so to speak. Is that what you're referring to in terms of inventory of your customers? Thank you.

Yeah, so for us, as we said, our Aero customers are flushed with inventory. And while they've been consuming some of the inventory, they told us earlier this quarter, in April, that they had so much inventory that they weren't intending to order some of our components until next year and actually need them until 2022. So for us, aerospace for the moment, our customers are full with inventory. We don't expect really that to change anytime soon. On a defense standpoint, I would say that our orders have been pretty good and they've been not only good year over year, but they've been also good sequentially growing, sequentially growing on several high-profile programs and so we expect for the year to be mid-single digits up in terms of orders, and revenue should also be okay.

Your next question comes from the line of Joe Giordano with Cowen.

Hi, Joe. Good morning. Hey, Joe. How are you? Good morning. Just curious, like, It's something we've been talking about, I think, since I've ever covered the company. So, like, what's the box that's right now? What was the impact that it has on the competition?

Hey, Joe, you're cutting in and out. Do you want to try one more time? And if not, we'll come back to you.

Can you hear me better now?

Yes, go ahead.

Okay, so on the asbestos, I think it's an issue we've been talking about for a long time. I'm just curious, like, what was

Joe, we're getting like every third word, so let's move on and then just ping us when you're back and we'll come back to your question when you have a better connection. Crystal, can you move to the next question, please?

Yes, sir. Your next question comes from Scott Davis with Mellius Research.

Hi, Scott. Good morning, guys. I always use a landline. I'm old school. I don't know how to use a cell phone anyways. I know... I'm sorry, presenters.

We have lost him. Your next question comes from the line of Vlad by Strickey with Citigroup.

Good morning, guys.

Hey, Vlad.

Fingers crossed here. I'm doing all right. Fingers crossed here that that lasts for a question or two.

We count on you, Vlad. Please, stay on.

So nice quarter, guys, obviously, and particularly on the order side. So you've now had, I think, 700 million plus in orders each of the past two quarters. So can you talk about sort of your confidence in sustaining these stronger order trends and just given all of the supply chain and logistics challenges throughout the industrial economy, are you seeing any, you know, pull forward or extra ordering from customers looking just to secure supply? Or do you think this is really, you know, sort of end market levels of demand that you're seeing on the order side?

Okay. Thank you, Vlad. Let me answer the question straight and then give you some color. No, this is the strength of the demand and it's the strength of the performance and the way that we work with our customers. So what we have seen in terms of trends in Q1 have been confirmed in Q2 across all the businesses. We saw it in rail. The orders grew sequentially over the year and happened again in Q2. We saw in auto with the awards. across the re-wins, the new awards in Europe, in China, North America, and the new awards in the electric vehicles. We saw it, of course, in connectors. We have seen it. As a matter of fact, if you look at the distribution connectors order in Q2 at roughly $46 million, this is the highest on record for ITT. And the inventory level at our distribution stays low. And then if we look at the short cycle for IP, it's very solid and robust Q2, month after month. So let me add to that how we saw in the month of July. July is really confirming all these trends. So it's not a buildup on the inventory. We don't see the inventory buildup in the auto. We don't see the inventory buildup on the connectors. So it's strength of demand, it's strength of our performance.

And Vlad, let me just add a couple of data on the customer inventory for Odo specifically. So inventory at customers are very low. And this is especially true for North America, where inventory is around 40 days, which is much lower than prior year, much lower than prior quarter, and is not expected really to recover for the four-year on the account of the chip shortage. So not only we're seeing strong orders, but there is strong customer demand pull in auto specifically, and that bodes well for the future.

Okay, that's really helpful. And then just digging in specifically on the IP side of the business, Can you talk a little more about sort of what you're seeing on the project side there? Obviously very strong shipments in the quarter. You know, sort of how long do you have visibility to sort of those strong project shipments? And then what are you seeing in terms of new project activity? Are you starting to see activity ramp for, you know, quotes on newer projects going forward?

So when we look at this project, Vlad, this project usually have, you know, you execute this project from everything between six months to two, three years. So if I think about our largest project recently, which was for Dangota, it lasted more than three years. So we have good visibility on the project for, you know, the next year, a couple of years. Now, one thing which is interesting, though, if you look at the backlog, The backlog for IP, which usually was 60% project and 40% short cycle, has swapped. Today, the short cycle backlog is 55% of the total, while project is 45%. And the short cycle backlog that we have today is the highest since 2015. So now going to the second part of your question, which is how do we feel about the projects? We said last quarter they were warming up, and they did. They warmed up. If I look at the orders for projects in June, it was a very strong month, and July was a strong month as well. To build on that, another dot for you is the funnel. The funnel of opportunities, and we're talking about the funnel of projects, continued to improve. Sequentially, Q2 over Q1 was up 11% and went up two percentage points in the month of July. Year over year, the funnel is still down, but if you take oil and gas out, the funnel year over year is up 22% and is up 37% sequentially versus Q1. All of these are good dots, good signs that make us think that the projects will resurge towards the end of this year.

That's really helpful, Keller, guys. Thanks very much. Thanks, Vlad. Thank you, Vlad.

Once again, in order to ask a question, please press star 1 on your touchtone phones. Your next question comes from the line of Joe Ritchie with Goldman Sachs.

Thanks. Good morning, everybody. Hey, Joe. Morning, Joe. So that landline comment was classic. Hopefully you don't lose me. I'm driving right now. But I think I heard Joe's earlier question. I'm going to add to it. So he asked, I think, about the asbestos and why the impetus, I think, from a timing standpoint was now. I think my question following on on that is really, you know, when you think about, like, what this opens up from a balance sheet perspective for M&A and I'd be curious how you're thinking about prioritization of dollars to grow inorganically.

Sure, Joe. Thank you. So let me frame a little bit briefly our capital deployment during the last couple of years. If you look at the last couple of years, we continue to invest organically in our businesses. We made two acquisitions in 2019. We increased our dividends consistently and more aggressively in the last couple of years. We repurchased $73 million in 2020, the COVID year, $50 million of shares repurchased in 2021. We transferred the U.S. pension liability, and most importantly, we transferred on July 1st all our pending and future legacies as best as obligation. Obviously, as you can imagine, the last period we were on a blackout period. So, This is just to tell you how we saw the capital deployment. It was really strategic to do all of these steps, and now we can really up our game even more focusing both on the organic but on the M&A with much more flexibility. Our pipeline is good. While we were in blackout and previously, we were really working hard to build a pipeline, and I can tell you it's good and presents opportunities across all the three businesses. One thing that we keep on reiterating, though, Joe, is that we will remain very diligent and very rigorous, both strategically and financially. The deals need to add value strategically and financially.

Got it. That's helpful, Luca. And then maybe my follow-on, you guys continue to just keep us updated every quarter on all your EV platform wins. It seems like you're getting some pretty good share, particularly in China. I'd be curious at this point, how big is your EV backlog? And how should we be thinking about that as a percentage of what we should see coming through from a growth standpoint in coming years?

Sure. Thanks, Joe. When it comes to EV, the story today is still very much an award success story. and the EV volumes are still very low. We are projecting, though, that our market share in EV to be substantially higher than our current market share in ICE in 2023, so pretty early. Now, this will not necessarily be very meaningful because also in 2023, the EV vehicles will not be that big a number. But you can imagine as EV adoption accelerates in the next eight, nine years from 2023 to 2030, we will benefit tremendously from already a starting high market share in EV. So I don't know if this helps you to frame it.

Yeah, that's perfect. Thank you. Have a great weekend. Thank you, Joe. Thank you.

We were able to reconnect, and we have Scott Davis with Milius Research.

Yeah, I guess my landline comment was a little premature. Maybe I'll try the cell phone next time and see if that works.

No, next time you will be in the room with us, Scott.

I think that's probably the safer bet. I'll just drive up to your office. It's not that far away. I had asked about on-time deliveries, and I have no idea whether you heard my question or not, but you just mentioned 99% in motion on OE, which is extremely high for the auto side. I mean, I don't know anybody that's anywhere close to that so far this quarter, but would love to just get some color on where you're at in your other major businesses, even if it's just ballpark.

Sure. So obviously, this quarter, we had some impacts due to supply chain issues. And if you look at the impact of all the other businesses, it's probably something around a little bit more than $10 million that we weren't able to ship because we didn't have the raw materials that was needed. A lot of it is in Wolverine, and that's specifically for steel. And then some of it is in IP and also CCT. So overall, not a very large impact. And we're working really hard with our suppliers to make sure that we correct this and arrive at the end of the year with a much better picture.

And if I can build a couple of points that I can build on that one, Scott. First of all, all this backlog is monitored. So we are looking at the aging to ensure that this disruption doesn't impact the customer experience. a lot that's first point and the second point it was i want to recognize all the friction plans because the performance in the oe was 99 plus in barge in termini in ostrava in wushi and in silao all of them and the supply chain did a terrific job to ensure 99 plus on time delivery okay that's really helpful um

And then just switching over gears to the EV side, because I think those questions are fairly relevant. You don't have a lot of cars on the road, but you've got enough cars on the road to see your performance of your brakes and seeing how that aftermarket is evolving. Is it evolving as you've kind of expected? Clearly, I think brake usage is a little bit less than an EV, but the brakes are a little different. Help us understand at least what you're thinking now that you've had some time in the space here, what you're thinking about the aftermarket potential.

Sure. It's probably still a little bit too early, Scott, to draw a conclusion because different OEMs are really adopting different approaches. There are OEMs that are using these brake pads exactly in the same way. There are different OEMs that are really reducing the thickness of the pads, and therefore, for them, the aftermarket probably will continue to persist. It's still probably too early to assess. It's still at the embryonic stage. It's not been matured enough to know exactly how it's going to pan out.

Okay. The aftermarket, I mean. I'll keep asking. I appreciate it.

Thanks, Scott.

Your next question comes from Mike Hollerand with Baird.

Hey, good morning, everyone. Good morning, Mike. So a lot of moving pieces on the motion side, specifically on the friction side. I'm looking for maybe a little longer-term view on how you think this shakes out in the next 12, 18 kind of months. So inventory per your comments is low. A lot of inflation, pricing actions, which seems like a little bit of a change versus history and how frequently you're going and trying to get those. Supply chain challenges are pretty high. Are you going to see pushouts on these numerous project awards, platform awards that you keep getting? How does that timeframe work out? How do you think this whole thing kind of cadences out if you take a little longer lens than just the next six months?

Okay. Okay. So thank you, Scott. Thank you, Mike. When you're talking about the supply chain disruption, Mike, we foresee this to continue for the foreseeable future. So this is exactly the state of mind and the mindset that we have in our plant and in our supply chain. So the management hour by hour that I was talking about will continue for a while. And therefore, it's important that our supply chain keep on working with our supplier closely and also find new supplier to reduce some of these disruptions. That's on the supply chain disruption. From a platform that we won in terms of delays, et cetera, if I look at the impact so far, the SOP delays that we've seen, there has been some. But to be honest, it's been immaterial. When different regions have acted differently, but overall worldwide, we're talking an impact of delay of roughly less than $5 million for a year. So less than that. So I would say it's rather immaterial. I think that what we have seen is that the OEMs have shifted their production to more profitable models, to more profitable platforms. And in some regions, like in North America, this probably has benefited us. And this is also why our outperformance of the market in North America has been very, very significant in this quarter. Thanks for that.

And then just on the connector side, maybe just a little bit, thoughts on sustainability underlying trends here. The short cycle pieces seem like they're doing well. How much of that is just kind of a catch-up from a bottom versus what you think of as sustainable demand as we sit here across those specific end markets?

When I talk to some of our distributors, some of our rep councils, some of our reps in connectors, it's really market demand. And this is confirmed by the low level of inventory that we see in all our distributors on the connectors. The strength of the connectors come on the defense, on the industrial, and we start seeing moving also in the aerospace in Q2. So it's really demand. The inventory level are low. Auto connectors is not a concern at all today. Thank you, Luca. Appreciate it. Thank you, Mike.

Your next question comes from the line of Damian Kairos with UBS.

Hey, good morning, everyone.

Hey, Damian. How are you?

Hi, Damian. Doing well, thanks. So I wanted to ask you a follow-up question on friction. You know, continue to see some really solid outperformance there, but Obviously, the market growth is quite high right now, given, you know, where we're coming off of versus last year. Just wondering, you know, based on some of your comments on EV and where you see the business as, you know, the market growth rate for auto OE starts to normalize. You know, we should be thinking about for friction versus the market.

So, Damian, it's true, but don't forget that what we are talking always is a business here that is outperforming the market. So it's true that the market probably is going to grow, you know, in 2021 between 8% and 10%, depending on who you're talking to. But if we look just at the market, I personally see some good tailwinds in the market because the production today is not satisfying the demand that is out there. And you see it in talking to our customers and in trying to buy a car today, for instance, if you go out there or talk even to the dealers. But then building on this one, as I said, We've always outperformed every single year for the last nine years, roughly 900 basis points every year. Today, in 2021, we will outperform the market even stronger. And because of this outperformance, Damian, we expect to surpass 2019 levels this year as friction, while the market will probably hit 2019 level in 2023. So it's always the game of outperformance of the market in the down and in the up. Okay, that's helpful.

And then just a follow-up on the raw materials inflation that you guys are seeing. Just wondering if, you know, as the copper can steal, you know, these products that you alluded to where you're feeling that, you know, should they start subsiding soon? you know, next year, would you see kind of a full offset on that? Or, you know, since it's mostly in MT, should we kind of view that as, you know, sunk costing?

Yeah. So in terms of raw materials, for the moment, there's no sign of abating. The copper has flattened out at the highest level. but still is really very much on an accelerating path. And so for us, the game is to go back to customers and to really negotiate price recovery to offset those negative impacts. And that's what we're going to do, and that's what we're doing also already to some success in the second quarter. Okay, got it. Appreciate it.

Thanks, guys.

Thanks, Damien.

Thanks, Damien.

Your next question comes from the line of Joe Giordano with Cowen.

Hey, guys. Can you hear me better now?

We can hear you great. Welcome back.

Perfect, Joe. Thank you. Excellent. So just on the raw materials, I'm curious, like, from a bigger picture standpoint, as you look at the markets and you think about the future, like, when do you start thinking about okay, this is something that's going to temporary increase that kind of goes back down cyclically, or maybe we should think about redesigning certain of our products to use different types of materials or be lighter. I know you guys are kind of going through that process in IP more broadly, but where is like that threshold where you begin to think about raw material costs on a more structural basis rather than kind of cyclical changes?

Okay, so this is a process that is already going on across all the businesses, Joe. is, of course, you mentioned IP, whether we have the BB2 pumps, but all the other family of pumps that we are redesigning in order to reduce metal. This is something that is happening in IP. But this has happened for the last 10 years in emotional technologies. So think about all the copper-free pads that we are producing now. They were zero a few years ago. Now I would say probably between 35% to 45% of our production is without copper and reducing our copper dependence. And this will accelerate. And we are constantly reviewing our recipes so that, for instance, we are going to be even less relying on tin because tin is another scarce resource whose price will keep on going up. So this is something that has happened constantly. on top of course of all the supply chain initiatives that you have when you're talking about from a time perspective as emmanuel said we we don't see the pressure in terms of raw materials uh inflation debating anytime soon right okay that that's helpful color there um i think you mentioned that wolverine coney and axtone were all at double digit margins in the quarter which is good to see um

you know, what's like a realistic target for businesses like that over like, you know, a one, two year period from here.

So, so Joe, for us, there's no reason why we are not able to bring those three businesses in line with where friction is today. That's going to require a lot of work. But we have definitely line of sight and we're making both the improvement or the investments in terms of our production capability and but also in the way we manage our existing assets and our existing resources. We've seen some really nice progress, especially in Wolverine that had been impacted very much so by the tariffs, but we're very confident that we can bring those businesses to the level that friction is at today in the next few years.

Awesome. Thanks, guys. Thanks for letting me jump back on.

No problem, Joe.

Your next question is from Nathan Jones with Stifel.

Good morning, everyone. Hey, Nathan. I just wanted to follow up on price-cost commentary in the brake pad business. Historically, that business has had a lot of fixed-price contracts, and also historically, auto OEMs are not the easiest to renegotiate fixed-price contracts with. I think, Luca, you noted being price-cost neutral in the second quarter and expecting to be price-cost neutral in the back half on break pads. Can you talk about how that's possible given that historical contract structure? Have things changed there? What's the mechanism that you're using to actually generate these pricing improvements given where the contracts have historically been structured?

Yeah, Nathan, just a quick rectification here. So in the quarter, what Luca said is that we were price neutral on the price. So we didn't give any price reductions to customers like we usually do. And usually it's something like between 1% to 3%. So we didn't give any price reductions because we were able to get some price increases. And then so we were neutral in terms of margin from a price standpoint in the quarter. the impact of commodities in the quarter were already high in Q2. And I would say that the price cost impact this quarter was around 200 basis points overall at ITT level, a little higher at Motion Technologies. And we expect that price cost impact to be around 200 basis points as well for the four year as the commodity pricing is ramping up but it is offset by higher price negotiations or higher price impact from the negotiations with customer. And keep in mind that there is a timing component to it where we're going to reach a much different picture by the end of Q4 than where we're going to be, for instance, in average in Q3.

And Nathan, if I can build on what Emmanuel said regarding the process. You know, there is no secret recipe here. It's really we need to work harder on pricing, sit down and negotiating with our customers a good and fair deal that reflects a completely different raw materials cost base. This is a must. This is what we have already started doing. with some good results and some mixed results. We've been able to sit down with some customers and have constructive conversations, and we had some strong resistance from others. Now, on our side, Nathan, what helps is our quality track record. We are the best quality supplier in terms of break patch. And our on-time performance at 99% plus during a period of supply chain disruptions helps us in the negotiation for sure.

You guys also generally have much, much higher margins in the brake pad business than the overall industry does. Most of the rest of the industry, I think, makes about low single-digit kind of margins, which would mean that they're under significantly more pressure from raw materials than you guys are. Are you seeing that present you any additional opportunities to gain market share as some of these competitors might be struggling even more than they have over the last few years?

I think that if I look at the priority today, Nathan, I think that we are already winning market share because of the performance we have, because of the differentiation we have in terms of our product, and because of the quality we are delivering. Those are the key criteria that are helping us to win market share. As of today, we are not envisioning really using price to win market share. Today, I think the effort would be really to use price to compensate some of the headwinds that we have because of the raw material cost. That would be the priority.

Just one last one. I think you guys had signaled last quarter that you were anticipating a poorer mix in industrial process with high project shipments in the quarter. I clearly had short cycle orders being stronger here. Are you expecting improvement in mix as we go through 3Q and 4Q? And any comments you can give us on how that impacts margins in the back half?

Yeah, Nathan, this is Manuel. Yeah, absolutely. We're expecting an improving mix in Q3 and then to the point that in Q4 as well, to the point that the mix impact for the four-year will be substantially lower than what we have experienced in Q2. And this is on the back of really strong short cycle growth. Obviously, year over year, but also very much so from a sequential basis compared to Q1. We've seen really strong service and valves order growth sequentially and some pretty decent also activity from a baseline standpoint. So we expect these will contribute very positively to the mix in Q3 and Q4. And I would say we're happy with that, but this is not what we're using to really drive margin expansion at IP. For us, progress on the fundamentals is much more important. We'll take a positive mix any day, but this is not the indicator of success for us.

We have reached the allotted time for questions. This does conclude today's conference call. Please disconnect your lines at this time and have a wonderful day.