ITT Inc.

Welcome to ITT's 2021 fourth quarter conference call. Today is Thursday, February 10th, 2022. Today's call is being recorded and will be available for replay beginning at 12pm ET. At this time, all participants have been placed in listen-only mode and the floor will be open for 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 star followed by two. If you should require operator assistance, please press star followed by zero. We ask that you please pick up your headset to allow optimum sound quality. It is now my pleasure to turn the floor over to Mark Macaluso, Vice President of Investor Relations. You may begin.

Thank you, Charlie, and good morning. It was my pleasure to welcome you to ITT's fourth quarter 2021 earnings and 2022 outlook conference call. Joining me here this morning, as always, 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- and 12-month period ending December 31st, which were announced yesterday evening. Today's remarks may contain forward-looking statements that are subject to certain risks and uncertainties, including comments related to company performance, strategic priorities, business mix, market conditions, and the effects of COVID-19 on ITT. These statements are not a guarantee 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 fourth quarter and full year results we present this morning will be compared to the fourth quarter and full year 2020, and in both cases 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, and acquisition-related and certain tax items. All adjustments in the quarter and 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. It is now my pleasure to turn the call over to Luca, who will begin on slide number three. Thank you, Mark, and good morning.

2021 was a challenging year, and I would like to thank our shareholders, our customers, and our suppliers for their continued support and investment in ITT. I'm humbled by what our teams accomplished in 2021. Thanks to all our IT tiers, the shop floor employees who have been continuously working safely day in and day out while diligently following our health protocols, and our teams in the office that have been at work in person since May 2020, despite the challenges we all know. At ITT, it is our firm belief that we are all in this together. As we strive to make ESG an integral part of our business model, safety is the number one priority. Building on our progress in 2020, more than 50% of our facilities had zero incidents for the prior 12 months. We continue to improve our safety performance this year. Our injury frequency rate and our injury severity rate both declined compared to 2020, despite more output. We will continue to drive better safety performance with diligence and passion until all our sites, not just 50%, have zero incidents. Our focus will deliver a better and more sustainable operational performance over the long term. And above all, it's simply the right thing to do. Before discussing highlights from 2021, let me share some details about the environment we have been living in the past few months. Like most industrials, our operations have been significantly constrained by supply chain disruptions. During Q4, I experienced firsthand the mess the global supply chain is in today. When I was in Weinstadt, Germany, just before year end, the team there had to deal with a brand new machining center for contacts that was idle just because a semiconductor chip was missing. We were also impacted by heavy absenteeism as COVID infections hit our shop floor employees at record high numbers, especially in our sites in North America and Europe. Then, backup plans kicked in, the resilience of ITT went into high gear, and senior management joined the team on the shop floor, like in Winestead, where Ellen, our GM in Europe, packaged connectors to ship to customers over the holidays. Thank you, Ellen, and thank you, Winestead. Despite all this, ITT delivers solid first quarter results and our full year operating margin and adjusted EPS far surpassed 2019 pre-pandemic levels. This is resilience. Moving to demand. Demand is strong in all our end markets. ITT's innovative products and technologies drove a 20% increase in organic orders for the full year, with broad strength across all three segments. 10% organic revenue growth, including 21% growth in auto, with strong outperformance. This is remarkable if you think about the demand volatility created by the cheap shortage in the second half of the year. And finally, 20% organic growth in ITT's reignited connector business. On profitability, we deliver 16% operating margins, 120 basis points above 2019, and a new record for ITT. We worked hard to overcome $80 million of raw material inflation with price and productivity. We continue to invest in growth and innovation, in friction to support new automotive braking platforms, in connectors to expand our product offering, and in industrial process to redesign our pump portfolio. Notably, research and development expense was again over 3% of sales this year, as it has been the previous two years. Last but not least, on capital deployment, We deployed $600 million in 2021 on dividends, ITT share repurchases, and the strategic asbestos divestiture. These amounted to two times our annual adjusted free cash flow in 2021. All in, we delivered 27% growth in adjusted earnings per share versus 2020, and 6% growth versus 2019. In the fourth quarter, which was the worst environment we saw all year from a supply chain perspective, we continued to execute pricing actions to counter over $0.30 of raw material headwinds. We executed with an all-hands-on-deck approach like Allen's to deliver for our customers, and we generated a justic segment operating margin that exceeded 18%. A big part of the improvement came from CCT. which grew over 500 basis points at an incremental margin of 60% to 18.4% segment margin. As I look ahead, the Q4 challenges will persist in 2022. Still, we have been capturing the strong demand and more in all our businesses to power ITT's revenue growth in 2022. These will support the expected 10% organic sales growth, while continued productivity and pricing actions will drive nearly 100 basis points of segment margin expansion. Together, our performance will drive earnings per share growth of 11% at the midpoint of our 2022 guidance. Our adjusted free cash flow margin will be approximately 11%. as the strong income generation is tempered by increased working capital requirements taken to support our customers. As already mentioned, our guidance assumes that supply chain challenges and high raw materials prices are with us through at least the first half of 2022, modestly abating in the second half of the year. If the market conditions improve sooner than we anticipate, there is a path towards the upper end of our guidance, which Emmanuel will discuss further in a few minutes. About 2022, I want to highlight three main points related to ITT's priorities. First, our products are winning in the marketplace, and we see that in the order rates and in the backlog today. Organic orders growth for the past three quarters was 47%, 27%, and 10% respectively. This drives an 18% increase in backlog that will convert in 2022 and beyond. We are seeing broad-based demand across industrial processes in our long-cycle pumps business and across our short-cycle offerings. The project funnel continues to increase, and we are seeing larger opportunities emerge. Orders in Connect and Control increased with a gradual recovery in commercial aerospace, with strong organic growth for the second straight quarter. Our connectors continue to grow in the marketplace alongside the EV infrastructure built out, helping our CCT backlog to grow 16% organically for the year. In Motion Technologies, we continue to position ITT as the D brake pad supplier of choice to OEMs, including electric vehicle manufacturers around the world. We want content on 33 electric vehicle platforms in 2021, with Ford, Rivian, NIO, and Tesla, among others. This and our leadership in EV platforms will drive long-term sustainable growth as the transition to electrification gains momentum. Second, we are accelerating innovation across ITT. We see the benefits of these in our EV wins as well as in IP and CCT, where we are advancing the VAV activities across our portfolio. We are increasing our growth capex to support customer demand and wins, and are ramping green capex investments to further our sustainability initiatives globally. Finally, we are carving out and cultivating certain disruptive technologies where we see outsized returns to ensure these initiatives receive the investment and attention they need over the long term. Third and finally, ITT is poised to execute strategic and accretive M&A in 2022. We have a revamped M&A team, a solid strategic focus, and plenty of firepower to deploy. With asbestos out of the way, the number and size of deals we are looking at is increasing, and the team is ready. This is on top of our share repurchases plan and a 20% increase in our dividend. Capital deployment continues to be a top priority for 2022. Let's turn to slide five to produce some of the most exciting wins across ITT in 2021. ITT operates in end markets which are poised to grow over the next several years. Rail, supported by our shock absorbers and couplers, will become even more important as public investments increase to support a greener and more sustainable world. Similarly, the rapid rise of electrified vehicles will further bolster global automotive production and the demand for our breaking products. Our aerospace business is at the forefront of a long-term recovery as people resume travel domestically and internationally. Our connectors business is actively participating in a world where electrification and digitalization are taking over. and our pumps and valves are already playing a significant role in energy markets to build a greener future. Regarding future growth platforms at ITT, our global OE market share for our friction business is up considerably compared to 2020. Electrified vehicles in 2021 represented more than 20% of friction sales. We will grow this to over 30% over the next two years. Corning won its first award for our new hydro-ride product for the defense sector. This solution offers better handling capability for military vehicles as the vehicle travels over rough terrain. Wolverine launched a groundbreaking new development tool that simulates SHIM performance. This is a great example of customer centricity that will improve R&D efficiency for our customers and internally in ITT. In industrial process, our ILR platform was selected to monitor 270 pumps over 5,000 miles of pipeline in the U.S., The algorithm-driven asset intelligence solution will enable, through more than 10,000 rules, the predictive monitoring of customer pipeline pumps and the identification of issues and potential failures, whilst providing recurring revenue for IP in-service subscription, pump repairs, and upgrades. We also had notable wins related to the new semiconductor plant projects in the U.S., while green projects added more than 200 basis points of growth to IP's orders in 2021. Finally, in Connect and Control, we were awarded a contract to provide actuators for the A321neo. This is a multi-year agreement beginning in 2022 on a growth platform used by leading airlines around the world. In summary, We positioned the company for a strong performance with the backlog and shared gains generated in 2021. We are driving innovation across the portfolio. And we are accelerating our capital deployment plan with a smart and strategic approach across our businesses and plenty of firepower to deploy. I'm really excited about the year ahead. And siamo pronti. Emmanuel, over to you.

Thank you, Luca, and good morning. Looking at the quality results, motion technology sales growth was tempered by an unusually strong Q4 in 2020, when friction OE grew 19% organically, and due to the ongoing OE chip shortage this year. Vehicle inventory levels remain at historic lows in North America and Europe, which suggests that as the chip situation improves, growth will accelerate in MT. The team in MT continues to drive price realization in partnership with our customers. Price was a positive 250 basis points in the fourth quarter. As Luca and I can tell you, this is not an easy task. It shows the persistence of our teams and the value our customers place on the performance and quality of our brake pads. Despite our efforts, we estimate that supply chain disruptions lowered top-line growth by over 450 basis points, with the most pronounced impact in industrial process. And based on what we saw in January, this dynamic is continuing into 2022. In Connect and Control, strength in distribution and conversion of our healthy backlog drove a 26% organic revenue increase in connectors. Our teams drove productivity in the quarter of roughly 350 basis points through a combination of shop floor and sourcing actions, which partially offset 500 basis points of material inflation. As Luca mentioned earlier, margins and EPS were impacted by higher growth investments which we are always happy to do. From an earnings perspective, we grew EPS by 5% versus 2020 and 7% versus 2019, despite 5% less revenue. Growth investments were more than offset by lower share count, foreign currency, and tax rate. While segment operating income was higher, Our working capital requirements, given the supply chain disruptions, continued to weigh on our free cash flow generation. Still, we delivered 11% adjusted free cash flow margin within the range of our previous outlook. And we are consciously investing in working capital, given the supply chain disruptions. Let's now turn to slide seven. I want to highlight a few additional points from Q4 which will impact our outlook for next year. First, in MT, the lower vehicle production we saw this quarter was due to year-end customer plan closures that occurred ahead of schedule in Q4 given the chip shortage. This stands against the very strong production in Q4 of 2020 as we were exiting the first wave of the pandemic. We also experienced delays in the start of production of some new auto platforms, mainly in Europe. Our friction business was exemplary with 100% on-time delivery despite supply chain disruptions. On the commodity side, the inflation impact increased sequentially in the fourth quarter, above our expectations. And we expect prices will remain at these elevated levels through at least the first half of 2022. This will cause a significant year-over-year headwind, particularly in MT. At Industrial Process, top-line growth was constrained by supply chain despite strong demand across project and short cycle. We are encouraged by the demand we see in orders, given the sequential increase every quarter in 2021. As a result, we're entering 2022 with significantly higher backlogs. Still, the challenge continues to be the timely conversion of these orders. IP's margin expanded 70 basis points to 15.8%, driven by favorable mix from the higher proportion of short cycle sales. This was partially offset by labor and material inflation, as well as expedited freight charges. The latest footprint optimization action we announced in Brazil was completed successfully this quarter, and it will provide savings into 2022. CCT had a very strong quarter in all aspects. Orders continued to be robust. Organic sales growth was above 10%, and margin exceeded 18%. We see strong demand in distribution, with orders up 55% for the four-year, and our distribution customers are not reporting higher stocking levels. As a result, distribution should again be a big driver for CCT's performance in 2022. With that, we're turning the page on 2021. On Flight 8, we discuss our current outlook across our major end markets. My message to you is demand is strong across the portfolio and we're winning in the marketplace. We see that in our backlog, our order rates, our awards and our project funnel. The challenge we see in achieving the 10% organic growth for the four year is mainly a first half dynamic. We see this most prominently in the chemical and industrial verticals. In both instances, the long-term trends are very attractive, and we feel confident ITT is well positioned here. In auto, the first half will be slower due to a combination of chip shortage impacts as well as raw material availability. But with OEM inventory at very low levels, we expect a top-line acceleration in MT in the second half of 2022. Regarding aerospace, Demand is improving, but we're still well below sales levels from 2019. We expect this market to start to accelerate in the second half, coinciding with a further increase in global travel and a reduction in aero OEM inventory. Let's turn to slide nine to discuss our financial guidance given the dynamics. For 2022, we expect to grow organic sales roughly 10% at the midpoint. However, unlike 2021, we expect that all businesses grow at a similar rate, with MT slightly above IP and CCT. Our outlook for 2022 assumes a continuation of the challenges related to the global supply chain. From a segment margin standpoint, CCT will expand margins more than any other business, followed by IP. We expect empty margins to be only slightly up given the raw materials headwinds in the first half and the time to receive price recovery from customers. Industrial process margin expansion will be impacted by the ongoing supply chain disruptions, which will continue to constrain deliveries in the first half. Additionally, the growth in IP's project business will temper margins. However, we still expect IP to approach 16% margin for the year after a lower first half. At the midpoint of our range, EPS will grow 11% or 16% if you exclude the 16 to 20 cent headwind related to unfavorable currency and an expected higher effective tax rate of 21.5%. If the supply chain disruption improves and raw materials inflation does not get worse, there is a path towards the high end of the range. We're planning to take further steps in the event this does not prove to be the case, including limiting non-essential spend, executing additional footprint actions, and most importantly, incremental pricing actions that we would expect to compensate for the higher raw material prices. In terms of the cadence for the year, we anticipate Q1 will be the toughest quarter of the year. Given the strength in the first quarter of 2021, stemming from pent-up demand in auto exiting 2020, our Q1 organic sales growth will be in the low single-digit range, thanks mainly to the growth in TCT. We expect the other two businesses will be roughly flat. Margins will likely decline to around 17% in Q1 due to the first half headwind stemming from elevated raw material prices. Margin will then increase on a sequential basis in every quarter in 2022. As a result, EPS is expected to decline in the first quarter in the high single digit range. Following Q1, EPS is expected to grow on a sequential and year-over-year basis for all remaining quarters in 2022. Given our capital deployment capacity and the market pullback, we have been and will continue repurchasing shares of ITT. We expect this will drive a further 1% reduction in our weighted average share count in 2022. However, our preference remains to deploy capital to growth investments and smart acquisitions, and we remain confident in our ability to execute acquisitions in 2022, given the active and growing pipeline. On flight 10, just a few things I want to highlight. You can see that we expect to generate approximately 80 cents of operationally driven growth, net of 70 cents of material inflation. through a combination of backlog conversion, share gains, price, and productivity. This will be partially offset by the impact of favorable non-recurring items, which we highlighted each quarter in 2021, as well as higher discretionary costs. One additional point on raw materials inflation. 60 of the $84 million of inflation in 2021 occurred in the second half of the year. There was essentially no impact in the first quarter of 2021, which means we will see continued year-over-year headwinds through the first two quarters of 2022. I would also point out the 16 to 20 cents of headwind from currency and tax. With that, let me pass it back to Luca to wrap up.

Thanks, Emmanuel. ITT performed extremely well throughout 2021. We reached new records for adjusted segment margin and adjusted EPS, which were both comfortably above 2019 prior to the pandemic. This would not have been possible without the resilience of our IT tiers. We are seeing demand across the portfolio continue to increase. We saw this in order rates throughout the year and exit in 2021. And we are entering 2022 with a very healthy backlog of orders to convert. And while we want our capital deployment in 2021, deploying two times our adjusted free cash flow to our asbestos divestiture, dividends and share repurchases, there is still much more to do. We have a heightened and intense focus on M&A. We are building and cultivating an active pipeline of acquisition candidates, and we have the right team in place to execute this deal. Lastly, I'm happy to announce that finally, ITT will host a Capital Markets Day for investors on June 16 in New York City. This is ITT's first event like this since 2011, and you don't want to miss it. As ever, it has been my pleasure speaking with you all this morning, and we will happily take your questions now. Charlie, please open the line for Q&A.

The floor is now open for questions. At this time, if you have a question or comment, please press star 1 on your touch-tone phone. If at any point your question has been answered, you may remove your question by pressing star followed by 2. Again, we do ask while you pose your question, you please pick up your headset to provide optimal sound quality. And please limit your questions to one question and one follow-up question. Our first question comes from Andrew Obin of Bank of America. Your line is open. Please go ahead.

Yes, good morning. Good morning, Andrew. Morning, Andrew. Good morning, Luca, Emmanuel, Mark. Pretty impressive operational performance by the ITT team, particularly given the volume headwinds. Kudos to everybody. The question I have, you know, how are you and the board are looking at at the future, you know, sort of specifically growth, costs, you know, investments. You did highlight the second point you made, you know, raising R&D and CapEx. As you talk to the board, Luca, you know, how different do you think the world will look like over the next several years versus the prior cycle? And as I said, how sustainable should we think these increases in R&D and CapEx, and what else can you do? Thank you.

Thank you, Andrew. So this is a conversation that we have regularly with the board. We have one event on a yearly basis, which is a strategic plan review that we have in September, October. And then every meeting with the board, we're actually re-reviewing the strategy of the different businesses. So this is a discussion that happens on a regular basis. So when we look at the business that we're in and the business that we have, we feel positive as most of our business are actually at the very beginning of a growth cycle. So we have a good investment that are going to feed this growth. There is a lot of conversation on innovation. This is really probably the biggest conversation that we're having with the board and our investment in innovation. And you will have seen that probably in our presentation there is one specific venturing that we are doing internally that we are detaching from the business and we were managing centrally just roughly in order to give the proper focus and the proper attention. And you've seen also our starting of the venture investment of ITT in external companies. So this is a regular conversation. I will add to that that a lot of attention with the board is also on China and the geopolitical environment. This is something that we are discussing and we're also looking for external speakers coming and talking to us.

And, Andrew, just to put a final point on what Luca was saying, so a lot of our 2022 assumptions include a step-up in capex, roughly from around $90 million to more than $150 million of capex. And some of that is dedicated to growth and to R&D because it's really important for us to be able to maintain the gap that we have with the competition and to maintain our competitive advantages. So we're going to be expanding in R&D in Italy, also in China, and we have many initiatives, like Lucas said, to really invest in innovative products.

Thank you. And just a follow-up question, specifically on slide 9, you highlighted supply chain disruption in industrial process, and I'm just comparing your outlook on chemical and industrial pumps versus energy. What specifically are you facing on chemical and industrial pumps versus energy? Because it seems a more conservative outlook for the first half. And on the energy side, is it as simple as just the difference, the connectors are the difference? Just provide some color as to exactly what's happening in the supply chain. Thank you.

So in IP, we're facing, I would say, supply chain disruptions across the board. If you look at what has happened in Q4, unfortunately the impact was worse than what happened in Q3. You remember in Q3 we had 350 basis points of top line impact. and a lot of it was due to IP. Unfortunately, in Q4, that situation worsened, and more than 450 basis points upline impact that we had due to supply chain and labor availability was mostly due to IP. So roughly 25 to 30 million of revenue was missed in IP, and we think Unfortunately, this situation is not going to abate and is not going to improve until the end of the first half of 2022. So those supply chain disruptions are impacting a lot of our end markets.

If I may add just one brief point, Andrew, if you look at Q4 revenue for IP, the most impacted one was the project revenue. Our revenue for projects in Q4 was the lowest that we had in the last couple of years, while on the short cycle was the highest revenue that we had in the last couple of years. Also because the short cycle, you're probably more in control of your supply chain. So that is probably the biggest difference that you will be able to see. Big projects are more difficult to manage. Gotcha. Thanks so much.

The next question comes from Joe Giordano of Cowan. Your line is open. Please go ahead.

Good morning. This is Michael. I'm asked to see you in for Joe. Hi, Michael.

Hi, Michael.

Great. This is a two-parter. So looking at the M&T, you mentioned there was an asset sale that helped margins for the quarter. Can you quantify that sale and what exactly it's related to?

Yeah, Michael. So every quarter, as you know, there are one-time items that affect our results. And also, we highlight those in the segment margins on a regular basis. In Q4, there was a lot of one-time items in MT, including the land sale that we referred to. And roughly 1 to 2 million was above our forecast. And we had included this benefit in our budget from the beginning. And this added, if you look at versus what we were expecting in our forecast, this added roughly 50 basis points of margin to MT in Q4. For the full year, the net of all, let's say, the non-operational items is around a 10 basis points benefit, so really minimal and immaterial.

Great. Thank you for the color there. And one more, if I may. You mentioned that the company is poised for inorganic growth. What areas are you finding most favorable at this time, and what do you see in terms of the market multiples and such? Thank you.

Sure, maybe I start addressing the first part of the question, and Emmanuel, if you want to follow up. Yes, we are ready. With as best as out of the way, we can really focus on M&A. We have a talented and experienced team, and we have good strategic deals at different stages in the funnel and mature opportunities. When you look at the different areas, we have a good pipeline in all the three businesses, Michael. We're talking about rail. We're talking also about flow and good opportunities in CCT on the connector side of the business. So now we always, though, follow our rigorous process to ensure that both strategically and financially we will create value. But those are the areas.

Great. Thank you.

The next question comes from Scott Davis of Meleus Research. Your line is open. Please go ahead.

Good morning, guys. Good morning, Scott. I wanted to ask about an eye alert just because I'm trying to get a sense of how broad that product can go. You talk about pipelines, but what are you measuring? Is it standard stuff, heat, vibration, temperature?

electricity usage is it is it pretty standard um and and how are you kind of aggregating that data and getting paid for it okay sure uh thanks for asking the question because i'm very proud and excited about about these windscouts um as a matter of fact you know our um our six it tiers uh in ip that work on this deal won the Customer-Centric ITT Award in 2021. They did a fantastic job. ITT launched this iAlert a few years ago and took some time to take traction. And the reason why it took time to take traction is because when you install it, you need to have a maintenance team at the customer side, but also your maintenance team be able to read that data. You need vibration analysts that look at the data, be able to interpret, analyze them, and see what is behind the data, and create value then for the customer. So it took a little bit of time to gain traction. But this eye alert works on every rotating equipment. So as a matter of fact, all these pumps are not good pumps, which makes it even nicer, I would say. And we have a vibration analyst engineer based in our Houston pro shop that is looking at the data, analyzing the data, look what is going wrong, and provide report to the customer. Your right is really measuring the vibration and the temperature, and it's working on really more than 10,000 rules based on a partnership with a company that we have on the Northeast. And as I said, it can work on every rotating compressor and anything.

Okay, that's helpful. And then are you sending out digital twins? When you send out a big project – custom pump. Are you sending out a digital twin with that? Is that something that you're already doing or something that you envision doing in the future?

Yes. In most of our project, in most of our pump, actually the frame is really shaped in a way that iAlert has got the exact position on that and it's almost by default position. The default is by default.

And so we offer this to our customers, whether they have requested it or not. I think that over the past few months, because of the chip shortage, we haven't been able to do that necessarily on every pump. But as soon as this abates, we'll return to putting one eye alert for every pump that we ship.

That's cool. All right. Thanks. Good luck, guys. Appreciate it. Thanks, Scott.

The next question comes from Jeff Hammond of KeyBank Capital Markets. Your line is open. Please go ahead.

Hey, good morning, guys. Hi, Jeff. Can you hear? Oh, good. So just back on MT margins, I guess even if you adjust for the gain, really nice sequential improvement. And I'm just trying to get a better sense of, given all the moving pieces, kind of how you're thinking about margins in MT sequentially and then just you know on you know friction supply chain you know we're hearing kind of you know optimism from some oems and pessimism from so oems and maybe just you know kind of what you're really seeing out there in terms of you know the auto supply chain you know starting to get better and why you think it gets better okay so let me let me start addressing the supply chain and then emmanuel you can you can take the margins uh

So as a matter of fact, the supply chain in Q4 was worse than what we saw in Q3. I gave you some examples in the prepared remarks, but I can tell you also that I've seen in Barge some lines that were completely stopped, either because of the supply chain or because of the absenteeism as Omicron had a massive impact in December and in January. So I haven't seen that situation improving in Q4 and not necessarily in January. Now, considering all of that, the fact that our friction team was able to deliver 100% on-time delivery made that result even more remarkable. We expect that situation on supply chain probably to improve towards the second half at the end of Q1 and in Q2, and be much better in the second half. Jeff.

And if you think about 2022, so obviously on a sequential basis in Q1 and in Q2, there's going to be a step down from the level of Q4 margins for MT. as we are really working with our customers to secure price recovery. And then as you go further along the year, you're going to see the impact of compounding productivity and pricing that's going to really help drive up margins at MTs to levels that we have seen probably to high teen levels.

Okay, excellent. And then you mentioned the labor issues in IP, and I'm just wondering if that's just an Omicron absenteeism issue or if there's something broader. Is it retention or adding people, or is it just kind of this Omicron blip? Thanks.

No, it's more the impact of Omicron, Jeff. Q4 and January have been a real challenge from an operational point of view. And Omicron, whilst we don't see serious cases, which is good, the impact, as I said, has been massive. Just to give you an example, end of December and entire January, we had more than 200 new cases per week. To that, you're going to add probably another 200, 300 people that are quarantining every week. So you can imagine the disruption that you have in operation when you have that amount of people missing. So you're going to work on overtime, which is inefficiency. You're going to have temporary workers, which is inefficiency. Or, you know, you have, like in the case of IP, talk to the customer in order to reschedule some shipments. So it was Omicron.

Okay, thanks, guys. Appreciate the color and tone change on capital deployment. Thanks.

Thank you, Jeff.

The next question comes from Vlad Bistriksi of Citigroup. Your line is open. Please go ahead.

Good morning, guys.

Thanks for taking my call.

Good morning, Vlad.

Maybe just – Hi. Maybe just following up on Jeff's last question around absenteeism and Omicron and understanding what you saw through January. But can you talk a little bit about how you're seeing things evolve now? Have you seen Omicron sort of peak, at least here domestically, and maybe what you're seeing from Omicron in some of the other regions and how you're thinking about labor disruptions impacting 1Q? Sure.

So what you see, as I said, during the month of January was more than 200 people, new cases every week. And to be honest with you, I cannot say that the peak has gone through because just last week it was 180 new cases in the week. So, sure, it's less than 200, but 180 new cases in the week is still very high. So it's true that Omicron came fast, and you see probably in the news and in the paper that the peak is there, but from an operational perspective, it's still very much there. And the regions that have been impacted the most are really Europe and North America.

And then from a results standpoint, you really see that in what we expect for Q1. So Q1 will be the lowest quarter in terms of growth and revenue in terms of dollars. And this is impacting obviously our factories, but also it's impacting our customers. And as a result, the lack of absorption, the lack of volume will result in lower margins, around 17% for Q1, and obviously lower EPS as well.

Okay, that's helpful, Color. And then maybe just... Shipping to sort of or shifting to sort of what you're seeing on the working capital front here. Obviously, you're exceeding 21 with a bit higher inventory than is typical for you. And, you know, some of that I think you highlighted reflects a strategic decision. But can you talk about, you know, is there some way to parse out how much of the increase in inventory is driven by you strategically securing supply as you're able to, you know, versus challenges around work in process or other products that you can't quite get out the door because of the logistical challenges?

Yeah. So as Luca mentioned, supply chain is really a mess. And so this has been a big reason why we have increased our working capital and specifically our inventory in 2021. I would say the majority of the increase is due to the higher inventory that we've taken in 2021 and that we're going to continue to take in 2022 in order to secure the shipments to our customers. In addition, I think the challenge we're going to see also from a working capital standpoint in 2022 is we're going to have a significant increase in activity. So we're planning to have 10% increase in revenue at the midpoint. And this is obviously impacting mechanically working capital and cash, obviously. And then finally, from a cash standpoint, I would add, you need to keep in mind that we will invest, we will continue to invest in 2022 in CapEx. to a level around $155 million. And we have to make those investments to support our customers, the growth that our customers are expecting from us and the wins that we've had during the past few years, especially in auto.

Okay, that's helpful, Calder. I'll get back into the Q&A score, guys.

Thanks, Fred.

The next question comes from Joe Ritchie of Goldman Sachs. Your line is open. Please go ahead.

Thank you. Good morning, everyone. Good morning, Joe. Good morning, Joe. So I want to focus on the chip shortages for a second. I'm just curious, Luke, what's your best guess on when some of these shortages start to ease? And then I'm curious as well, like, If you think about that growth number called 10% growth for the year, how much visibility do you have on the amount of chips that you actually need to ship your products?

OK. What we see and also what we get from talking to our customers is that the cheap short share is going to get better in the second half of the year. And this is also one of the reasons why when you look at MT, it's really for 2022 is the tale of two halves, right? Where H1 is going to be more similar to H2 of 2021. Now, so when we look at the forecast for the market in 2022, you know, the expert there, IHS, is considering probably an 8.5% growth rate. with North America and Europe growing, China staying practically flat. We assume that that is going to be a little bit less, but that growth is coming mainly in the second half of the year. But you know that we are counting to outperform the market like we have done for the last 10 years. And despite all of the problems, supply chain and chips, We deliver 100% on-time delivery in Q4, and we have done exactly the same as in January. So the delivery should – I think that we have learned how to do it.

Okay, that's helpful. And I guess my follow-on question to that is related. When you think about your margin expectations for the year, how much of that is dependent on the volumes coming through versus the self-help and productivity improvements that you're expected to make across your businesses?

Okay. So I think that when you look at 2022, And Emmanuel, correct me if I'm wrong, but I think that the biggest challenge that we have from a margin perspective in 2022 with all the improvement, continuous improvement that you have in operation is actually pricing, Joe. And this is the main focus. This is what we are talking every two weeks with the value center. This is the main topic to discuss the performance review on a monthly basis. And why? Because if you look at 2021, we recovered some, but not even close to what we should have received. Now, when it comes to 2022, I'm pleased to report that when it comes to friction, we have already closed the discussion on roughly 40% of our business. which is good because, you know, we are in February. The other side of the coin is that there are still 60% that need to be secured, and we're already in February. So that, I would say, probably is the biggest challenge from a margin point of view in 2022, Joe. Did I answer your question?

Yeah, that was great. Perfect. Thanks, guys. Thank you, Joe.

The next question comes from Mike Holleran of Baird. Your line is open. Please go ahead.

Hey, good morning, everyone. Hi, Mike. Hi there. So on the IT side of the business, maybe just some thoughts on short cycle versus project-oriented business from two perspectives. One, kind of revenue cadence into the year, but secondarily, how you expect the orders for those two buckets to progress as we work through the year.

Okay. Maybe I can tell you, I can start and then, Manuel, you jump in. The Q4 was a very good quarter for the orders with, you know, 39% increase in orders and very good performance on the project side and the short cycle. stay very strong. So if you look at 2021, the second offshore cycle was the strongest, and Q4 was the strongest of the two quarters. And what we have seen in January, which is an indication, you know, you always look at this leading indicator, is that that trend has continued. The trend has continued, so with very strong short cycle orders in January, reflecting the same that we have seen in Q4. We are expecting project orders to come in strong in the year, also because the funnel is rich, and we have seen in the funnel also big projects coming in. Anything to add, Emmanuel?

Yeah, so I think, as Luca was mentioning, the momentum, I think, in orders for 2022 is going to be pretty strong. We expect to grow orders on top of a really strong 2021 by roughly low single digits. The challenge, as we say, is going to be converting those orders into revenue. And I think that this is going to be a real challenge in the first quarter and to some extent also in the second quarter, even if things are going to improve from a top-line standpoint. And then we should be in a much better place, hopefully, in Q3 and Q4. And obviously, this has an impact on the margin progression at IP because you're going to see a first quarter, which is going to, from a margin standpoint, which is probably going to be lower than what we achieved in 2021. And then we're going to be able to ramp up as we ramp up the volume and as we ramp up productivity as well.

Thanks for that. Some of the related follow-up, but broader than just IP, does your guidance assume backlog normalizes to – more regular levels through the year, or how should I think about what the backlog normalization curve looks like from your perspective?

Well, we expect IP to, I'm sorry, in general, so the two business where we really, where backlog is really important is IP and CCT. And we expect IP to be able to continuously grow the backlog for the year. And we expect also CCT, and here the specific item is that CCT, you know, participates in the aerospace, and for the aerospace we book orders that probably have, we're going to ship over the next two to three to four years. And so we're going to continuously grow the backlog on aero that doesn't, probably not going to translate in immediate revenue, but is building long-term backlog anyway. Thank you.

Thanks, Mike. The next question comes from Nathan Jones of Stifel. Your line is open. Please go ahead.

Nathan.

Morning, everyone. Morning, Nathan. I wanted to follow up on the... Morning, Luca. I wanted to follow up on the CapEx stuff. It's greater than 5% of sales. Can you just talk in a little bit more detail about where the CapEx is going? Are these all growth investments? Is there... You know, some refreshing the asset base that's happening. Are these one-year projects? Should we expect elevated CapEx next year? Just any more color you can give us around where that CapEx is going and how long it lasts at this level.

Sure, Nathan. So $155 million of CapEx in 2022, the majority of those CapEx are going to be for growth and R&D. So roughly 80% of those CapEx are going to be for growth and R&D. And here we have specific projects with specific expansion plans in Mexico and in China, where we're facing a lot of increased demand from customers because all the platform wins we've had in our friction business. And then also we're going to continue to invest in R&D, both in Italy and in China. So in those R&D centers, what we're working on is increasing our testing capabilities uh to keep up with all the projects we're winning as well as to invest in rapid prototyping to better serve our customers and then the final the final aspects are with ip and cct where we're investing in va ve so the redesign of our products and also the increase in the the product range that is really important for future growth in cct and so

I mean, are these single-year projects and we should expect CapEx to return to a normal level? Is there a step function change in your long-term percentage of revenue that goes into CapEx?

I think this is, you know, we've won a lot of EV platforms. So obviously we have to put a lot of new capacity, especially in North America. But I wouldn't say that this is a step function change. I think that, you know, you usually invest very much in CapEx, in friction. And so that's no more activity. I would say one example that stands out is the capacity investment and the footprint investment that we're going to be making for Wolverine, which is a large investment over several years, but I don't think that necessarily moves the needle in terms of capital.

Okay. And then I wanted to ask about the target to expand the CCT product portfolio to Can you talk about the priority areas for adding products? Are these things that you can do all internally? Can you accelerate that product development with M&A? Any color you can give us around that.

Okay. Thanks, Nathan. It's a little bit of both. So just to give you an example, on the connector side of the business, you know, practically ITT, Canon invented the connector. But the innovation is something that we had to reignite in our connector business. So we do that organically, and we have reinforced our engineering team with some very good resources and give the team the investment that they needed in order to come up with the new products and testing, et cetera. But we've done that also with venturing. So we did an investment. We made an investment in a company in California, which is – whose product is complementary to ours. And also, we are looking inorganically at some potential acquisition. So it's a little bit of both. Great. Thanks for taking my questions. Thanks, Anita.

The next question comes from Brian Blair of Oppenheimer. Your line is open. Please go ahead.

Good morning. Thanks for squeezing me in here.

Good morning, Brian. Good morning, Brian.

Circling back on capital spending for a second, given your recent and planned capex and friction, at least in terms of what's baked into your 2022 guide, how much capacity are you adding to China and North America?

Okay. So I would say the beauty of the investment, Brian, is that we're investing capacity only after we won the awards. That's the beauty of this business. So I can tell you that when you're looking at the plant in Mexico today, our plant has got probably now installed five lines, and we could put another four, maybe five lines in it. So we can get to the goal eventually in five years is to get to a market share in North America of probably right in 40%.

uh so there is a still quite quite a while to go yeah appreciate the color there uh follow-up question i'm not sure you're you're going to be willing to answer directly but any related color would be would be great obviously cct margin has been a good guy in the back half uh you're ahead of schedule in you're getting back to pre-pandemic margin at If we look at the back half, 10%, 11% lower run rate sales versus 2019. So it's a good momentum there. If we look forward a couple of years, maybe to 2023, 2024 timeframe, given the growth prospects and self-help, fine-tuning, et cetera, available in their respective platforms, are we looking at a higher entitlement margin for M&C or CCT?

So just one thing, we're very happy about the financial results of CCT. And we are in the continuous improvement journey. I was there in California together with Ryan in urban in Valencia, and we have opportunity to improve. Having said that, Brian, that's exactly the reason why you don't want to miss the 16th of June, Investors' Day, because I'm sure that we will be able to answer that question properly. But the continuous improvement journey keeps on going, and we have room for improvement. So we are not going to stop there.

Understood. Thanks, Ian.

The next question comes from Damien Karras of UBS. Your line is open. Please go ahead.

Ciao, Damien. Good morning, everyone. Ciao, ciao. Ciao, Damien. Guys, I'm going to wait for another call, so sorry if I missed this. Just wondering on the sales guidance for the year, if you could spell out kind of what the price is

uh impact embedded in there versus volume is and maybe any color kind of at the at the segment level on that as well sure damon so the the price recovery that we're considering in 2022 is over 100 million dollars uh this is a large impact uh obviously it's a large task also and this is mostly coming from mt so probably something like 80 percent uh of that of that price recovery is going to be coming from empty and obviously that recovery is going to build a quarter after quarter but we have a decent chunk already planned for q1 as we're negotiating you luca mentioned that we have in friction we have secured right now 40 percent of the expected increase price recovery increases for 2022, which is a good thing as we start January, but also it means that we have 60% that we need to recover. So it shows how tall the task is ahead of us. And really, this is to compensate for the inflation that we see in materials, but also in all the other cost categories, such as labor and energy and general overheads.

Okay, great. Appreciate the caller. Best of luck, guys. Thanks, Damien.

Thanks, Damien. Thanks, Damien.

The last question comes from Matt Somerville of DA Davidson. Your line is open. Please go ahead.

Hi, good morning. This is Will Jellison on for Matt today. Morning, Will. Hi, Will. Good morning. I had a quick question for you regarding M&A. To the extent that the company's In your current pipeline that you're cultivating, are you seeing them facing any material impacts from supply chain and inflation? And to the extent that they are, do you see that exerting any downward pressure on multiple potentially and maybe offering you a better price?

So, absolutely. We're seeing the same impacts from a supply chain standpoint in the companies. And we look at companies in Europe and North America, and this is the same situation they're facing. I think the difference, what we're looking for, is how are they able to recover pricing. And so, because that gives us an idea about their pricing power. And so, I think that we've seen some good examples. of companies being able to retain value by really driving pricing. So we're very attentive to this, and unfortunately, this is pretty broad-based.

Understood. Thanks for taking my question.

No problem. Thank you, Will.

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