Operator
Welcome to the ITT's 2023 first quarter conference call. Today is Thursday, May 4th, 2023. Today's call is being recorded and will be available for replay beginning at 12 p.m. ET. At this time, all participants have been placed in 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 one on your touch-tone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. If you should require operator assistance, please press star zero. We ask that you pick up your handset to allow optimal sound quality. It is now my pleasure to turn the floor over to Mark Macaluso, Vice President, Investor Relations and Global Communications. You may begin.
Mark Macaluso
Thank you, Elliot, and good morning. 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 April 1, 2023, which we announced this morning. Before we begin, please refer to slide two of today's presentation, where we note that today's comments will include forward-looking statements that are based on our current expectations. Actual results may differ materially due to several risks and uncertainties, including those described in our 2022 Annual Report on Form 10-K and other recent SEC filings. Except where otherwise noted, the first quarter results we present this morning will be compared to the first quarter of 2022 and include non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures are detailed in our press release and on the appendix of our 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 three.
Elliot
Thank you, Marc, and good morning. As always, I would like to begin by thanking our shareholders and our customers for their continued support and investment in ITT. And again, I also want to recognize our employees around the world. It is thanks to your efforts that we were able to deliver such a strong first quarter. If there is one thing about ITT's Q1 results I would like you to remember, it's our performance on both growth and execution. We delivered solid starts to 2023 on all accounts. 10% organic revenue growth leading to ITT's highest quarterly revenue ever. 7% organic orders growth. 150 basis points of segment margin expansion, 21% EPS growth, and a more than $60 million improvement in free cash flow. We also signed a strategic aftermarket agreement in friction with our partner Continental, repurchased $30 million of ITT shares, and deployed $80 million toward the acquisition of MicroMod in May. Now, let's get into the details. On growth. industrial process orders grew 22% as a result of continued share gains. We generated significant commercial momentum in the green energy space, with large project awards and market share gains related to decarbonization. Project orders in IP grew an outstanding 54%, while on the short cycle, orders for aftermarket baseline pumps and valves grew 13%. The order's momentum drove IP's revenue growth above 25% this quarter, and added to an already large, and most importantly, profitable backlog entering Q2. In Motion Technologies, we won 41 electrified vehicle platforms awards, with leading OEMs including BYD in China, and Ford and Chrysler in North America. Continuing with electrification, Orders in our EV connector business grew over 15%, with sales growth eclipsing 20% as electrification investments continue. Moving to execution. Once again, industrial process led the way with 850 basis points of margin expansion to end above 21% for the third consecutive quarter. We are continuing the push on shop floor improvements and the lean-out of IP's manufacturing sites. accelerating strategic pricing actions across the short cycle portfolio and driving increased profitability on pump projects in backlog. Together with the ITT leadership team, I spent time at our Seneca Falls campus and reviewed our progress on the new lean layout. When it's completed in Q3, every single pump will be built using a one-piece flow process. By eliminating excess movements, we will accelerate throughput, reduce lead time, and improve our on-time delivery. We are on a journey of continuous improvement, and we have no finish line. Also this quarter, I finally returned to China and spent time with our Wuxi team. We reviewed the investments that were made on the shop floor and plans for the future. You may remember that our Wuxi employees achieved amazing feats last year by operating in isolation throughout the pandemic and working through a mass infection wave in December, all while adding new capacity and maintaining 99% on-time delivery. As our WUSHI plant continues to gain market share, especially in EVs, we're adding two new production lines and increasing capacity beyond what we initially thought was achievable. It was wonderful to be in person with such a high-performance team to discuss the vision for the new plant layout and how it will support EV growth in the region. We are making similar growth investments in IP, which I saw firsthand. Saudi Arabia had the perfect on-time delivery performance and impressive orders growth last year. This is why we are expanding their testing capabilities. In India, a market with great opportunity, we are also expanding our design center to support growth in the region. And in Germany, Bornemann is gaining share in decarbonization projects, which is driving the further expansion of its testing center. All of these sites have earned the right for investment. We also executed on cash and capital deployment. Free cash flow is rebounding with a $62 million increase versus prior year. This is a continuation of the positive trend we saw last quarter. And in the coming quarters, as supply chain disruptions begin to subside and we free up working capital, we expect cash generation will continue to ramp. We also repurchased $30 million of ITT shares and paid down roughly $70 million of outstanding commercial paper. Finally, yesterday, we announced the acquisition of specialty connectors manufacturer Micromode for approximately $80 million. Micromode has held a leading position in defense and space connectors for more than 30 years and brings a complementary technology portfolio to our profitable North America connectors platform. Each quarter, I'd like to highlight the progress ITT is making with our sustainability investments. As you hopefully saw last month, we announced a $25 million investment in green energy and sustainable projects, including solar panel installations and other energy efficiency initiatives. Together, these installations will reduce ITT's CO2 emissions by more than 6,000 tons annually once completed. Moving to our 2023 outlook. We are raising the midpoint of our adjusted EPS range by 5 cents after a strong first quarter. We have renewed confidence in our ability to deliver the midpoint of our updated guidance range due to our more than $1 billion backlog and exposure to growing aero, auto, and energy markets. In Q1, we delivered growth and execution. Double digit organic revenue and EPS growth, 150 basis points of segment margin expansion, and an over $60 million increase in free cash flow. So now, let me share some of our commercial wins this quarter on slide four. In March, we signed a 10-year $1 billion agreement with Continental to supply aftermarket brake pads in Europe. Our friction team consistently provides the highest level of quality and service for our auto customers, and this helped us secure this important partnership. Under the contract, Motion Technologies will continue to provide copper-free braille pads for ATE, Continental's premium braille pad brand. Additionally, Continental will market and sell highly trusted braille pads from Gaffer, an ITT brand, to help expand our aftermarket presence in Europe. The agreement contains improved volume incentives that will likely elevate the total value of the agreement to over $1 billion over the 10-year term. It also preserves ITT's ability to expand our aftermarket business in China. Congratulations to Vincenzo and the Friction team on this exciting next chapter. We are delighted to continue serving Continental and help them win in the car aftermarket. In industrial process, our Bornemann twin screw pumps are leading the way on large-scale green projects thanks to their multi-phase boosting technology. In Q1, We were awarded anti-flaring projects at two oil and gas sites in Nigeria. Thanks to our Boneman pumps, our customers will eliminate roughly 350,000 tons of CO2 per year and avoid environmental fines. In early April, we won another decarbonization project at the largest LNG field in Australia and one of the largest sites in the world. This carbon capture project, the largest in the world, is expected to reduce CO2 emissions by 100 million tons over the system's lifetime. I want to thank Jeroen and the entire Bornemann team for developing these opportunities, establishing an incredible customer intimacy, and working hard to share the value of our Bornemann pumps with our customers. The technology of our Bornemann pumps plays, and will continue to play, a pivotal role in the decarbonization of the energy industry. Decarbonization is good for ITT. Let's turn to slide five to discuss the MicroMODE acquisition. Yesterday, we announced the acquisition of MicroMODE products for approximately $80 million, and the company is now part of CCT. The effective purchase multiple was approximately 11 times EBITDA, and we expect it will improve from here as the value creation accelerates. MicroMODE is a leading designer and manufacturer of high bandwidth radio frequency connectors for HASH applications in radar, satellite, and smart defense systems. Micro-mode connectors are the product of choice on mission-critical applications, and they've been qualified on space programs for more than 30 years. With this acquisition, ITD gains further entry into niche defense and space markets with significant long-term potential, as this is a total addressable market of approximately $4 billion. MicroMod's customers love their performance, their responsiveness, and attention to their needs. Like Habonim, our recent VALS acquisition, which has been a great success, MicroMod has strong, long-lasting intimacy with its customers. Mike, Gerald, Brian, and the entire MicroMod team, welcome to ITT. I look forward to growing our business together. With that, I turn the call over to Emmanuel to discuss our first quarter results in more detail.
Marc
Thank you, Luca, and good morning. Let's begin on slide six. We generated 10% organic sales growth led by IP at 25% and a strong double digit performance by CCT. In IP, our book to bill was 1.23 this quarter, all the more impressive given our 25% organic revenue growth. We are seeing outgrowth in projects with significant awards this quarter and continuing into April. and our aftermarket orders were up 19%. In CCT, we continue to draw up top-line growth on the strength of the commercial aero recovery. As a result of this and our strong position on key platforms, controls grew 15%. Connectors grew 6% despite the deceleration in the industrial market. More on this when we discuss our 2023 outlook. Finally, in MT, pricing actions and share gains in friction OE offset lower volumes in the aftermarket. As we highlighted last quarter, there is a continued inventory correction occurring in the European car aftermarket, partially due to improved lead times and indirect impacts from the war in Ukraine. We initially believed this would be a one-quarter headwind, but we now expect it will continue into the second half of the year. In rail, we saw mid-single-digit revenue growth as the Kony and Axton businesses continued to execute and gain share. This is also the last quarter we will see a year-over-year headwind in Axton related to the war in Ukraine. Nevertheless, Axton delivered 11% growth in orders in Q1 to fully overcome the loss of its Russia business. And they continue to invest for future growth with the development of the digital automated coupler technology ahead of its European deployment in rail freight in 2025. More to come in upcoming quarters. For all of ITT, pricing contributed roughly half of the 10 points of organic sales growth this quarter. We are strengthening pricing actions through deployment of a value-based pricing model across the organization. On profitability, margin expansion was driven by an outstanding performance in IP. Its margins expanded over 800 basis points to 21.3%. Notably, CCT also expanded margins by an impressive 80 basis points. Overall, incremental margin was a solid 33% in Q1. I want to take a minute to discuss the outperformance in industrial process in a bit more detail. First, we're generating strong volume growth and demand across the projects, spare parts, and service businesses. Second, we're making good progress in pricing. In Q1, pricing actions drove approximately 25% of IP's top-line growth. And with the efficiency improvements Luca mentioned, the Seneca Falls team is creating best-in-class processes that are increasing throughput and will support volume growth from share gains. Back to ITT. In Q1, our productivity drove nearly 300 basis points of margin improvement, which partially offset nearly 450 basis points of cost inflation, despite some initial relief in commodities. Foreign currency was approximately 50 basis points headwind this quarter, mainly driven by the cost of our hedge instruments. Growth in EPS exceeded 20% in Q1 mainly driven by operations and pricing. Finally, on cash flow, we drove a strong improvement versus a weak Q1 last year, thanks to higher net income and a lower working capital impact. We will generate higher cash flow from the unwinding of inventory as our teams improve working capital. However, challenges in the supply chain, particularly with our suppliers in aerospace, continue to weigh on working capital. We also paid down $70 million of outstanding commercial paper given our strong cash generation, which will reduce interest expense over time. We continue to invest organically in our business through capacity expansions in friction, lean improvements in IP, and green energy investments, which collectively drove $29 million of capex for the quarter. All in, a strong start to 2023 that gives us renewed confidence in delivering the midpoint of our updated 2023 EPS outlook. Let's now turn to slide 7 to have a look at the Q1 earnings drivers. As you see here, we're driving strong volume growth and productivity. Pricing actions are upsetting cost inflation, although we're still seeing persistent inflation in labor and energy. The acquisition of Habonim and share repurchases each contributed $0.03, We deployed capital to share repurchases in the amount of $30 million in Q1, given the share price pullback. I also want to point out that we overcame $0.06 of negative impact from foreign currency, $0.03 from higher interest rates, and roughly $0.02 of lost earnings from our Russia business. As you can see on slide eight, we're increasing the low end of the range by $0.10, thanks to the strong start of the year And as a result, our EPS guidance is up 5 cents at the midpoint. We are continuing to gain share in friction on both EVs and ICEs, as well as in pump projects. Our ending backlog grew nearly $70 million this quarter and remains at over $1 billion, despite a 10% revenue increase in Q1. On the short cycle portion of our business, we see two different dynamics. On one hand, Demand for parts, service, and valves in IP continues to be strong, and we expect this to last for the next quarter or two. On the other hand, the acceleration of demand for the aftermarket brake pads and industrial connectors will likely persist into the second half. We're closely monitoring the demand patterns and mitigating the slowdown in connectors with pricing actions and cost reductions. Regarding the acquisition, we expect that the impact of Micromod's incremental earnings will be negligible this year. We do not see any other notable changes for outlook for sales, segment margin, or free cash flow. Revenue growth will be driven by a combination of share gains and conversion of our backlog, but tempered by slowing short cycle demand. For the second quarter, we expect high single-digit organic sales growth, led by industrial process with strong demand expected across projects and aftermarket. In MT, sales are expected to grow in the mid-single-digit range thanks to both friction OE and rail, partially offset by continued decline in the car aftermarket. CCT's revenue growth is expected to be slightly down in Q2, with a slowdown in industrial connectors outpacing the growth in commercial aerospace and defense. Segment operating margin is projected to be up between 100 and 150 basis points year-over-year. Both IP and MT will see strong year-over-year margin expansion, and MT should improve sequentially in Q2. We expect that CCT margin will be approximately flat year-over-year given the anticipated revenue decline. As a result, adjusted EPS will grow roughly 20% in Q2 and essentially be in line with the first quarter. Our tax rate remains at 21%, and interest expense will remain at an elevated level. Let me now turn the call back to Luca on slide nine.
Elliot
Thanks, Emmanuel. Before we move to the best part of the call, the Q&A, just a few points. This quarter, we focused on growth and execution in everything we did, and we delivered a strong performance. Through increased orders, project awards, and large green energy wins we delivered on growth. To our cash performance, capital deployment, and operational improvements we delivered on execution. The awards and shared gains we're bringing home and our execution give us the confidence to deliver on our long-term targets, 6% top-line growth, 20% segment margin, 10% plus EPS growth, and 12% free cash flow margin. We are proud of our performance this quarter and never satisfied. So our journey continues. I would like to thank all our stakeholders for their continued support of ITT. It has been my pleasure speaking with you all this morning. Elliot, please open the line for questions.
Operator
Thank you. The floor is now open for questions. At this time, if you have a question or comment, please press star one on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. Again, we do ask that while you pose for your question, you pick up your handset to provide optimal sound quality. Please limit yourself to questions, one question and one follow-up. Thank you. Our first question today comes from Jeff Hammond from Keyback Capsule Markets. Your line is open.
Jeff Hammond
Hey, good morning, gentlemen. Hi, Jeff. Just, I guess to start, you know, within your unchanged experience uh you know organic growth guidance there seems to be some moving pieces around kind of ip coming in better you know some of this this friction d stock and and softness and cct can you just maybe speak to to how you're thinking about the the segments differently from an organic growth uh you know standpoint for the year
Elliot
I think you got it, Jeff. I think that IP has come out stronger in Q1 and we see the strength in projects and also the strength in the short cycle in Q1. So probably IP will be better for the year. We continue to see our performance in the OE friction. But I would say the aftermarket in motion technologies, in automotive, is probably be slower than what we expected. The destocking will last for the entire year. And then when it comes to the connector side of the business, also the destocking of the connectors will probably last for the full year of 2023. This is really how it plays.
Jeff Hammond
Okay. And then, you know, just on the destock, what Usually these are kind of sharper D stocks and then you're kind of settled. What makes you think that these D stocks carry through the year?
Elliot
When it comes to the automotive is really talking to our customers and really the feedback that we're getting from them. When you look at the distribution on the connectors, for example, We see the decline in the orders, but we still see the inventory level still high. So when we look at the point of sales, their bookings, and the inventory level, we do our simulation, we talk to our distributors, and we think that this is going to last a little bit longer. This is how we got that.
Jeff Hammond
And on CCT?
Elliot
That was on CCT. I was talking about the distributors on the connector side, Jeff.
Jeff Hammond
Okay, okay. Okay, great. I'll get back in queue. Thanks. Thanks, Jeff.
Operator
Our next question comes from Scott Davis from Mellius Research. Your line is open.
Scott Davis
Good morning, Scott. Good morning, guys. Good morning. Presentation is really pretty clear, so I wanted to take a step back a little bit and talk a little bit about this anti-flaring technology. What is it that you guys are doing different? And maybe just help us understand what that really means. I would imagine there's a lot of those types of projects out there if your technology is perhaps differentiated or interesting or whatever. But I'll let you guys address that. Thank you.
Elliot
Yeah. Let me give you a couple of examples. Because the decarbonization is the anti-flaring, stop the flaring, but it's also the carbon capture. So when you have the flaring, for example, also normal wells in the Permian Basin, you extract the oil, and it comes out oil, water, and gas. And usually what happens is you separate there and then, and you separate oil from water, and you flare the gas. Now, with our Bornemann pumps, which are multi-phase boosting technology, practically are twin-screw pumps, where you can pump water, gas, and liquid together. in all the different mixes. What you take, you take all that mix, you pump it 50, 60 kilometers down the line so that you separate where you can actually use the gas and put the gas in distribution. That is the twin screw pumps. That is the multi-phase pump that will stop the flaring. The decarbonization is something similar in the sense that what we do, for instance, in this major site in Australia, What you have, you have the offshore field that produce gas containing CO2. The CO2 is then separated at the gas plant, and then our pumps will take that CO2, mix with water, and push it down two kilometers below the ground. And that is for the carbon capture.
Scott Davis
Pretty cool. I actually didn't know you could pump both a liquid and a gas at the same time, so thanks for that. The Continental deal, why do you need them, I guess, is kind of the question. Is it a question of channel access and brand? Do you cannibalize yourself a little bit because you're both then going to market under different brands? Perhaps just help me understand the dynamics of how that works. Thanks.
Marc
Yes, Scott. The partnership with Continental is really crucial for a friction business. At Friction, as you know, we excel at producing high quality parts and that we deliver on time. And we have great also material science. What we don't know how to do is distribute and market our product in the aftermarket. And this is why Continental is so key for us because they deliver that aspect of distribution, marketing and branding And we focus on what we know how to do. And so it's really the perfect combination between and playing to our strength, to our respective strengths with this agreement. So a really key strategic partnership. We have a 10-year partnership that we renewed. And we look for much more in the future.
Elliot
And also, Scott, think about it. If you go with Continental, the distributor, you have 10%. Thousands of product you can you can offer them where we are going there only with a break pad So they have a good value proposition It sounds interesting, thank you guys best of luck congrats on the start of the year, thanks, God, thanks Our next question comes from blood like whiskey from Citigroup your lines open Morning that I've had
Scott
Morning, guys. Thanks for taking my call. So can you just talk about on the IP business, your sort of level of confidence or visibility in the baseline pumps business, you know, continuing to perform well here and what you're hearing from your distributors about inventory in the channel there and sort of any, any concerns about potential destocking emerge in that business?
Marc
Yeah, sure. So, um, I have to say that in Q1, we were a little bit surprised positively by the order rate of our baseline business. Uh, the baseline business was up, um, even though, even though he was more driven by price than volume, uh, volume was actually a little bit, a little bit down, but, much better than what we were expecting. And when we check with our distributors, they don't report any excess inventory situation. So I would say that for the moment, it looks like our differentiation, which is providing reliable pumps that our customers know and that are easily swappable, in good lead times compared to the competition is really what's differentiating for our distributors and their customers. So pretty good start of the year for Baseline.
Elliot
And one other point as well to add to what Emmanuel said is that if you look at our short cycle, orders were also up sequentially, Q1 over Q4, which is a positive sign.
Scott
Okay, that's all really helpful, Culler. And then maybe just shifting to MotionTech, you highlighted again the OE wins in the quarter to drive share gains over time. Can you just talk about, in China specifically, your... wins and share with China OEMs versus, you know, versus foreign OEMs?
Elliot
Yeah, I'm glad that you asked this question because, you know, I was in China, you know, in Q1. And, you know, everybody is reading on the newspaper, you know, that the Chinese OEMs are gaining shares. But you don't really smell it. You don't touch it until you get there. And you drive from Pudong to Puxi. And actually, I can tell you, Vlad, I couldn't recognize any of the cars on the highway. They were completely different from when I was there three years ago. All these new OEMs, many of them were electric. So you really touch the importance of the Chinese OEMs. When you look at our data, in 2022, 62% of the brake pads that we produced in 2022 were for the Chinese OEMs. And the market share of the Chinese OEM in the China market is above 50. So we are very well positioned with them, with many of them. If it's NIO, if it's a Xipeng, if it's Li Auto, or if it is BYD, all of them. So I want to give credit to the China team because when we went to China, you know, eight, nine, 10 years ago, we went with one customer, one Western customer. We reduced the risk. We differentiated with all the Western. And several years ago, the team decided to go Chinese And this is paying off.
Scott
Now, that's great to hear. I'll get back into the key things.
spk12
Thanks, Matt.
Operator
Our next question comes from Mike Halloran with Baird. Your line is open.
Mike Halloran
Hey, good morning, everyone.
Operator
Morning. Morning.
Mike Halloran
So let's stick on the auto side. Certainly appreciate the destock that's happening. But, you know, Luca, like I said last quarter, I think you always give really good context on how you think the auto market holistically is going to perform. If you could give some thoughts by region on what you're seeing, that'd be great.
Elliot
Sure. So I would say Q1, really the market performed in the way that IHS forecasted. So when you look at the market, you have Europe that performed very well, plus 17% in the quarter. China was down 8%, and North America was up almost 10%. Now, we outperformed the market, roughly in Q1, by more than 100 basis points overall. Now, the way that the forecast is for my HS is still around 85.5 million vehicles. They are forecasting, you know, mid single digit growth for Europe and North America and flattish China. What our assumptions are, Mike, is that the market will probably grow low single digit worldwide. North America positive, mid single digit. Europe and China flattish. Now, with those assumptions, you know, we are always more conservative. we expect always to outgrow the market by roughly 400 and 500 basis points. The reason why we tend to be a little bit more conservative is also because we start seeing the level of inventory going up a little bit.
Mike Halloran
That makes sense. And backlog, obviously, is still really strong. Maybe talk about how you're expecting that to normalize as you work through the year and how that's embedded in the guidance.
Marc
Sure, yeah.