ITT Inc. (ITT) Earnings Call Transcript & Summary

Good afternoon, everybody, and welcome to the second half of our day 2 of the Industrial and Materials Conference. This is Joe Ritchie, covers the U.S. Multis, and I'm really excited today to have ITT here with me today. We've got Tom Scalera, their CFO; as well as Emmanuel Caprais, their Group Chief Financial Officer. And Emmanuel, congratulations on the recent promotion.

Thank you, Joe.

Really happy to have you guys here today. And I think maybe just kind of starting off, Tom or Emmanuel. There -- going into this year, I thought there -- look, there are a lot of great things that were happening for the company when this pandemic hit. You guys are taking a ton of share in Motion Tech and particularly the friction business. Your operations are really performing well. And look, still lots of margin opportunity there across each of your businesses. But obviously, the pandemic hits and I'm just wondering like how does that impact your ability to either accelerate some of the opportunities that you saw? Or does it kind of hold back some of the opportunity across your business?

Yes. Thanks, Joe. It's Tom. So I think, fortunately, for us, coming into the pandemic, we've been on kind of this really 3-plus year journey to reset the operating capabilities all across ITT and to really take the Motion Tech model of industry-leading execution, margin profile, share gains and really kind of populate that all across the ITT portfolio. So the obvious way that we did that is that Luca, our former MT Segment President, became our Chief Operating Officer, 2 years ago and really started to bring that mindset shift, that operational shift to all of the businesses within ITT. And now as CEO, obviously, we've been accelerating and enhancing those capabilities. So for sure, we've been on that journey, and we've had tremendous progress in our margin expansion at IP and CCT in the last 2 or 3 years, gaining share, driving on-time delivery and quality performance, resetting kind of the structural way that we run those businesses. So we've been on a journey. And I think what COVID has done has allowed us to take this next wave of opportunities that we had identified over this transformational reset and really start to accelerate those. So we were always going to make the organization flatter. And when COVID came, we accelerated those decisions and took out structural costs of around $50 million on an annualized basis, all across ITT. Not because of COVID, but because we want to operate in a more kind of hands-on, flatter, "closer to the customer", "closer to the operations way". That's been the philosophy that Motion Tech has been executing, and that's what we've been bringing across the businesses. And we've been moving product lines for the last couple of years within CCT out of some of the larger locations in North America, it -- down into low-cost regions, moving out of California into New Mexico, out of Germany into China, for example. These things were in motion and will continue to play out as the year goes on. So the idea is to kind of augment this journey, if you will, enhance this journey of betterment across ITT. We've had great momentum. We think that the environment allows us to accelerate those actions and really differentiate ourselves, maintain that competitive advantage as kind of the world leader in Motion Tech. And to take the IP flow business to the next level of on-time delivery, quality and margin. And we've had great progress in some of the elements of that, that we could talk about. And I think CCT, particularly on the connector side, you've heard us talk for the last couple of years how they've been getting those margins pre COVID into the mid- to high teens range. So all of these businesses have been progressing towards industry-leading margins, industry-leading execution, and that's been a 3-year journey. COVID is going to allow us to get in this phase to a lot faster, and we put $100 million of actions on the table this year. And we'll just keep driving those. But this is the new way that ITT is going to operate. It's not a temporary reaction to the dynamics related to COVID.

Yes. And maybe just along those lines, Tom, and we'll get into the cost actions, I'm sure in a little bit. But just along those lines, maybe just kind of remind folks you guys think about those longer-term margin entitlement for each business, where you are today? And like where you could see it potentially go?

Yes. So we are driving -- and there hasn't been any change in our view on where we think we can take these businesses. So particularly with IP, our goal is to kind of be in Industrial Process business as kind of leading margin profile within the flow space. And we think getting above 15% margins in the Industrial Process segment. Is the right target for us to set in the 3 to 5-year window. So that's what we're driving toward. And obviously, we took a lot of restructuring actions at the end of last year, and we've been on this journey to improve our project execution and to reset our short-cycle base pumps production, and we're starting to see meaningful benefits to accumulate in -- from those activities, and we're going to keep driving IP in that direction, and we've announced a lot of actions this year to help with that. Within CCT, 55%, 60% is the connector business. As we mentioned, we think that business should be at the targeting kind of Amphenol connector margins, right? They're the standard-setter with 20% plus margins in the connector space, we've been coming out of the low teens into the mid-teens, getting into the high teens, and we are on the journey because we really like our portfolio within connectors and where we play. Over time, we think setting our aspirations to kind of go after the Amphenol-type margins within connectors is the way to go. And we have had good momentum there. And then lastly, the other part of CCT, which is our components business, has been a nice margin business in aerospace and defense and industrial. And I think what we've been doing over the last couple of years through that transformation is, again, moving product lines. I think we moved 12 last year out of high-cost regions in the low-cost regions, so reset the operating environment for those components businesses and take them to the next level. They've always been very solid, it's always been a very good business, the components piece of CCT. But we want to make every one of our businesses a great business the way Motion Tech is, inside of the automotive market that it primarily serves. They are the standard setter of quality, on-time delivery, margin. And we want all of our businesses to get there. So we've said 15% plus margin target for IP and we've said high teens plus at CCT, and our view hasn't changed on that. We have to kind of navigate through COVID here. But we've taken a lot of aggressive actions to maintain that momentum towards those goals. We haven't given specific targets publicly for MT margin aspirations over the 3- to 5-year window. We don't think our customers would appreciate the goals that we've set for ourselves. But we know that we have continued margin upside within our friction business. And we've taken actions also in Motion Technologies to flatten that organization even further. And the other 30% that's non friction, call it, low teens margin on blend right now, we think those businesses should be in the mid- to high teens. So a lot of sources of opportunity in MT as well. We just don't like to remind our auto customers that a good chunk of our business in auto is at significant margins, particularly on the friction side, which gets into the 20s.

Yes. That makes a ton of sense, too, Tom. But maybe just kind of jumping off that point and just diving right into friction. One of the questions I often get from investors is usually the ones that are still trying to figure out what ITT is and then in each of the different businesses is just like this ability for you guys to outgrow in the Motion Tech business and specifically on friction? Yes, I often get the question like what is kind of the value proposition of the company. And so I think it probably would help folks for you to just kind of talk about like the -- your standardized manufacturing process, your low cost manufacturing. Just any details that you can give around the value prop would be great.

Sure. I'll give some insights and then invite Emmanuel to jump in because he's spent a lot of time with Motion Tech, as many of you know. Motion Tech is just a unique business in a uniquely advantaged position in its marketplace. We wish we had 5 more examples like this, but there's really only one Motion Tech situation, and I'll try to explain it kind of at a high level. So this has been built up over years and years and years. This competitive advantage within Motion Technologies. And it's also the way that we make brake pad, it's very, very different than the way our competitors do. We use a dried powder formula. Many of them use a slurry base. So what that means is fundamentally different supply chain, fundamentally different technology and an end-to-end different way of operating our manufacturing locations. We've kind of perfected or continuously improved the way that we operate, using heavy automation to make those brake pad. And those items in combination allow us to do R&D in close unison with mass manufacturing. So customers are receiving millions of versions of what we showed them in the R&D lab because some of the equipment, all of our properties are standardized from the R&D lab to manufacturing in Europe and then that manufacturing methodology, the equipment, the supply chain, the setup, we took to the next level when we moved to China and started operations there about 5 years ago. And then really took it kind of slightly to the next level on our first greenfield location in Mexico, where we kind of took the best-in-breed capabilities and put them all in one place. But generally speaking, all of our locations are standardized around a common operating approach. The equipment is the same. The way we make brake pads is the same. And we fundamentally serve about 20% to 25% of the global market using about 4 operating locations, very concentrated footprint. Our competitors generally are operating 15 to 20 locations to produce the same amount of volume. So we're concentrated. We're standardized, we're automated. We have a fundamentally more efficient way of producing brake pads. And those are the sources of this competitive structural advantage. When we design new automation with our suppliers, they're not allowed to sell that automation to our competitors for 5 years. But even still, our competitors make brake pads in a very, very different way. So they couldn't just buy a piece of equipment and catch-up easily to the way that we operate. So these are structural advantages. And the last piece I would share is, financially, we've been investing in the automation and nurturing these competitive advantages, investing in R&D. Our competition generally is very weak financially and has underinvested in their capabilities or has recently gone through bankruptcy or other kind of financial distress, which has further impacted their ability to invest for the long term. And that has accelerated opportunity for us to gain share. And we've talked about over the last 8 or 9 years, we've outgrown the market by 900 basis points on average for 8 years running. Last year, we were at 1,100 basis points of outperformance. We had a very strong Q1. But for the year of 2020, we're expecting to, again, outgrow the market by 700 to 1,000 basis points. So all of those elements are in play to create this kind of competitive advantage. And lastly, the margin profile that kind of further validates that level of outperformance is we're looking at friction margins that are in the 20s, low 20s, a lot of our competitors with similar products are in the low single digits on a good day. So there they don't have a lot of way to maneuver. And our goal is to organically continue to gain share and momentum particularly in China, North America, leveraging all of these competitive advantages. So I'll pause there because we could go a full day on just defining these advantages. But they are unique. I mean we recognize that this is a strange combination of competitive advantages that creates this very, very unique animal. That's Motion Technologies. We are trying to clone some of those core capabilities and mindset and bring them to our other businesses, but there's really no space that we see that have all of these kind of pluses. As long as we keep executing, this is a unique set of structural advantages.

Yes. I know, like you said, and thanks for the comprehensive answer. I do think it's incredibly unique, I mean, that level of outperformance has been staggering. And the fact that it's expected to continue, it just speaks to the advantage that you do have. I guess just along those lines, you think about kind of like 5, 6 years ago, your share in North America and your share in China was effectively in 0%. And you're now looking at 15% North America, maybe a little bit more than that, 20% in China. And I know you have this ambition to double your market share in both of those regions. So I guess a couple of questions there is like how do you think about the visibility that you already have in some of your platform wins to continue that trajectory? And then secondly, just given what you said about your competitors and the fact that we're in this really tough backdrop, like does this backdrop potentially accelerate your ability to do that? Tom, if you're answering then you're on mute.

Sorry, Joe, you got me on mute -- yes, we do believe that this environment accelerates our share capture. And we're seeing signs of that already. Our competition, particularly in North America, Akebono has -- used to be the dominant market player, and they are retreating from the market and leaving a lot of opportunities in their wake. So we do believe that we have good line of sight to double our share in North America. And part of that accelerating dynamic has been the strategic pivot that Akebono has taken, most likely focusing in a heavier way in Asia. And that's, again, a part of the story that there is share to be had. Now not all platforms are available at all times, but this environment does create more opportunity for us to win. And in China, for sure, we parlay our competitive advantages there. We've invested in EV R&D capabilities in region and our EV win rate has accelerated and is higher than even our conventional engine win rate, if you will. So a lot of areas of new competition, a lot of shift in technology, a lot of these geographic expansion opportunities really further support our belief that we're going to be able to double share in China and North America. And any weakness from our competition has already opened up more opportunities. So we're going to be opportunistic, and we're going to keep driving forward, but that's kind of my view. Emmanuel, anything you want to add there?

No. Just a quick stat. So in -- at the end of '18, our North America market share was around 15%. And at the end of '19, we grew it to 19%. And so as Tom was saying, we see really line of sight to double our market share over the next 5 to 6 years. And we have a lot of the future growth already in backlog. And then in China, we ended up '18 -- 2018 at 19% market share. And we ended 2019 at 22% market share. And there, again, we have seen a lot of growth, whether it is with the Western OEM as well as the local, Chinese OEM and a lot of that growth has been also on the EV -- with the EV manufacturers. And this is something that we think is going to help us solidify our leadership in terms of brake pads, as we are setting the standard for future EV break pad.

No. That's great to hear. Thank you both. And I appreciated the stats, Emmanuel. I guess just in the context then of this year and what you guys were able to perform in the first quarter, you outgrew the market by 2,000 basis points in 1Q. I know your expectation is 700 to 1,000 for the year. I guess was there anything notable to call out in 1Q on why you were able to grow that quickly? I mean obviously, you don't necessarily want to underwrite a 2,000 basis point performance for the rest of the year. But was there anything notable that you guys would call out?

Emmanuel, you want to give the perspective there?

Sure, absolutely. So I think one thing that's really working for us is the fact that we are very strategic in the platforms that we're targeting. And for instance, part of the story in North America and why we've been so successful at growing our North American revenue by 30% in 2019 was the fact that we targeted those GM platforms that are very popular. So we started producing for the T1XX, which is the Silverado and the suburban platform. At the end of '18, we had a nice ramp-up in 2019. And we're going to see further increases also in 2020 as GM is rolling our brake pads to the entire T1XX platform. The other thing also that we've seen is that we were able to gain another platform, which is very popular with GM that will actually start a little bit later during this year. And this is the crossover platform. That is very popular also in the Suburbs, the Acadia, the Traverse type of vehicles. And so those examples add to -- they're just to show that because we've been so targeted and because we've given the opportunity for those customers that -- with whom we were a lot weaker in the past, to experience what it is to work with ITT and what it is to work with our friction business, this will fuel future share gain. There was one thing that we were really proud of, in Q1, even if it really didn't participate to the outperformance of our business. Those are the wins we got with the leading EV manufacturer, which will further enhance our credibility in the EV segment. And will be really able to help us really set the standard going forward on that crucial area of growth for auto.

Got it. That's really great to hear, and we don't need to necessarily mention that manufacturer by the name, but got it. The -- I guess maybe kind of kind of thinking through then -- I know you guys just reported a couple of weeks ago, but folks are kind of starving for any type of like information around trends. And look, China was recovering nicely as of April. I'm just curious whether there's anything that you can add on what you're seeing so far in May and whether that has kind of continued?

Yes. I would say we like the trends, certainly on a sequential basis that we're seeing and others are seeing out of China, that will play nicely for ITT. But even in Q1, we were able to produce, with our friction business, 20% margins in China on the lower volumes that we had in the quarter. And we've been resetting -- China market has been very erratic over the last 2 or 3 quarters, 4 quarters, if you will. And I think our business has been able to scale, flex and pivot very effectively to a lot of the changing dynamics in China and still produce very, very solid financial results. So jumping off good internal execution in Q1 and watching some of the sequential moves in the market, I think gives us a little bit of hope. We don't want to get ahead of the market dynamics, but certainly, any kind of sequential improvement in China, the sooner it happens, the better it is for all of us. But in particular, as you know, that's a really profitable business for us even when top line has been a little bit tight. So that would be a nice plus if things continue to accelerate and move forward. And stimulus hasn't really come into play yet. So we'll see if anyone on a global basis sees additional demand driven by government stimulus, but that hasn't been a factor yet. But I'd say we're encouraged by some of the sequential movements in the market in China so far.

Good. That's great to hear. And I know that maybe just one last question on Motion Tech. I know friction gets all the all the buzz typically, but you do have a rail business, and that's been a great story as well over the last few years. It's one of the end markets that has been holding up positively. I know you guys mentioned it, up 5% in the quarter. I think there are others as well. Just remind us a little bit more about that rail business, how much of that is kind of tied to government spending, how much is freight versus passenger? And like what do you think this end market looks like throughout 2020?

Yes. I'll give some comments and Emmanuel is going to jump in. So very, very high level, we're more -- we're probably 60, 40 passenger to freight. Axtone was more of a freight-weighted business. KONI was more of a passenger-weighted business. Obviously, we're starting to run those to and leverage relationships and leverage capabilities. And we're trying to kind of level both of those businesses out to both the equal players, in freight and passenger. And I think some of the great growth that we've been generating has been coming off of the Axtone passenger-focused areas. So we operate both with the OEMs and the regional operators with 60% of our business in rail of our revenue is in the aftermarket. So we've been well positioned in some of the categories. And I think we're much more of a global, much more of a comprehensive player with this Axtone acquisition. And that's one of the very attractive low-cost footprint in Eastern Europe, and that's an area that we're going to continue to leverage and really drive some efficiency through the operations of our overall rail business. Again, getting it from kind of the low teens to the mid-teens, which is where we -- or higher, which is where we think this platform could go. But I think we've been well positioned with good diversification. And I think we've been kind of establishing ourselves as a major component player on the rise in rail. Emmanuel, anything you want to add on rails from your perspective?

The last -- the only thing I would add would be that -- a couple of stats. Our rail business is 60% aftermarket, which is really nice in terms of profile. And we have a lot of backlog. So I would say that even if we may see some postponements, some delays. We are linked to long-term expansion and monetization programs. And I think that gives us the ability to have that visibility in the future. And if you look at 2020, a large majority of our 2020 expected revenues are already in backlog. So we like that stability. We like that aftermarket side to it. And we're just focusing on outperforming the competition by delivering on time. We have the lowest level of PPM quality defects in years. And so all those things are things that customers really appreciate and allow them to come back to us and give us more business over time.

So we're not totally immune to the market, Joe. We're not totally immune to the market dynamics, but very well positioned relative to other end markets.

Got it. And I want to quickly touch on the other segments real quickly. Industrial Process, really nice margin expansion this quarter. I know baseline pumps is up about 4%. And just help level set folks on how much of your business is upstream versus downstream, oil and gas? And then how much of it is kind of like industrial pumps as well? Because, I guess, the expectation being here that oil and gas probably is going to be -- and both industrial are going to be tougher end markets, at least for the next few quarters. But maybe talk a little bit about how your business is going to kind of fare.

Sure. So today's IP is very well positioned, I think, certainly better than in the last downturn within the segment. And basically, today, we're about 25-ish -- 20 -- certainly below 30%, we'll call it 25%-ish oil and gas within the Industrial Process segment. And just simply put 60%, 65% of that is downstream. So the upstream oil and gas content is pretty low these days compared to where it may have been in the past. So we focus down in what we were good at in the upstream. And some markets have changed, and we didn't kind of follow those and stayed in our core, in oil and gas. So today, at the ITT level, oil and gas is less than 10%. Today, at the IP level, it's around 25% to 30%. And again, our upstream weighting is down significantly. At the ITT level, upstream is only 4% of the portfolio. And just to dimensionalize upstream a little bit more, we don't have a huge play in the Permian Basin, maybe $20 million to $25 million of revenue in the Permian Basin. We've never been big players in the shale space, at this point. So most of what we do in upstream is production and the extension of well output, no exploration, no drilling. So look, we're not immune, and we're going to see end market dynamics. But I think that the rest of the portfolio, the other 75% of the portfolio, heavily weighted towards general industrial, heavily with towards North American -- or huge installed base where we serve all industries and -- from pulp and paper to you name it. We're basically omnipresent in North America with one of the best distribution capabilities in North America, a large installed base, a great aftermarket, IP is around 45%, aftermarket these days. So I'd say that we're -- portfolio is very well balanced, probably as good as it's ever been including chemical, which is another core market for us in North America. But I think what we've done to kind of power our performance here is we've implemented in the last 12 months, 18 months, the one piece flow line for our baseline pumps. So powering the IP performance that you've been seeing from a margin perspective. And what's going to help us gain share and kind of outperform? We hope the markets in the IP world is, our bread and butter business, the baseline pumps, the anti business is now operating as effectively as it's ever done in its past. I mean well beyond what we actually even thought. We're talking about high 90% on-time delivery of our ANSI and baseline pumps business. One piece flow was always a decent margin business to begin with. After these resets, we are as competitive as we've ever been and well equipped to serve our customers as we've ever been. So that's a huge part of the driver of the IP performance. 75% of IP is in the short cycle. And our aftermarket parts is very, very effectively operated and run as is our baseline business, which is the next biggest piece of the IP portfolio. So we come to the table with all those capabilities in addition to one other thing I'll just touch on briefly. Our project execution has been improving year in and year out. It's a part of the margin story, Joe. You've heard us talk about 100 to 200 basis points of improvement in the project execution. And what's been great about that is it's identifying the right projects that we want to be a part of and keeping us away from products that are not in our wheelhouse. So we're picking the right projects. We're being more selective. We're executing those projects well, getting good margin profile on the projects. And then the follow-on activity from our customer, when they go to buy baseline pumps and ANSI pumps in the next phase of their build out, they are coming to us more than they have in the past. And then obviously, the parts are further downstream. So we're executing well across the entire value chain within IP. And we'll battle our way through the end market dynamics there. There obviously will be some pressures on capital spending with our customers, and we will be dealing with those as time goes on. But I think today's IP is well equipped to outperform and stay with what we're good at than we've ever been.

That's great to hear, Tom. And we're going to be bumping up against time, but I did want to ask you very quickly about CCT because aero is an end market that is super topical across industrials, and we have it at roughly 60% of the segment. Just remind folks how much of that business is commercial versus defense? And again, like this whole conversation has been really just around like where the margin opportunities are. I know you've been doing a lot within the components and the connectors business. So maybe just touch on the margin opportunities to maybe offset some of the weakness that we'll see on the go forward?

Sure. So today's CCT 35% commercial aero, 25% defense, 8% oil and gas-ish. And then the remaining 32% general industrial, including medical and all other kind of different industrial end markets that we serve. So in that commercial aerospace component, 35% of CCT, a lot of it's Boeing, probably 80% is Boeing. We've always been a legacy Boeing provider. But only about 10-ish -- 10%, 15% is in the aftermarket. So we're not as exposed to the miles flown. And the margin profile isn't aftermarket weighted, like you might see elsewhere in aerospace, when you're looking at competitor portfolio. So that's the nature of kind of where we operate. The aftermarket will be impacted, but I think it won't impact ITT as much as maybe other players in aerospace. So the goal for us is to kind of weather the storm, particularly on the MAX production. Obviously, we're baselining through that right now. And we'll kind of fight our way. We're seeing very low production levels this year and can't go below 0. So at some point, we'll see that pick back up. And what we've been doing in the meantime is getting that cost structure ready. We've taken out -- we did a lot of restructuring last year in CCT in Q4. And then we announced additional actions to flatten the organization, to streamline the organization. We've taken out about 17% to 18% of the structural costs within CCT in the actions that we announced in Q1. And we're continuing to move product lines out of these high cost regions. A lot of those are aerospace. Production lines coming out of California and going to Mexico. So those are some of the key actions that we're taking to kind of maintain the margin profile. And we will do more of that. We're looking at other footprint actions in the back half of this year as we keep moving lines. That will enable us to exit some of these $30 million, $40 million facilities and fully consolidate those into larger locations. Again, we're all about concentrated operating footprint capabilities in ITT. And CCT is also doing that as well. So we will in-source what makes sense and gives us competitive advantages. We'll outsource what doesn't help. And we'll continue to kind of migrate this footprint towards our best locations in our low-cost regions and all the while getting out as much structural cost as we can. So that's kind of where we are. Our margin targets for the long term are not changed, but I do think, obviously, we're going to feel more of the MAX pressure on the commercial aerospace front in the short term. And hopefully, when production comes back up, we'll have a much leaner and more effective cost structure to deliver those.

Yes. That all makes sense. And so I just wanted to say thank you, again, both, Tom and Emmanuel, for coming to the conference and spending time with us today. It's always great talking to you guys and hope you have a great rest of your week and weekend.

Thank you very much, Joe.

Thanks, Joe. Appreciate it.

Take care, guys.