ITT Inc. (ITT) Earnings Call Transcript & Summary

Good morning, everybody. This is Nathan Jones from Stifel. I'm here with management from ITT. We're pleased to have Luca Savi, CEO; and Tom Scalera, CFO, on the phone to take questions. There's a chat box on your webcast there, where you can type in questions if you want me to ask those to Tom and Luca, and I will just get started here. Thanks, guys.

ITT has had some businesses that have been especially impacted by COVID-19, both as a result of this severe demand disruption across as well as the location of some of your businesses, particularly the Northern Italy Friction business in Barge, which saw disruptions in your ability to operate the business. Could you just start off by giving us an update on the status of your facilities if there or anywhere you've experienced continued disruptions? Or if you're back to having something like full capacity available to you?

Sure. Thanks, Nathan. And as a matter of fact, at the beginning, we thought that the virus was really following us because it started in China, where we have the big operations. It went to South Korea, where we had our second largest plant for IP. And then it went to Italy, where the largest operation that we have in Friction. As a matter of fact, the business reacted incredibly, incredibly well. If we think about China, we were operating back running on February 10, which was the very first day that China reopened. And the reason for that was that the team was exceptional in putting together in China, what we call at the beginning, the China playbook, which has been a reason of our success in China. We didn't lose 1 day of operation because of supply chain or any problem since we reopened on February 10 in China. We were the first among all our competitors to open, and we maintained a performance, which was almost 100% on-time delivery, 0 delinquent backlog, if you think about China. And as a matter of fact, we conquered some business from the competition in China because some of the competition were not able to supply our customers. That's the story was true for Wuxi for our brake pads, but it's true for all other factories that we had in China that were very quick in reopen and had really 0 disruptions ever since. Korea was another amazing story. Korea was great as a country, but also our factory. We've been able to perform very well with exceptional on-time delivery. And then it comes to Italy and the other facilities around the world, if we can extend it. We applied the same approach to all of our facilities. We took the China playbook. We improved it. So at that, we closed some of these factories, in many cases, was just as a proactive measurement to match production with demand. And really no major facilities have been closed because of infection. In terms of the way that we were operating, really, we looked deeply in a granular way to our backlog to understand the real demand. We called our customers to ensure since we are a Tier 2 to ensure that there was no delay, and we really understood what was going on and the level of inventory that was in the channel. We planned also aggressive facility shutdown to drive full capacity production where we were reopening and also to adjust to a lower level of demand. In May, our Friction facilities in Italy and Mexico were mostly closed. But we haven't faced any major problem while we reopen, and we reopened our factories more than a week ago in Mexico as well.

Okay. So you're back up and running. You have that capacity available to you now, depending on wherever demand bounces back to. You're not concerned that you have any issues with delivering on to whatever demand happens -- ends up being?

That's absolutely right. And also on the supply chain, what we did, Nathan, when we were in the China playbook, we also tried to develop a kind of redundant supply chain. So we had our supply chain in Europe be ready to supply our China factories in case our China suppliers were not performing. That was not -- that was our backup plan. We didn't need to play with that, but that was the backup plan. And vice versa, conversely, when we were restarting our European operation, we had our China suppliers ready as a backup. But in any case, that was not needed.

Okay. I've been in a few of your facilities, and some of them are not, I guess, ideally laid out for social distancing. Can you talk about any of the changes that you've had to make to the manufacturing processes to enable social distancing and cleaning and those kinds of things? And how it has impacted your capacity or added additional cost? And do you see that being a material headwind to margins?

Okay. Sure. Well, all manufacturing facilities are not designed for social distancing. It's not the IP facilities, I would say, everyone and probably you have been in many plants, and they are all the same. As a matter of fact, I'm saying that we are pretty lucky. Because if you remember, in terms of visiting some of our facilities, if you think about our Barge facilities, you go there and you see the largest facilities in the world making brake pads, per shift you have less than 100 people, and you've got more than 400 robots. So in a way, you can see that in a very highly automated facilities, actually, you got -- you're better positioned on that social distancing. But obviously, we installed -- we started very strict and rigorous health protocols in terms of disinfecting, in terms of the canteens the way that you're operating them. And when the situation like in the canteen, for instance, you have, it would be difficult social distancing. We are separating, and we put Plexiglas stuff so that people are not staying close to each other, and there are the usual 6-feet distance that we need to guarantee. The other thing that we are taking advantage of as we are ramping up our capacity, we try to do more with less. So are we able to do 80% of our throughput with, let's say, 60% or 70% of our workforce? So that is another opportunity that we are trying to explore as we are ramping up and go back to the level of production that we are used to. So at the end, it's a strict health protocols for the employees reentry that we're applying across the board.

Okay. I'm just going to get a bit deeper into each of the businesses, starting with Motion. As the business is probably seeing the most severe disruption with OEMs in Europe and the U.S. closed down for April and parts of May, can you talk about your understanding of where OEMs are now in terms of restarting their facilities and actually producing cars?

Sure. So different regions will recover in a different way. So let's start looking at China, for instance. If you look at China production, January was negative. It was a big drop, more than 80% in February, then was minus 47% in March. For Q1, that was roughly minus 48%. Then what we saw in April was that it was slightly down versus previous year, and May was sequentially stronger. So when we look at the sales and the production in China, I would say, is a very nice recovery, moving in a very good direction. There are actually some of our OEM customers, like the Daimler, the BMW and also the Toyota and the Honda whose production actually is in -- is higher -- it was higher in April year-over-year. So all of this is pretty good. And then if you look at also at the inventory level, the inventory index that they use in China is lower than it was 1 year ago. So very good recovery in China. And I feel very positive about it, and I'm sure that we will take advantage of that. When it comes to Europe, it's a little bit of a different picture, and I'm not so sure that actually Europe and North America will recover in the same way. It's a little bit too early to tell. But even within Europe, you got different dynamics here. You have countries like German -- Germany and Northern Europe that have been impacted less from the COVID-19 and they continue to operate at the reduced level. But I will expect them to recover probably faster and stronger than other countries in the Southern Europe, like France, Italy or Spain or U.K. for that matter. So here, in Europe, we will have to pay attention to any stimulus that some of the OEMs are lobbying for the European Union to put in place. One thing that we know is that, as I said, it's too early to tell, is the May sales even as of sales, not production, even though they were considerably down year-over-year, they were better than what the expectations were. And this is a positive sign. When it comes to North America, North America has been restarting the auto production and probably you guys have seen some of the comments from Mary Barra on CNBC in terms of there were positive comments in terms of getting all their plants up to production. And one thing that I can confirm some of the information that she shared regarding the pickup truck demand that there might be pent-up demand. I was talking to an OEM CFO, and he was sharing with me that there are not enough pickups in the funnel. So I think that this is a positive information and positive doubt. Also because, as you know, we have a good position, both with GM and other OEM on that particular -- on those particular platforms. So -- but at the end of the day, I would like to emphasize, Nathan, that the name of the game for us is really the outperformance in the market that we are operating in. In 2019, we exceeded the market performance by 1,100 basis points. A very good outperformance also in Q1 this year. And for the last 8 years, has an average by 900 basis points outperformance, and that's the rule of the game, market share gains and resilience.

It's been great performance for a lot of years. Are the OEMs open enough to tell you anything about what their expected levels of demand and what their levels of production are over the next few months? And how that flows through to your own levels of production? Or are we still in -- they're opening back up, they don't really have any idea what demand is going to be, and you don't have a lot of visibility into that yet?

Okay. So one thing that I can tell you is that, usually, what we do is we do a scenario -- when we did the scenario planning, we looked at what our customers are telling us. We look at what IHS is telling us. And then what we tend to do -- but this is our approach, we tend to apply a more conservative and pessimistic scenario. The reason for that is not because we tend to be pessimistic but because we want to plan for the worst so that everything that comes back up is going to be the cherry on top. In addition, this allow us to adjust our costs and lower our breakeven point even further for when the recovery comes, we will be in a better position with better incremental. So this is our approach. Now when we talk about our customers, what I shared with you in terms of what a CFO of an OEM told me, so they're sharing with us this information. We tend to put it in our production schedule, we tend to take all of this into consideration, but this is really the way that we are running and operating the business.

Okay. The aftermarket business is primarily in Europe and has historically been less cyclical in the OEM side, obviously, but does still tend to see declines during recessionary times. As economies begin to reopen and people start getting back in their cars, can you talk about your expectation for how the aftermarket business recovers and when it gets back to some semblance of normalcy?

Sure. Just to put things into context, I would say that the Friction aftermarket business is really mainly European market. And when you look at Friction, 65% of the business is OEM and 35% is aftermarket. And when you take that 35%, it split really half and half. Half is independent aftermarket and half of it is OES, what you really get through the dealership. While we talk about the independent aftermarket, we are really playing in the premium segment, and we have a very strong partnership with Continental. So we have high loyalty from premium customers, et cetera. Now when you look at the volumes, as you know, the lockdowns are finishing, we expect the volume to come back as the cars are back on the road. You start seeing also in the U.S., for instance, I was reading an article today in terms of more cars and more trucks coming back on the road. But this for us is mainly a European market. When you look at the North America and China, those markets for us tend to be mainly in OE business. So this makes even the performance of a plant like Mexico even more remarkable because in Q4 of 2019, this was our best-performing plant around the world. And in North America, we are just playing -- we're just selling OE. So we have eventually in the future potential for aftermarket in North America and China, if we decide to play in those markets as well. As of today, as I said, it's mainly only European market.

Okay. Companies have been giving investors an unusual amount of detail on how things went through April on their 1Q calls. Wondering if you can comment on what kind of -- and this is Motion Tech specifically, what kind of aggregate declines you've seen in 2Q through May? And with OEMs now getting back open and back to making cars, whether or not you would expect to see some pretty meaningful improvement, at least sequentially, as we head through June and into the third quarter?

Okay. So as we -- as I shared in the previous question, some of our customers have talked about pent-up demand, particularly for pickup. So that could be a nice recovery also in North America. But I will say, at this moment in time, in my view, is still too early to tell. At the end, for us, it's really all about outperformance of the market. And I believe that Friction, Motion Technology will continue to outperform the market also in 20 -- also in 2020 in the region of between 700 and 1,000 basis points roughly. On top of that, I would say that the Motion Technologies, like all the other businesses have been very aggressive in adjusting their cost structure. So that concept of doing more with less is something that we're continuously trying to do every day. This is, I think, is what we can tell so far.

Okay. I'm going to jump over to Industrial Process now. That business is also going to deal with the dual hits of COVID-19 and lower oil prices. I know your upstream exposure is relatively small, but typically, lower oil prices impacts the whole energy value chain and lubricates the industrial economy overall. So I think that low oil price impacts more than just the upstream. Can you talk about the impact you're seeing in various parts of the business, short cycle, more project-oriented, energy-related and nonenergy-related businesses. Just in terms of order rates and the funnel of future opportunities and how those have changed and progressed over the last couple of months?

Sure. So once again, to put things into context, when we look at the oil and gas exposure in ITT is less than 10%. And when you look at that 10% -- less than 10%, 65% of the IP exposure to oil and gas is in downstream. So when we look at our IP exposure, in upstream, is really not related a lot to the North American shale, but it's mainly Middle East and Middle East customers. So when you look for instance Saudi Aramco, is a big customer of ours. Of course, you read Saudi Aramco reducing their CapEx by 25% or more. But when you look at the -- you go into detail and you need to go into the granularity of the understanding, that understanding of where the CapEx gets cut. It tends to be more on the exploration and production in new wells. So when it comes to old wells, somewhere where our multiphase technology of the Bornemann pumps actually is very well applied because they get more out of all the wells, this investment in those are still happening. So when we reported our results in Q1 and we look at the project funnel, we saw that the project funnel actually was relatively stable. And it hasn't moved really that much. In the short term, Nathan, I will expect that the project work will be impacted -- impacting negatively. But as I said, for the moment, the project funnel looks stable, even though I will expect some deterioration in the future. We have collected nice new orders in Q4 of last year. The orders were plus 13% in Q4. Nice new orders in Q1 as well. Even though year-over-year, there were less than what we collected in 2019, 2019 Q1 was exceptionally good and a strong quarter in terms of net order performance. So we have a good backlog, and we are focusing on really on executing on these projects. We're focusing on the positive momentum that we acquired in delivering good quality products, on-time delivery to our customers. May was actually the eighth month closing where the Seneca Falls plant delivered more than 94% on-time delivery for our ANSI line. So focusing on the performance is critical for us. The other part of the business is 75% of the business in IP is really short cycle. And here, we have -- we are serving industries like pulp and paper, biopharma. And obviously, the current lockdowns are impacting the short-cycle activity. The maintenance work, could have stopped or delayed, okay? Now -- but what I would say probably on the short cycle, we might be able to see -- we will see the impact more in the second half of the year. I would say that even in IP, the focus is to build a resilient business. You guys know that I always keep on talking about operating income resilience. And in IP, we have applied the same model of Motion Technologies, and we are quite advanced on this point to outperformance in the market. So if we go back to the oil and gas, the oil and gas market in 2020 probably will go down between 20% and 45%. We will probably be flattish in the oil and gas market for IP, outperforming that market substantially. And this is thanks to a very good Q1, where we were positive and a very healthy backlog that we have in our pockets right now.

Okay. I guess just following up on the comment you're mostly downstream there. We have started to hear about turnarounds getting pushed off out of spring into either fall or into 2021. Can you talk about -- if you're seeing the same thing and how that impacts the business?

Sure. So we have seen some postponement. We have seen some of the major projects, big projects, that for instance, we were counting towards the end of 2020. So we've seen some of those projects shifting to the right and becoming a 2021 project. We have seen a couple of minor cancellations. But as of today, those have been really minor and not really material, at least for the projects that we won so far.

Okay. I'm just going to jump over to CCT now, commercial aerospace, defense and general industrial exposure there. I think the commercial aero side being pretty heavily OEM is pretty well understood. So maybe if we start on the defense side of the business, which should be pretty healthy. Can you talk about what you're seeing in defense markets? Has COVID disrupted those businesses at all, whether it's delivery, supply chain, anything like that?

Sure. So when you look at the CCT business, Nathan, CCT has been in the perfect storm. And we should not -- I mean, we don't talk about the commercial aerospace. Everybody knows what's happening in there. When we look at the defense business specifically, the defense business is probably a business that we expect as a market to be stable in 2020. And this represents roughly 25% of CCT revenue. This business tend to be lumpy by definition in terms of defense. So when we look at the defense business, probably in 2020, we will be underperforming the market in here. And the reason for that is because we have some very good and large platforms in 2019. And for the first half, in particular, what we will see compared year-over-year, we will see some headwinds in the first half of 2020, whereas the second half of 2020 is where we will be, again, on the positive on a year-over-year basis. On this front of the defense, actually is that recent news came out on June 4, where actually we are part of the Invictus Team, which is the team together with Bell and other industry leaders for bidding for the U.S. Army Future Attack Reconnaissance Aircraft program, the FARA. So we are working with many of this project, but I would say is a good business for us. It's 25% of CCT business. And this is where we also shifted some of the engineering resources that were working on the commercial aerospace, working on the on defense industry.

Okay. Just on the general industrial markets, as a part of that business. Can you give us some color on the different pieces and different exposures you have in general industrial? Are you starting to see any improvement in short-cycle orders there and revenues as economies reopened? Or is that going to be more of a June third quarter kind of improvement in your view?

Sure. General industrial, thanks for mentioning because really represents 40% of CCT revenues. So in addition to the regular industrial products in here, what we have is also the medical connectors, which is roughly $30 million and also EV connectors, electric vehicle connectors, which is roughly $10 million. This has been impacted, sure, by the current environment, but also by the destocking, the distributor -- top distributors destocking. We expect the trough really here to be in Q2, beginning of Q3. This is what we see today, Nathan, on the industrial business of CCT today.

Okay. One more on commercial aerospace. It's one market that we think is likely to see a slow recovery, taking a few years to get back to prior revenue levels. Do you need to take specific structural actions to reduce the capacity of that business to match market demand and to rightsize the cost structure? And to the extent you're able, can you talk about the specific plans to do that in the commercial aerospace business?

Sure. When we were talking, Nathan, about building a resilient business, a culture of outperformance of the market and applying the Motion Technologies playbook that you know very well, you visit some of the plants, applying that to IP and CCT, I will say we are on a very good track on IP. We are a little bit behind on the CCT front. And this is really why we started tackling the cost aggressively on the CCT as well. So also because we do not expect a meaningful recovery in aerospace before the next 2 or 4 years, similar to the recovery after 9/11. Obviously, we are very excited and happy to read about 737 MAX restarted production, and that obviously is going to be a positive news for us. But as I said, we started -- we moved aggressively to reduce the cost at CCT structural, and some of those headcount reductions are permanent headcount reduction in order to reduce our decremental margin. As I said before, we also try to reallocate some of our commercial aerospace engineering resources to the defense industry, where we are working on some very important projects.

Okay. I'll just finish off with this. The old saying of never waste a good crisis. You guys have talked before about the war chest of opportunities to improve the businesses that are in your pipeline. Can you talk about plans to accelerate those as we go through this recession? And how that should improve the incremental margins as we return to growth in the various businesses? So when the businesses do return to growth and after you've accelerated those improvement plans, what kind of incremental margins do you think the businesses could produce in the recovery?

So maybe I start answering this question and I don't know, Tom, if you want to follow-up on the incremental margin. I will say that we have taken important actions in Q2 at all of our U.S. businesses. When you look at the rest of the world, like for instance, countries like in Europe, it's taking a little bit longer time just because you are following the local rules and local regulation. The restructure, the 75% of the restructuring that we shared with you guys in -- during our Q1 earnings, those are structural. We cut the compensation and benefit. We cut the overhead expenses and discretionary spending. We cut headquarter headcount by 40%. Whilst, at the same time, keep on playing offense for the future and protect some of the strategic investments so that when we come out of this crisis, and when the market is a little bit more stable, we come out stronger and faster. On top of that, there are footprint actions in addition to the $100 million actions that we discussed that will happen at the end of the year. This will make us more cost competitive when we will enter 2021. See if you look specifically at the businesses, I would say, IP has been very aggressive in both at the end of 2019 as well as in 2020. Motion Technologies has always been competitive, and we will be even more so after the actions that they're taking place right now. And CCT has moved aggressively also because heavily impacted by the commercial aerospace. On top of that, I will say our $35 million reduction on CapEx all of that is going to help to reduce the decremental and improve the incremental. Tom, anything to add to that?

Sure. Yes, Nathan, if you put it all together, typically, we would be targeting 35% incremental drop. But that I think is kind of normal conditions before you factor in all of the structural cost-outs and actions that Luca just articulated. So our goal is to get north of that 35% to start to see if we can get some incremental drops or the 4 handle, but a lot of what we've done here is accelerating actions that we knew we were going to take. And for sure when volumes come back, it's going to give us a bigger drop than we've seen in the past for a while.

Okay. And then just 1 quick last one. When you look at the portfolio as it stands currently and the end market exposures, do you still believe that all of your businesses in markets that you play in are structurally good businesses? Or are there businesses that are potentially structurally impaired and maybe become noncore to the portfolio as we go forward? And what kind of things are you evaluating to make those decisions?

Sure, Nathan. So when you look at the different markets, surely, we're playing the oil and gas, we play in aerospace. But as I said before, when you look at oil and gas and aerospace, those businesses have been impacted significantly by the current crisis, but exposure is limited. When we look at oil and gas, it's less than 10% of overall ITT and aerospace is less than 10% of overall ITT. Having said that, what will really our strategy is to build resilience. The same resilience that we have seen in Motion Technologies, which has allowed us to outgrow the market by 900 basis points as an average for 9 years, every single year. And this is what we are trying to build. That resilience also in IP and in CCT. IP is further along. And you see the outperformance of IP in terms of orders as well in terms of operating income and operating margin percentages, we've seen it also on the Q1. So applying that model of Motion technologies to IP and CCT is all the game, resilience and outperformance of the market that we're in.

Excellent. Okay. Well, we're at the end of our time for this. So I would like to thank you guys very much for participating in this. Thanks very much for your time, and I look forward to catching up with you later today.

That's great, Nathan. And I hope to see you soon. Stay safe.

Thanks, guys. Bye.

Bye, Nathan.