ITT Inc. (ITT) Earnings Call Transcript & Summary

Okay. Good morning. My name is Nick Heymann, and thanks very much for joining us for ITT's presentation at our inaugural What's Next for Industrials Virtual Conference. I'm the analyst here at William Blair that covers ITT, and I'm required to inform you that a full list of research disclosures and potential conflicts of interest are available on our website at www.williamblair.com. Joining us today from ITT is Emmanuel Caprais, who is the Vice President of Finance and Group Chief Financial Officer and CFO-elect. And this morning, we're looking forward very much to hearing a lot of insights on how ITT is lining up to be able to grow in 2021. Before we get started, I want to note that the -- we'll open the Q&A session following Emmanuel's presentation. [Operator Instructions] So Emmanuel, thank you very much for joining us, and you're set to go and open your slides.

Thank you, Nick, and thanks for joining us this morning to talk about ITT and our journey to build an industrial leader. We have some exciting content for you today so let's go right into our presentation. On Slide 3, ITT is a global manufacturer of highly engineered components for harsh environment applications. We supply components to the industrial, the transportation and the energy markets. We serve those markets globally with in-region footprint and expertise. Today's ITT is 1 of the 3 businesses that was borne out of a corporate spin-off in November 2011. Right off the spin, we organized our business in an effective company structure. We've built a strong foundation, and we've been focusing on driving the performance of these businesses and creating a lot of value in the process. Over the last 3 years, we elevated the strategic standing of execution and focused on 3 priorities: customer centricity, operational excellence and effective capital deployment. We expanded EBIT margins by 270 basis points from 2017 to 2019, and our free cash flow was 9.4% at the end of 2019, our free cash flow margins. All this has resulted in total shareholder returns of 272% since our corporate spin-off in November 2011. So now let's go into our 3 segments on Slide #3. Motion Technologies is a global, highly differentiated transportation player. With 18% operating margin and 17% working capital, Motion Technologies generates 19% ROIC. MT serves the auto and rail markets and sells brake components and shock absorbers. MT's main value creation drivers are a concentrated footprint and a highly automated production process designed in collaboration with our R&D. We also have material science leadership and the fastest lead types. Finally, our best-in-class quality at 1 PPM is so groundbreaking that we have decided to assess our performance in parts per billion to ensure continuous progress. Our friction business has outperformed global auto market by 900 basis points on average since 2012, and friction has generated an ROIC of 39% in 2019. We continue to see opportunities to further gain share in China and North America in particular. Our market share stands at approximately 20% in each of these markets, and we will double it over the next 5 to 6 years to be closer to our European market share, which is more than 50%. Industrial Process segment is our premium pumps and valves business. We play into niche industrial segments. Our end markets are general industrial, including pulp and paper and mining, chemical and oil and gas. In the last 3 years, we grew margins by 500 basis points as of 2019. And in 2019, we sequentially improved margins throughout the year while growing triple digits versus prior year. And we're continuing this trend in 2020. At IP, we focus on project management excellence and world-class manufacturing performance, resulting in industry-leading on-time delivery performance for our customers. We continue to invest to strengthen our technological leadership with more efficient and smaller pumps. Our main target in terms of margins is 15% plus, and we have line of sight to achieve this in the next 2 years. Connect and Control Technology segment primarily serves aerospace and defense and general industrial and oil and gas markets. We make connectors, composite components, valves, energy and noise absorption products. We are experts in harsh environment, and we deliver customized solutions for late-stage systems. In the last 3 years, we grew margins by 490 basis points as of 2019. Our margin target is 20% plus. Our initial 3 to 4 years execution timing will most likely be extended due to the current environment. Moving on to Slide 5. There is really no silver bullet explaining the success of ITT. We focus on driving multiple competitive advantages. Each of these drivers are working together to help us create value day in and day out. We talked about our 1 PPM best-in-class quality record at friction. Our IP business has great customer intimacy and boasts a premier distribution network in North America. Our large installed base of Goulds Pumps underpins our strong aftermarket business. You may have heard about our footprint rationalization initiative at IP and CCT that models our anti-concentrated footprint advantage. This allows us to produce the same volumes as our competitor with 3x less facilities. We align our organization onto these value creation drivers to create resilience and repeatable performance. Now moving on to the next slide. ITT is working on great innovations to drive future growth opportunities. We clustered them in 3 different categories: digitization, sustainability and adjacencies. Digitization allows us to extract more capabilities out of our products. And for example, the ITT Smart Pad provides intelligent braking, thanks to embedded electronics that enable real-time onboard diagnostics and improve vehicle performance and safety. During circuit testing, we were able to demonstrate from 5% to 10% reduction in braking distance and the capability to measure the residual drag connected with emission reduction and fuel efficiency improvement. We are in contact with several OEMs and Tier 1s and have also registered significant interest with aftermarket customers in China and an insurance company in Europe. Our i-ALERT Equipment Health Monitor developed by IP tracks vibration, temperature and other parameters on rotating equipment in order to predict potential failure and reduce downtime. It wirelessly syncs data to a proprietary mobile app via high-capacity Bluetooth and enables continuous remote monitoring without human presence. We recently partnered with an analytics firm to add machine learning capabilities, and our initial test has confirmed 90% diagnostic accuracy without human intervention. Moving on to Sentinel. It is a sensor-enabled shock absorber designed for automated storage and retrieval system by our teams at CCT. And our digital automatic coupler is a great innovation we're working on for the European rail market. It is a unique solution that combines the tensioning expertise of Axtone and KONI and the harsh environment data transfer capabilities of CCT connectors. This is expected to enter the market in 2024. Moving on to sustainability. ITT is focused on developing products that enable sustainability and reduce energy consumption while providing the same level of quality the market has come to know from ITT. We led the way for copper-free brake pad commercialization while maintaining the critical presence characteristics -- performance characteristics our customers demand and rely on. Our material science expertise and rapid design to manufacturing capability has allowed us to be first to market a copper-free product and gain significant market share from slower competitors. Still to date, we are the only qualified supplier for copper-free pads in some demanding customer platforms. Our friction innovation centers in Italy and China are focused on creating the standard for electric vehicle brake pads to meet the tougher NVH specification demands of an EV. The reduced noise and vibration and the higher weight of an EV put incremental performance constraints on brake pads. Our unparalleled ability to solve these issues is driving our higher win rates for EVs versus internal combustion. Sustainability also means performing value analysis, value engineering on our pump portfolio to reduce weight and footprint by taking metal out of pumps. We enhanced hydraulic efficiency by 30% and improved manufacturability to reduce cost. Our customers have responded well to this, so much so that in the first 6 months of 2020, we have already booked as many orders for our redesigned BB2 pump than for the entire year of 2019. Finally, we're developing patented improved variable frequency solutions that significantly reduce energy consumption for pumps. We will come back to you with more news in 2021. By focusing on customer centricity and driving market outperformance, we have pushed our way into adjacent close-to-core markets. With our inorganic investments into composites, our primary -- proprietary resin transfer molding technology at Matrix reduces production cycle time and allows us to manufacture complex geometries for harsh environment applications such as aerospace engines. And we're collaborating with Tier 1s on exclusive supply contracts to expand beyond our legacy platforms. We organically developed our rotorcraft vibration isolation business into a $60 million-plus high-margin franchise, and we're now expanding into defense with gearbox isolation and rotor control elastomerics for the FARA program. We are expanding our twin screw platform into food and beverage to meet growing consumer sanitary preferences as the industry transitions from old progressive cavity pumps to our technology. And we will launch in October our enhanced SLH high-reliability pump for new and existing distribution channels. Finally, rail provides many opportunities for Axtone and KONI. This is a fragmented industry caused by regional standard differences and is dominated by small companies. We leverage our global reach, best-in-class quality on a scalable platform to gain market share, and we aspire to grow to $500 million in revenue for the long term. For the past 3 years, we have reinvested some of our margin gains into R&D and innovation, and it is exciting to see that we're creating opportunities for renewed growth. Finally, let me close this presentation by highlighting ITT's commitment to sustainability, demonstrated by the importance of environmental management, stewardship programs, our focus on safety and quality standards and inclusive workplace as well as the strength of our corporate governance and ethics. Let me highlight some key points for you. At ITT, safety is our #1 value. It is embedded into our culture from the shop floor to our headquarters. We always start our business reviews by discussing past incidents and near misses, and our CEO, Luca Savi, is immediately informed when an incident occurs and personally reviews root-cause analysis. We have also allocated a specific CapEx budget for green initiatives within our factories. We recognize that we have a lot of work ahead of us, but we are determined to be a better and outstanding corporate citizen and increase our positive impacts in our communities. So I want to close by thanking you for your attention, and I'm now happy to take your questions.

Okay. Emmanuel, thank you very, very much. [Operator Instructions] That was really interesting, Emmanuel, and I guess I wanted to try to characterize in the right way kind of really both the evolution and what ITT is going forward. And it seems to be a unique engineering solutions company that works to apply its products and skills to a broad installed base that's similar but not identical set of customer applications. And that's iterative engineering capability, especially as it applies to new markets, seems to be the key source of growth for the company in the future, along with continued operational improvement, which perhaps has been the majority of the company's growth -- source of growth over the past decade or 8 years since you were spun out. Is that a fair assessment on how to think about what ITT does to really create future growth?

Yes. Yes. I think you're right, Nick. We've -- I think one of our strategies has been to successfully apply the MT business approach. And so to summarize it really quickly, it is about creating efficiencies in our manufacturing process so that we can reinvest some of those savings into R&D, innovation and also sales coverage, commercialization. And I think that while MT has a very mature system and a high performance given its margin, given its ROIC profile, IP and CCT still have work to do. And so IP has been at the forefront of this MT business approach. We have really been able to boost margins and reinvest some of those profits into whether it is VAVE, enhancing our distribution network. And so we've been pretty successful at this. And obviously, it's going to take time because when you focus on really efficiencies, you control a lot of things. But when it is about convincing customers to adopt you and really give you more business, it takes a little while. It takes a little while to build that loyalty. So we've been doing it very successfully by making sure that we deliver on time, that we provide really great support to them. But it's going to take a little time. And I would say, then CCT, there is also a lot of opportunities at CCT. We have some -- similar to IP, we have some footprint opportunities. We have some great products like the rotorcraft, for instance, where we created a business from scratch. And so we're in a long game. And we're really fixing and enhancing the fundamentals of our business so that we can make them more resilient and grow them over the long term.

Well, it sounds like you're almost evolving into a material science company that comes up with unique ways to engineer solutions for customers that don't even know what their core problem is. And you will basically identify it and then provide an integrated solution for them. It seems there's a multiple set of things that you're solving when you work with your customers. It's not just one silver bullet. We did have a question from the floor. And that was, does today's brake pad business have performance advantages versus competing products? So that's over at MT.

Yes, absolutely. So I think -- as we said and as you said it, also there is not a silver bullet. It's a combination of things. And if you look at Motion Tech and particularly our friction business, we have a significant set of competitive advantages. We have -- regarding our production processes and the way we organize production, we have a super concentrated footprint. We only have 5 plants in the world for friction. And those plants have the same standard and automated production process. So we're super competitive and super efficient in producing our brake pads. And just to put things in perspective, as I said, we have 1 PPM. So 1 part per every million parts that we deliver. It's so much so that we have to go to PPB, parts per billion, to really understand where we could improve. So now we have 1,000 parts per billion, right? And in that quality, that quality level is unmatched. Our competition is in the double digits. So when you're able to deliver that level of quality to our customers, then it's no wonder that we get repeat business and that customers give us their trust to be able to -- for us to build a plant like we did in 2018 in Mexico to supply our North American customers. So there is this production process, which, by the way, is completely integrated with R&D. So that means that when there's a production issue on the shop floor, around the table, we have production people and R&D that are helping us solve the issue. And then -- so that integration with R&D is really important because that means that the transition from prototype to mass production is seamless because our products are industrialized very easily. So you have that production advantage. Then from a material science standpoint, as you were pointing out, we have a great advantage also. And we've used that advantage to really push our market share. So the transition to copper-free brake pads and now the transition to EV brake pads is allowing us to increase our win rate, and therefore, to increase also our market share in the future because we're the first to be able to provide a solution that addresses our customer demands. So product also is really good. And then finally, to really couple this, you have this culture at friction, which is about customer intimacy, which is about solving issue, which is about being an entrepreneur that really differentiates this business. And even if we're a part of -- even if they are a part of a larger company, they really drive their business as if it was their own while always remembering that it is not.

Can you review where ITT is and how it's evolved in terms of the global scope of the brake business for MT, how it originated in Europe, moved to China, from China's move to North America, how you never get over your ski tips, you always have the orders before you actually almost build the production capacity and where you are today as you set up going forward and maybe we go around the world again on EVs now?

Yes. Yes. So yesterday -- this evening, I was reviewing a presentation for our initial foray into North America with our Mexican plant. And it's a presentation we made to the Board. And in there, we were asking for authorization to invest into this new facility, and we were saying that 70% of our expected demand was already awarded. So we knew going in with that plant that we were going to -- we wouldn't have any problems to fill with 70% of expected volumes. And that has been the case for us. We've been working from this European core, which was the beginning of this business and which was highly successful. We have more than 50% market share in Europe, and been able to expand and replicate that success everywhere else. So as you mentioned, we started in Europe, in Italy. We have 2 plants in Italy. We've expanded to Czech Republic, initially with aftermarket production for our partner, Continental. And then now we're converting more and more our Czech Republic plant also to OEM businesses as we really need to expand capacity because of the market share wins. We have expanded to China, and the expansion in China was probably around 2012. And at the beginning, our plant in Wuxi was really -- I'm sorry?

No, no, no, I'm sorry.

Our Wuxi plant was a small outfit, and we started really growing it by not only being able to supply the same customers we had in Western Europe but also by picking and choosing very carefully local OEM and Tier 1s to do business with. And then -- so if you look at our market share, today, we're around 22% of market share in China. There is no reason why we are not able to replicate the level of market share we have in Europe. In fact, we want to double that market share in China in the next 5 to 6 years. And that success in China, which was all about providing the same level of performance we had in Europe, we then exported it in 2018 in North America. So we built a plant in the desert in Silao, Mexico, and that plant now is delivering not only Tier 1s and OEMs in Mexico, like GMs and others, but also in the U.S. And that plant is so successful that it has the highest profitability of all the friction plants in Motion Tech. So we're very happy with this. I would say, finally, it is a feat, I think, to be able to expand in so many different regions and be able to be accretive in terms of very high level of margin, which is very -- which is a key characteristic or a key advantage to our competition. We -- as you know, we are in the high teens plus, right, for our Motion Tech business. And our competition is probably in the low single digits. So not only they are not making as much money as we are, but they are also undercapitalized. So they're not able because they're not generating a lot of profit to invest and catch up to us in terms of technology. So we're very focused not only on outperforming our competition but also increasing that advantage that we have against them.

And that's -- when you look at EVs, there's a lot of people jumping in, and you've got a very unique product in regenerative braking. And how do you make sure that all of the people that seem to be jumping in at the same time, that you may or may not align with and become a major supplier for, how do you ensure that you don't you gear up and tool up to supply customers that ultimately maybe don't prevail in the EV market?

Yes. And you make a great point. And I think that we're really replicating the strategy we have had when we were early penetrating China, which is in China, you have probably something like 200 OEMs. And so it becomes very strategically important to make sure that we pick the right partner. And so it's the same thing for EV. We have limited capacity in terms of R&D, in terms of production. And so it's really essential for us to be able to pick the right partner. And so we spent a lot of time in terms of scouting which OEM, which Tier 1s we should work with and allocate very efficiently our capabilities, both in R&D and production. I would say for EV, we view this as a clear opportunity for us. And the opportunity is to really showcase our material science and be able to solve those tough requirements in terms of vibration, in terms of noise, in terms of harshness. And EV is very different from a regular vehicle. It is much quieter. It does not vibrate because it doesn't have as many parts. It doesn't have an internal combustion engine. And it's very heavy, too, because of the batteries. So those requirements put a lot of strain on our brake pads. And as a result, we are really happy to be able to solve these new challenges for our customers because of our technological expertise in the material science.

Okay. Would you ever take the brake technology and brake pad production expertise that you have for light vehicles today and then with KONI, which is very involved in the rail sector, and Axtone, take and ever make brake pads, okay, for a similar market that you serve with different products? Is that a strategy that ITT would perhaps pursue?

So we have a couple of different options. The number 1 option we have is, obviously, first, we have much more market share to grab in -- especially in China and in North America, and we are working on this. There's another subset of what's -- of opportunity for us, which is with the light commercial vehicle, where those -- we're not very present on those. Those are increasing in terms of production because of the key aspect they feel in terms of supply -- in terms of providing transportation for the Amazon -- the digital business, Amazon type of business. So this is an area of opportunity for us. And it's also very interesting because not only it increases OE volumes but also it is a great aftermarket opportunity as well because those vehicles are much more used than a normal vehicle. We have a small presence in heavy-duty. And we -- and over the years, we have realized that it's a complete different business than light vehicles, passenger vehicles. So we're evaluating and understanding what can we do -- what more can we do with this. One option is to apply the Smart Pad technology to those heavy-duty vehicles. So how important it is for those types of the operators to really work on fuel efficiency. And as a result, if we're able to introduce Smart Pad into the heavy-duty, we have a way to help those operators and those fleet managers. Finally, on train, I think that there's a lot that we can do. I think that if we want to really be successful in train because it is a complete different market because also this industry is extremely traditional and conservative, I think the path for us is probably inorganic rather than organic, and then complement that inorganic investment with our existing brake pads knowledge in the auto business.

Okay. That's a great answer. How does ITT develop the aftermarket side, the replacement parts side of your business to help provide a steady kind of [ keel ] when end market demand fluctuations may change your OE side of your production? How developed is that across your different businesses?

So our aftermarket business is mostly European. And the reason for this is because, historically, we've been very present in Europe. And so our aftermarket business today is the result of an agreement we have with Continental over their ATE brand. And we -- and this is a premium brand that -- and we have a long-term contract with Continental, and we supply 95% of their production. And so when you talk about ITT and when you think about our aftermarket business for friction, it is mostly European. We have expanded the lineup and developed our aftermarket business also organically without Continental. It is a very -- still a very small business. And it is a function of the fact that we're a recent player in China. And then -- so we need to build the product portfolio before we can think about having a massive aftermarket program in China. So as we gain market share and as we build our presence in China, it will become more and more -- it will be easier and easier to really push for our aftermarket business. Keep in mind that aftermarket, it's all about parts coverage, right? And to get parts coverage, you need to have the tools to be able to produce the different type of pads. And so today, we don't have that coverage. Over the years, we will have as we grow market share, and it will make more and more sense to push that aftermarket. In the U.S., it is a completely different market, where, unfortunately, it's hard for us to differentiate because it's all about marketing. And we're not a marketer. We're not a distributor. We're -- what we know how to do is to produce cost-competitive, high-quality brake pads. And so in the U.S., the focus is less on the quality, less on the performance, more on the marketing, so it's difficult for us to differentiate. In addition to this, we don't have the presence that we have in Europe. So it's a longer-term play. We just have to think really well about how to go about it because for us, what's really important is to make sure that we enhance our competitive advantages, and we don't get defocused by the opportunity that may seem a great opportunity but very difficult to capture in actuality.