Itt Inc. Q3 FY2020 Earnings Call

Welcome to ITT's 2020 Third Quarter Conference Call. Today is Friday, October 30, 2020. This call is being recorded and will be available for replay beginning at 12 p.m. Eastern. It is now my pleasure to turn the floor over to Alex Sherk, Investor Relations Manager. You may begin.

Good morning and thank you, Laurie. Welcome to ITT's Third Quarter 2020 Earnings Call. This is Alex Sherk. And on the line this morning are Luca Savi, Chief Executive Officer and President; and Emmanuel Caprais, Chief Financial Officer. Today's presentation, press release and reconciliations of non-GAAP financial measures to the most comparable GAAP measure can be found on our website at itt.com/investors. Our adjusted non-GAAP results exclude certain nonoperating and nonrecurring items, including, but not limited to, asbestos, restructuring, asset impairment, acquisition-related items and certain tax items. All adjustments in the quarter are detailed in the reconciliations. Before we begin, I'd like to provide a brief overview of our Q3 GAAP results compared to prior year. Q3 total revenue decreased 17% to $591 million. Segment operating income decreased 22% to $84 million. Regarding EPS, we took our net asbestos liability to a full-horizon estimate, resulting in a noncash expense equivalent to $1.20, the main driver of the $0.55 EPS loss. Free cash flow increased 77% to $271 million. Please note that our remaining discussion will primarily focus on non-GAAP or adjusted measures, unless otherwise indicated. Lastly, today's call will contain forward-looking statements that are subject to risks and uncertainties, including impacts from the COVID-19 pandemic. Actual results may vary materially. All such statements should be evaluated together with the safe harbor disclosures and other risks and uncertainties that affect our business, including those disclosed in our SEC filings. Now let's turn to Slide #3, where Luca will take us through the Q3 highlights.

Thank you, Alex, and thank you all for being with us this morning. I truly hope that everyone stays safe. First, I would like to thank all ITT'ers around the world who continue to work tirelessly during this pandemic to serve our customers and to take care of each other in challenging conditions. To make sure we continue to operate safely, we're implementing our ready, safe, go program across ITT based on the successful containment strategy first developed by our Asia Pacific team. Today, we will present the results of ITT'ers' relentless efforts to drive our performance and fortify our resilience. During the last few years, we at ITT have elevated the strategic standing of execution. Q3's outstanding results are the proof of this and also a testament to our strengthening momentum towards full recovery. Last quarter, we highlighted our focus on protecting our employees and supporting our communities while providing superior service to our customers with flawless execution. We also committed to delight our shareholders with record cash flow generation and timely cost actions while playing offense for the future. This is exactly what we continue to do in Q3. We delivered record ITT operating income margin of 15.4%. We grew 92% sequentially in Friction OE sales. We delivered 19% segment decremental margin and 40% segment incremental margins sequential to Q2. Lastly, we generated record free cash flow of $271 million. We are firmly on the road to recovery. ITT's execution capabilities and our unprecedented granularity delivered higher volume than expected, increased top line sequentially, and through strict fixed cost controls, produced an ITT record quarterly margin performance. This is resilience. We achieved our highest-ever quarterly operating income margin and our highest-ever year-to-date free cash flow. This is even more remarkable given the current macro environment. This morning, we will share the highlights of our performance and the actions we are taking, as well as our outlook for the remainder of 2020. We will also provide our perspective on the markets we serve. Before going into Q3 performance, I'd like to highlight our safety record. Safety is, without a doubt, my top priority. We have made tremendous progress in all our businesses. Year-to-date, we reduced the number of incidents by 30%. Our injury frequency rate is at 0.8%, and 50% of our sites have been incident-free for more than a year. I'm grateful to our teams for their accomplishments and for keeping our people safe. Now let's turn to our Q3 results. On the road to recovery, we focus on what we control and broke some records along the way. We delivered solid EPS of $0.82, up 44% sequentially, strong segment operating income margin of 16.2%, up 360 basis points sequentially; record operating income margin of 15.4%; and record free cash flow of $271 million, representing a growth of 77% or $118 million versus prior year. From an operational excellence standpoint, we continued our journey of betterment. Our productivity and cost actions helped to offset the impact of materially lower volumes. In the third quarter, I was very fortunate, I was able to visit many of our sites in Europe and the U.S. Let me tell you, we have many opportunities, and we will go after them. I also experienced the progress made firsthand, progress that helped us to deliver 14.1% operating margin at IP. This is the highest Industrial Process Q3 margin ever, and we continue to confidently progress towards our long-term 15% plus margin target. The breadth of the operational improvements delivered by George and his team is impressive, not only because of the quality of execution, but also because of the care they put into structurally resetting IP for the long term. We are actively shaping our manufacturing footprint and redesigning our product portfolio to establish a lasting competitive advantage and superior margin performance for IP in the years to come. This 14.1% margin performance represented a 120 basis point expansion versus prior year, and 40 basis points higher than Q2 this year. Our progress was also evident when I was with the MT team in Barge. Motion Technologies delivered a strong operating margin at 18.5%, up 630 basis points versus Q2 and only 30 basis points below prior year. We continue to drive productivity through our factories, and China and Mexico, in particular, keep on impressing with margins near all-time highs. At CCT, I was encouraged by the many Kaizen events running in our Valencia site. And all across ITT, we drove high levels of productivity that produce significant segment margin expansion compared to Q2. These operational excellence combined with our speed and execution, enabled us to accelerate working capital reduction and post a year-over-year 180 basis points improvement. Lastly, I want to thank our leaders who helped to keep our people safe and advance ITT's operational excellence. On the customer front, our teams continue to focus on serving our customers with utmost dedication, showing through their actions that our customer-centric approach is a way of life at today's ITT. Our Friction OE sales grew 92% sequentially, and the momentum in shared gains continued with each one of our main regions outperforming global production year-to-date, including over 1,000 basis points of outperformance in North America and China. While we still experience inventory adjustment issues in Europe with certain customers in the first half of Q3, we saw encouraging signs in auto OE production, particularly in September and October. We now expect Friction OE outperformance for the full year at the lower end of our expectations based on the timing of new platform ramps in the fourth quarter. IP grew organic short-cycle pump orders by 14% sequentially on the back of strong part, which improved gradually during the quarter and showed year-over-year growth in September. IP delivered a book-to-bill of 1. And as a result, our backlog at the end of Q3 was up 6%, excluding foreign exchange compared to the beginning of 2020. IP continues to lead in on-time delivery performance. Today, our customers know they can rely on us to deliver top-quality Goulds Pumps on time at a competitive price and consistently. This is a key differentiator. We've been talking a lot about Seneca Falls' 95% plus baseline pumps delivery performance for the last 12 months. And I want you to know that today, the rest of our facilities have been performing at an industry-leading level as well. Finally, at CCT, we have been busy playing offense and finding new ways to partner with our customers. Our elastomeric rotorcraft business has been nominated for the next U.S. military reconnaissance helicopter code named FARA. This is a major recognition for our rotorcraft business, which we created organically just a few years ago. And our composites business is finalizing a strategic partnership with a large aircraft engine manufacturer that will propel our Matrix business to new top line heights. The team at CCT has been working hard to adjust our cost structure to the new aero market conditions while looking for growth opportunities by showcasing our engineering prowess. I was at our Valencia facility last week, and I was impressed by our new state-of-the-art sound chamber capabilities as well as our new product pipeline. Lastly, on capital deployment. We continue to drive cash generation through working capital efficiency and strict capital expenditure focus, further strengthening our liquidity. As a result, we are raising our free cash flow margin target to a range of 13% to 15% for the full year. Today, we have $1.5 billion of available liquidity, and we have ample capital to fund all of our operational needs and investment, positioning us to take advantage of other strategic opportunities. Our strong liquidity position prepares us well for what's ahead, whether it is facing headwinds or surfing tailwinds. Finally, in October, we successfully terminated and transferred our U.S. pension plan. This will not only provide our pension-eligible employees great service but also reduce ITT's administrative costs and eliminate any future funding requirements. Let's now look at our Q3 financial results provided on Slide 4. We produced a 16.2% segment operating income margin. We delivered these margins through productivity and aggressive cost actions that produced a segment incremental margin of 19%. We continued to drive down corporate costs and delivered an approximately 20% structural run rate reduction versus prior year. EPS of $0.82 per share declined 15% but was ahead of our expectations. And on cash, we generated $271 million of free cash flow year-to-date, up 77% versus prior year. Our trailing 12-month free cash flow margin now stands at a record 15.4%, a sequential improvement of 80 basis points. ITT'ers delivered strong Q3 results versus 2019, and these results are even stronger when we look sequentially. Switching to our sequential performance on Slide 5. Our segment operating income jumped 48%, an impressive growth compared to an organic revenue increase of 12%. This is the result of our business stepping up efficiency and cost actions as we continue to focus on what we control and benefit from operational leverage from a permanently lower fixed cost base. Our revenue growth was driven by a 92% increase in friction sales OE, mainly coming from outperformance in China and North America. Similarly, earnings per share grew 44% sequentially despite a one-time environmental benefit realized last quarter. While recovery remains uneven across the market, whichever way you choose to look at our financials, ITT's businesses delivered outstanding third quarter results. Now let me turn it over to Emmanuel, my copilot and new CFO, who will discuss the Q3 results by segment.

Thanks, Luca. Let's start with Motion Technologies on Slide 6. Organic revenue declined 13% on lower order production rates and slower activity in the rail segment due to reduced passenger traffic. In the quarter, Friction OE sales were nearly flat compared to the prior year. This is a strong showing with China and North America growing 11% and 14%, respectively, which was offset by Europe, where we experienced destocking with some Tier 1 customers. Sequentially, Friction OE sales skyrocketed 92%, gradually accelerating during the quarter to show mid-single-digit year-over-year growth in September. Segment operating income declined 12% to $50 million. MT successfully improved decremental margins to 21%. And sequentially, operating income increased 107% with 36% incremental margin performance. We drove operating income recovery through productivity and restructuring actions. Motion Technologies delivered outstanding Q3 margins of 18.5%, 30 basis points lower than the prior year, but increased 630 basis points sequentially. These results were fueled by strong performance in Friction China, which produced its highest margin since Q1 2018, and Friction Mexico is now approaching pre-pandemic margin levels. The MT team delivered above our expectations given the revenue decline versus prior year. In Q4, we expect to deliver margin expansion versus prior year on the back of continuing restructuring actions and productivity, as well as low single-digit organic revenue declines. These structural cost actions add to MT's many competitive advantages: material science leadership, best-in-class quality, and fastest lead times. All of these together form the foundation for continued outperformance. Lastly, from an award perspective, both Friction and Wolverine continued to gain share with Conquer wins and new platform wins, including the 15 new electric vehicle platform awards in the quarter. Moving on to Industrial Process on Slide 7. IP clearly demonstrated the resilience of its business model considering the challenging environment. With a 14.1% operating margin, IP expanded 120 basis points compared to the prior year despite an organic revenue decline of 19%. Sequentially, the growth was 40 basis points on flat revenue. The IP year-over-year revenue decline was driven by short-cycle bookings during the height of the pandemic last quarter. Lower project revenue is mainly due to large prior year chemical shipments related to the expansion of plastic production capacity in North America. Organic orders for the quarter declined 17%, coming from 33% lower project bookings and 12% short-cycle declines versus prior year. Parts orders recovered gradually during the quarter and posted year-over-year growth in September. IP's book-to-bill of 1 in Q3 and year-to-date backlog growth of 6%, excluding foreign exchange, provides solid revenue visibility into next quarter. Operating income declined only 12% to $27 million despite significant revenue declines. Our proactive cost actions, shop floor and sourcing productivity resulted in a best-in-class decremental margin of 8%. IP will continue to benefit from our footprint optimization strategy. In October, we completed step 1 of our European footprint project and announced a new facility closure. The Industrial Process segment operating margin of 14.1% was driven by productivity and cost control, sourcing and restructuring actions amid a revenue decline. IP continued to fund innovation, such as the new diagnostic capabilities added to our i-Alert remote monitoring platform and our product portfolio redesign projects. Let me expand on our BB2 pump redesign project as it demonstrates our strategy of playing offense. As you know, we have been hard at work improving our large chemical pump design to reduce materials content, improve manufacturability and source components from the best cost regions while improving hydraulic performance. This design has generated so much interest from our customers that we booked 43% higher orders year-to-date than for the entire 2019. We also made some significant headway in our purchasing performance, thanks to a team of experienced supply chain leaders. To date, we've generated large sourcing savings, and the team has established a long-term supplier strategy that will put IP on a path to supply chain excellence for years to come. Finally, IP improved working capital by 800 basis points as we reduced AR past dues by more than 20% and inventory by 14%. We continue to see more opportunities to further reduce inventory as we consolidate footprint and optimize materials management. IP finished the quarter with 19% working capital as a percent of sales. IP's outstanding performance reflects the multi-year strategy that we outlined back in 2017 and that we are faithfully executing as we advance toward our long-term margin target of 15% plus. We expect to produce a similar margin in Q4 as sequential volume increases will be driven by large project shipments. Now, let's complete the overview of our segments with CCT on Slide 8. CCT organic revenue declined 26% on weakness across our major end markets. The steep reduction in passenger traffic lowered commercial aero demand and continues to cause a major slowdown in OE build rates. We are also impacted by specific challenges related to the 737 MAX requalification process. Our CCT industrial business experienced only a 2% decline as our distribution partners reduced excess inventory and adjusted to lower levels of activity. Our BIW oil and gas connector business was impacted by reduced North American shale production and lingering difficulties with customer site access and service deliveries in the Middle East. However, we were able to gain share in that region on the back of better quality and delivery performance, and our year-to-date orders are up 30% year-over-year. Operating income declined 40% on the volume drop, and margins of 14% showed an improvement of 300 basis points over Q2. The primary driver of the decline versus the prior year was volume impacts from aero weakness. These impacts were partially offset by shop floor productivity, especially out of the Nogales and Valencia sites, restructuring actions, and benefits from product line transfers. In Q3, we continue to see aero debookings, albeit at slightly reduced levels compared to Q2, with significant disruptions coming from customers' ordering and receiving patterns. We expect weak OE build rates to persist. Additionally, lower aircraft utilization and weakened airline profitability result in a slow aftermarket recovery as less maintenance is required or gets deferred. CCT decremental margins of 28% improved sequentially from Q2 and reflect the aggressive restructuring actions executed by the business. Finally, in October, Ryan Flynn was appointed CCT President. Ryan had previously served as the President of our Asia Pacific region, where he drove critical growth initiatives. Davide Barbon, who is head of our KONI Axtone business, will now lead the Asia Pacific region, one of ITT's growth platforms. As you know, last quarter, we raised our cost action target to $160 million. Let me now give you an update on our plan on Slide 9. Our CapEx reduction plan is progressing well. We are hard at work on the remaining $125 million of cost reduction, a large portion of which is structural. To date, we have completed more than 90% of the full-year headcount reduction plan. On the spending front, we are exceeding our saving expectations driven by strong cost controls and sourcing performance. We are driving footprint optimization at both IP and CCT with several new actions progressing through granular planning and internal approval stages. Overall, we expect these actions will generate more than $90 million in benefits in 2020 and additional carryover benefits in 2021, partially offset by temporary compensation actions that have been rolled back in Q4. As a result, we are improving our decremental margin target, and we now expect total segment decremental margin for 2020 to range from 21% to 24%. Now I'd like to discuss the results on our net annual asbestos remeasurement on Slide 10, which is excluded from our Q3 adjusted results. As explained in our press release and 10-Q, we extended our asbestos liability to a full-horizon estimate as we benefited from favorable litigation developments that improved our visibility on insurance recovery and drove insurance settlements. These developments include a recent agreement with a group of insurers in which they acknowledge the availability of significant amounts of sovereign coverage. These events, coupled with stability in our underlying claim data, enabled us to extend the period for which we provide an estimate through 2052 from our previous rolling 10-year estimate. Since then, excluding the full horizon transition, our net liability declined 44%, and when accounting for these quarters, noncash $136 million full horizon impact, the net liability dropped 25%. This reflects our effective claims management and one firm defense strategy as well as aggressive insurance recovery actions that have improved the value of our insurance portfolio. Importantly, we now expect that our projected annual average net after-tax defense and indemnity outflows for the next 10 years will decrease to $20 million to $30 million, a reduction of 24% from the midpoint. Before Luca provides his closing remarks, let me share some perspective on how we see Q4 playing out. We expect continued sequential improvement in Q4 but still anticipate year-over-year revenue declines to range between high single digits and the low teens. We expect MT to deliver on low single-digit revenue declines as Friction revenue growth will be more than offset by lower Wolverine and KONI Axtone volumes. We expect auto production rates to improve sequentially, reflecting a market decline of approximately 20% for the full year. Friction OE outperformance is now expected to be at the lower end of our range. We also expect IP revenue to show sequential growth in Q4 and year-over-year declines to a low double-digit range. Most of our expected Q4 revenue is already in backlog at the end of Q3. Despite slowly improving passenger air traffic in Q3, we do not see commercial aero production rates materially improving sequentially. As a result, we expect flattish CCT revenue from Q3 to Q4. From a segment margin standpoint, we expect to produce strong Q4 margins, well over the 15.4% generated last year driven by benefits from productivity and cost actions. With outstanding margin performance to date, we expect IP to deliver healthy full-year margin expansion compared to 2019. Consequently, IP's Q4 margin will be similar to Q3 and prior year, while CCT may show a sequential reduction driven by unfavorable connector mix. We expect corporate expenses for the full year to be down approximately 40%. We also expect Q4 EPS to show low double-digit sequential improvement, and we are now targeting segment decremental margins of 21% to 24% for the full year. On free cash flow, we are raising our margin target to 13% to 15% for the full year as we rebuild some working capital to support our business and customers. Let me now turn it back to Luca for his closing remarks on Slide 11.

Thanks, Emmanuel. Today, ITT is firmly on the road to recovery, thanks to the resilience of our businesses and the resilience of our people. ITT's performance is the outcome of a sound and actionable strategy, one with clear priorities and a strong focus on execution driven by an unprecedented level of granularity. As a result, we generated strong levels of profitability and record free cash flow. We are managing through the storm, and ITT will emerge stronger and bolder than ever before. I look forward to continuing to share the progress we will make in our journey. And with that, let me now turn it back to Laurie to take your questions.

Our first question comes from Joe Ritchie of Goldman Sachs.

Luca, to start, the performance in Friction, especially in China and the U.S., remains quite robust. I'm interested in the comments made regarding the expectation that your outperformance now looks to be at the lower end of the range you previously shared. I would appreciate some additional insights on that. Also, what do you observe in terms of competition in the market currently?

Sure, thanks, Joe. So when we look at Q3, in Q3 we outperformed the market globally. We outperformed in China. We outperformed in North America. We did not outperform the market in Europe. What we experienced was still some destocking, particularly at the beginning of the quarter, and also some slower and lower ramp up for the new Conquer or also some of the rewins. To give you just a specific example in Europe, in France, one of our major customers is having a ramp-up of a new platform, while the existing one is winding down. The old is coming down, and the new is coming up a little bit slower, resulting in a dip for that platform. So what we see is that when you look at 2020, this is the quarterly performance, but it's very important to look at year-to-date because year-to-date in a year where it's very bumpy is more relevant. So year-to-date, Joe, we have Europe outperforming the market by 380 basis points year-to-date, North America and China outperforming the market by more than 1,000 basis points. So now the other thing that I would like to share with you is actually what has happened during the month of September and the month of October, where we have seen our numbers better year-over-year, and this is another positive sign. Looking at the order book, we see a good order book for Q4. So looking good for November and good for December. Having said that, we are really working closely with our customers as we are investigating how much of this is real demand and to ensure that we have a better understanding of what is in the funnel, in their inventory, so that we are able to match demand with supply. Now going back to the second part of your question, which is from a competitor's point of view, I can tell you that, for instance, we have been able to take advantage in Europe, exactly, of some of our competitors' strategic decisions, and therefore, in some of the awards that we reported in Q3, there have been some wins with a major customer of ours where we were able to further increase our market share. This is thanks to some competitors' decisions in the region.

That's super helpful, Luca. And then maybe I'll just ask one quick follow-on. Emmanuel, I just want to make sure that I heard you well. For the Q4 guide, you're expecting Q4 to be sequentially up low double digits, implying like $0.90 to $0.95 or so in the fourth quarter. I just want to make sure I heard that correctly.

Yes, that's correct, Joe.

Your next question comes from Damian Karas of UBS.

Great job on the margin execution. Speaking of which, I wanted to ask you about the cost reduction progress that you pointed to on Slide 19. It seems that on the areas you're exceeding expectations may be tilted more toward the discretionary side rather than the structural. But I know you mentioned you're sort of at 90% of the execution on the structural cost savings. Just wondering, as we think about progression from here moving into next year, is this 35% still the appropriate incremental margin to think about as the business recovers next year?

Yes. Thanks, Damian. You're right. Last quarter, we mentioned that our expectations for incremental margins were going to be north of 35%. This remains the case. For the full year, we expect to generate more than $90 million of impacts in 2020. We also expect a benefit of carryover into 2021. And remember that some of that will be partially offset by some compensation actions that we have rolled back into Q4, but we are very optimistic and very bullish on our ability to generate incremental margins that are higher than our decremental margins.

Okay. That's really helpful. And I guess specifically thinking about MT and the Friction business. Luca, as you mentioned earlier in the call, you're near-record margin performance in Wuxi and Mexico. As you think about production ramping, getting back to the level where you might have been pre-COVID, I'm wondering at what point does sort of that incremental margin maybe stabilize or perhaps invert as you need to start investing more in new platform build-out? Just maybe you can kind of help us think about kind of the longer trajectory on Friction moving from sort of earlier production levels to actually expansion.

Okay. So one thing to bear in mind, a couple of points to answer your question, Damian. One is that our approach in this kind of situation is when the market is going down, we are treating our fixed cost as variable, and we variabilize as much as we can our fixed costs. And then when the revenue growth returns, we are trying to retain those fixed costs fixed. This is a general approach. And in this way, it's helping us obviously to have better incremental margin. Second is the overall Friction and Motion Technologies DNA, which is really driving the improvement and productivity to a different level. Just to give you an example, I was able to be in the Barge plant during the month of September. This is our oldest, the most mature, the most complex plant. But they've reached levels of labor productivity, the highest that I've ever seen in my 9 years in Motion Technologies and in ITT, to the point that, for instance, I met 2 shop floor workers that set a record for the fastest ever changeover run safely that we had in Motion Technologies ever. So that's the general approach. Did I answer your question, Damian?

Yes, you did. Appreciate that, Luca.

Your next question comes from the line of Jeff Hammond of KeyBanc Capital Markets.

Can you just tell us a little bit more about this management change at CCT? What prompted it? And just some of the early opportunities you see here as you move towards this kind of Motion Tech manufacturing approach.

Sure. I personally recruited Ryan a few years ago while I was in China looking for talent. At that time, Davide, who was managing the Motion Technologies business in China, was relocating to Europe to oversee the Axtone acquisition and the rail business. We brought Ryan on board because he is a talented individual with deep knowledge of the Asia Pacific region and a strong focus on growth. Over the past three years at ITT, Ryan has excelled. He has experience working in Europe, South Africa, and Africa, and he is very familiar with Asia, giving him a global perspective. CCT will gain from Ryan's international leadership and growth orientation. Additionally, as Ryan transitions, Davide, who successfully managed the KONI Axtone integration, will return to China to oversee the Asia Pacific region and join the leadership team. I want to emphasize that if you look at our leadership team, you will see that five of us, including myself, Maurine the CHRO, Emmanuel, Ryan, and Davide, are internal promotions, highlighting our succession planning and development process at ITT. Both Ryan and Davide have extensive experience in Motion Technologies, positioning them to advance the Motion Technologies and Friction strategies in Asia Pacific and CCT.

Okay. Great. It seems that auto production has faced some challenges, and there are inventory adjustments in Europe. We are hearing that some parts of Europe might be shutting down again. I'm curious about how you are considering this in your guidance and whether you anticipate any risk to production in Europe in Q4.

Okay. Let me start by providing some context on our perspective regarding the COVID situation. We view ourselves as being in the middle of the COVID storm, which we have faced for about 9 months now, and we believe we are approximately halfway through it. To give you an idea of our past performance during the first phase, when we were still learning about COVID, we started seeing its effects back in January in China and Korea without any prior knowledge. Despite the uncertainty, our Friction plant was the first to resume operations. Our on-time delivery to customers was excellent across all divisions, with operations running smoothly for our Industrial Products business, and mostly for our CCT and Motion Technologies. We had only a few infections among our employees and even seized opportunities while some competitors struggled, allowing us to achieve some wins. This was our performance during the first wave when little was known about the virus. Now we are facing what seems to be a second wave, or perhaps a continuous wave, especially as winter approaches in the Northern Hemisphere. However, we are now better informed. Ryan Flynn, our new CCT leader, led a task force to evaluate our operations. We have implemented our ready, safe, and go program as our strategy to ensure all necessary precautions are in place, including masks and testing kits, to maintain our operations. We are focusing on safety and customer service. Ultimately, I believe we are halfway through this situation and will need to manage and coexist with COVID throughout the winter and spring.

Your next question comes from Michael Halloran of Baird.

So the IP side, maybe just some commentary on the underlying trends there. The short cycle business, I think you said, was year-over-year positive in September, good sign. Maybe talk about the drivers behind that and how you think about the sequential trend moving forward, if that's a good piece to build off of or just some pent-up demand type things, and then compare that a little bit with how you're thinking about the longer layer, larger project type activity. Obviously, you're going to be booking that at better margins, but just a little sense for how you're thinking about the ability to convert or even the desire to convert some of the projects right now.

Sure, thanks, Mike. In Q3, the orders improved slightly compared to Q2, but there are two different narratives at play. As you mentioned, there are projects experiencing postponements and delays into 2021, including several smaller ones. I spoke with one of our larger distributors in the GDPWW distribution network in North America, and he informed me that three out of five projects scheduled for 2020 have been delayed until Q2 2021. We are observing similar scenarios in the Middle East, where project awards are taking longer than expected. However, we believe 2021 will be abundant in quotations, based on input from customers and our regional leaders. Regarding short cycle, we saw significant sequential improvement, roughly 14% in parts and baseline. This area is crucial for us, and it showed good improvement during the quarter. In October, the figures also exceeded our expectations and posted year-over-year gains. In addition, for the month of October, our total orders were 2% higher than the previous year, marking the first time this happened in 2020. For short cycle, the hydraulic institute noted that the ANSI market in North America was down approximately 35%, but our ANSI business outperformed the market by about 800 to 1,000 basis points. Also, the situation regarding the project backlog remains consistent, as it is projected to yield better profitability compared to last year. Moreover, the margins on closed projects we have shipped are higher than last year, creating a positive feedback loop.

That makes sense. I have a question about the Friction business. You mentioned that the new platforms are being delayed a bit, but you are still achieving good wins. How are you planning the rollout of those platforms over the next couple of years? Is it just a matter of deferring everything on the calendar, or do you anticipate a slower adoption at first that will then pick up speed later? Any insights on your current thinking would be appreciated.

Okay. So I think that we have to differentiate in terms of awards and SOP. If you look at this year, we have been seeing lower activity in terms of platform awards. This situation plays to our advantage in Europe, where we have a very high market share. However, in countries like North America or China, where we are chasing market share gains, we need those awards and platforms to improve our market share gains. I think that this activity in terms of awards will probably accelerate in 2021 and for the next couple of years. An important point to highlight is that among all the awards we won so far in 2020, 60% have been re-wins and 40% have been new awards in Conquer, which is feeding the market share gains in the future. Also, Emmanuel mentioned 15 awards in the quarter for electric vehicles. This is a strategic platform for growth in the medium and long term because there is much talk about it, but electric vehicles currently represent below 10% of total vehicles. In Q4, production starts on an EV platform where we are collaborating with a leading EV manufacturer while Ford has announced the launch of the Mach-E platform, which we are also involved in. Good story on the awards, Mike.

Your next question comes from Scott Davis of Melius Research.

I'm kind of curious, I don't know if this is the right way to ask a question. But when you think about the structural cost out, is there kind of a percentage of footprint that you've been able to take out, if you think about just square footage reduction? Is that a way that you guys look at it?

Yes, Scott, that's a great question. In our cost reduction plan, we have highlighted several areas, and footprint is definitely one of them, specifically for IP and CCT. At IP, we already completed one in Europe, and we're really excited about this because this is going to help us reduce our fixed costs. We also announced one in October in North America. We're implementing the MT business approach, which emphasizes a concentrated footprint close to our customers with efficient manufacturing structures. So far, we are not realizing any savings in terms of footprint because it takes time, but this is going to benefit us in 2021 and 2022. The primary areas of focus will be smaller to mid-sized plants that we're going to consolidate into larger plants for IP and CCT.

Okay. That's helpful information. As a follow-up, could you explain the mechanics of the pension termination? It feels like it's been a long time since I've encountered one of these. What are the steps involved in closing out the pension? Will there be a need to issue a payment and finalize the arrangements? Is there an initial cash expense that would eventually be recouped since the obligation will no longer exist? How does this process work? I'll leave it there. What are the mechanics?

So maybe, Emmanuel, let me frame it first. As a company, we made a very good decision at the end of 2019 to freeze the pension plan. At that time, we were 108% funded. This was when we froze the plan, and it initiated the process.

Yes. In terms of process, it's a regular bidding process. We had five or six different insurers, and we went with MassMutual because they offered the best proposal. The final cash outlay was around $8 million, which is at the lower end of our expected range. We transferred the contribution that we had made and made that additional $8 million payment, and we terminated the pension plan as a result.

So only $8 million. Wow. Okay. I was thinking hundreds of millions, and now it's $8 million. So congrats on that.

Your next question comes from Bryan Blair of Oppenheimer.

I was hoping we could circle back to the Friction OE outlook from a slightly different angle. I understand the timing kind of restricts outperformance a bit in 2020. But based on prior wins and the degree of platform and SOP visibility that you have, is it reasonable to expect your typical 700 to 1,000 basis points outperformance next year? Or are there reasons to lean above or below that range based on the current outlook?

I would say that we need to observe how the market develops during Q4 because looking at our current outlook, I might be overly optimistic. We want to determine how much of what we're seeing in the Q4 order book represents real demand as opposed to just filling the pipeline or addressing concerns from major OEMs about a potential second wave. So, we need to see how Q4 unfolds to gain a clearer understanding and provide a guidance range for 2021.

That's completely understandable. And you've highlighted CCT's increasing adoption of the MT business approach. You've spoken for a while about making IP the Motion Tech of the flow world. We can see the operational momentum there. Thinking about CCT, what does the MT approach mean? And I guess, more directly, outside of resetting cost structure, what changes does that entail for the business?

Sure. So it's a very timely question, as I spent two weeks in California, in Valencia and Irvine, where we have our connectors and components plant and worked closely with the team. The MT approach will entail taking the level of granularity to an unprecedented level. You're talking about when you're running for a new opportunity, sales, a new award, or when you're running into production or a machine. To give you an example in terms of the level of data, we are looking closely at the Overall Equipment Effectiveness (OEE) of machines and labor productivity, analyzing each step involved in the operation. I spent some time every day together with Rob or Davide, the new plant manager of Valencia, examining how operations are running. They are conducting many Kaizen events, which have improved the profitability of the plant, but there is more potential to be tapped. This is really what we are driving for in terms of MT playbook for CCT—an unprecedented level of granularity in every operational step.

Your next question comes from the line of John Inch of Gordon Haskett.

What is happening and what has happened to your Friction aftermarket business in Europe? Presumably, lockdowns make it worse versus the recession of '08, '09, right, because, for obvious reasons, of driving. And can you just remind us what percent of aftermarket is in the mix currently? And is it higher or lower in terms of margins versus the segment average?

First of all, when you look at the aftermarket and OE, we are roughly 65% OE and 35% aftermarket. When you look at the 35% aftermarket, you can split it roughly half and half between independent aftermarket and OE segments. Now looking at performance in the quarter, I would say we didn't see any improvement in Q3. However, we are seeing a substantial improvement in Q4. Therefore, we have improved our full-year forecast of the aftermarket for the full year 2020. We previously estimated a decline in the region of minus 22% to minus 24% year-over-year. We are now thinking of a negative high teens for the aftermarket for the full year, indicating significant improvement related more to Q4 and the order book we see in Q4 than to the Q3 performance. When discussing margin, I would say that the aftermarket has higher margins than OEM. However, the highest profitability plants currently are in China and Mexico, and both of those are focused solely on OE sales. Thus, drawing conclusions comparing aftermarket margin and OE margins wouldn't be entirely accurate.

No, that's fair. In aerospace, they track takeoffs and landings, flight hours, all that sort of stuff. I mean, these lockdowns being re-imposed in Europe. Luca, I appreciate the wins. We all know it's a great business. I don't know if there's evidence that that's going to restrict driving capacity, but does that put a bit of a governor on the aftermarket business as you look ahead? So not about sort of wins that you just chalked up, right? But looking ahead, is there this correlation between these lockdowns and fewer cars on the road, resulting in less wear and tear that drives the aftermarket business?

I think that's absolutely fair, John. It's absolutely logical. One thing that happens conversely is the public transportation versus personal vehicles. Because of concerns over public transport, people might prefer driving their cars instead of using buses or flying. So you have some conflicting trends in that respect.

Yes, I agree with that. Lastly, could you discuss how your supply chain in Mexico has performed over the past 6 months during the pandemic? What is its current status? Are there initiatives you are trying to implement to enhance it, or are you satisfied with the current performance?

I think that the team has managed the risk and the process exceptionally well. When looking at the supply chain in Motion Technologies, we haven't suffered any disruptions at all. To be fair, we did see some disruption in IP when a major supplier faced technical problems and COVID-related delays in their deliveries. But we are working very closely with them and the customer, and everything has been managed properly. Overall, no major disruptions across ITT.

Your next question comes from Nathan Jones of Stifel.

Just one follow-up on IP. I think, Luca, you mentioned that the project margins in backlog are better than they were a year ago. We tend to see an environment like this where volumes are down pretty aggressively. The bidding, the pricing on these projects can get pretty aggressive. Can you talk about how you're approaching this? Do you need to fill your factories to absorb your fixed costs without looking to fill the backlog with low-margin projects?

Sure, Nathan. The discipline we currently have in place is quite ingrained within our team, and we are well aware of what we are doing. So our project proposals are reviewed diligently, focusing on technical aspects, costs, terms, and conditions. This diligent process is something we have been executing for the last three years, which is essential in allowing us to deliver better margins on our current backlog.

Okay. The second question I want you to talk about was free cash flow. A 15.4% trailing free cash flow margin. While we're on the call, I went back and looked at it historically, and post the spin of Xylem and Exelis from 2012 to '17, the margin was about 5%; '18 and '19, it was about 10%; trailing 12 months, it's about 15%. In environments like this, working capital throws off a bit of cash. How can you talk about how the approach to free cash flow generation has changed? And what do you think the sustainable free cash flow margin for the business is?

If we look at our working capital, that is an area where we have been focused tremendously. We have improved year-over-year for ITT by 180 basis points. MT has remained stable year-over-year. In CCT, we deteriorated slightly year-on-year. Then at IP, we improved by 800 basis points year-on-year, and we improved again from Q2 to Q3. Currently, IP's working capital stands at 19%, which is the best in ITT. The improvement primarily came from accounts receivable and current receivables past due, with more opportunities still to reduce inventory and enhance planning management. Overall, we have great potential to optimize our working capital, which contributed to the free cash flow margin increase.

In terms of long-term margins, we are not ready to provide a specific number, particularly because the 15.4% free cash flow margin that we realized thus far is the result of managing working capital well, though it is also influenced by a lower revenue base which improved that number. Thus, it does not represent a long-term target for us. We will continue to focus on working capital improvements and effective cost management.

Your next question comes from the line of Matt Summerville of D.A. Davidson.

Just one quick question. With respect to the incremental cost reduction benefits you're going to see in '21 from what you've done thus far in '20, can you maybe quantify that as well as what you expect to derive from the latest footprint actions that you just mentioned today in IP and CCT?

Sure, Matt. So as I said, we expect full 2020 P&L benefits of more than $90 million this year. The carryover impact of some of those actions that started midyear is going to bring us an incremental $40 million of positive benefits in 2021. Some of our temporary cost actions are going to have been rolled back already in Q4. So they're going to be a headwind to that carryover in 2021. But as I said, this is when footprint is going to kick in. Footprint should bring significant benefits probably in the second half of 2021 and into 2022. And this obviously doesn't include the regular productivity that we are driving through all three value centers. Finally, I would say for 2021, we expect to add more actions, and we're actively planning around what we can implement in 2021 that will have an impact on both 2021 and 2022.

Your next question comes from Brett Linzey of Vertical Research Partners.

Just one for me on Industrial Process, specific to the orders down 17%. Just curious how you see the order profile in that segment playing out over the next few quarters. I mean, do you think Q3 is the low ebb here? And maybe just share some differences in that business now versus '15, '16, whether it be the aftermarket mix, market complexion that might prevent those orders from worsening to those levels historically.

When we look at the orders for IP, I think that for the full year, Brett, we are looking at probably a decline year-over-year of roughly 11%. I would say certain geographic areas such as Europe, Latin America, or the Middle East present bright spots in terms of projects. Additionally, we are seeing improvements in short cycle orders since September, which improved again in October. The trend looks positive, with IP orders up 9% in October year-over-year, and Motion Technologies also showing favorable signs.

For the long term, when we analyze our funnel, it has been trending down. There was a little uptick in October, but it's too early to determine if this is a significant trend. The decline in the funnel is mainly due to upstream and downstream oil and gas paired with some chemical products, while G&I, which is the core of our IP business, is performing pretty well and showing promising signs. However, project activity is still subdued given the current environment.

And I guess just a follow-up point of clarification. So you said that total IP orders were positive in October?

That's correct.

Ladies and gentlemen, we have reached the allotted time for questions and answers. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.