Itt Inc. Q3 FY2022 Earnings Call

Good morning or good afternoon, and welcome to ITT’s 2022 Third Quarter Conference Call. Today is Thursday, November 3, 2022. This call is being recorded and will be available for replay starting at 12:00 p.m. ET. It is now my pleasure to turn the floor over to Mark Macaluso, Vice President of Investor Relations. You may begin.

Thank you, and good morning. Welcome to ITT’s Third Quarter 2022 Earnings Conference Call. Joining here this morning are Luca Savi, ITT’s Chief Executive Officer and President; and Emmanuel Caprais, Chief Financial Officer. Today’s call will cover ITT’s financial results for the 3-month period ending October 1, which we announced this morning. Today’s remarks may contain forward-looking statements that are subject to certain risks and uncertainties including comments related to company performance, strategic priorities, business mix, market conditions and the effects of COVID-19 on ITT. These statements are not a guarantee of future performance or events and are based on management's current expectations. Actual results may vary materially due to, among other items, the factors described in our 2021 annual report on Form 10-K and other recent SEC filings. ITT is not under and expressly disclaims any obligation to update forward-looking statements, whether as a result of new information, future events or otherwise. Except for otherwise noted, the third quarter results we present this morning will be compared to the third quarter of 2021 and are based on non-GAAP financial measures. These adjusted results exclude certain nonoperating and nonrecurring items, including, but not limited to, charges related to the suspension of operations in Russia, restructuring, acquisition-related charges and certain tax items, and in 2021, asbestos-related charges. All adjustments in the quarter are detailed along with the reconciliation of such measures to the most comparable GAAP figures in our press release and presentation, both of which are available on our website. It is now my pleasure to turn the call over to Luca, who will begin on Slide number 3.

Thank you, Mark, and good morning. I would like to begin, as I always do, by thanking our shareholders, our customers, and our ITT employees for their continued support and investment in ITT. As we continue to manage through this challenging environment, day in and day out, I’m reminded about the tireless efforts of all 10,000 ITT employees. These efforts were exemplified at the beginning of Q3 with our Wuxi team rising to the challenge by voluntarily sealing off the site to continue to deliver for our customers. This is also how the quarter continued with our teams all around the world stepping up to deliver record margins in Industrial Process and Connect & Control Technology with a 21% increase in EPS, the highest quarterly earnings on record for ITT. On the demand side, Q3 demand for our products and services remained strong in most of our end markets. We drove 13% organic orders growth with all 3 businesses generating over double-digit growth in orders. Let me share some highlights: 11% organic orders growth in Industrial Process driven by both pump projects and short-cycle; 12% organic orders growth in Connect & Control Technology driven by 20% organic orders growth in commercial aerospace and defense; and in Motion Technologies, we now have 26 new electrified vehicle platforms, reaching a total of 60 wins year-to-date, nearly doubling the total for all of 2021 through just 9 months. Leveraging recent order strength, we grew organic revenue by 15% because of step-up pricing and higher sales volumes across all our businesses. We are continuing to accelerate and expand our value-based pricing strategies across the organization with good early signs of success. The benefits of this can be seen in IP’s results this quarter, and we expect this to continue in IP and ramp up in CCT. On profitability, Motion Technologies expanded margins sequentially by 130 basis points. Connect & Control Technology grew margin well over 100 basis points year-over-year and sequentially. But the highlight of the quarter once again was Industrial Process, our flow business. The team at Industrial Process expanded margin by 550 basis points versus the prior year and 430 basis points sequentially. We are encouraged by the continued progress at Industrial Process. IP’s margin performance was driven by price recovery, productivity, and project execution. On top of this, the Habonim acquisition continues to exceed our expectations and was again accretive to segment margin in just its second quarter as part of ITT. The progress on the operational fundamentals can be seen most prominently in the expansion of the one-piece flow approach in IP. We began in Seneca Falls with a smaller high-volume ANSI pump line, which I mentioned in the past, and in Q3 expanded this approach to the larger pumps category. When Emmanuel and I spent time in Seneca Falls, we were really energized to see the teams continue to drive improvements and generate new ideas. As we ramp up our lean efforts throughout IP, we anticipate further improvements in safety, quality, on-time delivery, and competitiveness. Again, in Industrial Process this quarter, we made progress on the foundry closure announced in Q1, which will further improve our cost structure at IP. We successfully negotiated a new collective bargaining agreement with the labor union for the long-term future of the Seneca Falls facility. Moving to Connect & Control Technology, at 18.6%, this was the second consecutive quarter of sequential margin expansion and this time at similar revenue levels to Q2. We drove aftermarket revenue growth, cost management and improved price recovery. In Motion Technologies, we see signs that commodity pressures are easing. However, we are still working through higher price inventory, which will continue to negatively impact Motion Technologies’ margin in the fourth quarter. We expect to start seeing the benefits from the lower-priced commodities in 2023. Still in Motion Technologies, I’m proud to announce the first market launch of our gold Smart Pad on the Picasso Supercar, a true performance vehicle inspired by racing prototypes. The vehicle will be equipped with four smart pads that will provide safer braking and real-time performance data. When I sat in this machine, and experienced the unique engineering that makes the car incredibly light and superfast, it was clear to me that God is the brake partner for the future and beyond. I look forward to more announcements as the commercialization of this market continues. This quarter, like every other quarter, I spent a lot of time on the road working together with the teams around the globe. Let me share a few takeaways. At the KONI plant in Oud-Beijerland, the Netherlands, I saw firsthand that our investments in innovation and automation are driving growth at Motion Technologies. This is certainly the case for KONI’s Hydroride. We developed the Hydroride in 2015 and designed it to be a compact lightweight shock absorber capable of delivering a smooth ride and improved handling capability for our defense customers. KONI’s Road and Defense business leader showed many of you at our Investor Day the value and advantages of this product. This is why defense contractors like Patria have been selecting KONI as the trusted engineering partner. Still in KONI, we are expanding our patented SSD technology to the rail industry. The MK2 Frequency Selective Damping, which first launched in 2020, reduces wear and runoff caused by wheel and track friction. We are now demonstrating these advantages to rail operators and OEMs across Europe. The investments we are making do not pertain just to our products; it’s about having sustainable operations as well. In both Termoli and Barge in Italy, we’re expanding the use of solar energy and reducing our reliance on fossil fuels. Last month, I was fortunate to see the completed solar lake in Barge that will support approximately 30% of the innovation center's energy needs going forward. You can read about these green capital expenditure investments in our forthcoming sustainability report. Lastly, I was very happy to bring the Board of Directors to the MT Silao plant in Mexico this October. Our directors saw firsthand the investments we made in friction capacity, and our local team showcased their depth of knowledge and their safety and quality track record that makes the Silao plant truly exceptional. Thank you, and thank you, Silao team. Coming back to ITT as a whole: All of these and more delivered a sequential and year-over-year increase in EPS that exceeded 20%, thanks to strong pricing recovery, volume growth from share gains, and productivity. While the teams delivered outstanding results, we must not forget the challenges we have had to overcome, including the impacts of the war in Ukraine, a stronger USD, supply chain disruptions including the downstream effects on our customers, especially auto OEMs, continued high-cost inflation across materials and labor, the energy crisis in Europe, and the China lockdown. Because of all of the above and the uncertainty we see, we remain agile to quickly adjust our cost structure, as we did so effectively in 2020, and are taking steps today to smartly manage our spend. Let us now move to Slide 4 to discuss the 2022 Sustainability Report, which we will publish tomorrow. Sustainability is a priority for everyone at ITT, and I’m proud to report the progress we have made since our last publication in 2021. As you will see in the report, we are advancing our ESG strategy through: a, development of innovative products; b, investments in technologies to engineer a more sustainable future; and c, our social commitment to build a more diverse, inclusive, and talented workforce. Rather than issuing long-term inspirational targets, we are announcing credible and measurable near-term diversity, equity, and inclusion goals and targets for greenhouse gas emissions reduction. On emissions, after a 32% reduction in 2021 versus pre-pandemic levels in 2019, we are targeting an incremental 10% reduction by 2026. ITT’s emerging sustainability profile, a sustained differentiation that we demonstrated through our stepped-up execution and our sound capital deployment strategy such as with the acquisition of Habonim, will continue to drive long-term growth and value creation for all our stakeholders. Let me now turn the call over to Emmanuel to discuss the Q3 results in more detail.

Thank you, Luca, and good morning. We continue to see strong demand for our products in all our businesses. This quarter, we drove 15% organic revenue growth after 10% in the second quarter, with broad-based growth across all businesses. This was driven by short-cycle and pump project growth in Industrial Process, share gains in Connectors, over 30% growth in aerospace components in Connect & Control Technology, friction share gains, especially in Europe and North America, and pricing recovery actions across all segments. In Industrial Process, we continue to gain share in projects where orders grew 19% organically this quarter, contributing to an increase in backlog of nearly 50%. Orders for pumps were up 16% organically, with Parts and Services up 24%. In Motion Technologies, friction revenue was up 22% organically, driven by nearly 40% growth in original equipment, including pricing recovery. In addition, the 60 new electrified platform awards in 2022 will drive long-term profitable growth as electrification accelerates. Like others, we are impacted by the strengthening of the USD. This quarter, the headwind to sales was close to 800 basis points, which equated to a $0.04 EPS impact. On profitability, we drove significant improvements in operating income in addition to a sequential and year-over-year margin expansion. Operating margin was 16.9%, reflecting a 140 basis points improvement despite over 700 basis points headwind from cost inflation. Within the margin improvement, the team drove productivity of roughly 60 basis points through a combination of shop floor and sourcing actions. Furthermore, our strategic FX hedging we put in place partially mitigated the negative impact of the stronger dollar. Working capital requirements continue to weigh heavily on our free cash flow generation. We are purposefully investing in inventory to ensure continued delivery to our customers in this difficult time. Accounts receivable collection timing continues to be a drag on our free cash flow generation as well. Because of these factors, we are below our expectation for free cash flow for the year, which I will discuss more in a minute. Let’s now look further at the earnings performance on Slide 6. As you can see, pricing recovery ramped up significantly in the quarter with a notable step-up in Industrial Process. Further, the original equipment agreements secured at Motion Technologies through the first 9 months will mitigate the impacts of high cost inflation. We also continue to drive productivity to help overcome lingering inflation impacts. The direct and indirect impacts from the war in Ukraine cost us $0.04 of EPS versus the prior year, and we expect this will be an impact of approximately $0.22 of earnings compared to our original 4-year guidance. Finally, we continue to ramp growth investments to fund groundbreaking technologies such as Embedded Motor Drive and Smart Pad as well as further value analysis, value engineering product redesigns. The impact of over $250 million of share repurchases, a higher effective tax rate, and higher interest expense netted to a benefit of roughly $0.02. Let’s turn to Slide 7 to review the segment results. Let me begin with Motion Technologies. Friction maintained its outstanding quality and on-time performance, effectively managing the global supply chain disruptions and automotive original equipment production volatility to generate 22% organic growth. Aftermarket slowed to 1% growth due to high distributor inventory in Europe and the lost revenue due to the war in Ukraine. On profitability, we faced 870 basis points of raw material inflation, which were partially offset with pricing recovery and productivity benefits. Inflation drove a segment margin decline at Motion Technologies of over 160 basis points year-over-year. Nevertheless, Motion Technologies’ margin improved 130 basis points sequentially. Industrial Process performance this quarter was outstanding, with growth across most short-cycle product categories. On orders, we see strength in short-cycle and projects on a year-over-year basis. Our book-to-bill was an impressive 1.09, contributing to an ending backlog of $600 million, up 49% since the prior year. IP’s margin improved on both a sequential and year-over-year basis by over 400 basis points. In the quarter, there were approximately 200 basis points of one-time favorable items. Excluding these amounts, IP’s margin still grew to approximately 19% due to improved operational execution. This resulted in a 52% incremental margin in Q3. Lastly, in Connect & Control Technology, we drove another strong quarter of orders and revenue stemming from the continued recovery in commercial aerospace and in connected distribution. Distribution sales were up 20% organically this quarter. CCT's book-to-bill was 1.03, which was especially impressive given the 15% organic revenue growth and strong order growth in previous quarters. CCT’s margin expansion was driven by pricing recovery, higher sales volume, and continued shop floor productivity with an incremental margin of 32%. So all in all, a really strong performance in Q3. We are executing. We believe we are gaining share against competitors, especially in Industrial Process, while managing our costs effectively, and our performance is moving towards our long-term targets. Let’s now turn to Slide 8 to discuss our updated financial guidance. Because of our solid performance to date, a backlog of over $1 billion, and the pricing recovery we are executing, we’re tightening our organic sales guidance to the upper end of the previous range. However, we are at the low end of the previous segment margin range due to a few factors: persistent inflation, which is not abating at the pace we had anticipated, and unfavorable mix mainly in Connect & Control Technology and in Motion Technologies given the lower aftermarket volumes. By segment, for the full year, we expect that Industrial Process and Connect & Control Technology margin will expand to close to 18%, and Motion Technologies' margin should end close to 16%. The combination of the margin drivers I mentioned and lower aftermarket volumes in Friction, offset by increased price recovery in Industrial Process, results in our revised EPS range of $4.35 to $4.45. This is within our original outlook established in February prior to consideration of a number of headwinds that Luca mentioned earlier. On cash, we now expect that free cash flow will be approximately $150 million at the midpoint, given the higher inventory levels required to meet customer demand and timing of cash collections. We are clearly not performing up to expectations, and we’re taking steps to address this including weekly cash collection progress calls, deep dives in inventory, further review of customer and supplier payments, and where necessary, stopping shipments. Let me spend a minute discussing the dynamics of the fourth quarter. Organic sales growth is expected to be in the high teens, thanks to growth in Industrial Process and Connect & Control Technology and to a lesser degree, in Motion Technologies, where revenues will grow organically but decline sequentially due to lower friction aftermarket. Industrial Process will again be the standout with organic growth well above 20%. Total revenue growth in the quarter will be approximately 13% despite an FX headwind of roughly 9 points. Motion Technologies margin will be approximately flat compared to Q3, given the firming of our pricing benefits, offset by persistent inflation and lower aftermarket volumes, while both Industrial Process and Connect & Control Technology will expand sequentially in Q4 to exit the year above 20%. This will drive EPS growth in Q4 of roughly 18% at the midpoint year-over-year, a strong performance given the uncertainty we and others face today. For the quarter, we will overcome an approximate $0.12 headwind from FX. With that, let me pass it over to Luca.

Thanks, Emmanuel. As we approach 2023, let me highlight a few points on the end markets that will inform our 2023 outlook. We are completing our annual planning process, and there is still a lot of uncertainty due to supply chain, a potential economic slowdown, the impact of higher interest rates, and the cost of energy, to name a few. These items will evolve over time and will certainly impact the fourth quarter and next year. Auto production has been very volatile due to continued supply chain disruptions. However, low inventory levels, especially in North America, should continue to drive demand. Our current thought is that North American production will show improvement, while Europe might remain at current low levels and demand in China could still be impacted by further COVID lockdowns. We expect to continue to outperform the market in all geographies. In our industrial markets, we have seen an improvement in project activity, especially in North America, while we are seeing signs of sequential slowing in baseline pumps and industrial connectors. We continue to monitor distributor inventory levels to stay ahead of any potential slowdown. The aerospace recovery continues, notwithstanding some of the lingering supply chain challenges in the industry. This is evidenced by the continued strong order rates we are generating in Connect & Control Technology. Furthermore, defense demand should remain robust, which will drive orders for KONI shock absorbers and for Connect & Control Technology connectors that support soldiers’ modernization. Lastly, our rail business was hit hardest by the loss of Russia revenues in 2022. However, global investments in rail infrastructure, including as part of the Inflation Reduction Act in the U.S., should spur more spending. Additionally, as Emmanuel noted, foreign currency will likely be a headwind to revenue and earnings next year, given the stronger U.S. dollar and the expiration of the hedge protection at year-end. Now let’s turn to Slide 10 to recap. As I think about Q3, there is a lot to be proud of. Our pricing recovery actions are ramping with a notable step-up in Industrial Process, which, coupled with exceptional execution contributed to IP’s margin in Q3 above 20%. We are advancing our sustainability strategy and announcing 2026 environmental and social targets that are grounded in projects and specific action plans with dedicated teams in place to execute. We are encouraged by the strong demand across the portfolio and by our team’s ability to deliver for our customers while gaining share in all our businesses. However, we’re seeing signs of slowing in certain shorter-cycle markets, which we are monitoring daily. We remain cautious and ready to act in the event of a prolonged slowdown and will continue to work hard on what we can control and on achieving our long-term financial target and generating value for all stakeholders in the process. As ever, it has been my pleasure speaking with you this morning, and we will happily take your questions now. Adam, please open the line for Q&A.

Our first question today comes from Joe Giordano from Cowen.

I wanted to start on the industrial connectors and the commentary around that. How much of that do you see as market deterioration versus just a buildup of inventory and people were over-ordering previously and maybe the market is okay, but there’s just too much out there?

Okay. Let me start by saying a couple of points, Joe. When we look at our industrial connectors, including, for instance, also the EV, the electrification connectors, the industry connectors grew. It grew actually in Q3. But then when you peel the onion, and this is why we’re talking about the purely industrial connectors, we saw the softening. Now when we look at the inventory levels, talking to our distributors, we do not see a huge level of inventory in our distribution, and we still see good orders on that front. So we believe that is more a kind of softening on that side, and those are what we call the canaries in the coal mine that tell a little bit about the economy.

Perfect. And then just a follow-up on price more broadly. Is it becoming more challenging? Are customers still as willing to accept price increases as they were a couple of months ago when everything was spiraling? Or are people a little more judicious with accepting that kind of price increases now?

Well, I would say when it comes to price, Joe, it has been for ITT a very long journey, particularly from a Motion Technologies point of view. I think there has always been a lagging. I must say I’m incredibly proud of what we’ve been able to achieve in Q3 because, when you look at the ITT level, in Q3, it’s the first time ever that we’ve been price-cost neutral. So we expect that actually to improve a little bit in Q4. Obviously, there are customers that are starting to see easing on the commodity side, and therefore there is some talk and some negotiation going on, particularly when you begin to look at 2023, but also on the other side as there was a lagging in getting into this, we are negotiating a lagging also in getting out of this. Did that answer your question, Joe?

Yes. Thank you very much, Luca.

The next question comes from Jeff Hammond from KeyBanc Capital Markets.

Just on Motion Technologies, it seems like the margin progression is maybe a little bit less than you had hoped. I’m just kind of wondering, is it more the mix dynamic? Is it more pricing coming through slower? And just how should we think about margin progression into '23? I know you said kind of flattish sequentially into Q4.

Yes. So, Jeff, we’re seeing continued significant pressure from commodities. We had expected that the commodity pricing pressure would abate a little bit in the second half. And because we had secured and booked a lot of materials to protect our customers ahead, we’re not seeing that impact yet. We expect to see an improved benefit from commodity pricing in 2023.

And you also hit the nail on the head in terms of there was a negative impact on the mix in Q3, and we will see the negative impact on the mix also in Q4, as Emmanuel said in the prepared remarks.

Okay. Great. And then just on Industrial Process, margins are exceptional. I think you said there were some one-timers. Just maybe talk about the sustainability of that. I think you mentioned CCT to follow. Should we expect kind of more accelerating momentum in CCT along the same lines as IP?

Industrial Process is clearly the standout performer. We've achieved a growth rate of 15% and a remarkable growth of 59% in certain areas. Regarding one-time items, the margin sustainability is currently estimated at around 18%, possibly between 18% and 19%. I'm incredibly proud of what Industrial Process has accomplished because that margin reflects a strong foundation, including disciplined pricing in projects, effective project execution, and high throughput and velocity at our plants, like Seneca Falls and those in Germany. Since 2017, we've seen a transformation in Industrial Process, moving from mid-single-digit margins to posting a 21% growth year after year, irrespective of challenges like COVID. It's been an impressive journey, and I'm confident that you and others now have greater assurance in our capability to reach our long-term goal of a 20% operating margin.

Yes, it’s been a great story to follow.

Next question is from Mike Halloran from Baird.

On the pump side, Luca, let's start with a two-part question. First, the market share story looks promising for you. Could you explain why the energy aspect is currently less favorable? Is it simply that things are being delayed? I'd also appreciate your insights on why these delays are happening now. Lastly, are there any other concerns regarding the order base on the pump side?

Okay. When we look at the pumps, I would say the short-cycle is definitely a great story. If you look at Q3, we have another quarter of more than $200 million of orders. So the growth year-over-year sequentially, and as Emmanuel said, is the growth in terms of Parts and Service at 24%, which was roughly half volume and half price. So that’s incredibly good. When you look at the project side of the business, the projects have recovered. If you look at year-to-date, our orders on the projects are up more than roughly 36%. We see the projects and the funnel getting stronger in geographies like North America and the Middle East. The only geography where actually we see both the orders and the projects, as well as the sign-offs going down, is actually Europe, and this is where we start seeing some weakness. I don’t know, Emmanuel, if you want to add anything to that?

And then specifically, in terms of energy, I think what we’re seeing is that some projects that were discussed with customers are taking longer to materialize and to enter the budgetary phase. We are very well positioned with LNG, and so we’re ready to capture a lot of the business, including the fact that we’re getting engineering-only orders while the customer is waiting to finalize their budgets for their projects. This should help us with the project acquisition when the project comes to the market. But in general, we believe energy is strong. There’s secular growth there, but it’s going to take a little longer, especially on the project side.

And then your point, Mike, that you were talking about some concern on the pump side, is probably on the short-cycle. If you look at the baseline, the baseline is softening. This is what we said in Q2 last quarter and also what we have seen in Q3.

Thank you for the detailed information. It was excellent. Regarding the Motion segment, I appreciate the insights provided on the Friction side and the regional demand you're observing. Were those insights part of your initial outlook for next year, or are they more focused on Q4? Luca, you’ve often shared valuable perspectives on how your views align with the consensus production forecasts from an environmental standpoint. Any changes you notice in that regard would also be helpful.

Sure. Thanks, Mike. So when you look at 2022, it has been an interesting year because it has panned out to be quite different from what we thought at the beginning. Look at Europe. We thought that Europe was going to grow double-digit. It ended the first half at minus 11%. So it is recovering in Q3, and we expect it will recover in H2, but overall, Europe will probably end up negative low single digits for 2022. China, we thought was going to be flat or negative 1%, something like that. Then with the lockdown in Shanghai, we thought it was going to be even worse. As a matter of fact, China recovered strongly, finishing the half plus 1% and strong Q3, and we will have a strong Q4, ending the year 2022 probably at positive mid-single digits. North America was the one that was closest in their prediction to reality, and it will finish the year at positive double single digits. Overall, probably 82 million vehicles produced for 2022. Looking at 2023, what we think, although it’s too early to tell, is low single-digit growth for Europe, China probably stays flat to low single digit, and North America mid single-digit growth. So overall, for the full 2023 worldwide, we anticipate low single-digit growth.

And then your share gains will be on top of that, right?

Absolutely, Mike. Well said.

The next question comes from Damian Karas from UBS.

I have a follow-up question regarding Friction. I appreciate the information you’ve already shared. I’m curious if you still anticipate the usual ramp-up in capital investment for the fourth quarter as part of your previous guidance. Additionally, with the number of EV wins you’re achieving, do you foresee any risks of delays or cancellations for these new platforms?

Yes, on CapEx, yes, we expect a relatively stronger Q4 than what we’ve seen so far. I would say that we are trying to be balanced with the fact that we need to drive productivity, and we certainly need to support the growth of all the awards, especially in Friction that we’ve won. At the same time, we know that there is a looming recession in the future. So we want to make sure that we don’t set ourselves with really higher fixed costs when it comes to the moment of lower volumes due to the recession. We’re going to focus on productivity and driving capacity where we have won the business while staying mindful of the fact that 2023 could start the year of a worldwide recession.

Following up on the second part of the question, Damian, regarding the delays or lower start of production on the EV. Well, first of all, let me share what has happened in 2022. We have been looking at the SOP analysis on a quarterly basis, and for 2022, there have been zero delays worldwide. The situation is a little bit different in different regions. In Europe, there have been delays in the Start of Production, and there has been lower Start of Production in terms of volume; but this has been more than compensated in China, where the Start of Production accelerated with larger volumes. Overall, it has been neutral. When we look at the EV, we don’t see that happening, and if it happens, we believe it will be immaterial. Also, looking at the adoption and how many EV get bought or produced in the quarter, last Q3 in North America was exceptionally high. So we don’t see that happening, and electrification will be good for us.

One thing that was notable this quarter, Damian, is the fact that we won significant new platforms with BYD, which is really the leading EV manufacturer in China. As we discussed in the past, we have a really strong position and growing position with Tesla, and the same is happening with BYD.

The next question comes from Nathan Jones from Stifel.

This is Matt on for Nathan Jones. Follow up question. I think I might have missed it in the earlier remarks, but what was the impact of price cost on the incremental margins in Motion Technologies?

So I would say that, as Luca mentioned, price cost for the quarter at ITT level was neutral. This is the first quarter that we’ve seen this since the high cost inflation we’ve been facing since mid-2021. For Motion Technologies, the results by business are a little bit different. For Motion Technologies, we’re not yet at a point where the cost-price impact is neutral. So it has a negative impact in dollars and a negative impact from a margin standpoint. The margin impact for Q3 from a negative price cost was something like a lot less than 200 basis points for Motion Technologies.

Okay. When do you expect to achieve neutrality on a dollar to margin basis for Motion Technologies? Is that expected to happen sometime in late 2023? Any insights you could share?

Yes. For Motion Technologies, I think we could be really close to neutrality in Q4 as we will benefit from incremental price recovery from our customers as well as a little bit of slowdown from a commodity price standpoint from a sequential basis.

The next question comes from Vlad Bystricky from Citi.

Just looking at the longer-cycle project orders in Industrial Process, you’ve had several quarters now of really nice growth in the order side there. So can you just talk a little about the expected type deliveries on these longer-cycle project orders? And how much visibility these orders give you into 2023 IP demand?

Yes. As we discussed, we have a really strong backlog in Industrial Process, close to $600 million, up approximately 50%. Of that backlog, a lot less than 50% is from projects. The result is really due to many share gains we have had from a project standpoint. Typically, for us, projects take between 10 months to 24 months from when we take the order to when we deliver. Given the supply chain issues we are facing and our customers also are facing, I think we could be on the longer side of the conversion timing, but I think that remains probably between a little bit more than a year to 2 years.

If I may add some color to that in addition to the timing, I’d like to give some color on the margin because the project backlog margins are at historic highs. You and I both know that profitable growth starts with pricing discipline on these projects. You won’t be able to deliver this kind of margin if you don’t have that.

No, that’s great color. And then maybe just following up. If I look at your market outlook slide on Page 9, there’s more yellow and red versus green. So, just given what you’re seeing in the macro in your various end markets, can you just talk about how you’re thinking about the potential for growth or a more significant slowdown in 2023, and sort of how you’re balancing, planning for what seems like a potentially a wide range of scenarios into next year?

Yes. Let me walk through the different end markets. In terms of automotive, Luca already talked about what we expect for 2023 between 84 million and 85 million vehicles, low single-digit growth versus 2022. We obviously expect to continue to outperform like we’ve done in the past. While auto won’t recover to pre-pandemic levels before 2024 or 2025, we expect that we’ll be able to continue to grow and outperform the market. From an aerospace standpoint, the production of air framers is still well below what it was pre-pandemic. We think that there’s going to be a continuum of production increase from those customers into 2023. We expect by the end of 2024, commercial aerospace production will return to the pre-pandemic levels. As for the energy market, there’s a lot of concern around energy security and availability. Given that we need to transition, but there’s not enough renewable production capacity for the moment, this should lead to further investment in oil and gas, and we’ll be ready to support that. As I mentioned, there’s some concern about project timing, but overall, the energy market is still on a positive track. For rail, and general industrial, I would say, we expect a steady pace in line with GDP growth, with more upside in the U.S. than in Europe.

That’s great color. Thanks, Emmanuel.

The next question comes from Bryan Blair of Oppenheimer.

I guess to level set a little bit more on your outlook in Friction. You’ve walked through the market growth expectations. You said that outperformance should be in line with historical experience. Just curious if there’s any nuance to that across regions based on trailing wins, the EV platforms that should be ramping, thinking about Europe, China, North America outgrowth through ‘23?

Okay. I would say we had exceptional outperformance in Europe, but the outperformance is across the board. I would say when you talk about the dynamic behind it, let me give you a couple of examples on that front. One, of course, are the continuous awards, conquer awards that we do have, and electrification on that front is key because we won many electrified platforms last year and are winning many this year, which feeds the outperformance. Also, let me give you more color as an example that happened last month, where Friction and Luca Martinotto, the Head of R&D and the Head of Friction won an award that we lost 2 years ago. Two years ago, we lost this award, but the team kept on working on the product, continuously developing it at our own cost, knowing perfectly well that it might be just an investment with no return. Last month, the customer, a Tier 1 and OEM, came back; the current supplier faced some issues, and they’re looking to accelerate our qualification, and we won another award. This is how you win, conquer, and outperform the market.

Very helpful color as always. Emmanuel, wondering if you could walk us through price-cost progression in Motion Technologies for the year. You mentioned a little under 200 basis points impact Q3 moving toward neutrality in Q4. What was the hit in Q1 and Q2, moving into the back half? And with progression toward neutrality in Q4, I think you mentioned the top line should be relatively similar. Why would there not be sequential margin expansion along the lines of that price-cost improvements next quarter or this quarter?

As I mentioned, Bryan, the price-cost equation is improving in Q4 versus Q3, but this is not a massive improvement. This is more incremental improvement, and that’s where we’re going to be neutral in Q4 from a dollar standpoint. We have seen a significant improvement in the second half compared to the first half. In fact, in Q1 we had made a lot of progress versus 2021. However, we were still largely negative from a price-cost standpoint. In Q3, we went up to close to $40 million, and we’re going to continue to build that up in Q4 a little bit and then have the positive impact of commodities. This is kind of the timeline from a price-cost standpoint. When you look at Q4, a couple of things are happening in Motion Technologies, and this is why we’re not expecting to have significant margin progression from a sequential standpoint. The first one is volume. We will have less volume in Q4 compared to Q3, primarily coming from aftermarket, which tends to have a better margin than original equipment. This is a headwind to Motion Technologies’ margin expansion. As we look to 2023, we anticipate improvements. The lower aftermarket demand is primarily in Europe due to higher inventory and also because we lost business due to the situation in Russia.

The next question comes from Andrew Obin from Bank of America.

So I think you guys are like some of the smartest operators out there. So I’m going to make you answer questions that I think other people just want to know the answer, sorry for that. The first question was about interest rates going up. A lot of companies use floor financing for their working capital. What are you guys thinking about your strategy for working capital? What do you see your channel and your suppliers do in this high interest rate environment? And what does it do to the ecosystem?

Yes. You’re pointing out a real issue for us in terms of our free cash flow generation and the impact it has on our interest expense and for many other companies as well. What we are doing is driving a recovery in the cash performance. We are disappointed with the cash performance year-to-date, and we’re really focusing on getting that cash in. We have more or less $100 million of accounts receivable past due with our customers. About 75% of it is paid within the first 2 months. So this is not a long-term issue; it’s just customers adjusting their cash generation for quarter-end. We’re going to drive the fact that they need to pay us on time. As I mentioned before, we are ready to take action from a stop-ship standpoint to get paid on time. Additionally, there’s a lot of work that needs to happen also from an inventory standpoint, where we need to work on material planning effectiveness. We are doing that, but the reality is this will bring benefit in 2023, not so much in 2022. There’s also a delay between pricing agreements made and the customer payments. We will be pursuing collection of that roughly $15 million of pricing recovery.

Wow, that’s a great answer. I appreciate it. The second question is also on M&A. How has the M&A environment changed? You might not be generating as much cash as you would like to these days, but you still have a nice balance sheet and you are generating cash. What do you see in the M&A environment? What do you see in terms of availability? What do you see in terms of competition from private equity? Does it make it more likely or less likely to see a deal from ITT in the next 12 to 18 months?

Thank you, Andrew. I wouldn't say it's more likely; the competition from private equity seems to face more challenges today due to the current environment. We might observe more strategic competition in that area. However, we recognize that mergers and acquisitions are crucial for us regarding capital deployment. In this environment, we will continue to invest organically in the business with an emphasis on enhancing productivity. For M&A, we plan to proceed with a more cautious approach. We are actively examining opportunities in flow and in Connect & Control within our connector business. Our pipeline is filled with prospects that align with our strategy in both Industrial Process and Connect & Control Technology.

Our final question today comes from Matt Summerville from D.A. Davidson.

Just two quick ones. Just to put a finer point on pricing. When you look across the three segments, each one grew organically at about 15%. We come back into what price realization was in percentage terms in Motion Technologies based on the $40 million figure you mentioned. But can you provide what was price realization in Industrial Process? What was price realization in Connect & Control Technology? Is it 8% of the 15% organic growth you put in each segment? And then I have a quick follow-up.

If we look at pricing realization out of the 15%, as you know, it’s 15% across the board; that’s easy to remember. So 50% of that was price, and 50% was volume overall. The pricing recovery was the strongest in Industrial Process, followed by Motion Technologies and Connect & Control Technology.

Got it. And then maybe if you could just comment a little bit on the incoming order cadence you saw in the third quarter and what you experienced in October? Does that inform you that the slowdown you’re seeing in the general industrial side of things is getting worse? Is it sort of flattish? I guess I’m trying to get a sense of whether there’s real momentum behind that slowing that is building?

Sure, Matt. When we look at there was no really big seasonality when you look at Q3. Of course, Q3 in Europe, you have August, so there is a little bit of that, but no significant seasonality in different months. In Q3, we see that trend continues; it really didn’t deteriorate. Parts and Service in Industrial Process stays strong throughout the quarter, and the baseline was softening. This has been happening regularly in Q3. When you look at October, orders for ITT are showing a nice growth year-over-year and confirm the trends we saw in Q3. There’s not really a deterioration, nor really any change, but more of the same.

Thank you. This concludes today’s Q&A session, and this concludes today’s teleconference. Please disconnect your lines at this time and have a wonderful day.