Earnings Call Transcript - ITT Q4 2022

Operator, Operator

Welcome to ITT's 2022 Fourth Quarter and 2023 Outlook Conference Call. Today is Thursday, February 9, 2023. This call is being recorded and will be available for replay beginning at 12 PM ET. It is now my pleasure to turn the floor over to Mark Macaluso, Vice President of Investor Relations. You may now begin.

Mark Macaluso, Vice President of Investor Relations

Thank you, Candice, and good morning. Joining me 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- and 12-month periods ending December 31, 2022, which we announced this morning. Before we begin, please refer to Slide 2 of today's presentation, where we note that today's comments will include forward-looking statements that are based on our current expectations. Actual results may differ materially due to a number of risks and uncertainties including those described in our 2021 annual report on Form 10-K and other recent SEC filings. Except for otherwise noted, the fourth quarter and full year results we present this morning will be compared to the fourth quarter and full year 2021 and include non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures are detailed in our press release and in the appendix of our presentation, both of which are available on our website. This morning, we will begin with an overview of results and our outlook for the year. Emmanuel will then review the fourth quarter results before we close the book on 2022. Luca will discuss some key commercial achievements and our 2023 guidance, and we'll have plenty of time for your questions at the end. Please note there is additional information on the quarter and full year results as well as planning assumptions for 2023 in the supplemental data to our presentation, which I encourage you to review. With that, it's now my pleasure to turn the call over to Luca, who will begin on Slide number 4.

Luca Savi, CEO

Thank you, Mark, and good morning. Before we discuss ITT's results, I would like to start by thanking our shareholders for their investment in ITT, our customers, who we always keep at the center of everything we do, and our employees for their ongoing commitment to ITT. This quarter, more than ever, I was humbled by the efforts and resilience of all our ITTiers. First, in Wuxi, China, our employees delivered the highest production quarter ever despite a COVID infection rate of more than 75% in December. Our China team's performance was the highlight of the quarter. Next, across all our factories, we navigated supply chain disruptions and ensured on-time delivery to our customers. And in Europe, our teams worked through the energy crisis, the impact of the war in Ukraine, and ongoing inflation. I am grateful for the resilience you demonstrated this quarter and throughout 2022. It was your efforts that drove the record performance we are presenting today, including 12% organic orders growth following 13% growth in Q3, over 17% organic revenue growth in all businesses delivering double-digit growth, a record segment margin of 18.6%, 22% EPS growth after 21% in Q3, and over $130 million of free cash flow up 58% versus the prior year. In many regards, ITT's fourth quarter was another step-up in performance. Now to the details. Our seventh consecutive quarter of double-digit organic orders growth resulted in an ending backlog of more than $1.1 billion, up 22% versus the prior year. Higher volumes and price recovery drove the strong organic revenue growth, led by industrial process at 27%. This year, we drove over $170 million of price recovery with MT at the forefront. Execution momentum in IP continued across projects, baseline pumps, and aftermarket resulting in 27% organic revenue growth in Q4. CCT grew sales by 16% boosted by share gains in connectors and strong demand for aerospace components. And in MT, the outperformance continues in every region. For the full year, we surpassed global automotive market growth by roughly 400 basis points. Our price recovery, volume growth, and productivity led to a record segment margin in Q4, overcoming cost inflation impacts of roughly $50 million for all of ITT, a truly remarkable accomplishment indeed. And on cash, after a tough few quarters, we generated strong free cash flow with a 17% free cash flow margin in the quarter by far the best performance of the year. The common thread that underpinned these achievements was our people and their commitment to deliver for our customers. I was fortunate to experience this in Saudi Arabia, where Halid and the local IP team performed flawlessly and achieved 100% on-time performance for our customers in 2022. In the flow industry, this is a differentiator. And given this performance, we are investing in new testing capabilities to grow our presence in the region. This has already helped us win more than $20 million in incremental project orders. Or in South Korea, which has become our new center of excellence for vertical pumps, where we continue to invest in more technology, engineering resources, and lean practices. Speaking of lean, we are working now on our next transformation of the plant layout in Seneca Falls, to optimize material flows and efficiency. We are already realizing the benefits of IP's lean efforts with more than 40% incremental margin in Q4 and for the full year. This relentless focus on excellence, continuous improvement, and commitment to quality enabled us to deliver on our original revenue and adjusted earnings per share guidance in 2022, despite numerous unanticipated macro headwinds. On capital deployment, we deployed more than $600 million in 2022, or 3.5 times our adjusted free cash flow. CapEx increased 18% to support the growth of electrified vehicles and productivity. On M&A, Habonim was a strategic acquisition and a great deal. It expanded IP's valves business by more than 50% and was accretive to ITT's earnings. With this strong performance, our effective purchase multiple is now 8 to 9 times and dropping versus approximately 12 times at the date of acquisition. This morning, we announced a dividend increase of 10% after increases of 30% and 20% in 2021 and 2022, respectively, and we repurchased over $250 million of ITT shares, lowering our share count by 3%. Finally, on our 2026 long-term targets, we are making significant progress. A few highlights. Our relentless focus on safety drove reductions in both injury frequency and severity rates, leading to a 32% decline in the number of incidents in 2022 to a much improved incident frequency rate of 0.55. On sustainability, we are reducing our greenhouse gas emissions, increasing revenues from green products, and advancing our diversity, equity, and inclusion efforts. Our financial performance, organic revenue, and adjusted EPS growth in 2022 were in line with our long-term growth target. We are proud of what we accomplished in 2022 but never satisfied. That is why we're encouraged by the opportunities we see in 2023. With that, let me turn the call over to Emmanuel to discuss our fourth quarter and full year results.

Emmanuel Caprais, CFO

Thank you, Luca, and good morning. Let's begin on Slide 5. Revenue growth of over 17% was driven by double-digit growth in all businesses. In IP, projects increased over 70% organically. Here, we continue to benefit from share gains in large capital CapEx spend and near-shoring activities that are ramping up. Short-cycle revenue increased on a year-over-year basis across baseline pumps, parts, and service aided by pricing capture. The strength of the commercial aerospace recovery and accelerating demand for defense applications drove strong growth in CCT as well. Our aero components business grew 26%. However, we remain somewhat capacity constrained due to continued supply chain issues. Connectors grew 13% driven by market share gains as the benefit of new product innovations, particularly in defense, began to materialize. In MT, friction OE share gains in all regions and price recovery drove 12% organic growth. Friction's on-time performance was 99% again this quarter despite rising COVID infection rates in China, order volatility, and unplanned customer shutdowns. Our rail business grew 10% organically and orders were up 35%, with strength mainly in Europe. On profitability, volume and price added 800 basis points of margin expansion, which more than offset 650 basis points of cost inflation and roughly 100 basis points of FX. We're continuing the push on shop floor improvements as demonstrated by IP's margin of 22.9%, up 700 basis points year-over-year. Even excluding roughly 120 basis points of one-time items, IP's margin was still above 21%. This is quite an improvement from what was an 8% margin business in 2016. Next, CCT's margin grew 80 basis points to 19.2%, driven by higher volume and price recovery. For the year, CCT's margin ended at around 18%, up 270 basis points. Finally, in MT, margins declined 500 basis points to 14.7%. This was driven by a combination of higher material, labor and energy costs and unfavorable mix stemming from auto aftermarket declines in Europe. We also had a tough compare this quarter given the gain on asset sale realized in Q4 2021. This margin performance was clearly below our expectations, but we expect that MT's margin will return to its previous level as cost inflation subsides and we sustain pricing benefits. On EPS this quarter, we overcame $0.48 of cost inflation, $0.15 of negative FX, $0.03 for the loss of business in Russia, and $0.03 from higher interest expense. On cash, we improved significantly in the fourth quarter, exceeding our last forecast on the strength of AR collections. We're seeing the benefits of our daily collection efforts and expect further improvements as supply chain disruptions ease. Let's move to Slide 6. I want to make a few additional points on this page. First, price recovery again exceeded cost inflation in Q4. This is a testament to the differentiation we provide compared to the competition. Second, foreign currency was a significant headwind given the strengthening of the U.S. dollar. Third, with interest rates rising throughout the year, our interest expense was $3 million this quarter. We expect it will remain at this level throughout 2023. Finally, despite the long list of challenges we encountered this year, we didn't lose sight of the long term and continued to invest in new product development, redesign, and innovation. Let's turn to Slide 7 to discuss ITT's growth momentum. Friction continued to win content on new EV platforms. We're making progress on our, on our 2025 EV market share target of 37%. Further, in 2022, our total electrified vehicle revenue was over $100 million. We're also beginning to see investments in rail infrastructure materialize. Even with the significant loss of business in Russia in 2022, rail orders were approximately flat for the full year. IP is seeing strong growth in projects that will drive future revenue outperformance, enlarge our installed base, and drive aftermarket demand. In CCT, we saw another strong quarter with commercial aerospace demand continuing to ramp. We also drove significant orders in EV connectors. This business has grown organically to almost $40 million in orders in 2022. The orders growth in our ending backlog gives us good visibility into the revenue conversion through at least the first half of 2023. Let's turn to Slide 8 to wrap up the 2022 discussion. Here, I'd like to quickly recap ITT's 2022 performance. The headwinds on this chart for cost inflation, foreign currency, and the lost Russia business amounted to over $2.30 of impact, which was well above our expectations when we issued our guidance early last year. As Luca mentioned, execution was the differentiator; our commercial teams sprang into action to execute pricing negotiations. We ramped our effort on productivity to address rising costs, and we completed the acquisition and integration of Habonim. While we're incredibly proud of this performance and humbled by the team's achievements, there is still much more that we can and will do. We're driving improvements in our on-time performance in IP and CCT, further expanding our value-based pricing strategy, and increasing our cash generation to execute more strategic M&A, all of which will drive long-term value creation. With that, let me turn the call back to Luca on Slide 10.

Luca Savi, CEO

Thanks, Emmanuel. Before we cover our 2023 outlook, I'd like to share some examples of how performance and innovation are driving customer wins and market share gains across friction, pumps, and connectors. As we discussed during Investor Day, Motion Technologies is strengthening its leading position by taking full advantage of the EV transition. This year, we won content on 78 new electrified vehicle platforms, with awards from leading global automotive OEMs, including Tesla, BYD, Rivian, Poster, and Neo, among others. Our best-in-class quality with defects below one part per million and outperformance at 99% on-time delivery helped us win the front and rear axle pass on a premium German electrified platform that we will launch in 2024. Electrification is also good for our connectors business. We developed and are investing in an EV connectors portfolio catering to regional charging infrastructures, and we are seeing orders surge. Customers are choosing our connectors because of our engineering capabilities and responsiveness. In industrial process, we are capturing share in a market that's rebounding from two years of supply chain disruptions and component shortages. Over the next two years, we will deliver pump systems to an independent oil company in Nigeria using our Bornemann twin screw technology. This unique offering will stop flaring at site and eliminate roughly 1,000 tons of CO2 per day. Orders for green projects increased 50% in 2022 compared to the prior year. We are winning on near-shoring opportunities including a hazardous waste treatment system for a new semiconductor plant in Arizona and for a commercial EV battery recycling facility in Upstate New York. Finally, we are making progress on the embedded motor drive technology, or EMD, that we displayed at Investor Day. Initial testing showed that our Gen 2 prototypes exceeded expectations in energy efficiency, operating temperature, and vibration. We are currently in initial discussions and field trials with ten customers across various industries to demonstrate EMD's capabilities. In Connect and Control Technologies, we are qualifying new vibration isolation technology that reduces motor induced vibration for military applications with leading helicopter OEMs. We are custom designing to develop our Cannon connectors together with our customers to withstand the most harsh environments. This quarter, we are launching a new family of soldier worn connectors. We are also qualifying ruggedized connectors for the net warrior wearable mission command system. Clearly, there are a lot of exciting innovations that you will hear more about throughout 2023. Let's now turn to Slide 11 to discuss the growth outlook in each business in 2023. Starting with Motion Technologies, we expect friction to outperform the market as global production continues to recover to pre-pandemic levels. We foresee auto production to be flat to up low single digits in 2023 and are planning for a slowdown in demand, particularly in Europe in the second half. On the auto aftermarket, we think the weakness we saw in 2022 will persist through Q1 and then begin to improve from there. On the rail portion of MT, after a long year of declines stemming from the war in Ukraine, we exited Q4 with strong orders in both KONI and Axtone. Passenger rail is ramping up and with our 2022 awards, we think 2023 will be a strong year despite a potential slowdown in freight activity in the second half. Longer-term, this market will be strengthened further by public investments in rail infrastructure in the U.S. and in Europe. Moving to industrial process, we are entering 2023 with a healthy backlog. The project activity in this segment should continue to ramp with investments to support infrastructure, near-shoring, and clean energy. Parts and service demand, the aftermarket in AP has been strong and this trend continued into January. On the other hand, baseline pump activity slowed in Q3 and Q4. So we are monitoring industrial orders closely. Moving to Connect and Control Technologies, in the industrial components segment, the outlook is mixed. In Q4, we saw a sequential low in the short-cycle industrial connectors business, but encouraging demand in the EV and medical connectors space is providing a partial offset. In aerospace, there is no change to our positive outlook. Build rates are improving, and air travel is accelerating amidst the commercial aerospace recovery. In defense, demand remains robust given the current geopolitical conflicts and heightened level of military preparedness around the globe. Let's now talk about our 2023 guidance. We expect organic revenue growth of 7% at the midpoint. This is due to a combination of share gains and conversion of our backlog, tempered by slowing short-cycle demand, primarily in the industrial markets. In 2023, we will drive further value-based pricing actions with a notable step-up in IP and CCT, following an absolutely stellar performance in MT in 2022. To put this guidance into perspective, we expect to deliver approximately $3.2 billion in sales in 2023. On profitability, our productivity journey continues. We still see many opportunities to improve our supply chain effectiveness. Our assumption is that supply chain and material constraints will continue to ease, and higher raw material costs will subside in the second half. I do want to stress, however, that we are still largely in an inflationary environment even though it may be at a lower rate than last year. Our productivity actions net of inflation will drive adjusted segment margin expansion of 50 basis points at the midpoint to 17.7%. With the progress at IP and CCT and easing inflation at Motion Technologies, we are well on our way to the long-term margin target of 20%. The strong top line growth and margin expansion will drive adjusted EPS growth of 7% at the midpoint. On cash, improving our working capital will be a key priority in 2023. We expect to more than double our cash flow generation and drive free cash flow margin of 11% to 12%. On Slide 13, as you can see, our strong operational performance and pricing actions will outweigh cost inflation this year. However, we expect the other non-operational headwinds related to foreign currency and interest will impact our results. Still, we anticipate a solid 7% growth in adjusted EPS. For the first quarter, we expect to deliver mid- to high single-digit organic growth led by industrial process followed by CCT, more than 100 basis points of margin expansion at the midpoint, led by IP and CCT with MT approximately in line with its Q4 2022 margin rate, and adjusted EPS growth of over 15% year-over-year. We expect EPS growth in the first half of 2023 to be stronger than in the second half. We are prudently taking a cautious outlook to Q3 and Q4 until we have more clarity on the economic situation. Now before we move to Q&A, please let me share a few final points. First, all year, we executed for our customers, gained market share, and grew orders across all our businesses. The result is a strong, profitable backlog on which to execute and outgrow the competition in 2023. Second, we see positive signs in several markets, and we expect to perform well. The foundation for this performance has been laid over the past five years. Once again, we are executing. Still, there are signs that growth will slow in the second half in some end markets, and so we're staying laser-focused on what we can control. Third, as I said in June at our Investor Day, electrification is good for ITT. Friction's flawless performance and many competitive advantages are amplified as the industry transitions to EVs, and we are well on our way to achieving our EV market share target. Lastly, once again, in 2023, execution will be the differentiator, and that is ITT's strength. I would like to thank all our stakeholders for their continued support of ITT. As always, it has been my pleasure speaking with you all this morning. Candice, please open the line for questions.

Operator, Operator

So our first question comes from Nathan Jones of Stifel.

Nathan Jones, Analyst

Congratulations on 2022. I think that's a pretty phenomenal execution effort given all the incremental headwinds you had to deal with. A few questions on the guidance I'm going to go with. Just looking at the price versus cost inflation buckets in your 2023 bridge, I'm a bit surprised that they're largely offsetting. You had about $0.38, I think, of headwind from price versus inflation in 2022, but you were positive in the second half, and I would have thought that would carry over and you would make some of that back up in 2023. Maybe you can just give us some more color on price versus cost and why that's not reading through as more positive in 2023?

Luca Savi, CEO

Okay. So I would say when we look at 2023, we are getting roughly half the price that we got in 2022, and those are going to be incremental, right? So those are incremental to the price that we got in 2022. The other element that I would like to stress before maybe passing over to you, Emmanuel, is that when you look at 2023, we're going to be slightly price positive across all the value centers, something that we couldn't say in 2022. So it's a substantial improvement and is a continuation of what we have achieved in Q3 and Q4.

Emmanuel Caprais, CFO

Yes. Nathan, we experienced slight pricing positivity in the third and fourth quarters. Although it wasn't a significant improvement, I believe we can maintain this trend in 2023. It's important to note that we are facing some challenges from commodity prices, particularly in chemicals in Motion Tech and energy. We will be approaching our customers for additional price increases to offset these rising commodity costs. Additionally, we anticipate a slowdown in the latter half of 2023, so we need to consider this economic downturn when requesting price increases from our customers.

Nathan Jones, Analyst

Okay. The operational performance range suggests an incremental margin of around 30%, which aligns with my expectations for the businesses without considering additional productivity, where you clearly excelled in 2022. Can you share your expectations for productivity in 2023 and the possibility of achieving better incremental growth?

Luca Savi, CEO

I believe that in addition to that, Nathan, we have several investments in strategic initiatives that we are pursuing. For example, we are investing in products like the EMD mentioned earlier, the mass pad in Motion Technologies, and the digital automatic capital being developed for Axtone, as well as the SFO next lean transformation. We are completely revamping the SFO plant to elevate its operations. Additionally, we have started lean activities at CCT in locations such as Valence, California. All of this is alongside our initiatives aimed at sustaining growth, which we consider when evaluating the incremental margin.

Operator, Operator

Our next question comes from the line of Andrew Obin.

Andrew Obin, Analyst

Can you hear me?

Luca Savi, CEO

Yes.

Andrew Obin, Analyst

So I'm going to ask like a bit of a convoluted two-part question, apologies. So the first, you sort of highlight that IT projects were up 70%, citing reshoring, would love specific examples. But then a couple of slides later, you sort of talk about the fact that in the connectors business, you're seeing some weakness in short-cycle which I thought was sort of this lead indicator for potential weakness. So a, maybe specific examples of reshoring, but b, how do you square the circle with IP project bookings so strong, which indicates very solid underlying activity. At the same time, right, your short cycle can air in the mine, and maybe I'm wrong about that is sort of flashing yellow.

Emmanuel Caprais, CFO

Yes. When we discuss the slowdown in connectors, it’s important to note that our order volume is still growing rapidly. Our connected industrial business is primarily based in the U.S., where we are observing a decline in activity. However, in terms of IP projects, we are experiencing notable growth in the U.S. Specifically, we have highlighted opportunities in semiconductors and battery recycling, and we are also seeing substantial international growth. We have secured significant orders in energy projects, including Nigeria, Angola, Malaysia, and Saudi Arabia. While there is some project growth in the U.S., the majority is happening internationally.

Andrew Obin, Analyst

Great. I appreciate it. And then another question, sort of more of a big picture question. So effectively, if I look at your top line growth, the midpoint is 7%; EPS is midpoint of 7%. By the way, one of the best numbers in coverage. So I'm not saying it, but we look at Eaton, sort of not dissimilar dynamic. We'll look at Honeywell where in a normal environment, you would sort of expect more operating leverage from this sector. And the question I have is this sort of the new reality, just less operating leverage as we sort of shift into this high growth, high inflation mode? Or does this normalize eventually?

Emmanuel Caprais, CFO

We definitely have not given up on achieving incremental margin. I would say that 2023 is quite unusual because we are still experiencing significant cost inflation. At the same time, we aim to strengthen the growth and performance we have achieved so far. This requires investments in resources; we are investing in the supply chain as well as in products. I think this somewhat limits our margin and EPS growth. However, we are also very focused on productivity. Looking ahead, especially in relation to our long-term targets, we are striving for better than average incremental margins.

Mike Halloran, Analyst

So a couple of questions just to make sure I understand the guide. First, on the Motion guidance, Luca, I think you said flattish to slightly positive overall, kind of global Stars type number. You guys typically have a level of outperformance that kind of puts you above what that mid-single-digit guide would look like. It seems like the rail commentary is at least directionally favorable. So is there what kind of sinks at all to get to the mid-single-digit guidance? Is it some negative price downs, kind of normal contract stuff? It doesn't seem like that's the case, but maybe just help us think everything together for me.

Luca Savi, CEO

Okay. So when you look at Motion Technologies that we have seen that the market will be, as I said, you said 0 to 2 points of growth worldwide. We tend to outperform the market on the OE side, absolutely correct. Now one thing that you need to take into consideration, if you look at the outperformance this year has been 400 basis points. As we continue to win market share and get higher market share, that outperformance cannot be in the 900 points, like it has been in the past. That is something to take into account. Then second, I would say, is the aftermarket. In the aftermarket, we see that Q1 probably we still suffer like we have seen at the end of 2022, and it will improve in the second half when it took probably the aftermarket. I would say that is everything that needs to be taken into consideration for Motion Technologies. The other aspect that you might want to think about is also the potential slowdown in the second half, particularly in Europe.

Mike Halloran, Analyst

And that's actually good rich to the next question. We've been pretty clear that there's some conservatism about in the second half of the year because you have concerns over the pace of global economic growth, which makes a ton of sense. If I think about those points of concerns, it's the European OE that you just mentioned, it's the shorter cycle IP pieces. Are there any other areas we should be thinking about? I mean, is this being reflected in how you're thinking about incremental margins as you move to the back half of the year? Is it being reflected in any of the other areas that you touch?

Luca Savi, CEO

You're referring to margins, and I understand your question is about our ongoing efforts with available opportunities. Pricing continues to be a significant factor overall, and we really need to enhance our approach, especially in IP and CTT. We are going through a lean transformation at Seneca Ford, which involves a complete redesign, as well as a lean transformation in the balance side of CCT. Additionally, we've previously discussed our make and buy strategy, which we are concentrating on. Specifically, in Seneca Force, the foundry closure, which we announced last year, is a process taking two years and will conclude by the end of 2023, alongside the in-sourcing of contacts on the connector side. All of these initiatives will contribute positively to our margins.

Emmanuel Caprais, CFO

Yes. And I would say also in 2023, in many regards, will be different from 2022. You have seen in 2022 that we had a ramp really in margin and in revenue also in the second half. This is not what we think is going to happen in 2023. We think that the first half of 2023 is going to be pretty strong in terms of EPS growth and similar in so many regards to Q3 and Q4. But we think that the global economy is going to significantly decelerate in the second half.

Joe Ritchie, Analyst

Not to pile on to the guidance questions, but maybe I'll just tackle this a little bit differently. In taking a look at the range, right, I don't think that we were surprised at all by the high end of the range, but the low end of the range came in a little lower than expected. Maybe one way to address this is what percentage of your business do you expect to see declines, not just decelerate but actually decline in the back half of the year? And are you already seeing that in your kind of like leading indicators? Are you seeing it in your business today? Or is it more around just an expectation on the broader economy?

Luca Savi, CEO

Okay. Let me say it is definitely an expectation on the broader economy, Joe, that's number one. But as you know, we have some short-cycle businesses in the portfolio. That means the industrial connectors; it means also the short cycle in IP. When you look at the short cycle in IP, even though we see still good numbers. When you look at OSAT, Q4 is still good for service and good for parts but we saw baseline actually declining. Now, service is growing, both because of price but also volume. Part is growing mainly because of price in Q4. So we start seeing some weaknesses there. When you look at the industrial connectors business, this, I would say, even though they are still growing year-over-year, which is good, if you look at the distribution in detail, you see that sequentially, the distribution orders have declined Q4 over Q3. So you start seeing these signs. Did I answer your question, Joe?

Joe Ritchie, Analyst

Yes, you did. I guess maybe just to kind of contextualize it, and we were talking about maybe about one-fourth of your business that you're seeing this potential weakness.

Emmanuel Caprais, CFO

So let me take you through the breakdown. In IP, we're probably talking about something like 40% of the business. It's probably around 30% of the business. This is industrial connectors. This is industrial components. And MT is mostly driven by auto.

Joe Ritchie, Analyst

Okay. All right. That's super helpful. And then my follow-on question is just around the IP margins. Clearly a great story over the last several years. I mean, even adjusting for the one-time items above 20% is pretty incredible. As the business starts to shift more into projects, what's your expectation for the margin trajectory of this business moving forward?

Luca Savi, CEO

The trajectory doesn't change, Joe. The trajectory for this business is up. We have been very, very rigorous, very disciplined; everybody understands in IP that the rigor and the discipline in pricing is fundamental for us to deliver the performance that we are delivering. Just to give you another data point, if we look at the backlog that we do have today, also the projects backlog is at a record high of profitability. Everybody understands it. We have the proper processes, and we are executing that way.

Damian Karas, Analyst

I want to start off asking you about the friction. I know you mentioned with respect to EV still targeting getting to that 30% global market share by 2026 and share gains continued to be expected this year. But there have been some headlines out recently about the global market leader in EVs losing some market share to some of the Chinese manufacturers. In general, it seems that the EV space is getting more competitive. I'm just curious to hear your thoughts on what it means for ITT friction, your market positioning, and profitability.

Luca Savi, CEO

That's a valid point, Damian. The competitive landscape is definitely evolving. The market is set to continue growing rapidly, and that hasn't changed. In terms of competition, we can still distinguish ourselves effectively. Our speed in addressing challenges is a key factor in our differentiation, and this advantage has served us well thus far and will continue to do so in the future. This is evident in the number of electric vehicle platforms we've secured in 2022, totaling 78 for the entire year.

Emmanuel Caprais, CFO

And Damian, I would say that the greatness of friction is that we play with everyone. Whether it is a Chinese electric vehicle or a more traditional OEM also continuing to develop ICE platforms, we made a point to apply the same focus and to defend our existing business and go after the competition. Even if there's a transition that changes a little bit or slows down, this does not impact our business.

Damian Karas, Analyst

Understood. And as it relates to capital deployment, it doesn’t seem like you’re planning for much buyback this year. Are you maybe expecting some acquisitions to hit, or why is that? If not on the deal front, would it possibly make sense to repurchase more shares or offset some of the higher interest expense? Really appreciate just any thoughts around that.

Emmanuel Caprais, CFO

Sure. As you mentioned, Damian, we are really focused on growing this business through M&A and adding complementary businesses to strengthen ITT. We mentioned several times that we have a very healthy pipeline. We’re going after great opportunities. When we travel around to see all these opportunities, it’s really refreshing to see that the team can relate immediately to the business opportunity or even the customers. We feel pretty good about our M&A activity in 2023. That’s why it’s going to take precedence above repurchases. If that doesn’t materialize for whatever reason, then we’ll continue to be aggressive in repurchases as we’ve been in 2022.

Joe Giordano, Analyst

I wanted to begin by discussing the cost expectations for 2023. While you're projecting lower inflation than in 2022, there is still some incremental inflation from a high baseline. Emmanuel mentioned chemicals and energy, and there's likely some labor costs involved as well. I'm interested in understanding the time lags associated with these costs, especially since prices for chemicals and energy are linked to oil and gas prices, which have declined significantly in the U.S. and are down about 85% from their peak in Europe, returning to levels from late 2021. I'm curious about your exposures in this regard and whether we can expect some relief in energy costs soon.

Emmanuel Caprais, CFO

No, we agree, Joe. For now, we are still experiencing high costs. It's important to remember that even if there is a significant decline in markets, such as energy or steel prices, there is a delay before we feel the effects. The first quarter aligns closely with what we saw in the latter half of 2022. We expect to see gradual benefits starting in the second quarter and continuing throughout the year. Much of the additional inflation you're noticing is due to chemicals and other raw materials. For example, the price of aromatic fiber has surged and shows no signs of decreasing. We will see the decline in commodities later in the year.

Joe Giordano, Analyst

Could you provide an update on MT, particularly regarding the margins? There's clearly significant potential for improvement compared to the past. How much of the current situation is tied to COVID-related expenses in China, specifically the need to keep personnel on site and the additional measures taken during lockdowns? If we return to a more normal state in China, living with the virus as we currently do here, how quickly could that improve your situation if some of those extra precautions were lifted?

Luca Savi, CEO

I would say that is a known issue, Joe. China has managed to handle those performance aspects, and the costs have been fully offset by productivity and volume. Not at all. That's the short answer.

Vlad Bystricky, Analyst

Maybe just following up on Joe's question there and I'll ask them in a different way. I think about the progression of MT profitability going forward. Can you talk about the path back to high teens margins in that business? Given what you know today, how you're thinking about the timeline to get back to those prior peak-ish ranges?

Luca Savi, CEO

When we think about MT, the long-term target we shared at Investor Day has not changed. MT can reach the operating margin long term; that is for sure. When we think in terms of timeline, just because of what has happened, they will probably get there a little bit later than CCT and IP. That 20% is achievable; we just have to get a little bit of this as they go through this make out of this NIC. But we have a clear visibility to get there.

Emmanuel Caprais, CFO

Yes. I would say, Vlad, that when you think about the past, obviously maintaining pricing is important for us, while commodities are slowly declining. Productivity has been a war machine in terms of productivity. We continue to count on that. When you think about the other businesses out of friction, they've also been quite impacted by commodities inflation businesses like Axtone and Wolverine as well. We are really driving the recovery in those businesses to help us get back to that 20% margin target. That, as Luca was saying, may not be around that 3-year horizon but more around the 5-year horizon.

Luca Savi, CEO

If you think about Axtone, 25% of Axtone business disappeared overnight, and that was a very good profitable Russia business. Despite all of that, Axtone was profitable in the mid-single digits. As you see now, they have to recover and rebuild with a different footprint and a different market.

Vlad Bystricky, Analyst

Maybe just as a follow-up. I wanted to ask you a little about Habonim; that business seems to be performing quite well versus your expectations. You highlighted how the business expanded IP's valves portfolio. Can you talk about your opportunity in VAVE and how you're thinking about the potential to continue expanding your presence there, either with Habonim or through incremental capital deployment in that end market?

Luca Savi, CEO

Thanks for your question, Vlad. That's spot on. VAVE is an area where we are investing and growing organically and inorganically. We have some very differentiated products with IP, with intellectual property that can be used in pharma and biopharma that happens with some key accounts. We keep on investing on that front. On an organic point of view, we have opportunities in the pipeline, so we will keep on investing also inorganically and leverage the Habonim acquisition to expand more with the Habonim happening products in North America. All of that is happening. There are some key markets where Habonim is strong. It might be cryogenic, pharma, hydrogen that we are penetrating more and more, in terms of investment, in terms of opportunity for the future, M&A, etc. When it comes to the results, it's been a great acquisition. It's been a very well-executed integration that was not so focused on the integration as much as value creation. If you think about the multiples related to today, they are between 8% and 9%. It was, as I said, a great deal and very well executed by Ilan and by Kasturi and the entire team.

Emmanuel Caprais, CFO

I would add to this that as we had previewed when we acquired Habonim, it is also helping that acquisition is also helping us see things differently in the way we manage our existing engineered VAVE business. We have been driving a lot of the margin up in that business, which has participated in the margin expansion story also of IP. I would say on that business, engineered valves, which was the legacy business of ITT, we are seeing significant opportunities from the biopharm standpoint. So also in that regard, Habonim as well as our existing business is expected to grow significantly in 2023.

Jeff Hammond, Analyst

I think you gave some good color on the segment guidance for 1Q, but I'm just wondering if you can rank order kind of confidence in the level of margin expansion for each of the segments or where you see the most and least.

Luca Savi, CEO

When I look at the three different businesses, they are facing a little bit of different challenges, Jeff. In terms of IP, we have a very good momentum there, and we are taking to the next level. We need to invest. We need to invest there and keep on investing in this business. But we need also to keep a very close eye because you have a short cycle business that is slowing and a long cycle with big projects that is really hard. So you really need to wait and decide properly where to invest. Good momentum, keep an eye on what is going on out there in the industrial. When you look at Motion Technologies, it is working like crazy on the operational efficiency while sticking on pricing and negotiate pricing as well as you can. There is still quite a lot of work to do, and it's quite difficult because you are dealing with automotive in a very difficult market scenario. When it comes to CCT, CCT has got plenty of opportunities due to the aerospace growth. What we experienced in CCT in Q4 was a challenge on the supply chain, which were higher than expected. If we look at Q4, probably we were not able to deliver roughly $10 million to $20 million of revenue just because of supply chain issues and labor shortages.

Emmanuel Caprais, CFO

So Jeff, in terms of margin trajectory, I think that if you think about IP and CCT, as Luca is mentioning, they are in a different dynamic than MT, where if you think about IT, we probably closed from a sustainable margin performance in IP at around 18% in 2022. We’re going to drive roughly 100 basis points higher in 2023 than that. CCT is also going to drive significant margin expansion, a little less than 100 basis points compared to the roughly 18% in 2022. Really good momentum there. In MT, we're clawing our way back into the high teens. You’re going to see a nice improvement, but still very much affected, as we mentioned, by material cost inflation that remains pretty big.

Jeff Hammond, Analyst

Okay. That's very good color. Maybe I guess, within MT and maybe broader, you talked about particularly, I think, aftermarket weakness in Europe in the front half, production slowdown in auto in the back half in Europe. Maybe just dial in a little more on how you're thinking about North America and China? More broadly, what's your expectation for the kind of rate of recovery here? We hear a lot of different things on China in general and just want to understand what's kind of built into your guidance.

Luca Savi, CEO

When we consider the market for 2023, we anticipate a growth of 0 to 2 percent, and we believe we will exceed that. In Europe, we estimate flat growth, while in China and North America, we expect low single-digit growth. That is our forecast, and we expect to do better than that. Regarding China, from an economic standpoint, I think it will perform well. In December, we faced challenges as 75 percent of our workforce contracted COVID, which was unprecedented. However, everyone has returned and is currently working. Overall, my outlook on China is quite positive.

Emmanuel Caprais, CFO

We anticipate achieving overall global outperformance in the market in 2023, which will be slightly higher than what we observed in 2022. We expect to outperform across all markets, with the most significant outperformance likely in China, followed by equal outperformance in both Europe and North America.

Bryan Blair, Analyst

I guess following up on the frictional outperformance question, it sounds like step up a little bit relative to the 400 basis point run rate; at least globally, that's certainly below the 900 that we've grown accustomed to over the years, but it makes sense given the share gain trajectory that you've been on for so long. If we think about the next few years, is mid-single-digit outgrowth the right place to kind of hang our hat and modeling friction OE? How should we think about that? By region, we've also gotten accustomed to strong outgrowth in China, really significant outperformance in North America, then more modest based on your elevated share in Europe.

Luca Savi, CEO

Spot on, Bryan. It would be different by geography; what you said is correct, probably lower in Europe and more in North America and in China. I would say even higher in China because also our performance in terms of award has been outstanding in 2022, thanks to our sales team over there. One positive tailwind that might be on top of that, on top of what we said is the EV. Our win rate in electrified platforms is much higher than our market share, which could feed a larger outperformance in the years to come. We don't see that yet because the start of production is going to be in the next 2 to 3 years, but with that materializing, that could be a tailwind to our lower outperformance.

Emmanuel Caprais, CFO

What we're seeing is that the hydrogen opportunity is definitely present, and we're expanding significantly in that market. Bone is gaining market share and taking it from competitors. From an order perspective, we’re seeing impressive numbers, clearly exceeding the expected model. From a revenue perspective, we're also noticing an improvement in margin across the board, including cash, with a notable reduction in working capital in the fourth quarter. The next opportunity we have with Abom is to really enhance productivity. They are still producing in batches, which limits their production capacity. We plan to implement lean practices to free up a lot of capacity, allowing us to support future growth without needing capital investments, just by reorganizing the line. We expect to see improved volume and margin as a result.

Operator, Operator

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.