ITT - Q1 2024

Transcript

Operator (participant)

Welcome to ITT's 2024 first quarter conference call. Today is Thursday, May 2nd, 2024. Today's call is being recorded and will be available for replay beginning at 12:00 P.M. Eastern Time. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star one one on your touch-tone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing star one one again. We ask that you please pick up your handset to allow optimal sound quality. It is now my pleasure to turn the floor over to Mark Macaluso, Vice President, Investor Relations and Global Communications. Please, you may begin.

Mark Macaluso (VP of Investor Relations and Global Communications)

Thank you, Victor, and good morning. Joining me this morning in Stamford 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 three-month period ending March 30, 2024, which we announced this morning. Before we begin, please refer to slide two 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 several risks and uncertainties, including those described in our 2023 annual report on Form 10-K and other recent SEC filings. Except where otherwise noted, the first quarter results we present this morning will be compared to the first quarter of 2023 and include certain 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. With that, it's now my pleasure to turn the call over to Luca, who will begin on slide three.

Luca Savi (CEO and President)

Thank you, Mark, and good morning. ITT had a very good and active start to the year. We grew revenue, margin, and EPS above expectations, closed the Svanehøj acquisition, invested to sustain our differentiation, and continued to gain share with new profitable awards. We also reached an important milestone on our multi-year safety journey. Because of our unrelenting focus on safety, we delivered a 40% year-over-year reduction in recordable incidents, leading to an injury frequency rate of 0.5, approaching best-in-class performance. Our plants are safer and more efficient every day. So for the results you delivered and for your focus on safety, I want to thank all ITTers. A heartfelt thank you. Now, on to the results. In Q1, we built on 2023 momentum in orders, revenue, margin, and EPS, and all of our businesses contributed to this performance.

Here are the highlights: 7% organic orders growth or 13% in total. Nearly $1 billion in orders, leading to a book-to-bill of 1.07. 9% organic revenue growth or 14% total, surpassing $900 million of sales in a quarter for the very first time. 120 basis points of adjusted operating margin expansion to 17%, with all businesses making significant progress on our long-term targets. Although we no longer report total segment margin, on that basis, we would be just 100 basis points shy of our 2026 long-term target. As a result of all of this, we drove over 20% adjusted EPS growth to another new level of earnings for ITT. Now, the details. On orders, CCT led the way with 23% growth, fueled by record aerospace orders and recovering demand in connectors.

The connectors performance was encouraging after the business managed through a year of distributor destocking. MT grew 11% with strong growth in rail. Friction also won 47 new hybrid and electric vehicle awards with Tesla, Xiaomi, Geely, and Mercedes, among others. IP's short-cycle business grew 9% sequentially, while winning nearly $70 million of project awards, leading to a book-to-bill of 1.06. On revenue, all three segments deliver strong revenue growth, driven by 8 percentage points of volume. This was led by Industrial Process, which drove 64% growth in profitable pump projects. MT delivered 8% growth, led by strong Friction OE outperformance and double-digit growth in rail, while we continue to see a recovery in the Friction aftermarket. Finally, CCT grew 7%, with 13% growth in aerospace and defense.

We have seen a multi-quarter ramp in defense that we expect will continue throughout 2024 and beyond. We are driving profitable growth, resulting in a 23% increase in operating income, nearly 2.5x our organic revenue growth rate. Looking at margin by segment, MT surpassed 18% margin in Q1 after improving sequentially every quarter in 2023, highlighted by KONI, which drove margin above the MT segment average. Well done, Jeroen and KONI China. CCT also delivered more than 18% margin, driven in part by pricing. Our new CCT president, Michael Guhde, is already hard at work leveraging his operational experience from Parker Hannifin and ITW to drive CCT towards its 22% margin target. Finally, on a like-for-like basis, IP's margin was up 140 basis points, even as the mix of revenues shift to projects....

Including acquisitions, IP was still above 20%. Because of this performance, we are raising the low end of our EPS guidance by $0.20, or $0.10 at the midpoint, to a new range of $5.65-$5.90. We now expect EPS growth of 11% at the midpoint, above our long-term target, and given the strong top-line performance and momentum in orders, we are raising our organic growth guidance to 6% at the midpoint, with a 20 basis points increase in our margin outlook as well. Our teams delivered this performance while investing in the businesses. These investments will continue to drive strong returns for our shareholders, and I was fortunate to see some of this firsthand last quarter. In India and Saudi, I saw the investments that IP is making to expand testing capacity and capabilities.

Khaled and the Saudi team will be able to test larger pump packages, sustaining our ability to gain share in the Middle East. Similarly, in India, Lalit and team are installing nearly four times their current power capacity to shorten lead times to customers and improve testing availability. As we expand our in-region for regional strategy, IP expects to continue to gain share in these growing markets. We are also investing in our capabilities to execute decarbonization projects. At our Bornemann site in Germany, we are upgrading our testing facility to replicate field conditions on large pump packages. ITT will be one of few companies in the world with this capability. We're also making progress penetrating the high-performance brake pad segment.

We expect the new production lines in Termoli, Italy, to be up and running later this year as part of our EUR 50 million investment for plant expansion and upgraded R&D capabilities. Notably, the Friction team has already won low-emission brake platform awards on high-performance vehicles even before the facility construction is complete. In addition, the team secured approval for over $20 million of government incentives in Europe, which will significantly reduce our cash outlay for the facility expansion. And again, in Friction in China, working closely with local OEMs, we drove 38% growth in Friction OE, a substantial outperformance in the largest automotive market in the world. Well done, Friction team. And finally, on innovation, the embedded motor drive, or EMD, is delivering continued positive results in customer field trials.

On average, EMD delivers energy savings of over 50% compared to a standard motor and significant CO2 emissions reduction. We expect to start product commercialization in 2025, and we share more with you on EMD in the coming quarters. All of these investments will sustain ITT's differentiation over the long term through profitable growth. A significant proportion of that growth will come from the nearly $1 billion of orders we booked this quarter. Let me tell you more about this on slide four. Building on our 2023 momentum, we grew orders 13% in total and 16% sequentially, with strong performances in all businesses. We are focused on growing and growing profitably. This means we look at each opportunity with a strategic lens and an opportunity level of selectivity.

Here are a few examples: By leveraging our proprietary EnviZion valves technology, IP engineered valves won an award of more than $20 million to support the production of a groundbreaking weight loss drug. This strategic award reinforces our partnership with this leading global pharmaceutical company. We're also winning on green orders, not just in IP with large decarbonization projects, but also in Friction with awards with hybrid electric vehicles and in CCT with battery connectors. With this and other awards, green applications now represent approximately 16% of ITT's revenue annually. Moving forward, this will be bolstered by Svanehøj, with its exposure to low carbon and green fuel applications as part of the clean energy transition. This quarter, Søren and team grew orders by more than 30% year-over-year, and we expect this will help deliver double-digit revenue growth for the next several years.

Moving to CCT, we are seeing good orders momentum in connectors distribution, especially in North America. While this is encouraging, we don't expect full recovery in connectors until the second half of the year. Additionally, aerospace and defense components recorded its highest orders quarter ever. And finally, in IP, orders were up 37%. As you can see, ITT's growth is accelerating, with organic orders growth of 7%. And with a strong performance from Svanehøj, we grew orders 13% in total. Our Q1 performance demonstrated once again that ITT is well positioned to grow profitably. Now, let me turn the call over to Emmanuel on slide five.

Emmanuel Caprais (CFO)

Thank you, Luca, and good morning. Beginning with revenue, we generated 9% organic sales growth with all segments contributing. Volume drove most of the growth this quarter. IP projects were up 64%. CCT aerospace and defense components were up 21%, and Friction OE was up 12% with an outperformance well above the historical 800 basis point average.... Svanehøj added 5%, 5 points to the total revenue growth, and I also want to reemphasize that its orders were up over 30% compared to the prior. On profitability, margin expansion was primarily driven by MT, which grew more than 300 basis points to surpass 18% faster than we anticipated. Excluding M&A, IP's margin was up 140 basis points. This was driven in part by over 200 basis points of margin expansion on projects as we continue to improve execution.

Collectively, our businesses drove 60 basis points of productivity, which more than offset 40 basis points of strategic investments related to new Friction product formulations and product redesigns in IP and CCT. On earnings, adjusted EPS growth of 21% was driven by volume, price, and productivity. In addition, we absorbed higher interest expense and a slightly higher effective tax rate. Finally, on cash, after generating $430 million for all of 2023, this quarter we grew our free cash flow by 2% versus prior year, driven by increased profit. We continue to see significant opportunities for stronger cash generation as inventory and AR improve. All in, a strong start to 2024 that gives us confidence in delivering the midpoint of our new EPS outlook. Let's move to slide six to review the EPS bridge for Q1.

Adjusted EPS grew 21% for the quarter to a record $1.42. Strong volume growth and higher price drove $0.23 of operating leverage, while net productivity contributed another $0.05. The investments Luca described earlier had an impact of $0.03 this quarter. Included in the net M&A bar is roughly $7 million of intangible amortization coming from both Svanehøj and Micro-Mode. Of the $7 million, approximately $4 million is related to amortization of backlog that will be recognized over the next 12-18 months and then tail off. Once we finalize the purchase price allocation for Svanehøj, we will provide more color. Wrapping up the bridge, interest on the term loan and commercial paper drove a $0.03 headwind this quarter. As cash generation picks up, we anticipate paying down our outstanding debt further.

Let's turn to slide seven to discuss our 2024 guidance. Today, we are raising our guidance for organic revenue, operating margin, and EPS, given our strong first quarter performance. To begin, we are increasing the midpoint of our organic revenue guide to approximately 6% due to Friction performance, improvement in connector orders, and the backlog we accumulated at the end of Q1, which is up 11% organically year-over-year. On operating margin, we expect 17.4% at the midpoint. Both MT and CCT eclipsed 18% this quarter, and IP is driving higher margin in the core business, mitigating M&A dilution. The higher revenue growth and operating margin is expected to drive adjusted EPS growth of 11% at the midpoint, $0.10 improvement from the previous guide.

Before I move on, I also wanted to provide some color on what to expect in the second quarter. Organic revenue should grow in the mid-single digits, led by CCT and MT, while IP will navigate a tough prior year compare on revenue and orders growth. We expect total margin expansion of 50-80 basis points, which will drive EPS growth in the high single-digit range compared to the prior year. Let's turn to slide eight to discuss capital allocation. Let me start by saying that we will always invest organically, given the proven returns and organic growth we can generate. And now we're intensifying our focus on M&A. We expect this will be a significant value creation driver for ITT, and so we thought it would be beneficial to shed more light on our capital deployment framework.

In M&A, our primary targets are close to core acquisitions in flow and connectors. We focus on companies with leading market positions, that manufacture highly engineered components and have strong management teams. These targets may also present margin expansion potential, but the deal rationale always starts with a strategic fit. We have significant dry powder, and we intend to effectively deploy capital in order to strengthen further our existing businesses. Along with acquisitions, we also regularly review our portfolio to ensure the businesses that we own align to our longer-term strategy. After M&A, we focus on returning capital to shareholders through dividends and share repurchases. If we don't find the right targets for M&A, we intend to ramp up the pace of share buybacks, allowing shareholders to benefit from ITT's strong financial position and our $1 billion share repurchase program.

... With that, let me turn the call back to Luca.

Luca Savi (CEO and President)

Thank you, Emmanuel. Before I wrap up, I want to reemphasize a few points Emmanuel made on M&A. Historically, we created value through growing organically and expanding our margins. And while this will continue, now we also expect to drive further value inorganically as we continue to build the M&A muscle. In the past few years, we added experienced deal makers to our leadership team and strengthened our M&A teams in the business. As a result, we have stronger capabilities, and our success in this area is growing, as evidenced by the three acquisitions in the last two years. Among these was Habonit, which expanded our Valves business by more than 50%, generated more than 100% cash conversion in 2023, and exceeded our expectations in all metrics, adding $0.08 of EPS in year one.

And while it's too early for Svanehøj, the initial signs are encouraging. We continue investing in our capabilities and expect to accelerate the pace of M&A in a disciplined manner. And as Emmanuel said, it all starts with a strategic fit. Now, let me wrap up with a few points before Q&A. Q1 was another milestone quarter for ITT, and as a result, we raised our sales, margin, and EPS guidance. Our businesses are outperforming their end markets, be it energy, transportation, or air and defense, generating nearly $1 billion of orders and a book-to-bill above one, leading to a record $1.5 billion backlog. We have many opportunities still to create value organically, and with our strong financial position, we are working to compound this growth with enhanced M&A performance. As always, it has been a pleasure speaking with you today. Thank you for joining.

Victor, please open the line for Q&A.

Operator (participant)

Thank you. The floor is now open for questions at this time. If you have a question or comment, please press star one one on your touch-tone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing star one one. Again, we do ask that while you pose your question, you pick up your handset to provide optimal sound quality. Please limit your questions to one question and one follow-up. One moment for our first question. Our first question will come from the line of Joe Giordano from TD Cowen. Your line is open.

Joe Giordano (Managing Director)

Hey, good morning, guys.

Luca Savi (CEO and President)

Hi, Joe.

Emmanuel Caprais (CFO)

Hey, Joe.

Joe Giordano (Managing Director)

Hey, so on MT, I mean, the margins there were really good. I'm guessing, like, higher than maybe you thought in the 1Q. I see in the slides you're talking about full year kind of being roughly similar for- than you did in 1Q. Can you kind of just frame that with, you know, you got new platforms ramping, and you have, you know, where are you with price? Like, how much of that full-year guide, it feels kind of conservative in light of what you've put up in the 1Q. So maybe just walk us through the puts and takes there.

Luca Savi (CEO and President)

Sure. Thank you, Joe. So, first of all, we are very happy with the performance that MT put in, in Q1, more than 80%. Now, I think that we are working on consolidating this, for the full year, Joe. Now, when it comes to the dynamic of the price cost, as you can see, the price cost in for the full year will be roughly neutral, when it comes to Motion Technologies, and will be roughly neutral for ITT as well. Of course, there are a lot of programs that what we won, and therefore there is a lot of SOP and a lot of process validation that are happening in the line. And while this will help in the future, sometimes it's also impacting the efficiency in the line.

Joe Giordano (Managing Director)

Perfect. And can you maybe on, on CCT, on connectors specifically, just the -- what's going on here with you guys on the order side? It just seems very different than what we're seeing at others. I mean, you know, it goes end market, or end market by end market, but generally, one of the only markets we see doing well right now are aerospace and connectors and, like, IT with, you know, with, with data centers. So where are you seeing this kind of strength, and how kind of company specific is this to, to ITT?

Luca Savi (CEO and President)

Sure. Thanks, Joe. When it comes to the orders of CCT, they were at the record high, and specifically on the connectors, at roughly $122 million total, they were a record high as well. The growth there were aero, for sure, was up, defense was up, but also industrial orders were up. The only orders where we saw some declines were actually in the EV connectors. Now, if you want to look at also another dimension of the connectors between the OEMs and distribution, we had good growth both on the OEM side and on the distribution side. This was probably the highest order on record for connectors that we had. Having said that, it's just one quarter.

Joe Giordano (Managing Director)

Great. Great to see you. Thanks, guys.

Luca Savi (CEO and President)

Thanks, Joe.

Operator (participant)

One moment for our next question. Our next question will come from the line of Jeff Hammond from KeyBanc Capital. Your line is open.

Jeff Hammond (Managing Director)

Hey, good morning, guys.

Luca Savi (CEO and President)

Morning, Jeff.

Jeff Hammond (Managing Director)

So yeah, I want to stay with the orders. So, you know, clearly impressive orders on MT. I'm just wondering, a little more color in terms of what's inflecting there and, you know, how much is just, you know, the aftermarket kind of, you know, through the destock and growth. And then just on CCT, any, you know, lumpiness in any of that orders, you know, particularly on the aero side? I know that can change quarter to quarter.

Luca Savi (CEO and President)

... I would say when you look at the orders picture, Jeff, Q1 orders are definitely one of the highlights of the quarter. For total ITT, a record, almost $1 billion. And when you look at each value center, it's a good picture in each and every one, and in the business in there. In Motion Technologies, don't forget about rail. Rail is a good market right now, and then the business is outperforming tremendously, both in Europe and in China. The Friction awards, I mean, those 47 awards are also in EV and a hybrid. We are already, in terms of the awards, at more than 40% of the total full-year target, and we don't tend to give easy target, Jeff.

On CCT, the highest, you know, orders on record when it comes to distribution connectors, the highest on the components, obviously pushed from the defense. When you're talking about Aero, and for sure there are news out there in terms of some of the production coming down, we are keeping an eye on the production rate of some of our customers. So far, talking to our customers, things have not changed, but we're keeping an eye. Last on IP, the short cycle performed very well as well, with a 1% growth year-over-year and 9% growth sequentially. So overall, a very good picture on orders.

Jeff Hammond (Managing Director)

Okay, great. And then, appreciate the slide on, you know, capital allocation. Just wondering, you know, as we look a year or two out, what you think the kinda optimal balance sheet leverage is, and, you know, do you think you have, you know, a pipeline that can, can support getting there over a couple of year period?

Emmanuel Caprais (CFO)

Yeah, Jeff. So, definitely, we're very happy with the health of our balance sheet. We have almost no debt. We have worked really hard to make it the way it is today. When you think about the prospects from an M&A standpoint, clearly, you know, as I discussed, we created a lot of value organically, both from a top line and a margin standpoint, thanks to those organic investments. In fact, if you look at our margin expansion, it was 350 basis points since 2019. And obviously, we will continue with that. But as I said, you know, we're accelerating on M&A. Luca had mentioned that we've been building the muscle on M&A.

We have built a talented and experienced team. We have a clear and effective strategy. And so as a result, we've been able to really build a rich and actionable pipeline of targets. We have today a pipeline of like serious targets of more than 10. The average revenue size of each company is around $200 million-$250 million. And I think our goal internally, obviously, doing it in a disciplined manner, as Luca mentioned, is to try to deploy roughly $500 million-$700 million on average each year to really grow ITT inorganically. Our targets are still flow and connectors. That hasn't changed.

So we're patiently building our execution on M&A.

Jeff Hammond (Managing Director)

Okay, perfect. Thanks, guys.

Emmanuel Caprais (CFO)

Thanks, Jeff.

Luca Savi (CEO and President)

Thank you.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Mike Halloran from Baird. Your line is open.

Mike Halloran (Senior Research Analyst)

Hey, good morning, everyone.

Emmanuel Caprais (CFO)

Hi, Mike.

Mike Halloran (Senior Research Analyst)

So, a couple here. You know, following up on the order side, MT specifically, maybe just talk about the auto piece and how you're thinking about production on a full year basis and just inventory levels in the channel.

Luca Savi (CEO and President)

Sure. Thanks, Mike. So when you look at the, at the quarter, the quarter worldwide was declining roughly 0.8%. And it was a little bit different than what expected. In terms of Europe, was much weaker. Europe was down 2.5%, whereas China was surprisingly up more than 4%. And I'm talking about car production here, of course.

Mike Halloran (Senior Research Analyst)

Mm-hmm.

Luca Savi (CEO and President)

North America was up a low single digits. So when we look at the full year, Mike, we're expecting Europe to be down, low single digits. We expect China, actually, the projection on China is better than at the beginning of the year. We expect it to be up low single digits, whereas North America, up low single digits as well. Overall, the production for 2024, we expect roughly around 90 million vehicles. On all of this, as you know, we outperformed, and the outperformance was amazing in Q1, granted it's a quarter. And I want to mention two data point. One is China, that despite the market growing 4.4, I mean, our business grows 38%, an outstanding performance there.

Europe, even though the market declined, the business not only outperformed, but was able to grow year-over-year. So an exceptional performance from the Friction team.

Mike Halloran (Senior Research Analyst)

Appreciate that. And then on the IP side of things, maybe just talk about underlying dynamics there, specifically two areas. One, what you're seeing on the short cycle chemical side of the business, general industrial side of the business, any trend changes either way there, as well as how Svanehøj is doing as far as the organic business goes and kind of the momentum you're seeing there?

Luca Savi (CEO and President)

... Sure. Let me talk about the short cycle, maybe the market. I leave it for Emmanuel. When you look at the short cycle orders, as I said, they were up 1% year-over-year, and that was mainly thanks to valves and service. When you look at sequentially, they were up 9%, and that 9% is mainly only volume. And all the components of the short cycle in the quarter were up sequentially, baseline, parts, service, and valves, and all of that is really volume. If you look at that short cycle orders, is probably the second highest ever when we look at the millions of dollars that we recorded per week.

Now, when it comes to market, I would say that, yeah, I would say that, you know, we see some, you know, weakness probably on the chemical side, but the general industrial was strong. Now, on the geographical basis, I would say the strength is mainly in North America.

Emmanuel Caprais (CFO)

Yeah. And I would just add, even with when we look at our funnel, a lot of activity coming from the Middle East, really strong oil and gas, chemical, mining prospects for orders. So very healthy market for the moment for IP. And you see it in the book-to-bill. Our book-to-bill was 1.06. I think, Mike, you had also a question on Svanehøj. And so just to give you a little bit of update on this. So we closed Q1 in line with expectations both on sales and income. And as Luca mentioned, on top of that, we had really strong orders. They registered 30% growth on orders.

And so when you think about the strategic fit, that continues to, they continue to ring, to ring true. They're a market leader, they're an, a very, very active player in energy transition, and we continue to see that they, they continue to build long-term backlog, so we're booking orders well into 2025 now. The integration also is progressing really well. So all this is reinforcing our, our strategic rationale. And then finally, I would say, they already started generating cash, which, which is always good.

Mike Halloran (Senior Research Analyst)

Great. Really appreciate it, everyone. Thank you.

Emmanuel Caprais (CFO)

Thanks, Mike.

Luca Savi (CEO and President)

Thanks, Mike.

Operator (participant)

Thank you. One moment for our next question. Our next question will come from the line of Scott Davis, from Melius Research. Your line is open.

Emmanuel Caprais (CFO)

Morning, Scott.

Scott Davis (Chairman and CEO)

Hey, good morning, guys.

Emmanuel Caprais (CFO)

Hi, Scott.

Scott Davis (Chairman and CEO)

Congrats, congrats on the start to the year. It's been, it's been fun to watch you guys, kick some tail the last few years. So anyways,

Emmanuel Caprais (CFO)

Thanks.

Scott Davis (Chairman and CEO)

You've been very generous on the M&A commentary, but I'm just kind of curious, you know, we've been talking about flow in particular, consolidating for, you know, two decades now, and there hasn't been a lot of consolidation. What has been the main barrier to perhaps maybe some of the transactions not occurring already? Is it more just a function of timing? Is it price? Is it that a lot of these things are niche assets, and there just hasn't been much of an appetite? I'm just kind of curious, more big picture than anything else, Luca, in your years of working in this, why we haven't seen more consolidation already?

Luca Savi (CEO and President)

Yeah, sure. I think that, you know, it's a good question. I'm not so sure I do have the question, the answer, Scott. It's indeed a very fragmented market. There are plenty of opportunities. I think probably, sometimes these people tend to play in the courtyard that they know, and therefore they've, you know, they haven't made the proper acquisition. But there is also a lot of things to do in cleaning your house, in putting your house in order first. So I think that when I look at many companies in flow, probably the performance is not up to what it's supposed to be before starting M&A.

If you're asking me, for example, Scott, five years ago, it would have been very difficult to be, you know, bullish on acquisition in IP. It's a different story now.

Scott Davis (Chairman and CEO)

Okay. That's helpful. And guys, just to clean up item, are rail margins higher than auto, or are they pretty similar?

Emmanuel Caprais (CFO)

So, when you look at KONI business, rail margins are clearly on par, a little higher than our Friction business. And then when you look at Axtone, Axtone is in the low teens. And the reason for this is because we're still driving pricing to offset the cost inflation, and the cost inflation has been really taking longer than expected, because we had such a long backlog. So we have good line of sight to bring Axtone to the mid to high teens this year. But I would say rail margins, especially in KONI, are trending really well.

Scott Davis (Chairman and CEO)

Okay. Best of luck this year, guys. Thank you.

Emmanuel Caprais (CFO)

Thank you, Scott.

Luca Savi (CEO and President)

Thank you.

Operator (participant)

Thank you. One moment for our next question. And our next question will come from the line of Joe Ritchie from Goldman Sachs. Your line is open.

Emmanuel Caprais (CFO)

Morning, Joe.

Joe Ritchie (Managing Director)

Thanks. Hey, good morning, guys. Great start to the year.

Emmanuel Caprais (CFO)

Hi, Joe.

Joe Ritchie (Managing Director)

Let's just maybe focusing the first question on IP. So the projects business, you know, up 64%, but you still saw, you know, margins north of 20%. That's pretty incredible, just given historically what the mix has been on that business or what the margins have been on that business. Can you just kinda mark-to-market the margins that you're seeing on the project business? And then if there's an update that you can give us on the foundry closure that occurred last year and whether you're starting to reap those benefits as well.

Luca Savi (CEO and President)

Sure. Well, well spotted, Joe. I think that, you know, despite the big headwinds of mix, the margin improved more than 140 basis points on an organic basis, on a like-for-like. And the, the reason is really the result of the selectivity that we had in other acquisition and the good project, execution and the rigor that we have. Just, and, we expect this to continue, Joe. I think that we are not done here. So just to give you an example, the backlog that today we have in our project business is very healthy margin, and on a year-over-year basis is up 300 basis points. So this will continue the improvement of margin in IP on an organic basis. That is for, for the project. And that rigor continue both in acquisition as well as in execution.

Now, when you think about the foundry, the foundry is closed. So, we've been able to close it successfully. We now have been able to reduce our headcount in Seneca Falls because of the closing of the foundry, improve our safety performance, and also improve the quality of the castings that today we are getting, either from low-cost region or also from North America and Mexico. So it has gone well and completed.

Joe Ritchie (Managing Director)

That's super, super helpful and great to hear. Then I guess maybe just continuing on the margin front, I know there was a question earlier on Motion Tech and, you know, obviously the strong incremental margins this quarter. Just help us kinda understand maybe the trajectory of the margins from here. You know, do we move higher off of the, you know, 18.2% number? And, what does that look like for the rest of the year?

Emmanuel Caprais (CFO)

Yeah, thanks, Joe. So you're right. Incrementals were super strong in Motion Technologies, over 60% in the first quarter. We expect a similar number for the rest of the year as well. So we're very excited with the performance. There was a lot of work that was done from a pricing standpoint, from managing the commodity cost as well, and trying to book in advance steel prices, for instance, and taking advantage of the reduction that we've been seeing towards the end of last year and at the beginning of this year.

If you think about from a margin standpoint, I think we can confidently say that we expect Motion Tech to improve sequentially its margin quarter after quarter, but I would say remain still within that 18%-18% range, right, for the full year. So as Luca say, we-- as Luca said, we're gonna work on sustaining that higher level of margin. You know, this is a business that not very long ago was much lower than this. And what we wanna do is to make sure that we're able to deliver on a consistent basis, a higher level of profitability.

Joe Ritchie (Managing Director)

Great, guys. Thank you.

Emmanuel Caprais (CFO)

Thanks, Joe.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Damian Karas from UBS. Your line is open.

Damian Karas (Senior Equity Research Analyst)

Hey, good morning, guys.

Emmanuel Caprais (CFO)

Hi, Damian.

Luca Savi (CEO and President)

Damian.

Damian Karas (Senior Equity Research Analyst)

Apologies, I'm joining the call a little bit late here, so sorry if I'm rehashing anything you've already discussed, but thought maybe you could just give us a little bit of a, you know, walk across the globe for your auto business. You know, any updates on kinda how you're feeling about the, you know, the OE side, in each region, as well as European aftermarket?

Luca Savi (CEO and President)

Maybe I'll start with the European aftermarket, Emmanuel. So when you look at the, at the market, Damian, the market was down in the Q1. I'm talking about production, roughly 0.8%. We expect the market to be flat for the full year, overall, at 90 million vehicles produced. Was a little bit a different picture from the beginning, what we expect at the beginning. In terms of Europe was worse, was down 2.5% in Q1, and we are expecting Europe to be down low single digits in for the full year. China, which was expected to be flat, was actually up 4.4, which tells you something about the resilience of the market, and we expect to be up for the full year, low single digits. So this is the great news.

And then North America was up low single digits, and it will be up low single digits also for the full year. In each and every one of these region, we outperform quite well. Europe, despite the decline of the market, we actually grew. And China, we grew 38%, so an incredible outperformance. We won an incredible number of of awards already in Q1, and when it comes to the aftermarket, Emmanuel?

Emmanuel Caprais (CFO)

So on the aftermarket, we continue to see a little bit the same pattern we saw in Q4, where we are showing increased revenue for aftermarket. So revenue growth in Q1 versus prior year. Modest +3% for our Friction business. But we continue to monitor really closely. We think that we're done with destocking, and we continue to monitor the end and end customer demand.

Damian Karas (Senior Equity Research Analyst)

... That's very helpful. Thank you. And then the Svanehøj orders up 30%, really stood out. Would you say that Svanehøj is outperforming your expectations since you acquired the company? And maybe if you could just, you know, any color that you can share on that part of the business would be appreciated.

Emmanuel Caprais (CFO)

Sure. So keep in mind, Damian, that we said that for the next five years, this company should be able to deliver a low double-digit in terms of revenue growth. So obviously, that implies significant growth from an order standpoint, especially because this is a long-term business, so there's a lot of long-term backlog. That being said, we weren't expecting as much as 30% year-over-year order growth for Q1. So it's only one quarter, so we take it for what it is, but we're very happy. I think it really demonstrates the leadership that they have. I think then, from a financial standpoint, you know, Luca mentioned that it was really a good business.

Really delivered revenue and income in line with our expectations. Cash, as I mentioned, was very positive. So if you think about it, this is a roughly 20% currently, or 20% EBITDA business. They delivered that in Q1, and we expect that they will deliver that for the full year as well. So yeah, a lot, a lot of really good positive things, but it's just the beginning.

Damian Karas (Senior Equity Research Analyst)

Thanks, guys. Keep up the good work.

Emmanuel Caprais (CFO)

Thank you.

Luca Savi (CEO and President)

Thanks, Damian.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Vlad Bystricky from Citigroup. Your line is open.

Emmanuel Caprais (CFO)

Morning, Vlad.

Vlad Bystricky (Equity Research Analyst)

Hey, good morning, guys. Thanks for taking my call. So I wanted to ask you guys about the rail strength that you're seeing. You know, obviously, 37% rail orders growth in 1Q is quite strong. So can you talk about you know, the duration or expected timing of delivery of these orders, and then also how you're thinking about you know, potential lumpiness in rail orders going forward, and whether you think you can sustain double-digit growth in orders in rail through the year?

Emmanuel Caprais (CFO)

So, let's put some context around this. So, as you know, there is massive government programs on rail in all three main regions where we are. In Europe, we're around $60 billion of direct investment in improving rail, both in infrastructure and in cars. In the U.S., I think this number is around $50 billion. And in China, because ridership is back to pre-pandemic level, we know that the government is continuously investing as well. So we have a very favorable backdrop for our rail business, and we're seeing the early signs or the benefits of those government programs being executed. On top of that, we're gaining a lot of market share.

So if you think about China, for instance, we are clearly the leader in high-speed train, and there's a lot of investment that is happening right now, for that, for that market. So, so that's the context, you know, strong market, strong demand, and then, the outperformance. I think if you think about the way our rail business works, is that we usually book orders that will deliver between 6-12 months later. So right now we're continuously booking backlog that we will deliver in at the end of 2024, and then also at the beginning of 2025.

Luca Savi (CEO and President)

If I can add to that, when you think about the visit, we like this market because 60% of this market in rail is aftermarket, Vlad, and on top of that, you have an incredible amount of visibility. Some of the awards that we're winning are gonna last for the next 30-40 years. So it's a, it's a very good business to be in.

Vlad Bystricky (Equity Research Analyst)

That's really helpful color, and clearly an exciting time for your rail business. Just separately on the capital allocation topic, that was a helpful slide. And you had mentioned on there that you regularly review the portfolio as well. So can you talk about, you know, whether we should be thinking about, you know, potential for any meaningful divestitures over time, or just how you're thinking about the go-forward portfolio from here?

Luca Savi (CEO and President)

Sure. This is, this is something that we do on a regular basis, you know, Vlad. In terms of this is also what we started doing last year, right? When we were able to, to sell the [Inanco] business and the Matrix, the [Inanco] business in the first half of last year, and Matrix by the end of the year. So this is something that we have been doing more and more since Bart came on board. We made our strategy crisp and, and very focused. We looked at the long term, and therefore we are reassessing, we are assessing that.

So I say, as we are adding more and more businesses through M&A in terms of, you know, leaders in their market, close to core, critical components, technology and proprietary technology, it might well be that some other pieces of the business, we are not the rightful owner anymore, and that probably there will be underperforming parts of the business, I would say.

Vlad Bystricky (Equity Research Analyst)

... Okay, that makes sense. Appreciate it. Look, I'll get back in the queue.

Luca Savi (CEO and President)

Thanks, Vlad.

Operator (participant)

Thank you. One moment for our next question. Our last question will come from Andrew Obin from Bank of America. Your line is open.

Sabrina Abrams (Research Analyst)

Hey, good morning. You have Sabrina Abrams on for Andrew.

Emmanuel Caprais (CFO)

Morning, Sabrina.

Luca Savi (CEO and President)

Morning, Sabrina.

Sabrina Abrams (Research Analyst)

When we think about the margin cadence through the year, how should we think about the balance between productivity and reinvestment? And I think you have more capacity coming online. You have the Termoli plant. Should we think that reinvestment ramps sequentially through the year?

Emmanuel Caprais (CFO)

Yeah. So, thank you for the question. For us, productivity is one of the drivers that allows us to really drive reinvesting in the business. And that has been the story of a lot of our businesses. You know, KONI was an underperforming asset. We drove operational improvement, and so we reinvested in modernizing the factories, invested in R&D. Same thing for IP. If you think about the VAVE, the VAVE activity initiatives that we drove, those were possible because we started increasing profit tremendously. So when you think about this year, we expect to continue to drive productivity significantly through our businesses. In Q1, productivity gave us 60 basis points of margin expansion, and we expect to continue to be able to do that.

In terms of investment, the contribution or let's say, the impact on the margin of investment this quarter was around 40 basis points, and we expect also to be along those lines for the rest of the year. So, we are driving productivity, we're driving pricing to offset material impact, and reinvest some of that to make sure that we gonna be able to drive long-term profitable growth.

Sabrina Abrams (Research Analyst)

Thank you. And then question on China and Friction OE, the share gains are really impressive, and the outgrowth is really impressive. What is ITT doing that's driving such strong performance in this particular region, and what sort of visibility do you have in this market, you know, relative to Europe and the U.S.?

Luca Savi (CEO and President)

Thanks, Sabrina, for asking this question. You know, we got a special eye on China. Our China business is performing incredibly well. And when you look at our China business, roughly $350 million is 90% is Motion Technologies, which is made of rail and auto. So don't forget about rail, because rail is big in China, it's a big market, it's growing, and we are outperforming that market. When it comes to auto, listen, the team has been performing exceptionally well. Flawless execution. You have in Q1 an on-time delivery in China of 100%, quality less than one PPM. If you look in Q1, they had 50 starts of production. So 50 new programs started production in Q1. Now, not all of those were successful, but think about that, one more than 100 process validations, which are future SOP.

So when you look at all of this, think about the disruption that you have in the line, and despite all of that, the OEE, the overall efficiency of the lines is more than 90% and OTD of 100. If you're a customer and you have a company that's performing like this for you, you tend to be loyal, and this is what we see.

Sabrina Abrams (Research Analyst)

Thank you.

Luca Savi (CEO and President)

Thank you, Sabrina.

Operator (participant)

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