ITT - Q3 2024

Transcript

Operator (participant)

Welcome to ITT's 2024 Third Quarter Conference Call. Today is Tuesday, October 29th, 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 11 on your touch-tone phone. If at any point your question has been answered, you may remove yourself from the queue by hitting star 11. 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. You may begin.

Mark Macaluso (VP of Investor Relations and Global Communications)

Thank you, Gigi, 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 September 28th, 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 for otherwise noted, the third quarter results that we present this morning will be compared to the third quarter of 2023 and include certain non-GAAP financial measures.

The reconciliation of such measures to the most comparable GAAP figures is detailed in our earnings 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 (President and CEO)

Thank you, Mark, and good morning. I would like to begin by thanking all ITTers for another exceptional performance in the third quarter. Once again, our teams deliver strong, profitable growth with even more robust growth in orders. First, in our legacy business, we continue to drive value creation through outsized organic growth and margin expansion, with an operating margin above our long-term target nearly two years ahead of schedule. And while we continue to drive profitable growth in the core, we are also building the M&A muscle through strategic capital deployment. We are seeing strong results from our recent Svanehøj, while early indications on K-SARIA's value proposition are encouraging. I want to thank our teams once again for over-delivering on our commitments. Let's now discuss a few highlights from Q3. We grew orders 14% on an organic basis and, importantly, 6% sequentially versus Q2.

Our book-to-bill of 1.1 resulted in a record-ending backlog of $1.7 billion. This is even more impressive given that organic revenue grew 6% with all segments contributing. We also drove 60 basis points of margin expansion, or 100 basis points excluding M&A impacts. All in, we delivered 7% adjusted EPS growth and 9% when excluding the impact of the Wolverine divestiture. Excluding the temporary acquisition amortization, we are driving to more than $6 of earnings in 2024. A truly strong performance, compounded by the $1 billion of capital deployed. With K-SARIA closed, we have now deployed over four times more capital than we did in the corresponding period in 2023, and more than two times our expected free cash flow. Let's get into the details on our Q3. Our orders growth in the third quarter was a standout.

IP grew orders 30%, with pump project growth well above 100% for the quarter. Year-to-date, our project orders are now up 10% on top of 29% growth last year, overcoming the tough compares we experienced in the first half of 2024. We also saw orders growth in nearly every short-cycle product category and industrial process, led by valves and aftermarket. CCT grew orders 7%, driven by continued defense share gains and connectors. The CCT team has secured several important defense wins, including connectors on a transportable surveillance radar system, and in Motion Technologies, Koni Rail secured multiple large orders in Europe and China, while Friction continued to conquer new platforms with all OEMs and on all powertrains. On revenue, all of our businesses are contributing. CCT grew 6% on the strength of defense, connectors, and the commercial aerospace aftermarket, all of which grew 20% or more organically.

Our connectors business continues to grow profitably, with new products and faster speed to market driving share gains. IP grew 6% with strength across all short-cycle product categories, including the Habonim valves business. Notably, September was Habonim's highest month of sales since the acquisition. In MT, aftermarket demand in Friction, as well as share gains in Koni Rail, drove 5% organic growth. Additionally, Friction's outperformance was over 700 basis points in a challenging auto OE market. In total, we grew 8%, Svanehøj and K-SARIA, despite the Wolverine divestiture. On margin, we grew 60 basis points to over 18%, with strong volume and pricing growth, completely overcoming the dilution from acquisitions and foreign currency impacts. IP remained above 20% or above 23%, including acquisition dilution, representing an incremental margin of 37%.

CCT hit the 19% milestone with another outstanding performance in connectors, overcoming 40 basis points of dilution from the K-SARIA acquisition. MT was again above 18% with strong productivity that more than offsets significant foreign currency headwinds. And IP was above 20% margin for the very first time. Well done, Jeroen and IP team, especially in China. Shifting to our outlook, today we are raising the midpoint of our full-year adjusted EPS guidance by $0.05 to $5.83, overcoming unfavorable foreign currency, higher interest expense, and temporary acquisition amortization. To recap, another strong quarter for ITT, with double-digit organic orders growth that will continue to power our future top-line performance. Now, let's turn to slide four to talk more about how we are furthering ITT's differentiation.

The Friction China team has nearly reached its full-year target for total platform awards, thanks to wins with local OEMs, including Geely, Chery, BYD, Zeekr, and Tesla. One of the ways we continue to differentiate in this competitive market is our world-class testing capabilities. In August, I was together with Zhulai, Sunny, and the team in China to see the testing facility we have invested in and built there. Our investment in a new state-of-the-art brake testing center in Huangshan, China, is already delivering strong returns. Our engineers and drivers trained in Barge, Italy, are able to deliver fast and real-time testing data to our customers that accurately predicts the brake system's performance in harsh conditions and terrains, and because of the investment we made in Huangshan, we are also able to replicate extreme temperatures and humidity levels indoors.

This unique facility enables our team to work side by side with all our customers in China, hence the level of our performance. Moving to IP, Svanehøj secured awards for 24 new vessels, including 11 that are capable of handling ammonia. Svanehøj is leading the way for ammonia pumps on commercial vessels with over 2,000 ammonia-ready marine pumps in operation or on Svanehøj's deep well fuel pumps can handle LNG, LPG, methanol, and ammonia. This will ensure that vessels are essentially future-proofed while also securing a long-term installed base for growth Svanehøj. As you can see, Svanehøj is indeed powering a better future. Next, on cargo pumps. Thanks Svanehøj's best-in-class quality and 100% on-time delivery in the third quarter, we have become a preferred partner to EPCs and end users in the region.

Additionally, thanks to our close technical support and product localization, the team drove a near-perfect win rate with these customers. And as a result, we secured close to $50 million in orders for pumps on the Amiral Petrochemical Complex in Saudi Arabia. Because of this, and to ensure we continue to outperform in this important region, we are investing further to enlarge our facility in Saudi, building on our capacity investments we announced last year. Well done, Khaled, Omar, and the entire Middle East team for delivering on our commitments and driving more than 100% project awards growth this quarter. Moving to aerospace and defense, our connectors team is continuing to differentiate through the speed at which we deliver these highly customized interconnect solutions. In Q3, we won awards on leading defense platforms, including the Nett Warrior soldier-worn communication system and the world's leading integrated defense system.

On top of these, we won developmental engineering contracts for the next-gen advanced military aircraft. These are just a few of the awards from across the portfolio that will continue to feed ITT's backlog and future growth. Let's now take a deeper dive into our record backlog on slide five. In the last nine months, we have grown our backlog to a record $1.7 billion, a whopping 34% increase, with a book-to-bill solidly above one. This is driven both by our legacy business and our strategic acquisitions. First, on our legacy business, aerospace and defense orders were up 15% due to large program awards. Rail orders grew roughly 20%, driven by Europe and China share gains. Rail continues to be a great market for ITT.

A recent example is Koni China, where the team is in the final testing phase on a new high-speed train, which will operate at 400 km per hour. This is a significant step to ensure Koni shocks are the right engineering solution for when the trains begin operating in 2026. Based on all of this and the project's share gains in IP, it is clear that our legacy business is growing, and this will be enhanced further by our recent acquisitions. Svanehøj, less than a year in, the results are already outstanding. With a book-to-bill of 1.4, we added $190 million to our backlog. We leverage Svanehøj's leadership in the energy transition and our engineering expertise to drive stronger growth as low-carbon and sustainable fuels are more widely adopted.

In Q3, Svanehøj unveiled a new high-pressure ammonia fuel pump capable of safely handling highly corrosive carbon-free liquids. This, and the wins we have already secured, gives us confidence in Svanehøj's double-digit growth outlook. Finally, on K-SARIA. K-SARIA serves as an extension of customer engineering teams, taking high-level concept to production in record time. Revenue is highly visible with the programs we are on, including content on the F-35, F-16, and the Joint Strike Fighter program, among others. K-SARIA cable assemblies are the connectivity that ties defense systems together. Like Svanehøj, K-SARIA provides good visibility to future revenue given the programmatic nature of the business, which we expect will drive high single-digit growth over the near term and has already added $130 million to ITT's backlog.

Recently, Michael and CCT leadership were on the ground at K-SARIA sites across North America to welcome the local teams to ITT, including at headquarters in New Hampshire, where cable assemblies are currently being built for the Virginia-class submarine. We continue to have confidence in K-SARIA's value proposition and are focused on executing the commercial synergies we identified. As you can see, our value creation through strong organic growth and margin expansion continues, and now through M&A as well. Now, let me turn the call over to Emmanuel to discuss our results in more detail.

Emmanuel Caprais (CFO)

Thank you, Luca, and good morning. Let's begin with revenue. Volume, once again, drove most of the growth this quarter, with all segments contributing. In IP, we saw strong growth across baseline pumps, as well as parts, service, and valves, while project sales were flat. Habonim was a standout this quarter with 16% revenue growth.

Svanehøj also added 14 points to IP's total growth. In CCT, defense share gains, connectors, and aero aftermarket growth drove a 6% revenue increase. CCT is continuing the multi-quarter recovery in connectors distributions at attractive margins. Additionally, we are overcoming a slowdown in order activity from Boeing, given the production stoppage and elevated inventory levels. In MT, revenue grew 5%, driven by strength in rail and the Friction aftermarket. On the OE side, Friction outperformed global auto production by over 700 basis points. Additionally, Koni grew 16% and expects to grow roughly 15% for the full year due to share gains. On profitability, margin expansion was primarily driven by higher volume and productivity, particularly in MT, which grew more than 100 basis points despite 160 basis points of FX headwinds.

CCT exceeded 19% margin with 90 basis points of margin expansion, overcoming 40 basis points of dilution from K-SARIA, which closed in September, and in IP, excluding the 300 basis points of dilution Svanehøj, margin grew 60 basis points to 23.9%. For all of ITT, price, operational leverage, and productivity outpaced favorable impacts from foreign currency of 80 basis points. On earnings, we delivered a strong performance driven by core volume growth and margin expansion. This is ITT's DNA. Lastly, on capital deployment, Svanehøj and K-SARIA, we continue to cultivate a rich, actionable pipeline of targets in flow and connectors, while also putting the balance sheet to work on other capital deployment priorities. We invested over $75 million in growth and productivity, mainly in Friction, to support share gains and the expansion of our high-performance business.

In Q3, immediately after funding the K-SARIA acquisition, we repurchased another $25 million of ITT shares, bringing the year-to-date total above $100 million. Let's quickly turn to the operating margin and EPS bridges on slide seven. The key highlight here is the strong performance of our businesses. We overcame $0.07 of unfavorable FX, $0.06 of higher interest expense, $0.04 of dilution from the Wolverine divestiture, and a higher tax rate to deliver $1.46 of adjusted EPS. If you exclude M&A impacts and the temporary amortization, adjusted EPS would be up 9% for the quarter. Now, let's move to slide eight to discuss our updated 2024 guidance. Today, we are raising our full-year revenue, operating margin, and EPS guidance above the previous midpoint.

We're fully absorbing an incremental $0.10 impact from higher interest expense and acquisition amortization related to K-SARIA, while raising the midpoint of adjusted EPS to $5.83 for a growth of 12%. On the top line, we expect to see continued outperformance in Friction, as well as strong growth in IP and connectors. A combination of this profitable growth and our relentless focus on productivity and pricing will drive margin expansion of over 60 basis points at the midpoint, or over 140 basis points excluding M&A. Our adjusted free cash flow guidance remains at approximately $450 million for the full year. Let's briefly look at the adjusted EPS outlook on slide nine. I wanted to highlight the strong operational performance in our legacy business in 2024.

This has allowed us to invest organically to support share gains, while also overcoming significantly higher interest expense, amortization related to acquisition, and lost earnings from the divestiture of Wolverine. As a result, we're raising the midpoint of our full-year EPS guidance. This is a testament to the resilience of the ITT team. For the fourth quarter, total growth will be low double digits, driven Svanehøj and K-SARIA, more than offsetting the divestiture impact. We expect to grow the top line in the low single-digit range organically, with IP delivering the strongest top line growth. This assumes that CCT will be up slightly with a strong connectors performance offset by slower aerospace demand due to the Boeing work stoppage, and MT will be roughly flat year-over-year due to expected OEM shutdowns in December.

On margin, we expect that both IP and MT will deliver margin expansion, while CCT will be in the mid-teens due to temporary amortization from K-SARIA. However, for the full year, we expect that both MT and CCT will be above 18%, while IP will finish above 20% once again. This will drive adjusted EPS growth in the high single-digit range at the midpoint. Let me turn the call back to Luca on slide 10 to wrap up.

Luca Savi (President and CEO)

Thank you, Emmanuel. Few points before Q&A. This quarter, once again, we deliver value creation through organic growth and margin expansion. This is ITT's DNA. Our execution and innovation are delivering share gains across all our businesses to a record backlog ahead of 2025. On top of this, we continue to build our M&A Svanehøj is already delivering. K-SARIA's early signs are good, and our M&A pipeline remains active. Thanks to our team's performance, we're once again raising our outlook. As always, it has been my pleasure. Thank you for your continued support and interest in ITT. Gigi, 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 touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by hitting 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 while we compile the Q&A roster. Our first question comes from the line of Joe Giordano from TD Cowen.

Joe Giordano (Managing Director and Senior Equity Analyst)

Hey, good morning, guys.

Luca Savi (President and CEO)

Hey, morning, Joe.

Joe Giordano (Managing Director and Senior Equity Analyst)

Hey, I'm just curious. Maybe this is a little bit more on IP, but I guess it could be broad. How reflective do you think your results are of the underlying conditions in the market that you're operating in? Because we're hearing some kind of mixed about push-outs of projects and even in industries like process, where we think things are generally pretty good, we're hearing some mixed kind of color. And clearly, that's not what's happening in your results here. So can you maybe compare what you're seeing in your order book versus what underlying conditions on the ground might look like?

Luca Savi (President and CEO)

Sure. I think that what you're seeing here, Joey, in the results is the differentiation of ITT when it comes, particularly, on the performance side. So if you think of the IP, the example that we gave of our Saudi operations, in Q3, they deliver 100% on-time delivery, good quality products. This is the reason why we continue to win market share on the project side. This year, year to date, we are 10% up versus last year that was already a very tough compare. The story is the same when it comes to rail in China or in Europe and North America, Friction, and also on the connector side, particularly on defense.

Emmanuel Caprais (CFO)

Joe, if I can add, if you look at our orders, they grow on all the different end markets. The 30% growth from an organic order standpoint is driven really by all the markets. We're really outperforming with every customer in all end markets.

Joe Giordano (Managing Director and Senior Equity Analyst)

Fair enough. Then just curious on M&A, right? So you've done the Wolverine divestment. You've made two deals here. You mentioned that the pipeline looks good. How interested are you in terms of timing, right? You have a lot going on. You're executing well, but how much is too much in the short period of time internally from a bandwidth standpoint? And if I can just tack on one, Emmanuel, just on the. I'll nitpick a tiny bit on the free cash flow. Can you maybe give us the nuances there? You're kind of raising the core in revenue and EPS, but the free cash flow guide kind of unchanged there. So if you could just address that. Thanks, guys.

Emmanuel Caprais (CFO)

Thank you, Joe. So when we talk about the M&A, the pipeline is active. We are cultivating. We are active on the M&A front. And the reason is because when you look at the last two acquisitions, for example, Svanehøj and also K-SARIA, they are well-performing companies with a good position in the market and a strong management team.

If you look at Søren and Morten, all the team Svanehøj is really doing a great job and focusing and over-delivering. K-SARIA, its early signs are good, and we have a strong management team there with Mark leading K-SARIA, so we have room to do more acquisition, but it depends, of course.

Luca Savi (President and CEO)

And on the free cash flow question, Joe, so for sure, free cash flow was a little bit frustrating this quarter. We didn't hit what we wanted to do, and the reason for this is because working capital and specifically AR and inventory, so I think what you're seeing here is the fact that from a timing standpoint, it takes us a little bit more time to reduce the inventory than we were expecting, and that's why you're not seeing free cash flow going up at the same time as earnings.

Joe Giordano (Managing Director and Senior Equity Analyst)

Thanks, guys.

Luca Savi (President and CEO)

Thanks, Joe.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Scott Davis from Melius.

Scott Davis (Chairman and CEO)

Hey, good morning, guys, and congrats again on what's been a great year. Guys, when you see numbers like 136% growth in pump projects, we've had some other companies just comment that purchasing patterns have changed a little bit on the project side where orders are coming in a little earlier than maybe historically they have, and have you guys seen? I mean, again, just kind of in reference, it's such a big number. Are the EPCs kind of racing to get ahead of each other on making sure they get orders in? Are there some concerns about shortages of product out there? Or is that not relevant for you guys?

Luca Savi (President and CEO)

No, I wouldn't say so, Scott. I think that because of the projects, sometimes you have a little bit ups and downs. So this is the reason why, for example, we emphasize a 10% project growth year to date on what was already an exceptional year last year because probably that is a little bit more relevant. What we have seen in the way that the EPCs are working is that if you are delivering well, if you're working well with the EPC, they tend to work now probably a little bit more in partnership with you. And this is what is differentiating now there in the market. So maybe a little bit more working closely together, particularly if you are working well and if you're delivering well for them.

Scott Davis (Chairman and CEO)

Okay. That's helpful. And then when you think about the ebbs and flows of what's going on at Boeing right now, I mean, it's not just as a customer you have to manage this disruption, but also I know you guys are in the middle of renegotiating or negotiating your contract moving forward. How do you manage your production around this uncertainty? And does this push back that negotiation at all? Just a little update on Boeing would be helpful.

Luca Savi (President and CEO)

I see. Thanks, Scott. First of all, we are working closely to ensure that we support them when they're going to restart the production. And it's not going to be a smooth restart because every single time you got one of these events, it takes a little bit of time. So we have to stay super close with them so that when they start, we will be able to support them. When it comes to the, we're not shipping anything today, just to give you an idea. This will have probably an impact in the Q4 of roughly $10 million for CCT. When it comes to the negotiation, that negotiation has to happen because some of these contracts have an expiry date at the end of the year and at the end of Q1 2025. So the negotiations are happening still today.

Scott Davis (Chairman and CEO)

Okay. That's helpful. All right. I'll pass it on. Thank you, guys. Best of luck.

Operator (participant)

Thanks, Scott. Thank you. One moment for our next question. Our next question comes from the line of Andrew Obin from Bank of America.

Andrew Obin (Managing Director of Equity Research)

Hey, guys. Good morning.

Luca Savi (President and CEO)

Hey, Andrew.

Emmanuel Caprais (CFO)

Hi, Andrew.

Andrew Obin (Managing Director of Equity Research)

Yeah, just a question on pricing. It's been a large focus in recent years and seems that it's really improved. Can you talk about structurally what you've done, what other work there is to do going forward, and early thoughts on pricing into 2025?

Luca Savi (President and CEO)

Sure. The pricing is different for the different businesses. I would say when you look specifically at 2024 and in Q3, we are price cost positive both when it comes to dollars and when it comes also to margin. The situation is particularly positive on the CCT front, and here is working strategically looking at both at the pricing into the distribution, but also in the renegotiation of the long-term agreements. On the MT side, what we've done structurally is ensuring that all the contracts now we got commodities indexed and so that this is covering both for us as well as giving some security for the customers as well.

And then on the IP side, on the short cycle and the distribution, we have been very active in terms of looking at our discount rates and our leakage to ensure that we do not have any leakage there when it comes to pricing. In the future, the second part of your question, we probably need to be even more strategic. So being even more analytical, looking at, okay, if you look at this pump, this application in this region for this distributor, what is the value that we're delivering and the price that we can get? So more analytics to be able to get a little bit more pricing, but it's more normalized

Andrew Obin (Managing Director of Equity Research)

. I gotcha. Thank you. And just to follow up, you sort of noted short-cycle business. It seems yours continues to hold up well. Just what's the balance between share? Could you just give us some color as to what are you seeing on the distributors? Are they turning more positive on the short cycle?

Luca Savi (President and CEO)

Yeah. Thanks, Andrew. If you split it, if you look at valves, this is clearly an area where we're gaining share. And here our orders in Q3 were up 16%. The majority was volume. And we're gaining share both on large projects like the methanation projects in our engineering valves as well as on the short cycle. Short cycle, including the aftermarket for valves, has been pretty strong. Service for pump service, so repairs, is also doing really, really well. And I think here, because we're focused on reducing as much as possible the machine downtime at our customers, we're able to reduce our lead times and ship back the repaired pump to our customers faster.

I think that drives a lot of volume into our shops. Then if you think about the aftermarket parts, here the focus has been to really the turnaround to really improve the turnaround times. And if you think about what our distribution center for aftermarket parts in the U.S. is doing, they're able to deliver roughly 50% of the orders in a one-day turnaround and then 95% of those orders in two-day turnaround. So again, here you win the battle in aftermarket if you have the parts available for your customer when they require.

Andrew Obin (Managing Director of Equity Research)

And just in terms of destock, are we done? What's the message? Sorry if I missed it.

Luca Savi (President and CEO)

So in IP, we are not seeing any signs of destocking. Inventories are not also historically higher than they used to be. I think it's hard to say on the connector side because inventories are higher than what they were historically, and we haven't seen any type of decline. What we saw, though, that is interesting is that point of sales continues to increase. So there may be a re-rating of the inventory levels at our distributors.

Andrew Obin (Managing Director of Equity Research)

Thanks very much.

Luca Savi (President and CEO)

Thanks, Andrew.

Operator (participant)

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

Mike Halloran (Associate Director of Research and Senior Research Analyst)

Hey, good morning, everyone.

Luca Savi (President and CEO)

Morning, Mike.

Mike Halloran (Associate Director of Research and Senior Research Analyst)

Why don't we just start with the auto outlook? I mean, obviously, choppy trends depending on the region. How are you thinking about it for the remainder of the year? But more importantly, what's the best guess at this point for what industry demand looks like as we head into 2025?

Luca Savi (President and CEO)

Sure. Sure. The market is challenging, particularly when you look at the European market. But what is interesting to see here is that we continue to outperform in every single market. This is in Europe, in China, where the outperformance was almost 1,000 basis points, and in North America, where we performed incredibly well as well. So despite the fact that the market will be down in 2024, we are supposed to grow. And our outperformance for the full year is probably going to be around 700 basis points. Now, when you look at 2025, it's a little bit early, but probably we expect the market to be flat to upper low single digit. And because of the awards that we won in the past and the awards that we continue to win in 2024, we expect outperformance in 2025 as well.

The outperformance, Mike, is not only in every single region, but is also in every single powertrain. Despite the fact that internal combustion engine production is coming down, we are growing there, and our market share will be above 30% in total worldwide for the very first time this year.

Mike Halloran (Associate Director of Research and Senior Research Analyst)

Makes sense. And then just on the guide, could you just help me understand the impact of K-SARIA in the fourth quarter specifically on a net basis, both the operational piece as well as obviously you've got some step-up amortization type things in the numbers? So just maybe net that out for me so I understand how that's impacting the guide.

Emmanuel Caprais (CFO)

Sure. So if you look at our fourth quarter, definitely the orders momentum, the positive momentum will continue. And a lot of growth will be driven by IP, which will still be in the double digits. From a revenue standpoint, think about it as the highest quarter of 2024 from a dollar revenue standpoint. And that is pretty typical. So really good performance, and the teams are getting ready to ramp up those shipments. IP will be driving a lot of that organic growth thanks to projects. In total, Svanehøj and K-SARIA, revenue will be up 12%. And then CCT, as we said, will be flat as we're trying to overcome the impact from Boeing.

We expect in our guidance that volumes will not restart meaningfully in Q4. And so that represents $10 million that was included in our guidance from a revenue standpoint.

Mike Halloran (Associate Director of Research and Senior Research Analyst)

And then from a margin standpoint.

Emmanuel Caprais (CFO)

Yeah, go ahead.

Mike Halloran (Associate Director of Research and Senior Research Analyst)

No, no. Please continue.

Emmanuel Caprais (CFO)

I was just going to say from a margin standpoint, really quickly, in line with Q3, the FX impacts that we saw, namely in MT, that really impacted our margins by 160 basis points in Q3. We don't expect that in Q4. We expect a sequential improvement in MT as a result. Then CCT will step down because we'll be impacted roughly 400 basis points by the K-SARIA dilution.

Mike Halloran (Associate Director of Research and Senior Research Analyst)

So that was a far more interesting answer than the question I asked. I was just looking for K-SARIA impact, but that was a lot of really great detail. So could you just net out the K-SARIA piece? Because I know that was included this time around.

Emmanuel Caprais (CFO)

So K-SARIA, you're right, was accretive in Q3. I think when you think about Q4, we expect K-SARIA to modestly contribute from an income standpoint. And then revenue for K-SARIA in Q4 will be around $50 million.

Mike Halloran (Associate Director of Research and Senior Research Analyst)

Thank you. Appreciate it.

Emmanuel Caprais (CFO)

Thanks, Mike.

Operator (participant)

Thank you. Our next question comes from the line of Vlad Bystricky from Citigroup.

Emmanuel Caprais (CFO)

Good morning, Vlad.

Vlad Bystricky (VP and Equity Research Analyst)

Good morning, guys. Thanks for taking my call. And congrats on another nice quarter. I guess just stepping back, given the margin performance you're putting up across the portfolio, and you mentioned you're essentially performing at or above your longer-term targets on the legacy businesses. So can you just talk about how you're thinking about the path for margins going forward into 2025 and as we think out beyond 2025 at this point?

Emmanuel Caprais (CFO)

Yeah. So first of all, let me say that most likely in the first half of 2025, we'll come out with new margin targets for all our businesses. So if we think about the margin on the legacy businesses, we expect in 2025 broadly to continue to improve. The way to think about it is that, as Luca said, Friction will continue to outperform. And with that outperformance, we get a lot of benefits from a bottom-line standpoint. IP will start shipping some of those large projects that we've been developing and that are really profitable. Again, our backlog for projects, the margin in our backlog was up several hundred basis points versus the prior year. And then think about also the Boeing price renegotiations, potentially the restart of some of the volumes, real share gains. That's a really positive top-line environment that will drive also bottom-line improvement.

Vlad Bystricky (VP and Equity Research Analyst)

Okay. That's helpful, Emmanuel Caprais. Appreciate it. Maybe just following up on that comment around the project margins and the margin in backlog, can you just talk about the $50 million in awards for Amiral? Can you talk about sort of the visibility, the timing on the delivery of those? And would you say that that particular win is consistent with that commentary around higher margins in backlog?

Luca Savi (President and CEO)

Sure. Vlad, this is Luca. I think that these $50 million is working across different EPCs. And the reason for these good wins is exactly the performance of the Saudi team. Because of the performance, we've been able to work very closely with the EPCs and supporting them. And I think that because of the localization, because of the way that we perform, these projects will be good, profitable projects. When you look at the timeline of projects of this size, you're looking at for the next two years, two to three years, this is when you will be able to recognize the revenue.

Vlad Bystricky (VP and Equity Research Analyst)

Great. That's helpful. Appreciate it.

Emmanuel Caprais (CFO)

Another example of that. So for instance, the decarb business that we won in Q1 and Q2 of last year, we will start shipping them in the first half of 2025. So those large projects take a little bit of time between definition of specification, development, delivery, and then documentation.

Vlad Bystricky (VP and Equity Research Analyst)

Yep. That makes sense. Appreciate it, guys. Thank you.

Luca Savi (President and CEO)

Thanks, Vlad.

Emmanuel Caprais (CFO)

Thanks, Vlad.

Operator (participant)

Thank you. Our next question comes from the line of Damian Karas from UBS.

Luca Savi (President and CEO)

Morning, Damien.

Damian Karas (Senior Equity Research Analyst and Broker)

Hey, good morning. Nice work on the quarter.

Emmanuel Caprais (CFO)

Hi, Damien.

Luca Savi (President and CEO)

Thank you.

Damian Karas (Senior Equity Research Analyst and Broker)

Thank you. Buongiorno, Luca. I wanted to ask you guys to follow up on Friction, seeing continued share gains and strength there, particularly in China. But kind of under the hood, just curious how things are progressing with the high-performance pads, kind of a newer area of the business, and how are you thinking about the potential to expand your aftermarket presence in other regions like China? I know that's something you've been looking into and testing.

Luca Savi (President and CEO)

Sure, so the market share gains are across the board, and we said across all the different regions, so the teams around the world are really working very well closely with the customer, with R&D, and on top of that, their performance in terms of on-time delivery and quality in the PPBs, in hundreds of parts per billion, makes the difference, so this is for across the board.

For high-performance specifically, funny you asked because in October this month, at the beginning of October, we were there together with ITT's board of directors. They approved this investment, so it was only natural to take the board of directors there to see what we have done. Think about this speed, Damian. We broke ground. We say in Italian, we put the first stone down in the summer of 2023, and in less than 15 months, we got the permit. The building is completed, is up and running. The machines are being delivered and installed right now, starting operation, the SOP, in Q1 of 2025. We have won the right and the targeted platform, so the team internally has done an outstanding job at an incredible speed, and I'd say we also received a lot of support from the local authorities and institutions, so that is for high performance.

So, good picture there. For the aftermarket, it's true that we are testing a little bit of the aftermarket in China. But I would say as we stand today, we got opportunity to grow on the OE side and grow profitably around the world. So for the aftermarket, right now, we are sticking with the European geography only.

Damian Karas (Senior Equity Research Analyst and Broker)

Got it. That makes sense. Thank you. And then on the connectors business, sounded like order strength was pretty broad-based. Maybe you could just elaborate on what you're seeing across connectors and your sense for how much of that growth you're experiencing is underlying market versus ITT share gains.

Luca Savi (President and CEO)

Sure. Connectors has been a great story. To be honest with you, I would say that connectors has been a great story for the last couple of years. So that's shown good resilience despite the challenges that there was out there in the market. I think that I was in August, I was in China. So I was able to visit Shenzhen, which is our factory of the connectors, where we have the factory for connectors there.

We are small in China. But the team, Serge and the team, are really localizing our engineering, the development, and we're winning market share there across the board with the market. So we are more and more in China for China. And we got a very good position, particularly on the medical side. But we have good performance on the industrial side. Our connectors industry were up 21% in the quarter. And also defense.

In defense, we are really winning market share thanks to, A, our product expansion, but also what Dan and Art and the team are doing in terms of speed to market, how we are able to come up with the right solution for that program and be specified for that program. So very strong in defense as well.

Damian Karas (Senior Equity Research Analyst and Broker)

Glad to hear. Thanks again. Good luck, guys.

Luca Savi (President and CEO)

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Joe Ritchie from Goldman Sachs.

Emmanuel Caprais (CFO)

Morning, Joe.

Joe Ritchie (Managing Director and Senior Equity Research Analyst)

Hey, good morning, guys. Hey, morning, guys.

Luca Savi (President and CEO)

Hi, Joe.

Joe Ritchie (Managing Director and Senior Equity Research Analyst)

Hey, so we've long talked about the market share story for the friction business. You guys went into some detail on the pumps business earlier. It just seems like you're just seeing share gains really kind of across the portfolio. I was hoping that maybe you could dive in a little bit further on the rail business and the aerospace and defense business, what you're doing there. And maybe if there's a way to describe what the opportunity is across those businesses, that would be helpful as well.

Luca Savi (President and CEO)

Sure. When you look at rail, Koni is performing exceptionally well in rail for our customers. Their on-time delivery is similar to Friction, is in the 90s, very good quality, providing good service, engineering very close to the customers. We are in China for China, as an example. And this enables us to work very closely with the customer. I remember when Davide went to China the very first time, we had zero market share on high-speed train. You're talking about 10 years ago. Today, we are one of the leaders in high-speed train.

Our shock absorbers are tested on their new 400-450 km per hour high-speed train for the future. All of that is feeding growth. There is plenty of opportunity in the market because of the investment in Europe, as well as the investment in North America. Rail, we benefit from the green trend of the future. Good market and outperformance on top of it. When it comes to defense, defense has been a very good story, both from a revenue perspective and orders. Our revenue for the full year probably will grow 20% in defense and the orders 25%. Here, we have been working very closely with the customer from an engineering point of view in customizing the solution. It's brought results, our speed and our engineering, both for the connectors as well as for the CCT side.

Joe Ritchie (Managing Director and Senior Equity Research Analyst)

Super helpful, Luca. Appreciate all the color. And then I guess just a more near-term question, Emmanuel, just talking about MT margins. You said you had a very big headwind this quarter from FX, still expecting 18+% margins for the year. I guess maybe as we head into 2025, any initial comments on where margins could go if we kind of cut the line today on FX and say that's potentially not as much of a headwind next year? How are we looking for MT margins next year?

Emmanuel Caprais (CFO)

Yeah, Joe. So we expect FX not to be an impact already in Q4. And really, when you think about the 160 basis points margin impact in Q3, that was due to our FX hedge, that balance sheet position that we had to unwind because the dollar became stronger compared to the euro. So this is a one-off impact, and we don't think it's going to repeat in that magnitude in the future. So when you think about Q4, we expect already MT to be sequentially up versus Q3 and contributing to MT being for the full year above 18%. Now, when you think about 2025, obviously, we continue to drive a lot of productivity, a lot of cost reduction.

And so I think it's logical to assume that MT will grow margins in 2025 compared to this year. For us, what's really important is the long-term target. And you know that the long-term target is 20%. Our commitment is to achieve it by 2026, which implies that there's going to be significant progress also in 2025 because we will be a little bit above 18% at the end of 2024. So we feel good about MT. We feel good about our opportunity to expand margins. And yeah.

Joe Ritchie (Managing Director and Senior Equity Research Analyst)

Perfect. Thank you, guys.

Luca Savi (President and CEO)

Thanks, Joe.

Emmanuel Caprais (CFO)

Thanks, Joe.

Operator (participant)

Thank you. Our next question comes from the line of Nathan Jones from Stifel.

Luca Savi (President and CEO)

Good morning, Nathan.

Emmanuel Caprais (CFO)

Good morning, Nathan.

Nathan Jones (Managing Director and Senior Equity Analyst)

Good morning, everyone. Hey. Firstly, a follow-up question on the profitability of large IP projects that Emmanuel, I think you mentioned. I think you called them highly profitable. And historically, the larger projects have been less profitable. Maybe just some more color, some more commentary on what's leading those larger projects to have much higher profitability than they may have historically.

Emmanuel Caprais (CFO)

Yeah. So keep in mind when I call them highly profitable is because when you think about our legacy IP business, this quarter, we were at 23.9%. And so sure that aftermarket is super profitable, but at some point in time, projects need to contribute as well. That's what you're seeing also. You're seeing that as we're taking projects at a certain margin level, we work through the development cycle and the production process to improve that margin so that the margin when we deliver is higher than the margin when we were awarded. That's what's happening.

Here, specifically, what we're doing is that we're working in really close collaboration with our customer in order to really define specifications so that there's no room for error. Once we do this, we are focused on making sure that we develop flawlessly those projects. We also include engineering changes that our customers are requesting. This is a big difference from the past because in the past, and I'm talking 2015, because our performance in developing projects wasn't great, we were, in a lot of cases, eating those engineering changes.

Now we are pricing those engineering changes and making sure that we recover margin on this as well. And then when you think about the delivery, it's all about customer service, making sure that we provide the documentation also because when you deliver a pump without the documentation, the customer can't do anything with it. And so it's really a positive cycle that we've been able to implement with our customers that is resulting in growth, feeding growth.

Luca Savi (President and CEO)

But it's fairly easy to say that the projects tend to be a little bit more challenging. So you need always to maintain the rigor in order acquisition so that you really bring in the orders at the right profitability and then the rigor in execution.

Nathan Jones (Managing Director and Senior Equity Analyst)

Yeah. Makes sense. And then I guess my follow-up questions around strategic pricing. Luca, you talked earlier on the call about needing to elevate your game even further on strategic pricing. Can you talk about where you think the biggest areas to implement more value-based pricing, to target those pricing increases come from, and what impact that could have to margins?

Luca Savi (President and CEO)

Yeah. I think that probably is on the CCT side and specifically on the aero, on the component side. I think that this is the area where probably we can be even more strategic and we can have even bigger impacts. And I'm not just talking about the long-term agreements that we discussed already in the past, but in general, I think that there are opportunities there when it comes to the aftermarket and when it comes to some of the components in CCT, the repairs, for example. So this is the area where we got more opportunities.

Emmanuel Caprais (CFO)

And here, if I could just add, Nathan, I think the team has been doing a really good job at reducing the lead times for those repairs. And so that's why we've been getting much more volume. And we've been also able to extract pricing because every day that when you get a repair, every day that passes, it's an airplane that's on the ground, not flying. And so here, this is a really differentiation that we've been really focused on developing so that we can grow this business even more.

Nathan Jones (Managing Director and Senior Equity Analyst)

Awesome. Thanks very much for taking my questions.

Emmanuel Caprais (CFO)

Thanks, Nathan. Ciao.

Operator (participant)

Thank you. Our last question comes from the line of Matt Somerville from D.A. Davidson & Co.

Luca Savi (President and CEO)

. Good morning, Mike.

Matt Somerville (Senior Analyst)

Thanks. Just a good morning. Just a couple of quick ones. Obviously, Friction aftermarket has had some pretty nice growth, in particular this last quarter, up high single digits. How do you view kind of the growth trajectory of that business kind of going forward and into 2025? And what's your assessment on customer inventory levels there? And then I have another quick follow-up.

Luca Savi (President and CEO)

So when you look at the aftermarket, I would say on a year-to-date basis, it's growing 6%. I would say the OES is practically flat, and the independent aftermarket is in the high teens. So I would say when it comes to 2025 or the near term, we will expect a more normalized growth when it comes to independent aftermarket and probably more opportunities on the OES side. When it comes to the inventory, I think that the destocking, I think, has been completely overcome. So we are beyond that.

Matt Somerville (Senior Analyst)

And then just lastly, on the project side of the business, can you talk about you've referenced in the past, Luca, funnel metrics that you track in that business? Can you sort of maybe provide an update as to the go-forward funnel as you see it for IP projects and maybe add a little bit of end market and geographic color to that funnel? Thank you.

Luca Savi (President and CEO)

Sure. The funnel is staying at a very high level, Matt. The funnel is up despite the fact that we have a good growth in revenue. And on top of that, a book-to-bill, which is above one, the funnel is up 9% year-over-year. So pretty outstanding, which tells you a little bit how rich the opportunities are out there.

When you look at the region specifically and the market, it's fair to say that there are good opportunities on the green side, a lot of opportunities in the traditional oil and gas, and from a geographic point of view, the regions that continue to present good growth are Middle East and Asia-Pacific, and we expect those areas to continue to provide good opportunities and good orders in the future.

Matt Somerville (Senior Analyst)

Thanks, Luca.

Luca Savi (President and CEO)

Thank you, Matt.

Operator (participant)

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