Welcome to ITT’s 2020 Second Quarter Conference Call. Today is Friday, July 31, 2020. Today’s call is being recorded and will be available for replay beginning at 12 p.m. Eastern. 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.

[Operator Instructions] It is now my pleasure to turn the floor over to Emmanuel Caprais, Group Chief Financial Officer. You may begin..

Good morning, and thank you, Maria. Welcome to ITT’s second quarter 2020 earnings call. This is Emmanuel Caprais and on the line this morning are Luca Savi, Chief Executive Officer and President; and Tom Scalera, Chief Financial Officer.

Today’s presentation, press release and reconciliation of non-GAAP financial measures to the most comparable GAAP measure can be found on our website at itt.com/investors.

Our adjusted non-GAAP results exclude certain non-operating and non-recurring items, including but not limited to asbestos restructuring, asset impairment, acquisition-related items and certain tax items. All adjustments in the quarter are detailed in the reconciliations.

Before we begin I'd like to provide a brief overview of our Q2 GAAP results compared to prior year. Q2 total revenue decreased 29% to $515 million. Segment operating income decreased 65% to $37 million and EPS of $0.53 decreased 29%. Free cash flow increased 205% to $169 million.

Please note that our remaining discussion will primarily focus on non-GAAP or adjusted measures unless otherwise indicated. Lastly today's call will contain forward-looking statements that are subject to risks and uncertainties including impacts from the COVID-19 pandemic. Actual results may vary materially.

All such statements should be evaluated together with the safe harbor disclosures and the other risks and uncertainties that affect our business including those disclosed in our SEC filings. Now let's turn to slide 3 where Luca will take us through the key highlights. .

Thank you, Emmanuel, and thank you all for being with us this morning despite the many challenges and unique circumstances that you're dealing with at this time. I truly hope that everyone stays safe as we continue to adjust to the widespread repercussions of the COVID-19 pandemic.

Before we start this call, I'd like to thank our customers and suppliers who have worked with us to ensure that we deliver our products safely and in a timely manner. I'm also very grateful to our shareholders for their support.

And I want to give a heartfelt thank you to all our ITTs across the globe who continue to work relentlessly to serve our customers and shareholders in the most dedicated fashion and to take care of each other in challenging conditions.

On our Q1 call, we highlighted our 2020 focus to strengthen ITT's resilience and to drive aggressive cost actions while playing offense for the future. And this is exactly what we did in Q2. We delivered a 25% segment decremental margin. We accelerated and increased our cost and spend reduction actions to $160 million.

We generated record free cash flow of $169 million. We bolstered our liquidity to $1.4 billion, and we signed an LOI to acquire a niche European rail company. Building on this strong foundation, we will continue to drive operational execution that further reduces decremental margins while fueling future growth opportunities.

We can only truly demonstrate our resilience through actions and results. This morning, we will share with you the actions we will keep on driving to strengthen the operational and financial performance as we continue to mitigate the COVID-19 impact and reinforce the resilience at ITT.

Today we will also give our understanding of the markets that we serve and our expectations for the balance of 2020. Before going into Q2 highlights, a word on safety. Safety is my top priority.

And when I talk weekly with our facilities across the world, I'm energized by the accomplishments of our teams who diligently and effectively execute our health protocol. This enabled us to contain the global number of infections to fewer than 70. Now let's turn to our Q2 results. We focus on what we control and produce better results than expected.

During the second quarter, ITT's resilience, the resolve of our teams and our pivot to play offense were on full display. From a financial perspective, we delivered solid EPS of $0.57 exceptional segment decremental margin of 25%, record free cash flow of $169 million, representing a significant growth of 205% or $114 million.

And segment working capital reduction of 210 basis points compared to prior year and 100 basis points compared to the first quarter. Operational excellence is a fundamental pillar of ITT's long-term success.

And during the month of June, I was able to experience it first-hand over and over again when visiting our Seneca Falls plant and seven facilities in Europe. SFO operational improvement enabled industrial process to deliver a 13.7% adjusted operating margin. This is 120 basis point expansion versus prior year despite a revenue decline of 17%.

The 13.7% margin also represents an improvement of 240 basis points over Q1. We moved quickly to take out costs and we are progressing nicely towards our long-term 15% plus margin target.

IP continues to impress with strong operational execution and as an example the NC line at Seneca Falls achieved above 90% on-time delivery for the tenth consecutive month. Whilst in Europe, I was also pleased to see all the Kaizen projects we have underway to improve our operations.

Being an assembly line efficiency workshop in KONI Oud-Beijerland or boosting output in Axtone Stalowa Wola in Poland. Last but not least in Barge, our Friction teams continue to improve our manufacturing processes by repurposing and driving the utilization of existing equipment.

All across ITT, we drove high levels of operating efficiency at our manufacturing plants in Asia, Europe, Middle East and the Americas. And lastly, this operational excellence combined with our speed in execution enabled us to accelerate and boost our cost reduction plan adding $25 million of new actions that increase our target to $160 million.

All of the operational excellence was possible because all our leaders get our people safe through the adoption of rigorous health protocols. Thanks for this.

On customer centricity, our teams passionately serve our customers and we're creative in satisfying increasingly demanding requirements showing in actions once again that our customers are our priority. Let me elaborate. Momentum in Friction OEM share gain continued.

In the first half of 2020, we outperformed the global market and each of our main regions. And based on platforms ramping in the second half, we continue to expect to outperform global markets by 700 to 1000 basis points this year. Our end ordering unit grew new business awards by 94% in the quarter.

The improvement that Logan and his team executed have put this business back on a growth trajectory. IP grew organic pump project orders by 22%. Project orders were consistent with the level reached in the first quarter. As a result, our backlog at the end of Q2 was up 3% excluding foreign exchange compared to the beginning of 2020.

The project order performance is an emerging sign of customers' recognition of IP's operational improvement and the innovation in our products. IP customers were also delighted by Seneca Falls 95% plus baseline pumps delivery performance during Q2. This outstanding delivery performance pairs nicely with the rest of our U.S.

facilities and our Korean and Saudi plants. Well done IP. This level of execution mirrors the Motion Technologies' playbook where our Friction business maintained 99% on-time delivery performance despite operating in areas hit hard by COVID-19. Lastly on capital deployment.

Our effective capital deployment strategies consolidated and protected our outstanding liquidity position. This will enable us to continue to invest in future growth opportunities as we pivot to play more often.

Today, we have $1.4 billion of available liquidity and we have ample capital to fund all our operational needs and investments and position us to take advantage of other strategic opportunities. And we continue to protect our cash position through daily and weekly cash reviews and we added a record $169 million cash flow year-to-date.

While we play offense for the future, we will continue to strictly control our capital expenditures. In Q2, we reduced CapEx by 25% compared to prior year and our tracking to our $35 million reduction target for the full year. Our strong liquidity position enabled us to weather the present storm while we sow the seeds of future growth.

We will continue to invest in smart and energy-efficient applications that will drive revenue growth in the long-term. In 2020, the ITT Smart Pad is making new inroads in both aftermarket and OE customers. And at IP, we are currently testing a revolutionary energy-efficient power source for our pumps.

Lastly on capital deployment, we signed an LOI for a new niche rail acquisition as we continue to build out this long-term growth platform. All of these actions executed with speed helped us deliver the Q2 results provided on slide four. Segment operating income margin of 12.6% despite the revenue decline.

We delivered this margin through strong operational execution and fast and decisive trust actions that produce segment decremental margin of 25% and an EBIT decremental margin of 20%. We achieved 52% corporate spend reduction versus prior year. EPS of $0.57 per share was ahead of our expectations and declined 35% excluding unfavorable FX of $0.03.

And lastly, we generated $169 million of free cash flow year-to-date representing a 205% improvement over the prior year. In summary we delivered a solid second quarter in a difficult environment by executing decisive action early and with speed. Now let me turn it over to Tom to discuss Q2 results by segment.

Tom?.

Thank you, Luca. Let's start on slide five with Motion Technologies. MT organic revenue declined 35% due to wide-ranging auto production shutdowns impacting our Friction and Wolverine businesses. In the quarter Friction declined 42%. However, for the first half of 2020 Friction outperformed each of our major OEM auto markets.

In North America, we outperformed by 1,000 basis points. In Europe, we outperformed by 400 basis points. And in China, we outperformed by 1,600 basis points. As discussed during our Q1 call, we expected Q2 top line results to be impacted by unfavorable customer order phasing.

Nonetheless, we continue to project 700 to 1000 basis points of global OE outperformance for the full year, as new platform awards enter the production phase in the second half. Wolverine declined 38% in the quarter but was able to deliver 800 basis points of outperformance for the first half.

And finally KONI and Axtone revenue decreased 9%, as solid Europe OE rail growth, partially offset lower aftermarket revenue in North America and Asia. MT's adjusted segment operating income declined 57% to $24 million, due to volume declines and unfavorable FX of $2 million.

However, MT successfully contained decrement margins to 27% .due to increased manufacturing efficiency, proactive plant shutdowns, restructuring benefits and aggressive discretionary cost actions.

The 27% decremental margin improved sequentially and is also much lower than the decremental margins during the 2008 2009 recession reflecting the true resilience of today's MT. MT delivered solid Q2 margin of 12.2%, mainly reflecting the volume decrease.

Axtone continued to expand margins both compared to the prior year and to the first quarter and Friction China almost returned to pre-COVID-19 margin levels. Continuing restructuring actions in the second half will further bolster MT's structural competitive advantages, which are the foundation for our continued market outperformance.

And these reductions will also help to improve decremental margins in the second half. It is also worthy to note that MT improved working capital by 120 basis points and produced record operating cash flow.

And lastly from an award perspective both Friction and Wolverine continued to gain share with key conquer wins and new platform wins both on conventional and electric vehicles. These awards continue the share gain momentum that will power MT's significant outperformance in the global markets we serve well into the future.

Let's now turn to industrial process on Slide 6. IP delivered outstanding results considering the challenging environment. Organic revenue was down 17%. However, margins expanded 120 basis points compared to the prior year and 240 basis points sequentially.

The IP revenue decline was driven by lower project revenue due to large project shipments in the prior year. Short-cycle revenue was up 4%, mostly driven by lower industrial valve activity more than offset relatively flat aftermarket and baseline activity.

Organic orders for the quarter declined 9%, as 22% project growth, driven by general Industrial market share gains was partially offset by reduced capital investments across major markets due to COVID-19.

IP's backlog at the end of Q2 was up 3% excluding foreign exchange versus the beginning of 2020, providing solid visibility into the second half of 2020. Operating income declined 9% to $26 million, as George and the IP team confined decremental margins to a near 6%.

This was a major accomplishment driven by proactive measures taken in late Q3 of last year and rapid restructuring actions implemented in 2020. And as a result, IP segment operating margin grew 120 basis points to 13.7%.

This operating margin performance was driven by mix, restructuring and sourcing benefits, continued strong project execution, price and government incentives more than offsetting the impacts of volume declines and increased customer payment risks.

Working capital improved 760 basis points as the IP and shared services teams were hard at work securing payments from customers and deleveraging the balance sheet. Thanks to significant inventory reductions that resulted in a 20% improvement in inventory turns versus prior year.

IP's resilience reflects the Motion Technologies business approach as global on-time performance and product portfolio redesign accentuate differentiation with customers. IP will continue to reduce costs in the second half as we implement new restructuring actions and execute on footprint optimization projects. Now let's turn to CCT on Slide 7.

CCT organic revenue declined 29% and weakness across all major end markets. The steep reduction in air traffic lowered commercial aero demand and caused a major slowdown in OE build rates that was further compounded by the specific challenges related to the 737 MAX requalification.

Our Industrial Process business experienced a 7% decline and distribution inventory adjusted to lower levels of activity and medical connector surge in demand to accommodate COVID-19 patient care. Operating income declined 55% on the volume drop and margins declined to 11.1%.

The primary drivers of the declines were volume impacts in COVID-19 and OE production weakness. These impacts were partially offset by strong productivity, restructuring actions, government incentives and lower materials inflation. We expect volatile market conditions to persist for the balance of the year affecting OE build rates at airframes.

CCT's decremental margins of 35% improved sequentially from Q1 and reflected aggressive restructuring actions executed by the business.

CCT executed a footprint move in Q2 and will continue to drive product line transfers to lower cost regions and additional restructuring for the balance of 2020 as a part of the comprehensive operational reset designed to better align with current demand expectations.

So now I'll turn it to Emmanuel, our future ITT, CFO for an update of our cost actions, liquidity and balance of the year expectations starting on Slide 8..

Thank you, Tom. As you can see here, in 2020, we are laser-focused on what we can control. And we implemented aggressive and large restructural cost actions in all of our businesses as well as our corporate at the onset of the pandemic to protect margins and to produce strong free cash flow performance.

In Q2, as a result of this focus, we increased our savings target of $260 million exceeding the original guidance that we communicated during Q1. We have already executed a large portion of our restructuring plan and the remaining actions will mostly take place in international regions in the second half.

We are also detailing incremental actions across ITT as part of our increased cost target of $160 million. Specifically, we added annualized savings coming from our global industrial footprint optimization mainly dealing with IP production facility.

We already announced one closure and the relocation into a larger production site is scheduled for Q4 this year. We continue to prepare plans for additional consolidations. And our discretionary spending cuts were very impactful in Q2 and we will exceed our original target for the year.

Finally, we reduced CapEx by 25% in Q2 and continue to track to our overall target of $35 million reduction. We remain flexible on our CapEx strategy and continue to focus the reduced capital allocation towards productivity and targeted growth projects.

Overall, as a result of the great progress made to-date and the decisive incremental actions we took, our 25% decremental margin in Q2 has significantly improved from Q1 and we now expect total segment decremental margin in 2020 to range between 22% and 28%. Now on slide 9.

We ended the quarter with liquidity of $1.4 billion which was significantly strengthened compared to Q1. Our balance sheet and liquidity position are key strength of ITT and this provides us the ability to effectively deploy capital when opportunity materialize and value creation targets are achievable.

From a cash flow perspective, we continue our strict routines to monitor collections and other working capital improvements on a daily basis. We scored some good wins with customers and our collections in Q2 helped generate a record $169 million of free cash flow year-to-date. This represents an increase of 205% versus the prior year.

We also collected significant past due receivables early in July with key customers to continue our successful receivable harvesting actions. We optimized segment working capital by 210 basis points year-over-year and we have more opportunities to further improve in the second half, especially, regarding inventory at MT and CCT.

However, we also expect demand to increase sequentially at MT and IP which will start to weigh on our second half receivables. Based on this, we are now targeting a free cash flow margin of more than 11% on for the full year which is 160 basis points better than prior year.

The next few quarters will continue to be unpredictable even though the visibility has improved compared to 90 days ago. As a result we will continue to suspend formal guidance until demand certainty improves. But let me provide some perspectives on how we see the year playing out for the balance of 2020.

We expect gradual sequential improvement in the second half, but still expect high-teen revenue year-over-year declines mainly driven by CCT. Despite improving passenger air traffic in Q3, we do not see commercial aero production rates materially improving sequentially.

However, we expect defense revenue to pick up compared to the first half on the back of improved project order intake. We expect auto production rates to improve sequentially reflecting a market decline of approximately 25% for the full year.

We also reaffirm that our Friction OE business will outperform this global market decline by 700 basis points to 1,000 basis points for the full year. Sequentially in Q3, we expect MT revenue to improve more than 20% versus Q2 with further improvement expected in Q4.

This MT revenue growth combined with our aggressive cost actions will fuel solid sequential margin expansion in Q3 and Q4. We expect IP revenue to be consistent with Q2 levels in Q3 and show modest sequential growth in Q4. Finally, we expect corporate expenses in Q3 and Q4 to be similar to Q1.

Overall, we have not integrated in our forecast another global lockdown like we experienced in Q2. Even though we have seen improvements in June and July from certain end markets, we expect the sequential recovery to be erratic because of COVID-19. We expect Q3 EPS to show mid-teens sequential improvement.

The gradual improvement will come from cost actions combined with gradual market recoveries. We are now targeting segment decremental margins of 22% to 28% for the full year. And finally from a free cash flow standpoint, we're targeting more than 11% of free cash flow margin. Let me turn it back to Luca for his closing remarks. .

Thank you, Emmanuel. Q2 has been a very demanding quarter. And I'm very proud of ITTiers' achievement when it comes to our customers. We serve them even better than before by assisting them in navigating this crisis and delivering our products safely and on time day after day.

For our ITTiers we kept our people safe by rigorous respecting health protocols. For our communities the civil right movements have been an inspiration to us all. At ITT we reject racism. Racism has no place at ITT full stop. We at ITT are upstanders and live by the principles of diversity equity and inclusion.

And we're taking concrete actions to make ITT a better workplace. And for our shareholders, we delivered record free cash flow, and aggressively reduced costs to limit the impact of lower demand. We're already playing offense and using our strong competitive position to our advantage.

We will continue to focus on what we control, and drive of operational excellence, customer centricity and effective capital deployment. These are our value-creation drivers. Before taking your questions, I would like to take a moment to acknowledge my colleague Tom Scalera.

As you are aware, Tom will be stepping down as ITT's Chief Financial Officer as of October. At this time, he and Emmanuel Caprais who will be succeeding him as ITT's next CFO are working closely on the transition. You should know that, it was Tom and I who recruited Emmanuel in 2012. This is when our partnership started.

I want to express my deepest appreciation to Tom for all he's done for ITT, for our customers, our ITTiers and of course our investors. Tom has been with ITT since 2006 and was named CFO in 2011, as we navigated the spin-off. Since that time under Tom's leadership among many others accomplishments ITT's market value tripled.

I'm sure that many of you have gotten to know Tom professionally during his time with ITT. He has spent a lot of time with many of you in all of his roles here. By my calculations, Tom has made more than 50 quarterly earnings calls.

Also, between conferences and other meetings he has been part of more than 1,700 investor and analyst meetings during his tenure as CFO. That number is even higher when you consider all the interactions he had with many of you, up until he became CFO.

But for those of you lucky enough to have gotten to know Tom personally, you also know that, he is not only a special finance leader, but a truly special person, who cares about people and who always bring a fresh perspective. And he does it with a great sense of humor.

I found his counsel and partnership, during our time working together to be invaluable. When I was getting ready to start into my new role as CEO, ITT provided some – provided me some coaching on the IR side. Still, I can tell you today that the best coaching was in working day in and day out with Tom.

And listening to his perspective and absorb from his experience. As he goes on to his next venture to focus on the charitable foundation, he co-founded with his late wife Rebecca The Cancer Couch, I want to wish Tom the best of luck and from my heart thank you Tom. Now, we are ready to take your questions.

Maria?.

Thank you..

The floor is now open for question. [Operator Instructions] Thank you. Our first question coming from the line of Mike Halloran of Baird..

Good morning, everyone, and best of luck Tom. Enjoyed working with you the last decade. It was a little mean to look at kind of all those earnings seasons and conference calls and everything. I tried my best not to do it myself, but it's been very enjoyable and best of luck..

Thanks, Mike..

So a couple of questions here. First on the motion side, certainly helpful with some of the sequential commentary, but maybe you could dig into the regions.

What you're seeing on a regional basis from a recovery perspective? What kind of production assumptions you guys are using at a high level for the back half of the year on a regional basis? Obviously, the outperformance will be there and it's always great to see but a little bit more granularity on just what the end markets are doing would be great?.

Sure. So, Mike, let me tell you about our view of the market. Now, when as you know when you look at HIS, IHS is projecting a global market decline for the full year roughly of 22%, heavier in Europe and North America, and in the minus 13% or something like that for China.

What we are projecting today is a little bit worse than HIS, but better than our previous forecast. We like to be a little bit more conservative, because this help us in adjusting our cost in a more aggressive way.

But I can tell you that in the last three months, we have revised upwards our forecast for each of those regions for Europe, China, and North America. The reason for that is, of course, what we have seen in China, in Q2 with a very good recovery and a growth roughly of 9%.

You have to watch carefully, if there was some pent-up demand there coming from Q1, and also in talking from our customers. So this is why we revised our forecast upwards from our view three months ago. Let me share a couple of more data points that might give you some more color. We are – we do not have big concerns on programs. There might be delays.

But we have not experienced any cancellation and the majority of the programs are really starting maybe a little bit later and maybe a little bit lower, but no major cancellation that we at ITT are experiencing.

And then the last data point on the markets, I would say, we talked in the past I shared with you that, when we are looking daily at our order book, because we are tracking that on a daily basis, we look at what we call the variation factor.

The variation factor is the variation that you get in your order book from the beginning of the month until when you close the month. And what we have seen is that the variation factor, which was huge, which showed a lot of volatility in the past improved – continued to improve in China in Q2.

We saw Europe and North America behaving in Q2 like China did at the beginning of Q1 and then in Q2. And then when we look at the July variation factor is almost at normal level. So all of these is good, because this needs less volatility, more stable market and a supply chain that is more in control.

So Q3 will see a substantial sequential growth over Q2..

That's super helpful. And then on the IP side, maybe help with the backlog commentary and the order commentary in context, the strength in the general industrial side was surprising and the overall orders were pretty reasonable relative to what the environment looks like.

How does that inform how you're thinking about the next 12 months here? How do you think this backlog spins off? What's the ability to replenish as we sit here? Any kind of context around that would be helpful..

Sure. Thank you, Mike. So when you look at the orders, right? The orders were down 9% year-over-year roughly 10% sequentially. But you have two different stories within those orders.

You've got the project side of the business which was 22% positive year-over-year and flat sequentially while actually slightly positive and the short cycle which was minus 17% with the baseline and parts around in the low-20s. So when you look at this, what you see is also a backlog, which overall is up 3% year-to-date.

Once again the same things in the backlog. You have the project backlog which has gone up, since the beginning of the year and the short-cycle backlog that has gone down.

So what you have -- I'm sharing this because when you look for instance at some of these great improvement in margins that you see in IP despite the revenue decline comes also from the mix. This has been a tailwind for our Q2.

It would be more of a headwind when we move to Q3 and Q4 as the short-cycle orders lower in Q2 because of the lockdown, which was supposed to be delivered in Q3 of course they're representing a headwind from a mix perspective.

When you look at the funnel, I would say the -- interesting enough, the North America funnel has grown year-over-year has grown since the beginning of 2020 and has also been growing since March 2020. So we see on the North America, it's strong funnel. And when you're talking about general industrial, you know that this is our bread and butter.

This is really where in North America we are strong both directly and also with our GDPWW which is our distribution network, which is the envy of the industry. Where we have seen a little bit more challenges on the funnel and probably you will expect that is in the Middle East, which is our second largest geography.

When you look at the Middle East funnel that has gone down during Q2. And this is mainly because orders have been assigned. But what this means is that really the replenishment of the funnel is not as fast as it was in the past. And that is the region where that has gone a little bit slower.

When you look at July, we see some positive sign though in July in terms of some opportunities coming into the funnel..

Great. Appreciate the color. As always it was helpful..

Thank you, Mike..

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

Thanks, good morning, everyone..

Good morning, Joe..

Hey, Joe..

Tom, echo what everybody else has already said just really great work with you over the years and thank you for all the help wish you nothing but the best and congratulations to Emmanuel as well..

Thanks, Joe..

Thank you, Joe..

So maybe just starting out, I think I'm just going to focus my questions on really just the margins. And your comment on mix notwithstanding Luca on the IP business, the results this quarter from a margin perspective was really, really good.

And so I'm just thinking about kind of like that longer-term entitlement that we've talked about mid-teens type entitlement, do you feel like your -- the progress that you guys are making is allowing you to hit that -- or is going to allow you to hit that number in a quicker way even despite this backdrop that we're experiencing?.

Well I think that the performance has been outstanding at IP. And I really applaud George, Dave and the entire IP team for what they've done. A decline of 17% in revenue, an improvement of 120 basis points, you have to think about that improvement.

We had a headwind of volume which was roughly 500 -- I want just to give you a color to put in context, a headwind on volume of roughly 500 basis points, but we had a positive mix which contributed roughly 340.

The net productivity is 250 basis points and that was good because when you see this net productivity of 250 and it comes both from the productivity in operation, productivity in supply chain and productivity in restructuring savings all of this makes it a nice path to tracking towards our 15-plus margin.

Now when it comes to the timing, I would say I will still stick to our two years' time to get to our 15-plus. And I will -- and this will come in two ways. We will keep on having headwinds because of the COVID-19 the rapid demand. In the next couple of quarters, we will have headwinds in terms of the mix.

But because of the extra actions that we are taking and the footprint action that we are taking and the continuous productivity, I believe that in the next couple of years we will hit our 15-plus target..

Okay. That's super helpful context, Luca. And then just staying on the margins for a second maybe conversely just talking about CCT and the headwinds that business is seeing from an end market perspective.

How do you think about the path for that business from a margin standpoint as well? And maybe talk specifically around some of the actions that you're taking to drive better profitability longer term?.

Okay. When you look at the CCT I like to think about CCT in -- the business in CCT you have the aerospace and we know -- you guys know better than anybody else in terms of what's happening out there and it's practically lower for longer.

And then another part of the business the connector business the short-cycle business and this business will react fast if the recovery happens. So, when we look at the aerospace this is -- we have to be very aggressive on our cost structure and we are aggressive on working on our working capital.

So, this is where our restructuring action has been more impactful. If we think from a business -- from a margin perspective I would say probably more than 300 basis points improvement came from restructuring actions at CCT. But at the same time, we need to be ready to play offense also in CCT because of the short cycle.

So, because when we want -- when the economy starts again we want to jump on that surf and ride the way. And with the connectors and with the short-cycle business we can do that. But really it's a cosplay addressing our cost structure and reducing our structural costs even further. .

Yes, Joe if I could just build now on what Lucas highlighting there I think we're on a good trajectory with the connector business when markets do start to recover across the end markets that we serve.

I think we'll see a more immediate or shorter medium term benefit in the margin profile of our connector business which as you know has been gaining a lot of momentum prior to COVID-19. And I think the actions we're taking are going to give the connector portion of CCT even more upside when we're dropping incremental margin performance.

Certainly, the question on the duration of the segment target is around the aerospace component side of the business which right now is little bit more and manage cost and wait and see until the topline becomes more certain in the future.

But I think where we have the leverage and the torque and the momentum is probably more on the connector side of the portfolio particularly if the market demand comes back..

That's helpful guys. Thank you so much..

Thanks Joe..

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

Hi good morning everyone and Tom thank you for all of your help over the years..

Good afternoon Damian. Thank you..

I wanted to follow-up on some of your comments on IP and specifically on the margins given the various moving pieces there with the cost productivity actions and then sort of the order dynamics with the short-cycle but the higher project orders and obviously some timing around project delivery.

What's the margin cadence that we should be thinking about for the second half in IP?.

Yes, I think Damian one of the things -- so we mentioned that there's mix pressure that we're going to be offsetting as we roll from Q2 into Q3.

And fortunately, one of the offsets as the restructuring actions that we've been taking and the incremental restructuring benefits we're expecting in Q3 is going to give us some nice offset to a less favorable mix as we progress through the quarter.

So, there's opportunity for us to outperform the prior year from a margin perspective in Q3, but I think sequentially we're kind of little bit too much mix to overcome but I think we're going to be in the same zip code for the balance of the year from a margin perspective plus or minus 20, 30, 40 basis points from kind of where we jumped off Q2 based on mix and restructuring savings.

But I think fortunately we do have a lot of momentum built up on our cost actions and restructuring actions and those will gain momentum as the year progresses..

And if I may add to what Tom said and because obviously when you look at the mix the short-cycle obviously is more profitable than the project. But one thing I can share with you is this beautiful chart of the profitability of our project backlog and you could see this line which for the last three years has constantly gone up year-after-year.

And the backlog that we have at the end of Q2 the profitability of the backlog is the highest has ever been for our project backlog which is a good position to be in..

That's really helpful. And then switching over to MT. It seems China is going to be leading you out of the recovery for the Friction business. I was wondering if you could maybe just discuss how that business is progressing for you and how you're feeling about your market share objectives in the region.

And also just wondering if you've seen any changes structurally in the market or any evolving competitive dynamics just kind of coming through the pandemic?.

Okay. So, when we look at China we outperformed the China market in the first six months by roughly 1600 basis points. And when we look at our awards year-to-date I'm very happy about the performance of the team in general. But specifically when we look at China one-third of the awards that we had year-to-date in 2020 are actually in China.

And one-third of the total awards are actually new conquer and the platforms where we are not in. So, I'm feeling positive about the trajectory of the market share gain momentum and because of this new awards because of the conquer awards.

And when we look at the China performance in general also of the business I would say even though the utilization of the machines of our equipment is not even close to where it was supposed to be overall, in the world the efficiency that we have of these machines is already around 85% and the labor productivity is already above 80%, when you're not running a fully loaded factory is already a pretty good achievement.

So, feel good about the market share gain, and I feel good about how China is performing from a P&L standpoint..

Okay, great. Thank you. I’ll pass it on. Best of luck, guys..

Thanks, Damian..

Thank you, Damian..

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

Thanks, and I echo the same sentiments Tom, best of luck..

Thanks..

Sure. With respect to CCT, I want to make sure I understand.

Can you talk through kind of the organic cadence for that business in the back half of the year? With incoming order rates I think down 37% I'm curious as to whether organically that business gets worse before it gets better?.

Yes, Matt. This is Emmanuel. Sorry. So we don't bxpect a significant improvement in terms of top line from CCT on a sequential basis, because it's linked. As a reminder, 35% of our revenue there are aerospace. And we know that passenger air traffic is not really going to improve sequentially and probably OE build rates are not going to improve as well.

So, we don't expect a meaningful recovery. We expect year-over-year declines to be similar to what we've seen in Q2. And so, as Luca said, CCT for us is a -- for the moment is a focus on taking our cost and reducing as much as possible decremental margins, so that we can benefit for -- from really nice incremental margins when the business picks up.

We think that for aerospace we're going to see a recovery that is probably similar to what we experienced after 9/11, it's probably going to take two to three years.

And as Luca said, we have discrete opportunities to really repurpose some of our resources to projects mainly in defense some other short-term opportunities to try to boost the top line in the meantime. I would say that -- I would say to finish that our connector business is very short cycle. So we've dipped pretty quickly in Q2.

And so as the economic recovery happens even slowly that business of connector is going to bring us a little bit of growth from a sequential standpoint..

Thank you. Just as a follow-up, what sort of P&L benefits should we expect to carry over into 2021 when we think about incremental pluses from all the cost takeout you're doing this year? Thank you..

And Matt, you mean for all the businesses correct?.

Correct. .

Okay. So, our $125 million plan is an accumulation of several different actions. What we expect is that for 2020, a benefit of around $90 million of those actions. And then when you look at 2021, we expect around $100 million.

And the reason for this increase is that you're going to see some of the discretionary cost actions that are going to come back in 2021 compared to 2020 but you're also going to see some restructuring benefits and we're going to enjoy the full year benefit from those actions. So, $90 million roughly benefit in 2020 more or less $100 million in 2021.

We expect as I said, some of those -- the majority of those cost actions will be structural. We expect some of them to come back. I think when you think about incrementals, they're going to be larger than our decrements and we expect that they are going to be north of 35%..

Great, thank you, guys..

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

Hey, good morning, guys. Best of luck Tom look forward to staying in touch..

Thanks, Jeff..

Just on, I guess back to MT, I'm just trying to better understand kind of what region like regionally how you're thinking about production and where you're maybe more different than IHS and then just maybe speak to what you're seeing in terms of aftermarket trends?.

Sure. Good morning, Jeff. I would say then on IHS, we are definitely more conservative compared to IHS across all the three regions. Both in Europe, in China, and North America is spread across all three compared to them. So when they're talking about a 21% decline, so they're thinking about roughly 69 million, 70 million vehicles produced in the year.

We are more in the region of 65 million vehicle produced in the year, and these are spread, as I said, across all the three different regions.

And what was the second part of your question, Jeff?.

Just aftermarket trend for....

Aftermarket, yes. When we look at the aftermarket, we see at Q2, was actually a worse deterioration compared to Q1. We saw Q2 roughly around minus 20%, and when we look -- so this for the full year we are around -- probably around between minus 15%, minus 16% and we expect these probably to continue for the full year in terms of this range.

This is the feedback that actually I got from one of our major aftermarket customers just the other day over the phone. This is what they are expecting as a market. .

Okay. And then, just -- I mean I know, Emmanuel, you gave some good color on CCT and like sequentially, but I'm just trying to -- the orders tend to be lumpy, and they're pretty ugly in commercial and defense had the comp.

But like, where do you think the commercial business is falling out in terms of kind of run rate declines? And then, what's ex kind of the lumpiness? What's kind of the outlook on the defense side?.

So, on the defense side we have -- defense is a little bit more lumpy. So what you have if you look at defense probably overall for the year we will be -- while the market is roughly flat, we will be around minus 7%. Now it's different first half and second half.

We have a good second half comparing versus prior year just because of the way that they program, and whereas in the first half we were on the negative side. When it comes to defense aftermarket, we are positive year-over-year mid-single digit. .

And same on the commercial?.

On the….

So on the commercial, we think that for the full year we're going to be impacted by the lower build rate. So probably we're going to be around 50% in terms of revenue declines for our commercial aerospace business. One thing that's to note here is that portion of our business is linked to interiors.

And so as airlines cut their discretionary spending on refurbishing the interiors, we are impacted disproportionately on this business. And that's why you see a little higher aerospace decline..

And what's the difference between you and the market for defense?.

So we expect the market to be around flat for defense. And so as Luca said, we're going to be down mid-single digit..

Is that just program timing or…?.

Yeah, you're right Jeff. Defense is very programmatic for us. And so this is why we're seeing a second half that is stronger than what we've seen in the first half..

But it's just a question of program Jeff..

Okay. Luca good to see you back down on the road again..

Absolutely..

And Jeff just to finish off on the industrial side of CCT. So I would say all of the industrial facing parts of CCT are probably outperforming the markets that they serve. Obviously there's a lot of different subcategories.

But if you really look at it, aerospace market for CCT generally in line -- with different pressures across the commercial aerospace sector, but generally in line. Defense a good second half but probably facing a little bit more programmatics on a full year basis, but a solid second half in defense.

And then I would say the overall industrial portion of CCP probably slightly ahead of the markets that we serve just to give the full perspective for the year..

Okay, great. Thanks guys..

Thanks, Jeff..

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

Thank you. Good morning everybody. And Tom I hope you get some nice parting gifts, maybe a new brief case..

Sounds great..

You're welcome. The old ones are the best ones.

Hey are you guys -- maybe this is for Luca and Emmanuel, are you increasing your cost reduction targets because you're finding more opportunity or because the outlook has become more challenged than you thought versus last quarter?.

So let me address this. And then Emmanuel you can deal on that one. I think that it's just part of the way of our operating in terms of being proud, but never satisfied and ensure that you continue to build your war chest of opportunities.

As a matter of fact, I would say, looking at how the market is evolving, I think that our biggest market, which is -- our biggest sector, which is Motion Technologies and automotive, we had the trough in Q2 and we expect sequential improvement in Q3 and in Q4 as the recovery happens. So that would be the answer.

It's a question of way of operating and reaching our war chest and this is it really..

And specifically on the increase to $160 million, it is driven by some footprint actions. And here the footprint is mainly at IP. And we always had those -- some of those plans but we were very not to disrupt the customer. So we were really slow rolling those.

And as demand has declined significantly, we have seen this as an opportunity to really accelerate our footprint operation, and we've announced a footprint consolidation at IP in Q2 and we'll continue to do so in the rest of the year for several other sites. And then additionally, we were really aggressive in reducing discretionary costs.

And then -- so we're benefiting from that increased targets of $160 million..

So as kind of dovetails in with that question, I mean where would you guys say versus where we were at the beginning of last quarter? Where would you say things are playing out better or worse versus your expectations in the end markets?.

Okay. So when we look at -- and let me give you also some color in terms of July. We think that we have seen China recover it nicely on the automotive market. And we are seeing also when we look at the month of July, what we told a variation factor, which is almost back to normal.

So I will say in general Motion Technologies is and that market is performing better than what we were expecting. And this is also why we changed our forecast. It's not like what IHS is saying, but definitely better than what it was three months ago.

And then when we look at also on the IP side, I'm encouraged by some of the things that they've seen in July. When I look at -- we are always looking at some leading indicators. So on the short -- we got a good picture on the project.

But then when we look at the short-cycle, we looked at daily rates for parts or weekly rate for baseline or service or valves, and I'm encouraged by the numbers that we have seen in July, which are a little bit better than our forecast..

What about the oil and gas Luca? I mean, you had talked about potential share gains. Is that industry -- it's obviously a pretty tough spot right now.

Is that industry playing out the way you had thought? And are you still on track to put forward those share gains that you had talked about in the past?.

I think we are. So when you look at oil and gas you are looking at two parts of the business in oil and gas for ITT. So first of all, oil and gas in ITT represents roughly 10% of all ITT business. And we have the connector side of the business where -- that are playing only in the upstream, and we will outperform this market.

Upstream would probably be for the full year roughly minus 40, minus 50. We will be in the region of minus 20. And this is because of market share gain particularly in the Middle East. Now when we look at oil and gas for IP, we play in the downstream, upstream, as well as midstream. And we will be outperforming in that market as well.

And what we saw there we haven't seen really any project cancellation, John. We are seeing some projects get delayed. But our strategy on those delayed projects is really to win engineering orders. And even if you don't get the full order of the project with engineering you build in the customer intimacy and you've got the foot in the door.

In July, actually we had a positive news on, the oil and gas was an order that was put on hold during Q2 in July came back active and we are starting talking again to the customer. So I would say confirming the market share gain and that order was in Kazakhstan..

Yeah. Got it, great. Thanks. And good luck, Tom..

Thanks, John..

Our next question comes from the line of Bryan Blair of Oppenheimer..

Good morning, guys. Tom, thank you for all your help, over the years..

Absolutely, Bryan. Thank you..

Good morning, Bryan..

I was hoping you could break out the monthly sales rate for Friction aftermarket in the quarter. I assume April was quite painful. And then, there is some degree of recovery to get to the down of low 20s.

And if you could also speak to the July sales rate just trying to gauge the pace of sequential recovery?.

Okay. So definitely there was an improvement. I mean, when you look at the quarter of Q2 obviously, April was -- because also you think about it -- our aftermarket is a European business. So what you see is that April was definitely the worst, May was not much better but May is when actually some of the lockdown became easier.

And then, you have a better situation during the month of June. July was still -- is still catching up. So that is the normal -- I would say the normal trend that you will expect with the easy of a lockdown in Europe..

Okay, understood. And you called out the rail M&A pipeline? It sounds like that build-out could accelerate a bit over the near-term.

Can you remind us of the run rate size of your KONI/Axtone platform? And I know we tend to discuss entitlement ranges in terms of margin but do you have a target in mind for the scale of the rail platform as you continue organic and M&A investment?.

Sure. So when you look at the KONI/Axtone business you're talking roughly about 200 -- $200 million to $210 million platform. And when we look at building a rate platform we're talking about in the long-term to be a business of roughly $500 million $600 million.

When you look at this acquisition this inorganic opportunity it's a small -- it's a niche acquisition so it's a small one. But is a good -- is a well-run company that might enable us also to play a bigger role on the service side of rail. So that is a nice and need addition. What we have been doing Bryan is really cultivating this heavily.

We have paused because of COVID of course. We have reactivated recently because of the easing of the lockdown, but I would say, it's a niche application and is a bolt-on..

Okay. I appreciate all the color.

And again, if we think longer-term for the rail platform can that business structurally, get to Friction type margins?.

Yes, it can..

Okay. Excellent, thank you..

Thank you..

Our next question comes from the line of Brett Linzey of Vertical Research..

Hey good morning everyone. Many thanks to Tom and congrats to Emmanuel..

Thank you, Brett..

Just first a point of clarification on the cost savings, Emmanuel you indicated $90 million this year $100 million next year.

I just want to make sure that $100 million is in fact incremental to the $90 million?.

No, no. It's not. It's not. What's incremental is roughly the $10 million to go from $90 million to $100 million. And the reason for this you basically have restructuring actions that are carrying over and that gives you an incremental benefit. And then you have some of the discretionary spending that is rolled back..

Got it. Okay. And then just on the balance sheet obviously in great shape. The pension I know is frozen at 108%. Is there an opportunity to move that off balance sheet? And then just second on the asbestos.

Could you just provide a little more color on the qualified settlement fund noted in the slides? And then strategically, is there an opportunity to fully eliminate and remove that this year or next?.

Yes. Thanks Brett. Certainly a lot of momentum and positive elements to the balance sheet story that you're highlighting. So for sure to start with pension that 108% funded our plan is to terminate the pension plan to move it off balance sheet to an, insurance company this is the U.S. pension plan specifically that we're referring to here.

So that effort is in motion and that is something that we are trying to accomplish by the end of the year for the U.S. plan. So that's in good shape. And we're progressing with that with a good team working on it. The QSF is basically -- that is where we store all of our proceeds from settlements with our insurance providers.

And that QSF continues to grow now and basically that's cash that we could use for many asbestos and the majority of our environmental spend that we have. So the good news about the QSF is no operating cash is going towards satisfying those legacy obligations. That money is already in our internal QSF fund.

And when we have to make asbestos claims or environmental claims, we can use that cash to satisfy those claims and that's going to give us really good coverage for the next, roughly two years, potentially plus around both asbestos and environmental cash outflows. And then, lastly, continuing the momentum on asbestos. We've driven that liability down.

We've done a lot of things to structure it in a certain way, so that if there is an opportunity, Brett, to find a counterparty or transaction, obviously, that could make sense, there are options or examples out there of different ways to address this liability.

And I would just highlight that we are constantly evaluating all of those and would look for an opportunity that might make sense. But in the meantime, we'll drive that net liability down 45%, 50%, as we have. We'll use our QSF cash to satisfy the obligations, which will maintain minimal draw on operating cash.

And if we see a good strategy to do something in the future, we're certainly actively reviewing those on a constant basis..

Okay, great. Congrats on a good quarter and best of luck..

Thank you..

Thanks, Brett..

Our next question comes from the line of Andrew Obin of Bank of America. .

Hi. Good morning. This is Emily Shu on for Andrew Obin. I wanted to extend my thanks and best of luck to Tom and congrats to Emmanuel..

Thank you, Emily..

Thank you, Emily..

Just a question on supply chain. Did you adjust your sourcing at all in the quarter or move some production in region? And also how did the Mexican facility function, given that there were extensive government-mandated shutdowns? Thanks..

Okay. Thanks, Emily. So when it comes to supply chain we had good savings in supply chain across all the different businesses in the region of roughly triple-digit, more than 100 basis points improvement from a margin point of view. We had no major disruption on supply chain, because of the shutdowns.

We had our backup plan, particularly when you think about Motion Technology in terms of our suppliers, so we have built the kind of resiliency and some redundancy in the supply chain, but no major disruption on the supply chain.

And when we had some hiccups because of, maybe, some suppliers coming -- some casting coming from Asia, we've been able to work together with the customer to adjust a bit the schedule. Now, going to the second part of your question, which is Mexico. Our Mexican operations in Nogales kept on operating across the quarter.

We had several audits with the government and in some cases we're at 30%, at 50% or 70%, based on the situation that was in the state of Solana where Nogales is.

When it comes to the Mexican facilities in Silao for Motion Technologies, we shut down that facility during the month of April and part of May and that was mainly because of customer demand and customer demand only. They restarted and we are operating it right now..

Okay, great. Very helpful. And then a follow-up question on Motion Tech. Any outlook on autos into 2021? In terms of maybe build rates being revised up and with Motion Tech's outperformance, could Motion Tech be up in 2021? Thanks..

I would say, when we look -- what we see is, obviously, 2021 is going to be -- the focus is going to be higher than 2020. So the growth will continue. But there -- it's not going to go in 2021 to the level of 2019 and I think that exactly where this growth is going to land is probably a little bit too early to tell.

So there is growth, that the trajectory is there, but it's probably a little bit too early to tell. But one thing that we can commit is that, Motion Technology will continue to outperform the market..

Okay. Good. Thank you very much..

Thank you..

Our next question comes from the line of Joe Giordano of Cowen..

Hey, guys. Good morning and good to see you guys are finally upgrading the CFO job. It's been long due. No, Tom, I’m going to miss you, man. [indiscernible] So you -- Luca, you mentioned that the project profitability in IP in the backlog is the highest it's been in years.

Just given some virus flare ups and now there's kind of some confusion about what the pacing of opening up and things is going to look like.

Like, what's the risk of the longer stuff stays in backlog, what that does to the profitability?.

Okay. So, when you look at what -- how the funnel and the backlog have evolved in the last six months, Joe, and the last six months, I would say, have been the worst.

And I expect the last six months to be the worst in this COVID-19 crisis, because we didn't know when this happened in Asia Pac, there was a major complete lockdown in Europe for more than a month and the same in North America. In all this environment, what we had is our backlog for our project actually went up 3% since the beginning of the year.

And if we look at the funnel in the two main regions that we operate North America and Middle East, the Middle East went down during the last quarter even though in July it started replenishing up and in North America it's actually gone up.

So, I would say and adding to that I haven't seen any major cancellations only some postponement, some shifting to the right. I would say I don't see any major issues with the project side of the business.

Now, if there are some changes on the contract, usually there is some protection there in terms of the terms and condition that you have with the contract but we are not experiencing any of those at this moment and this has been -- probably been the most demanding quarter for the business in Q2. .

That's helpful there. And then I just wanted to ask one more on rail.

Can you kind of just describe the landscape there? Like how regionalized are the companies that you're looking at as targets? Like, if you're buying a business that's in one region, can you globalize that? Or would you have to buy similar companies that make -- that do similar capabilities in different regions of the world.

How -- are there are there big companies out there or are there going to be a lot of kind of rolling up of smaller players kind of just go off on that a little bit?.

Yes. It's a little bit of a mix Joe in the sense that rail is very regional. And therefore you tend to have more small medium companies that have a good foothold in the region. Sometimes it may be in a specific country. So, this is the first thing in general.

Then of course, it depends on the product because, if you think about our business county, we have our shock absorbers that go on the cars of the train in locomotives, high speed trains, coach and they are both on the GE locomotives here in the U.S. as well as in India as well as the locomotives in China.

They are on the high-speed train from Siemens, Bombardier, Alstom, CRRC, so those products for instance are more global. So it depends. But generally, it's a very fragmented market with small medium companies..

Thanks guys..

And ladies and gentlemen, that was our final question. I'd now like to turn the call back over to Tom for any additional or closing remarks..

Yes, thanks. Thanks Maria and thanks to everyone. I just wanted to take a quick second. I know we ran long to thank all of the analysts and investors, it's been my pleasure and my honor to get to know you and to work with you and to represent ITT and to help you understand and appreciate this company and all the potential that we have.

And I've enjoyed the experience and the opportunity to get to know many of you very well over quite a long period, so I'll miss you all and I just wanted to thank you. I want to thank my world-class team and in particular Michelle my support that many of you know that they've all helped to make me much, much, much better than I am.

Certainly, want to thank Luca for all of his support and his incredibly kind words and no I did not script those for him. Those were from his heart and from his pen. So I really appreciate his kind words. And lastly to Emmanuel best of luck and congratulations. I know ITT is in great hands. And we have a great balance sheet and a tremendous future.

And Emmanuel, Luca will certainly help us realize even greater value creation going forward. So, thank you all and hopefully we can all connect at some other point in the future. And with that Maria, I think we're pretty well concluded. .

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