Welcome to the ITT's 2023 First Quarter Conference Call. Today is Thursday, May 4, 2023. Today's call is being recorded and will be available for a replay beginning at 12 p.m. ET [Operator Instructions]. It's now my pleasure to turn the floor over to Mark Macaluso, Vice President, Investor Relations and Global Communications. You may begin..

Thank you, Elliot, and good morning. Joining me here this morning are Luca Savi, ITT's Chief Executive Officer and President; and Emmanuel Caprais, Chief Financial Officer. Today's call will cover ITT's financial results for the three month period ending April 1, 2023, which we announced this morning.

Before we begin, please refer to Slide 2 of today's presentation where we note that today's comments will include forward-looking statements that are based on our current expectations.

Actual results may differ materially due to several risks and uncertainties, including those described in our 2022 annual report on Form 10-K and other recent SEC filings. Except or otherwise noted, the first quarter results we present this morning will be compared to the first quarter of 2022 and include non-GAAP financial measures.

The reconciliation of such measures to the most comparable GAAP figures are detailed in our press release and in the appendix of our presentation, both of which are available on our website. It is now my pleasure to turn the call over to Luca, who will begin on Slide 3..

Thank you, Mark, and good morning. As always, I would like to begin by thanking our shareholders and our customers for their continued support and investment in ITT. And again, I also want to recognize our employees around the world. It is thanks to your efforts that we were able to deliver such a strong first quarter.

If there is one thing about ITT's Q1 results, I would like you to remember, is our performance on both growth and execution.

We delivered solid start to 2023 on all accounts, 10% organic revenue growth, leading to ITT's highest quarterly revenue ever, 7% organic orders growth, 150 basis points of segment margin expansion, 21% EPS growth, and a more than $60 million improvement in free cash flow.

We also signed a strategic aftermarket agreement in Friction with our partner Continental, repurchased $30 million of ITT shares and deployed $80 million towards the acquisition of Micro-Mode in May. Now let's get into the details. On growth, Industrial Process orders grew 22% as a result of continued share gains.

We generated significant commercial momentum in the green energy space with large project awards and market share gains related to decarbonization. Project orders in IP grew an outstanding 54%, while on the short cycle, orders for aftermarket baseline pumps and valves grew 13%.

The orders momentum drove IP's revenue growth above 25% this quarter and added to an already large and most importantly, profitable backlog entering Q2. In Motion Technologies, we won 41 electrified vehicle platforms awards with leading OEMs, including BYD in China and Ford and [Chrysler] in North America.

Continuing with electrification, orders in our EV connector business grew over 15% and with sales growth eclipsing 20% as electrification investments continue. Moving to execution. Once again, Industrial Process led the way with 850 basis points of margin expansion to end above 21% for the third consecutive quarter.

We are continuing to push on shop floor improvements and the lean out of IP's manufacturing size, accelerating strategic pricing actions across the short cycle portfolio and driving increased profitability on pump projects in backlog.

Together with the ITT leadership team, I spent time at our Seneca Falls campus, and reviewed our progress on the new lean layout. When it is completed in Q3, every single pump will be built using one-piece flow process. By eliminating excess movements, we will accelerate throughput, reduce lead time and improve our on-time delivery.

We are on a journey of continuous improvement, and we have no finish line. Also this quarter, I finally returned to China and spent time with our Wuxi team. We reviewed the investments that were made on the shaft floor and plans for the future.

You may remember that our Wuxi employees achieved amazing feats last year by operating in isolation throughout the pandemic and working through a mass infection wave in December, all while adding new capacity and maintaining 99% on-time delivery.

As Wuxi plant continues to gain market share, especially in EVs, we're adding 2 new production lines and increasing capacity beyond what we initially thought was achievable. It was wonderful to be in person with such a high-performance team to discuss the vision for the new plant layout and how it will support EV growth in the region.

We are making similar growth investments in IP, which I saw firsthand. Saudi Arabia had a perfect on-time delivery performance and impressive orders growth last year. This is why we are expanding their testing capabilities. In India, a market with great opportunity, we're also expanding our design center to support growth in the region.

And in Germany, Bornemann is gaining share in decarbonization projects, which is driving the further expansion of its testing center. All of these sites have earned the right for investment. We also executed on cash and capital deployment. Free cash flow is rebounding with a $62 million increase versus prior year.

This is a continuation of the positive trend we saw last quarter. And in the coming quarters, as supply chain disruptions begin to subside and we free up working capital, we expect cash generation will continue to ramp. We also repurchased $30 million of ITT shares and paid down roughly $70 million of outstanding commercial paper.

Finally, yesterday, we announced the acquisition of specialty connectors manufacturer, Micro-Mode for approximately $80 million. Micro-Mode has held a leading position in defense and space connectors for more than 30 years and brings a complementary technology portfolio to our profitable North America connectors platform.

Each quarter, I like to highlight the progress ITT is making with our sustainability investments. As you hopefully saw last month, we announced a $25 million investment in green energy and sustainable projects, including solar panel installations and other energy efficiency initiatives.

Together, these installations will reduce ITT's CO2 emissions by more than 6,000 tons annually once completed. Moving to our 2023 outlook. We are raising the midpoint of our adjusted EPS range by $0.05 after a strong first quarter.

We have renewed confidence in our ability to deliver the midpoint of our updated guidance range due to a more than $1 billion backlog and exposure to growing aero, auto and energy markets.

In Q1, we delivered growth and execution, double-digit organic revenue and EPS growth, 150 basis points of segment margin expansion, and an over $60 million increase in free cash flow. So now let me share some of our commercial wins this quarter on Slide 4.

In March, we signed a 10-year $1 billion agreement with Continental to supply aftermarket brake pads in Europe. Our Friction team consistently provides the highest level of quality and service for our auto customers, and this helped us secure this important partnership.

Under the contract, Motion Technologies will continue to provide copper-free brake pads for ATE, Continental's premium brake pad brand. Additionally, Continental will market and sell highly trusted brake pads from Galfer, an ITT brand, to help expand our aftermarket presence in Europe.

The agreement contains improved volume incentives that will likely elevate the total value of the agreement to over $1 billion over the 10-year term. It also preserves ITT's ability to expand our aftermarket business in China. Congratulations to Vincenzo and the Friction team on this exciting next chapter.

We're delighted to continue serving Continental and help them win in the car aftermarket. In Industrial Process, our Bornemann twin screw pumps are leading the way on large-scale green projects, thanks to their multiphase boosting technology. In Q1, we were awarded anti-flaring projects at 2 oil and gas sites in Nigeria.

Thanks to our Bornemann pump, our customer will eliminate roughly 350,000 tons of CO2 per year and avoid environmental fines. In early April, we won another decarbonization project at the largest LNG field in Australia and 1 of the largest sites in the world.

This carbon capture project, the largest in the world, is expected to reduce CO2 emissions by 100 million tons over the system's lifetime. I want to thank [Yaron] and the entire Bornemann team for developing these opportunities, establishing an incredible customer intimacy and working hard to share the value of our Bornemann pumps with our customers.

The technology of our Bornemann pumps plays and will continue to play a pivotal role in the decarbonization of the energy industry. Decarbonization is good for ITT. Let's turn to Slide 5 to discuss the Micro-Mode acquisition.

Yesterday, we announced the acquisition of Micro-Mode Products for approximately $80 million, and the company is now part of CCT. The effective purchase multiple was approximately 11x EBITDA, and we expect it will improve from here as the value creation accelerates.

Micro-Mode is a leading designer and manufacturer of high-bandwidth radio frequency connectors for harsh applications in radar, satellite and smart defense systems. Micro-Mode's connectors are the product of choice of mission-critical applications, and they've been qualified on space programs for more than 30 years.

With this acquisition, ITT gains further entry into niche defense and space markets with significant long-term potential as this is a total addressable market of approximately $4 billion.

Micro-Mode customers love their performance, their responsiveness and attention to their needs, like Habonim, our recent valve acquisition, which has been a great success, Micro-Mode has strong, long-lasting intimacy with its customers. Mike, Gerald, Brian and the entire Micro-Mode team, welcome to ITT. I look forward to growing our business together.

With that, I turn the call over to Emmanuel to discuss our first quarter results in more detail..

Thank you, Luca, and good morning. Let's begin on Slide 6. We generated 10% organic sales growth, led by IP at 25% and a strong double-digit performance by CCT. In IP, our book-to-bill was 1.23 this quarter, all the more impressive, given our 25% organic revenue growth.

We are seeing outgrowth in projects with significant awards this quarter and continuing into April, and our aftermarket orders were up 19%. In CCT, we continue to drive top line growth on the strength of the commercial aero recovery.

As a result of this and our strong position on key platforms, Controls grew 15%, Connectors grew 6% despite the deceleration in the industrial market. More on this when we discuss our 2023 outlook. Finally, in MT, pricing actions and share gains in Friction OE offset lower volumes in the aftermarket.

As a result, as we highlighted last quarter, there is a continued inventory correction occurring in the European car aftermarket, partially due to improved lead times and indirect impacts from the war in Ukraine. We initially believed this would be a 1 quarter headwind, but we now expect it will continue into the second half of the year.

In rail, we saw mid-single-digit revenue growth as the KONI and Axtone businesses continue to execute and gain share. This is also the last quarter we will see a year-over-year headwind in Axtone related to the war in Ukraine. Nevertheless, Axtone delivered 11% growth in orders in Q1 to fully overcome the loss of its Russia business.

And they continue to invest for future growth with the development of the digital automated coupler technology ahead of its European deployment in rail freight in 2025. More to come in upcoming quarters. For all of ITT, pricing contributed roughly half of the 10 points of organic sales growth this quarter.

We are strengthening pricing actions through deployment of a value-based pricing model across the organization. On profitability, margin expansion was driven by an outstanding performance in IP. Its margins expanded over 800 basis points to 21.3%. Notably, CCT also expanded margins by an impressive 80 basis points.

Overall, segment's incremental margin was a solid 33% in Q1. I want to take a minute to discuss the outperformance in Industrial Process in a bit more detail. First, we're generating strong volume growth and demand across the projects, spare parts and service businesses. Second, we're making good progress in pricing.

In Q1, pricing actions drove approximately 25% of IP's top line growth. And with the efficiency improvements Luca mentioned, the Seneca Falls team is creating best-in-class processes that are increasing throughput and will support volume growth from share gains. Back to ITT.

In Q1, our productivity drove nearly 300 basis points of margin improvement, which partially offset nearly 450 basis points of cost inflation despite some initial relief in commodities. Foreign currency was approximately 50 basis points headwind this quarter, mainly driven by the cost of our hedge instruments.

Growth in EPS exceeded 20% in Q1, mainly driven by operations and pricing. Finally, on cash flow, we drove a strong improvement versus a weak Q1 last year, thanks to higher net income and a lower working capital impact. We will generate higher cash flow from the unwinding of inventory as our teams improve working capital.

However, challenges in the supply chain, particularly with our suppliers in aerospace, continued to weigh on working capital. We also paid down $70 million of outstanding commercial paper given our strong cash generation, which will reduce interest expense over time.

We continue to invest organically in our business through capacity expansions in Friction, lean improvements in IP and green energy investments, which collectively drove $29 million of CapEx for the quarter. All in, a strong start to 2023 that gives us renewed confidence in delivering the midpoint of our updated 2023 EPS outlook.

Let's now turn to Slide 7 to have a look at the Q1 earnings drivers. As you see here, we're driving strong volume growth and productivity. Pricing actions are offsetting cost inflation, although we're still seeing persistent inflation in labor and energy. The acquisition of Habonim and share repurchases each contributed $0.03.

We deployed capital to share repurchases in the amount of $30 million in Q1 given the share price pullback. I also want to point out that we overcame $0.06 of negative impact from foreign currency, $0.03 from higher interest rates and roughly $0.02 of lost earnings from our Russia business.

As you can see on Slide 8, we're increasing the low end of the range by $0.10, thanks to the strong start of the year. And as a result, our EPS guidance is up $0.05 at the midpoint. We are continuing to gain share in Friction on both EVs and ICEs as well as in pump projects.

Our ending backlog grew nearly $70 million this quarter and remains at over $1 billion despite a 10% revenue increase in Q1. On the short-cycle portion of our business, we see two different dynamics. On one hand, demand for parts, service and valves in IP continues to be strong, and we expect this to last for the next quarter or two.

On the other hand, deceleration of demand for the aftermarket brake pads and industrial connectors will likely persist into the second half. We're closely monitoring the demand patterns and mitigating the slowdown in connectors with pricing actions and cost reductions.

Regarding the acquisition, we expect that the impact of Micro-Mode's incremental earnings will be negligible this year. We do not see any other notable changes for outlook for sales, segment margin or free cash flow. Revenue growth will be driven by a combination of share gains and conversion of our backlog, but tempered by slowing short-cycle demand.

For the second quarter, we expect high single-digit organic sales growth led by Industrial Process with strong demand expected across projects and aftermarket. In MT, sales are expected to grow in the mid-single-digit range, thanks to both Friction OE and rail, partially offset by continued decline in the car aftermarket.

CCT's revenue growth is expected to be slightly down in Q2 with the slowdown in industrial connectors outpacing the growth in commercial aerospace and defense. Segment operating margin is projected to be up between 100 and 150 basis points year-over-year.

Both IP and MT will see strong year-over-year margin expansion and MT should improve sequentially in Q2. We expect that CCT margin will be approximately flat year-over-year given the anticipated revenue decline. As a result, adjusted EPS will grow roughly 20% in Q2 and essentially be in line with the first quarter.

Our tax rate remains at 21%, and interest expense will remain at an elevated level. Let me now turn the call back to Luca on Slide 9..

Thanks, Emmanuel. Before we move to the best part of the call, the Q&A, just a few points. This quarter, we focused on growth and execution in everything we did, and we delivered a strong performance, through increased orders, project awards and large green energy wins we delivered on growth.

Through our cash performance, capital deployment and operational improvements, we delivered on execution. The awards and share gains we're bringing home and our execution give us the confidence to deliver on our long-term target, 6% top line growth, 20% segment margin, 10% plus EPS growth and 12% free cash flow margin.

We are proud of our performance this quarter and never satisfied. So our journey continues. I would like to thank all our stakeholders for their continued support of ITT. It has been my pleasure speaking with you all this morning. Elliot, please open the line for questions..

[Operator Instructions] Our first question today comes from Jeff Hammond from KeyBanc Capital Markets..

Just I guess to start, within your unchanged organic growth guidance, there seems to be some moving pieces around kind of IP coming in better, some of this Friction destock and softness in CCT.

Can you just maybe speak to how you're thinking about the segments differently from an organic growth standpoint for the year?.

I think you got it, Jeff. I think that IP has come out stronger in Q1, and we see the strength in projects and also the strength in the short cycle in Q1. So probably IP will be better for the year. We continue to see the outperformance in the OE Friction.

But I will say the aftermarket in Motion Technologies in automotive, is probably be -- slower than what we expected. The destocking will last for the entire year. And then when it comes to the connector side of the business, also the destocking of the connectors will probably last for the full year of 2023. This is really how it plays..

And then just on the destock, what -- usually, these are kind of sharper destocks and then you're kind of settled.

What makes you think that these destocks carry through the year?.

When it comes to the automotive, it is really talking to our customers and really the feedback that we're getting from them. When you look at the distribution on the connectors, for example, we see the decline in the orders, but we still see the inventory level still high.

When we look at the point of sales, their bookings and the inventory level, we do our simulation, we talk to our distributors, and we think that this is going to last a little bit longer. This is how we got that..

And on CCT?.

That was on CCT, that -- I was talking about the distributors on the connector side, Jeff..

Our next question comes from Scott Davis from Melius Research..

Presentation is really pretty clear. So I wanted to take a step back a little bit and talk a little bit about this anti-flaring technology. What is it that you guys are doing different? And maybe just help us understand what that really means.

I would imagine there's a lot of those types of projects out there, if your technology is perhaps differentiated or interesting or whatever, but I'll let you guys address that..

Let me give you a couple of examples because the decarbonization is the anti-flaring, stop the flaring, but it's also the carbon capture. So when you have the flaring, for example, in also normal wells in the Permian Basin. You extract the oil, and it comes out oil, water and gas.

And usually what happens, you separate there and then, and you separate oil from water and you flare the gas. Now with our Bornemann pumps, which are multiphase boosting technology, practically are twin-screw pumps, where your pump -- you can pump water, gas and liquids together in all the different mixes.

What you take, you take all that mix, you pump it 50, 60 kilometers down the line, so that you separate where you can actually use the gas and put the gas in distribution. That is that the twin-screw pumps, that is the multiphase pump that we stop the flaring.

The decarbonization is something similar in the sense that what we do, for instance, in this major site in Australia, we -- what you have, you have the offshore field that produces gas containing CO2.

This CO2 is then separated by the gas -- at the gas plant and then our pumps will take that CO2, mixed with water and push it down 2 kilometers below the ground, and that is for the carbon capture..

I actually didn't know you could pump both the liquid and the gas at the same time. So thanks for that. The Continental deal. Why do you need those -- why do you need them? I guess, is kind of the question.

Is it a question of channel access and brand? And do you cannibalize yourself a little bit, because you're both then going to market, but under different brands, perhaps just help me understand how the dynamics of that, how that works..

The partnership with Continental is really crucial for our Friction business. At Friction, as you know, we excel at producing high-quality parts and that we deliver on time. And we have great also material science. What we don't know how to do is distribute and market our products in the aftermarket.

And this is why Continental is so key for us because they deliver that aspect of distribution, marketing and branding, and we focus on what we know how to do. And so it's really the perfect combination between -- and playing to our strength -- to our respective strengths with this agreement. So a really key strategic partnership.

We have a 10-year partnership that we renewed, and we look for much more in the future..

And also, Scott, think about it, if you go with Continental distributor, you have thousands of products that you can offer them where we are going there only with the brake pad. So they have a good value proposition..

Our next question comes from Vlad Bystricky from Citigroup..

So can you just talk about on the IP business, your sort of level of confidence or visibility in the baseline pumps business continuing to perform well here and what you're hearing from your distributors about inventory in the channel there and sort of any concerns about potential destocking to emerge in that business?.

So I have to say that in Q1, we were a little bit surprised positively by the order rate of our baseline business. The baseline business was up, even though it was more driven by price than volume. Volume was actually a little bit down, but much better than what we were expecting.

And when we check with our distributors, they don't report any excess inventory situation.

So I would say that for the moment, it looks like our differentiation, which is providing reliable pumps that our customers know and that are easily swappable in good lead times compared to the competition, is really what's differentiating for our distributors and their customers. So a pretty good start of the year for baseline..

And another point as well to add to what Emmanuel said is that if you look at our short cycle, orders were also up sequentially Q1 over Q4, which is a positive sign..

And then maybe just shifting to Motion Tech. You highlighted again the OE wins in the quarter to drive share gains over time.

Can you just talk about, in China specifically, your wins and share with China OEMs versus foreign OEMs?.

Yes, I'm glad that you asked this question, because I was in China in Q1. And everybody is reading on the newspaper that the Chinese OEMs are gaining shares. But you don't really smell it, you don't touch it until you get there and you drive from Pudong to Wuxi. And actually, I can tell you Vlad that I couldn't recognize any of the cars on the highway.

They were completely different from when I was there 3 years ago. All these new OEMs that many of them were electric. So you really touch the importance of the Chinese OEMs. When you look at our data, in 2022, 62% of the brake pads that we produce in 2022 were for the Chinese OEMs.

And the market share of the Chinese OEM in the China market is above 50%. So we are very well positioned with them, with many of them, if it's NIO, if it's XPENG, if it's Li Auto or if it is BYD, all of them. So I want to give credit to the China team because when we went to China 8, 9, 10 years ago, we went with 1 customer -- 1 Western customer.

We reduced the risk we differentiated with all the Western and several years ago, the team decided to go Chinese, and this is paying off..

Our next question comes from Mike Halloran with Baird..

Let's stick on the auto side. Certainly appreciate the destock that's happening, but Luca, as you said last quarter, I think you always give really good context on how you think the auto market holistically is going to perform. If you could give some thoughts by region and what you're seeing, that would be great..

So I would say Q1, really, the market performed in the way that IHS forecasted. So when you look at the market, you have Europe that performed very well, plus 17% in the quarter. China was down 8% and North America was up almost 10%. Now we outperformed the market roughly in Q1 by more than 100 basis points overall.

Now the way that the forecast is for IHS is still around 85.5 million vehicles. They are forecasting mid-single-digit growth for Europe and North America, flattish China. What our assumptions are, Mike, is the market will probably grow low single digits worldwide. North America positive mid-single digits, Europe and China, flattish.

Now with those assumptions, we are always more conservative. We expect always to outgrow the market by roughly 400 and 500 basis points. The reason why we tend to be a little bit more conservative is also because we start seeing the level of inventory going up a little bit..

And backlog, obviously, is still really strong. Maybe talk about how you're expecting that to normalize as you work through the year and how that's embedded in the guidance? That's a holistic question, by the way, not just -- not just tied to Motion..

No, no, no, for sure. One thing that when we entered Q1 we weren't thinking that we were able to grow backlog even further that the record we had. And in fact, we did. We grew backlog even by another $70 million this quarter. And if you look at our two main businesses where backlog is really a key metric.

IP backlog grew sequentially 10% versus prior year. We're up 30% and then in terms of CCT, our backlog grew 13% versus prior year, pretty stable sequentially, but both businesses had a book-to-bill above -- largely above one turn. So really good news from a backlog standpoint.

And as Luca mentioned, especially in IP where you have a lot of projects, a growing presence of our projects in the backlog, that backlog is also getting more and more profitable..

Our next question comes from Damian Karas with UBS..

I wanted to ask you guys, first on IP margin, the performance remains quite impressive, especially when you compare that to what we see from some of the other pump and valve manufacturers out there. So Luca, I'd like to hear your thoughts on how sustainable this profitability is.

Have you gotten any customer pushback on some of the pricing actions? And how are you thinking about any potential market share impacts as a result?.

When it comes to the -- let me address the pricing action first. We are pricing -- when we win a project, we are very diligent. This is the first thing. But we are pricing in markets. So what you are finding is that the cost competitiveness of IP is really top notch.

And we are managing this project very well in terms of from an execution point of view, changes, et cetera, which obviously improved the profitability of the business. So I would say, no pushback at all when it comes to pricing.

And the approach that we are having today is really value-based, the value that we are delivering to the customer, the value that we are delivering to the company. And this is what many of the customers are willing to pay. So that's on the first point. When it comes to sustainability, listen, this is the third quarter in a row.

Obviously, the business is performing well. The sites are performing well. There are opportunities to continuously improve, but there is also a lot of investments that we need to make in this business. The re-layout of the Seneca Falls, more VA/VE, more investment on the product side, so in systems. So those investments will need to be paid for.

And this is something we need to bear in mind..

I have a follow-up question on the Conti agreement. You mentioned partnering with them in China. Could you maybe tell us a little bit more about that? I mean, what's the aftermarket opportunity there? I'm assuming it's a pretty competitive market.

So what angle are you thinking about playing there?.

Actually, what we are saying is that China is really gives us the flexibility and is -- China is not with Continental. So the agreement with Continental is mainly a European agreement for the European market.

And in Continental, we have the flexibility to go ourselves and to try different things, also because it's a very different market, very entrepreneurial, and we need to test different things over there..

Our next question comes from Nathan Jones with Stifel..

This is Matt on for Nathan Jones. So you guys mentioned a lot about short-cycle pump orders.

I just wanted to talk -- if you could talk about the funnel of longer-cycle project opportunities and kind of your expectations for potential orders in 2023?.

So when you look at the funnel today, we have an ever-growing funnel. The total funnel we're seeing is around $1 billion for IP and half is basically oil and gas or energy and half is the rest of the industry, so chemical, mining and other stuff. And then really, it's growing pretty much everywhere. Obviously, North America is growing the fastest.

But Europe is going back to -- on a growth path. And it's even increasing -- so that's year-over-year. And on a sequential basis, it's still increasing by high single digits. In terms of industry, where we see the largest increase are around oil and gas, chemical, mining, but even general industrial is participating into that growth.

So we're seeing a very dynamic funnel. Despite all the orders that we've been acquiring, the funnel keeps on growing. So for us, it's a really good sign..

And then any -- could you talk about the price-cost dynamics in kind of the different pieces of the business?.

So let me start by saying that from a price-cost standpoint, this quarter, we were neutral from a dollar standpoint. And what we're seeing is that continued good performance from a pricing standpoint in IP. So that more than covers our total inflation.

In MT, the situation is still very difficult, especially in Friction where we don't get 100% of our cost inflation covered. But that's -- but we're progressing, it's a matter of progressing small percentage points over what we did last year. And then in CCT, we're really starting with the value-based pricing.

So we're seeing price/cost equation that's a little bit tilted towards the negative, but we expect this to really change in the next few quarters as we are able to execute on our value-based pricing plan..

Our next question comes from Joe Ritchie with Goldman Sachs..

So I wanted to start with Industrial Process margins, greater than 21% now three quarters in a row. I know we've asked a few questions about this already. The two questions I have are, number one, is this the right baseline moving forward? And number two, like your projects business was up over 50% this quarter.

Typically, I think we would think about it as being mix negative, but clearly, it's not having an impact on your business. So maybe just talk through some of the dynamics about how you're managing your project margins and why you're still getting that kind of leverage on them..

So let me start and Emmanuel, please jump in. So yes, the project business, the orders of projects are up 54%. And by the way, the compare was not an easy one, because the growth Q1 last year was 45%. So it's really good in terms of value. Now the profitability of these projects is the highest it's ever been.

The profitability of the projects backlog that we have is the highest it's ever been. Not comparable to the short cycle, of course, but we have never seen that level of profitability. And this is the result of a very rigorous process in the order acquisition. The sales are very disciplined and also a very good execution.

If you think about Saudi Arabia delivering 100% on-time delivery, this means that your negotiation with the customer are going very well. You can ask the changes. You have a customer experience very positive, which also facilitates any negotiation that you have on price and on changes.

Now this quarter, we had actually a headwind, even if it was a small one in terms of the mix, roughly 20 basis points headwind. And we will see this headwind probably become a little bit bigger in the future, Joe, because today, the backlog that we do have is 48% projects, 52% short cycle.

You remember, last year was 60-40, 60% short cycle, 40% projects, and I do expect by the end of the year to be 60-40 with 60% being projects. So that will probably be a headwind, but not a one that we cannot manage..

And just a follow-up, that was helpful, Luca. But so the 21%, probably not the rate dipping off point, but in and around that area going forward with mix potentially being an impact.

Is that the right way to think about it?.

Yes, Joe, that's the right way to think about it. We -- for sure, we're not going back to 15%. So we're in that vicinity, the 19% to 20%. And there's a lot of more work that is needed, as Luca said, in terms of investment to make sure that we continuously improve. And also in IP, there's a lot more opportunities that we need to go after.

We still have a couple of sites that are losing money in IP that we want to go after. And so I think that's -- the IP situation from a margin standpoint has been really, really positive for us and very much faster than what we were anticipating from a margin expansion standpoint..

Our next question comes from Matt Summerville from D.A. Davidson..

Just a couple quick -- just a couple of quick questions.

Just on MT, what does the pathway look like to get back to kind of where margins were in either 2020, 2021 more firmly into the high teens? Is it a matter of closing that gap between price cost? Is it a matter of mix normalization? Can you kind of talk about timing and walk through how we should be thinking about the margin progression in that business?.

So let's say, around '19,'20 MT was around 18% margin. So being at a little less than 15% right now, we still have quite a bit to go. But I would say we're pretty confident in us being able to get to that level of margin of around 18% in 2024. I would say a couple of things to think about.

The first one is, obviously, we're driving pricing as much as we can to cover our cost. We have a slew of new platforms that are going to enter into production in the next few years that are -- that have been priced with a level of raw material pricing, that is the one that we're seeing today.

So we don't expect to be impacted as much by the price-cost equation. And then productivity, productivity is central to MT. And this is something that has been difficult during the pandemic and the supply chain disruptions. We are firmly back on track. And so I expect that Motion Tech productivity will contribute to the Motion Tech margin expansion..

Well, just as a quick follow-up. With respect to IP, obviously, pretty strong margin performance for a handful of quarters now.

How much of that is being driven by the Lean initiatives out of Seneca Falls and is there still incremental margin benefit to be realized? And if so, is there a way to quantify that?.

So I would say that lean in Seneca Falls and outside of Seneca Falls has been contributing quite a bit, between 150, 200 basis points. And obviously -- and what's best about it is that we're nowhere near to be done. So a lot more potential there. I would say also price has been a really large contributor.

As we mentioned, right, this quarter, price had a positive impact of over 500 basis points in terms of -- from a margin standpoint, which allows us to offset, obviously, the cost inflation and the negative mix that Luca was talking about. So a lot more in the tank for IP to continuously expand from a margin standpoint..

Our next question comes from Bryan Blair with Oppenheimer..

I wanted to quickly circle back on the flexibility that the Continental agreement affords you to go on your own in China in the aftermarket. We really haven't focused on that opportunity quite as much. I think it's still a relatively small scale for you guys.

I recall, going back a while, but pre-pandemic, maybe it was $10 million -- a little over $10 million in revenue at that point.

Can you speak to the current run rate revenue in China aftermarket and what the future may hold there, potential size of that revenue stream looking forward?.

So our aftermarket business in China is a little less than $5 million in terms of revenue for the year. So it's quite a bit smaller than what we are in Europe, but it's also understandable because we are a relatively new player in China. We've been there for 10 years.

So we don't have the product portfolio that maybe people that have been there for longer have. And then also, we don't have the distribution as we do have it in Europe. So I think that the great thing about the agreement is that it frees us up to really go the way we want in China.

So we have been talking to several partners to see if they would like to do the distribution and the marketing for us. This is still something that is evolving. We're trying to really build the business case for the China business, aftermarket.

But I think that for us, the important thing was to have the option and to be able to work on a business model that is really going to play to our strength..

Okay, definitely makes sense. And perhaps offer a little more background on Micro-Mode, unique technology that they offer and trailing our expected growth rates. And please confirm deal valuation. Luca, I believe you said around 11x EBITDA that implies a rather attractive margin profile..

So yes, it's 11x EBITDA. That's correct, Bryan. Now what we like about Micro-Mode is that their focus on space and defense is in a market where we play, where we're strong. They have a complementary set of products to the one that we have.

We do not have the highly customized radio frequency and hermetic connectors for harsh application that they can offer. And the -- when Emmanuel and I visited the site in California, we were also very pleased to see the investment that they made from a manufacturing point of view.

The site that they have there is very simple and -- but nice vertically integrated. So that will fit very well with the way that we want to expand. The team there has got very good expertise on product and process as well. So very, very synergistic.

And I can tell you yesterday was the first day I was talking to the team last night, and they're already working on a couple of opportunities together that will allow Micro-Mode to grow. So very good acquisition for the connector business, a platform that we want to grow organically and inorganically..

Our last question comes from Michael Anastasiou with TD Cowen..

So CCT saw year-over-year increases, but it seems like order growth was kind of offset from weakness maybe on the industrial side. Can you just provide some color there on order cadence throughout the quarter on specifically the industrial side? Any end market commentary there would be helpful..

So you're right. The industrial side of our connector business is the one that has declined and has really offset all the good growth we're seeing in Aero and Defense. So our industrial connector business in the quarter from an order standpoint declined by 21%, which caused our connector business to decline by 17%.

And this is driven by industrial and also what's in the periphery of industrial such as medical, for instance. So I think that we're monitoring that, Luca mentioned that the inventory at our distributors has not gone down.

So what we're seeing today is that they're reflecting the improvement in the supply chain, and so they don't need to preorder as many components, but we don't see yet the inventory declining. We're seeing some of their POS data that is stabilizing. So that makes us a little bit hopeful.

But we think that in terms from an inventory reduction -- from an inventory reduction standpoint, where we haven't -- they haven't really started reducing inventory.

And so we checked also -- the last point I wanted to make is that we checked on the market share side, and it's really a market-driven event, and it's not really driven by our ability to supply connectors to them..

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