ITT Inc. 2019 Form 10-K Summary
Business context and reporting period
ITT Inc. reported for the fiscal year ended December 31, 2019. ITT is a diversified manufacturer of engineered components and technology solutions serving transportation, industrial, energy, oil and gas, aerospace and defense markets. Its three reportable segments are Motion Technologies (MT), Industrial Process (IP), and Connect & Control Technologies (CCT). The company operated in approximately 125 countries, employed approximately 10,500 people, and generated 65% of revenue outside the United States according to the business overview.
ITT acquired Rheinhütte Pumpen in April 2019 and Matrix Composites in July 2019. These acquisitions contributed eight and six months of operations, respectively, to 2019 results.
Key financial metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Revenue | $2,846.4 million | $2,745.1 million | +3.7% |
| Gross profit | $910.1 million | $887.2 million | +2.6% |
| Gross margin | 32.0% | 32.3% | Down 30 bps |
| Operating income | $411.4 million | $397.3 million | +3.5% |
| Operating margin | 14.5% | 14.5% | Flat |
| Income from continuing operations attributable to ITT | $323.4 million | $332.4 million | Down 2.7% |
| Net income attributable to ITT | $325.1 million | $333.7 million | Down 2.6% |
| Diluted EPS from continuing operations | $3.65 | $3.75 | Down 2.7% |
| Operating cash flow | $357.7 million | $371.8 million | Down 3.8% |
| Adjusted free cash flow | $318.8 million | $308.9 million | +3.2% |
| Cash and cash equivalents | $612.1 million | $561.2 million | +9.1% |
| Total debt and finance leases | $99.4 million | $125.0 million | Down $25.6 million |
| Working capital | $599.5 million | $542.1 million | +10.6% |
Adjusted segment operating income increased 10.3% to $456.7 million, and adjusted segment operating margin increased to 16.0% from 15.1%. Adjusted EPS was $3.81 versus $3.23 in 2018. These are non-GAAP measures and should be reconciled to the reported results.
Segment revenue and operating income were: MT revenue of $1,241.8 million and operating income of $216.1 million; IP revenue of $943.8 million and operating income of $104.7 million; and CCT revenue of $663.9 million and operating income of $111.5 million. CCT operating margin improved to 16.8%, while MT margin declined slightly to 17.4% and IP margin remained 11.1%.
Orders declined 2.7% to $2,813.2 million, while organic orders declined 1.7%. Backlog was $853.6 million at year-end, compared with $870.3 million in 2018; management expected to recognize approximately 90% of backlog revenue in 2020.
Capital expenditures were $91.4 million. Investing cash outflows totaled $203.4 million, including $113.1 million for acquisitions. Financing cash outflows totaled $101.5 million, including $52.1 million of dividends and $41.4 million of share repurchases. The annual dividend declared per share increased to $0.588 from $0.536.
Material changes versus the prior comparable period
- Revenue growth reflected $54.5 million from acquisitions and a $76.4 million unfavorable foreign-exchange impact. Organic revenue increased 4.5%.
- IP revenue increased 14.1%, helped by Rheinhütte and strong pump-project activity. However, IP organic orders declined 4.7% and year-end backlog declined 11.0%.
- MT revenue declined 2.5% as foreign exchange and weakness in Wolverine offset rail growth and automotive friction market-share gains.
- CCT revenue increased 2.7%, driven primarily by commercial aerospace and the Matrix acquisition; industrial and defense orders weakened.
- Gross margin declined because of higher commodity costs, tariffs and unfavorable mix, partly offset by productivity and supply-chain improvements.
- Reported EPS declined despite higher operating income, primarily because 2018 included a $38.5 million gain on the sale of excess property and favorable deferred-tax valuation adjustments. A higher 2019 effective tax rate of 21.7%, versus 14.8%, also reduced earnings.
- Operating cash flow declined because of unfavorable working capital, higher postretirement contributions and the absence of a $19.0 million environmental insurance settlement received in 2018.
- ITT adopted the new lease accounting standard in 2019, recognizing an $80.0 million right-of-use asset and an $83.4 million lease liability at adoption.
Guidance, outlook, risks and unusual items
Management did not provide a quantified full-year 2020 financial outlook in the supplied filing text. Management stated that it intended to pursue productivity, innovation, organic growth, close-to-core acquisitions and shareholder returns. It raised the first-quarter 2020 quarterly dividend by 15%, representing the eighth consecutive year of dividend increases.
- Asbestos: ITT recorded an undiscounted liability of $817.6 million and related insurance assets of $386.8 million, for a net recorded exposure of $430.8 million. The liability covers pending claims and claims estimated through 2029; potential claims thereafter are not reasonably estimable. Approximately 24,000 active claims were pending at year-end. Net asbestos cash outflows were projected at approximately $20 million to $30 million annually over the next five years, rising to approximately $35 million to $45 million annually thereafter. In February 2020, ITT signed an agreement-in-principle with insurers involving $66.4 million, with the accounting impact still under evaluation.
- Pension plan: The board conditionally authorized termination of the U.S. qualified pension plan. If completed, ITT expected a non-cash pretax settlement charge of approximately $130 million to $140 million in the second half of 2020, subject to regulatory review, interest rates and annuity pricing.
- Coronavirus and Boeing 737 MAX: Management cited uncertainty from the 2019 novel coronavirus outbreak, including potential plant, supplier and customer disruptions in China, and expected temporary effects from the halt in Boeing 737 MAX production.
- Trade and commodities: Tariffs, commodity-price volatility, foreign exchange, raw-material availability and pricing pressure could adversely affect margins and demand.
- Customer concentration: Continental represented approximately 9.8% of consolidated 2019 revenue and 22% of MT revenue. The loss or reduction of this relationship could materially affect results.
- Environmental matters: The recorded environmental liability was $61.9 million, with a reasonably possible high-end estimate of $108.4 million. ITT estimated annual environmental investigation and remediation spending of $5 million to $7 million.
- Other legal matter: ITT paid $11 million to settle a U.S. Department of Justice civil matter relating to certain connector products and received a related $1 million insurance recovery.
- Liquidity: ITT had $84.2 million of commercial paper outstanding, no borrowings under its $500 million revolving credit facility, and access to potential increases in the facility up to $700 million. The facility maturity was extended to November 25, 2022.
The company disclosed effective disclosure controls and internal control over financial reporting. Deloitte & Touche issued unqualified opinions on the financial statements and internal controls, while excluding the 2019 acquisitions from the internal-control assessment because of their acquisition timing.
Most important facts for investors to verify
- Reconcile reported EPS of $3.65 with adjusted EPS of $3.81 and evaluate the effect of asbestos, tax, restructuring, acquisition and other special items.
- Assess the sustainability of organic revenue growth against the 1.7% decline in organic orders and the $853.6 million backlog.
- Review the assumptions, insurance recoverability and cash-flow timing underlying the $817.6 million asbestos liability and $386.8 million insurance asset.
- Evaluate the potential 2020 pension settlement charge of $130 million to $140 million and whether plan assets will fully fund the proposed termination.
- Monitor IP project orders and backlog, automotive and aerospace demand, Boeing 737 MAX production, oil and gas and chemical capital spending, tariffs and foreign exchange.
- Confirm liquidity after acquisitions, dividends, repurchases, asbestos payments and any pension-plan funding requirements.
- Review the effect of Continental concentration, environmental exposures, guarantees of $138.1 million, and unresolved tax examinations and uncertain tax benefits.