ITT Inc. 2018 Third-Quarter Form 10-Q Summary
Business context and reporting period
ITT Inc. is a diversified manufacturer of engineered components and technology solutions serving transportation, industrial, oil and gas, aerospace and defense, and related markets. Its reportable segments are Industrial Process, Motion Technologies, and Connect & Control Technologies. The unaudited filing covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $680.6 million | $645.0 million | $2,066.7 million | $1,901.7 million |
| Gross profit | $226.5 million | $203.8 million | $676.7 million | $611.9 million |
| Gross margin | 33.3% | 31.6% | 32.7% | 32.2% |
| Operating income | $137.8 million | $133.1 million | $328.7 million | $249.2 million |
| Operating margin | 20.2% | 20.6% | 15.9% | 13.1% |
| Net income attributable to ITT | $110.9 million | $86.9 million | $281.8 million | $180.7 million |
| Diluted EPS | $1.25 | $0.98 | $3.18 | $2.03 |
- Q3 revenue increased 5.5%, while nine-month revenue increased 8.7%. Organic revenue growth was 6.6% in Q3 and 5.2% year to date.
- Q3 segment operating margin was 15.9%, up 330 basis points, driven by volume, productivity, supply-chain and project-execution improvements. Each segment improved operating income: Industrial Process to $23.7 million, Motion Technologies to $58.5 million, and Connect & Control Technologies to $26.0 million.
- Q3 operating income benefited from a $38.0 million net gain on the sale of a former operating location, partly offset by a substantially smaller asbestos-related benefit than in the prior year.
- Effective tax rates declined to 18.9% in Q3 and 13.1% for the nine months, versus 31.8% and 25.0%, respectively, in 2017. Benefits included deferred-tax valuation allowance reversals, Tax Act adjustments, and the lower U.S. corporate tax rate.
- Orders were $722.1 million in Q3, up 9.6%, and $2,225.1 million for the nine months, up 13.8%. Q3 organic orders increased 10.8%.
Cash flow, liquidity and capital allocation
- Cash provided by operating activities was $246.6 million for the first nine months of 2018, compared with $178.3 million in 2017. Capital expenditures were $63.8 million, producing reported free cash flow of approximately $182.8 million before management adjustments; adjusted free cash flow was $214.1 million.
- Investing cash use was $21.1 million, versus $189.3 million in the prior-year period, reflecting the absence of the 2017 Axtone acquisition and $40 million of proceeds from the property sale.
- Cash and cash equivalents were $525.8 million at September 30, 2018, compared with $389.8 million at December 31, 2017.
- Total debt and capital leases were $156.2 million, including $144.9 million of commercial paper, versus $171.9 million at year-end 2017. No borrowings were outstanding under the $500 million revolving credit agreement, which may be increased to $700 million with lender consent.
- ITT repurchased $50.0 million of shares under its repurchase program during the first nine months and declared quarterly dividends of $0.134 per share. Management planned incremental share repurchases of up to $25 million during the fourth quarter of 2018.
Material changes, outlook and unusual items
- Management attributed performance to broad-based end-market demand, automotive friction share gains, stronger pump project activity, connector growth, productivity actions, and improved project execution. Higher commodity costs, automotive pricing pressure, growth investments, and foreign-exchange effects remained offsets.
- Industrial Process backlog was $463.8 million at September 30, 2018, up 20.0% from January 1, 2018. Remaining performance obligations under contracts greater than one year were $38.8 million, of which approximately $8 million to $12 million was expected to be recognized during 2018.
- Management expected 2018 net cash outflows for asbestos defense and indemnity, net of tax benefits, to average $20 million to $30 million annually over the next five years and approximately $35 million to $45 million annually thereafter during the projection period.
- Asbestos accounting produced a $4.3 million net benefit in Q3 2018 and a $10.5 million benefit for the first nine months. The 2018 benefit included insurance settlements, while the prior-year Q3 included a $76.4 million favorable remeasurement.
- At September 30, 2018, recorded asbestos liabilities were $845.1 million and related insurance assets were $389.4 million, producing net estimated exposure of $455.7 million. Management cannot reasonably estimate costs for claims beyond the ten-year projection period.
- Tariffs on Chinese imports and potential retaliatory tariffs may increase material costs and affect customers, suppliers and markets. ITT expected to mitigate effects through pricing, sourcing and supply-chain actions but could not estimate the ultimate financial impact.
- Removal of six military-specification connector products from the Defense Logistics Agency Qualified Products List could affect annual revenue estimated at $8 million to $10 million. ITT expected to restore certain products in 2019, but further effects remained uncertain.
- Environmental liabilities were $64.8 million, with 32 active investigation or remediation sites and a potential high-end liability estimate of $115.4 million.
- ITT accrued $5 million as its current best estimate of probable loss related to a Department of Justice civil investigation involving certain connector products. The DOJ Criminal Division declined to prosecute at that time, while civil exposure could exceed the accrued amount.
- ITT adopted the new revenue recognition standard in 2018 using a modified retrospective approach, resulting in a $4 million net reduction to opening retained earnings. The company expected to adopt the new lease standard in the first quarter of 2019 and was still assessing its impact.
Most important facts for investors to verify
- Whether segment margin gains and organic order growth persist after the benefits of unusual items, productivity actions and favorable project execution.
- The sustainability of the reduced effective tax rate, including the final resolution of provisional Tax Act accounting and the company’s unselected GILTI accounting policy.
- Actual asbestos claims, insurance recoveries, cash payments and potential exposure beyond the recorded ten-year forecast.
- The financial effect of tariffs, commodity inflation, foreign exchange, automotive pricing pressure and the DLA connector qualification issue.
- Whether cash generation supports planned capital investment, dividends, share repurchases and future acquisitions while maintaining commercial-paper access and credit-agreement compliance.
- The potential outcome and timing of environmental matters and the DOJ civil investigation, including losses beyond amounts currently accrued.