Business Context and Reporting Period
ITT Corporation filed an unaudited Form 10-Q for the three months ended March 31, 2016. ITT manufactures engineered components and technology solutions for energy, transportation, and industrial markets through Industrial Process, Motion Technologies, Interconnect Solutions, and Control Technologies.
Financial Performance and Position
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $609.1 million | $588.7 million | 3.5% |
| Gross profit | $195.3 million | $199.0 million | (1.9%) |
| Gross margin | 32.1% | 33.8% | (170) bps |
| Operating income | $51.0 million | $57.9 million | (11.9%) |
| Operating margin | 8.4% | 9.8% | (140) bps |
| Income from continuing operations attributable to ITT | $37.7 million | $38.7 million | (2.6%) |
| Net income attributable to ITT | $37.4 million | $42.1 million | (11.2%) |
| Diluted EPS from continuing operations | $0.42 | $0.42 | Flat |
| Adjusted diluted EPS | $0.59 | $0.65 | (9.2%) |
| Operating cash flow | $5.7 million | $8.2 million | Down $2.5 million |
| Adjusted free cash flow | $(4.5) million | $(9.1) million | Improved |
The lower operating result reflected approximately $21 million of unfavorable volume, mix, and pricing effects, $10 million of unfavorable foreign exchange effects, and operational disruptions related to the Interconnect Solutions relocation. These pressures were partly offset by acquisitions, Lean initiatives, restructuring benefits, and cost containment.
- Industrial Process revenue declined 18.3% and operating income declined 55.9%, primarily due to weakness in oil and gas and mining markets. Backlog was $381.7 million, down 7.1% from December 31, 2015.
- Motion Technologies revenue increased 34.4%, including $42.0 million from Wolverine, and operating income increased 23.7%. Organic revenue increased 14.2%, driven by automotive demand and share gains.
- Interconnect Solutions revenue declined 6.6% and operating income declined 58.3%, reflecting oil and gas and industrial weakness, unfavorable mix and pricing, and relocation-related disruption costs.
- Control Technologies revenue increased 9.3%, primarily from Hartzell Aerospace, while operating income declined 27.3%. Organic orders increased 23.4%, supported by aerospace and defense demand.
Cash and cash equivalents were $430.9 million at March 31, 2016, compared with $415.7 million at December 31, 2015. Total debt and capital leases were $277.9 million, including $123.0 million of commercial paper and $151.1 million outstanding under a $500 million revolving credit facility. The company reported compliance with its interest coverage and leverage covenants. Capital expenditures were $21.0 million, and dividends declared were $0.124 per share.
Material Changes Versus the Prior Comparable Period
- Reported revenue increased because acquisitions contributed $50.8 million, partly offset by $13.7 million of unfavorable foreign currency translation; organic revenue declined 2.5%.
- Orders increased 2.6% to $623.5 million on an reported basis but declined 3.5% organically.
- The effective tax rate decreased to 23.7% from 31.9%, benefiting from a more favorable geographic earnings mix, South Korean tax-holiday benefits, and reduced losses in Germany and the United Kingdom for which no tax benefit was recorded.
- Restructuring costs decreased to $5.5 million from $9.3 million. Industrial Process recognized $3.2 million for additional headcount reductions, bringing planned reductions under the program to approximately 280 employees.
- Net asbestos expense decreased to $12.8 million from $15.4 million because of a $2.6 million insurer settlement benefit, while the company continued to accrue for its rolling 10-year forecast.
- Repurchases under the existing share repurchase program were zero in the quarter; $6.9 million of shares were repurchased for employee tax-withholding obligations.
- Cash increased by $15.2 million, aided by $7.5 million of cash from discontinued operations, foreign exchange effects, and financing inflows.
Outlook, Commentary, Risks, and Unusual Items
Management expects continued volatility in the global macroeconomic environment, with ongoing pressure from foreign exchange, low oil and gas prices, and weak industrial and mining markets. Management intends to focus on controllable costs, business alignment, restructuring, productivity, and capital investment, including a new North American automotive brake-pad facility. The filing does not provide clear quantitative full-year revenue, earnings, or cash-flow guidance.
- Oil and gas-related products represented approximately 20% of 2015 revenue; sustained low prices may reduce customer capital spending, maintenance, and demand and may create further pricing pressure, restructuring costs, or impairment risk.
- Asbestos liabilities for pending claims and claims estimated over the next 10 years were $1,045.1 million, with related assets of $405.8 million and net exposure of $639.3 million. Approximately 36,000 claims were pending at March 31, 2016.
- Net asbestos cash outflows are projected at $15 million to $25 million annually over the next five years and approximately $35 million to $45 million annually over the remainder of the projection period, subject to significant uncertainty. Costs beyond the 10-year forecast are not recorded.
- The company had 47 active environmental investigation and remediation sites and estimated a potential high-end environmental liability of $134 million. A $34.2 million insurance settlement-related environmental asset was recognized, including funds placed in a qualified settlement fund.
- ITT is responding to a Department of Defense Inspector General civil subpoena concerning Interconnect Solutions products purchased or used by the U.S. government. The filing states that the timing and outcome cannot be estimated.
- Tax examinations are ongoing in several jurisdictions. Unrecognized tax benefits could change by approximately $16 million over the following 12 months, and legacy tax matters may affect obligations under the Tax Matters Agreements with Exelis and Xylem.
- On May 5, 2016, after quarter-end, ITT announced a planned reorganization into a holding-company structure. The company intended to complete the reorganization in mid-May, with no expected change to shareholders’ economic rights or consolidated assets and liabilities.
Important Facts for Investors to Verify
- Whether weakness in Industrial Process, oil and gas, mining, and industrial markets persists and affects backlog, pricing, and margins.
- Whether Motion Technologies’ acquisition-driven growth and automotive share gains offset declines in other businesses.
- The timing and cost of Interconnect Solutions relocation remediation and the pace of margin recovery.
- Actual asbestos claim activity, insurance recoveries, cash outflows, and potential exposure beyond the recorded 10-year forecast.
- The outcome of the Department of Defense investigation and ongoing environmental and tax matters.
- Availability and cost of commercial paper and revolving-credit liquidity, including compliance with financial covenants.
- The effect of the planned holding-company reorganization and future capital allocation among acquisitions, investment, dividends, and repurchases.