ITT Corporation Form 10-Q Summary
Business Context and Reporting Period
ITT Corporation is a diversified manufacturer of engineered components and technology solutions serving energy, transportation, industrial, aerospace and defense markets. Its four reportable segments are Industrial Process, Motion Technologies, Interconnect Solutions and Control Technologies. This unaudited report covers the quarter and six months ended June 30, 2014, compared with the corresponding 2013 periods.
Key Financial Metrics
| Metric | Q2 2014 | Q2 2013 | Six Months 2014 | Six Months 2013 |
|---|---|---|---|---|
| Revenue | $663.0 million | $609.2 million | $1,337.5 million | $1,217.4 million |
| Gross profit | $214.8 million | $197.8 million | $429.6 million | $388.3 million |
| Gross margin | 32.4% | 32.5% | 32.1% | 31.9% |
| Operating income | $54.5 million | $41.4 million | $102.8 million | $78.6 million |
| Operating margin | 8.2% | 6.8% | 7.7% | 6.5% |
| Net income attributable to ITT | $38.3 million | $25.8 million | $70.5 million | $46.6 million |
| Diluted EPS | $0.41 | $0.28 | $0.76 | $0.50 |
- Q2 revenue increased 8.8%; organic revenue increased 7.5%. Six-month revenue increased 9.9%, including 9.0% organic growth.
- Q2 segment operating income rose 20.5% to $88.6 million, while segment operating margin improved to 13.4% from 12.1%.
- Adjusted income from continuing operations was $55.4 million, or $0.60 per diluted share, versus $47.0 million, or $0.51 per diluted share, in Q2 2013. These are non-GAAP measures.
- The effective tax rate declined to 23.0% in Q2 and 25.1% year to date, versus 36.7% and 39.9%, respectively, primarily because the prior-year U.S. deferred-tax valuation allowance was not repeated and more Korean income qualified for a tax holiday.
- Six-month net cash provided by operating activities was $84.3 million, compared with $68.8 million in 2013. Adjusted free cash flow was $62.2 million versus $71.3 million.
- Capital expenditures were $45.7 million year to date, primarily for Motion Technologies capacity expansion and an Industrial Process testing and production facility.
- Cash and cash equivalents were $527.7 million at June 30, 2014, compared with $507.3 million at December 31, 2013.
- Total debt and capital leases were $32.7 million, including $22.5 million of commercial paper. No amounts were outstanding under the $500 million revolving credit agreement, and the company was in compliance with its covenants.
- Cash dividends declared were $0.11 per share in Q2, a 10% increase from the prior-year quarterly dividend. Six-month share repurchases totaled $14.9 million.
Material Changes Versus the Prior Comparable Period
- Motion Technologies was the largest growth contributor, with Q2 revenue up 15.5% and operating income up 48.9%, driven by automotive brake-pad aftermarket volume, KONI rail growth, manufacturing efficiencies and favorable product mix.
- Industrial Process revenue increased 7.7%, but operating income declined 9.6% because of unfavorable sales mix, project pricing pressure, strategic investment costs, restructuring charges and foreign-currency effects.
- Interconnect Solutions revenue increased 3.4%, while operating income increased 83.6% as restructuring, productivity and sourcing savings improved margins. The segment incurred $16.0 million of restructuring costs in the first six months, principally for approximately 250 planned headcount reductions and production transfers.
- Control Technologies revenue increased 5.0% and operating income increased 5.2%, supported by commercial aerospace, aftermarket spares and industrial energy-absorption products.
- Operating expense growth was limited to 2.5% in Q2 and 5.5% year to date, causing the expense-to-revenue ratio to decline by 150 and 100 basis points, respectively.
- Discontinued operations generated a $2.9 million loss in Q2 and a $3.9 million loss year to date, compared with income in the prior-year periods.
- Restructuring costs were $3.8 million in Q2 and $19.1 million year to date, compared with $3.4 million and $8.9 million, respectively, in 2013. Management estimated approximately $17 million of annual net savings from first-half 2014 restructuring actions.
Guidance, Outlook, Commentary and Risks
- Management cited continued growth in energy and mining projects, automotive brake-pad market share, aftermarket activity and KONI rail shock absorbers. Q2 orders increased 8.8%; total six-month orders increased 5.5%.
- Industrial Process backlog was $698.8 million at June 30, 2014, up 2.5% from December 31, 2013. Management expected most delayed project orders to be received in the second half of 2014.
- Management expected restructuring actions to produce approximately $17 million in annual net savings and expected approximately $2.0 million of additional ICS restructuring costs over the following nine months.
- ITT expected to fund working capital, dividends and capital expenditures through operating cash flow, cash on hand and commercial paper. Management stated that alternative liquidity, including the revolving credit agreement, would be sufficient for short-term needs if commercial-paper access were adversely affected.
- Asbestos-related liabilities and recoveries remain a significant uncertainty. At June 30, 2014, the recorded liability was $1,263.4 million, related insurance recovery asset was $489.1 million and net estimated exposure was $774.3 million. Approximately 51,000 active asbestos claims were pending.
- Management estimated asbestos-related net cash outflows of $10 million to $20 million annually over the next five years, increasing to approximately $35 million to $45 million annually thereafter during the projection period. The company cannot reasonably estimate claims beyond the next ten years, and actual costs or recoveries could materially differ.
- The company faced environmental liabilities at 55 active sites, with a reasonably possible liability range of $70.4 million to $161.9 million.
- Several tax jurisdictions were examining ITT. Net unrecognized tax benefits could change by approximately $85.0 million over the following twelve months.
- ITT continued litigation involving insurer coverage for asbestos and environmental liabilities. A trial concerning exhaustion of certain primary insurance policies was scheduled for November 2014.
- Revenue recognition for certain long-term pump design-and-build contracts uses percentage of completion and depends on estimates of contract revenue, costs and progress. Changes in estimates could affect reported earnings.
- Management disclosed that a hypothetical remeasurement of Venezuelan operations from the official exchange rate to the SICAD 2 rate would have resulted in an estimated $3.5 million charge at June 30, 2014.
- The filing contains standard forward-looking-statement cautions and states that no material changes occurred in previously disclosed risk factors.
Most Important Facts for Investors to Verify
- Whether revenue growth and margin improvement persist after the favorable timing of automotive brake-pad shipments and large Industrial Process projects.
- The sustainability of Motion Technologies’ aftermarket and KONI growth, including the effects of OE pricing and capacity investments.
- Execution and realized savings from the Interconnect Solutions turnaround, including planned headcount reductions and production transfers.
- Changes in asbestos claim activity, insurance recoveries, litigation outcomes and the projected long-term net cash burden.
- Environmental remediation costs and the resolution of pending insurer coverage litigation.
- Future effective tax rates, tax examination outcomes and potential changes in unrecognized tax benefits.
- Working-capital conversion, particularly the increase in receivables and the level of operating cash flow relative to adjusted free cash flow.
- Management’s assumptions supporting percentage-of-completion revenue recognition and the timing of delayed Industrial Process orders.