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 and industrial markets. Its four reportable segments are Industrial Process, Motion Technologies, Interconnect Solutions and Control Technologies. This unaudited Form 10-Q covers the three and six months ended June 30, 2013, compared with the corresponding 2012 periods.
Key financial metrics
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $609.2 million | $557.9 million | $1,217.4 million | $1,126.0 million |
| Gross profit | $197.8 million | $170.4 million | $388.3 million | $340.6 million |
| Gross margin | 32.5% | 30.5% | 31.9% | 30.2% |
| Operating income | $41.4 million | $57.0 million | $78.6 million | $93.7 million |
| Operating margin | 6.8% | 10.2% | 6.5% | 8.3% |
| Net income attributable to ITT | $25.8 million | $16.8 million | $46.6 million | $20.0 million |
| Diluted EPS | $0.28 | $0.18 | $0.50 | $0.21 |
Gross profit benefited from sourcing, Value Based Lean Six Sigma and volume-related savings. Consolidated operating income declined because higher corporate costs, asbestos-related charges and repositioning and restructuring costs more than offset segment improvements. The effective tax rate decreased to 36.7% in the quarter and 39.9% year to date, compared with 69.8% and 69.9%, respectively, in 2012, primarily because of the 2012 valuation allowance on U.S. deferred tax assets.
- Q2 reported revenue increased 9.2%; organic revenue increased 2.0%. Six-month reported revenue increased 8.1%; organic revenue increased 1.9%.
- Orders increased 13.3% in Q2, including 7.8% organic growth. Industrial Process backlog was $634.4 million at June 30, 2013, up 9.6% from the comparable prior-year figure.
- Segment operating income increased 9.4% in Q2 and 8.1% year to date, while consolidated operating income decreased 27.4% and 16.1%, respectively, due principally to corporate and asbestos-related costs.
- Adjusted income from continuing operations was $47.0 million, or $0.51 per diluted share, in Q2, compared with $46.3 million, or $0.49, in 2012. Year-to-date adjusted income was $91.3 million, or $0.99 per diluted share, compared with $83.1 million, or $0.88.
- Net cash provided by operating activities was $68.8 million for the first six months, down from $102.0 million. Adjusted free cash flow was $61.3 million, compared with $143.6 million.
- Capital expenditures were $36.8 million, including spending for a new Industrial Process facility in South Korea and an expansion in Seneca Falls, New York.
- Cash and cash equivalents were $517.7 million at June 30, 2013, compared with $544.5 million at December 31, 2012.
- Total debt and capital leases were $51.3 million, compared with $26.9 million at year-end 2012, including $40.0 million of commercial paper. No borrowings were outstanding under the $500 million revolving credit agreement, and the company remained within its interest-coverage and leverage covenants.
- ITT repurchased $87.9 million of common stock during the first six months and declared dividends of $0.20 per share. The remaining authorization under the repurchase program was $370.7 million at June 30, 2013.
Material changes versus the prior comparable period
- The November 2012 acquisition of Bornemann contributed $38.4 million of Q2 revenue and $68.7 million of six-month revenue, primarily within Industrial Process. The acquisition also increased selling, marketing, amortization and other operating costs.
- Motion Technologies revenue increased 10.5% in Q2 and 8.7% year to date, driven primarily by automotive brake-pad share gains, particularly in China and Europe.
- Industrial Process revenue rose 15.3% in Q2 and 14.4% year to date, but organic revenue declined because of weaker mining-related project shipments and baseline pump demand.
- Interconnect Solutions revenue was broadly flat in Q2 and down 0.9% year to date. Its Q2 operating margin improved to 6.7%, but year-to-date operating income declined because of restructuring costs, product mix and foreign currency effects.
- Control Technologies revenue declined 1.8% in Q2 and 2.0% year to date, reflecting defense sequestration, European weakness and the completion of an actuator retrofit program. Cost reductions nevertheless improved operating margins.
- Net asbestos-related costs increased to $15.9 million in Q2 and $31.9 million year to date, compared with $9.7 million and $22.3 million, respectively, in 2012.
- Other corporate costs increased substantially because of lower environmental insurance recoveries, the absence of a 2012 insurance-related asset recognition and higher repositioning costs.
- Discontinued operations produced income of $1.1 million in Q2 and $2.8 million year to date, versus $0.6 million and a $6.7 million loss in the prior-year periods, primarily from reversals of warranty reserves and legal contingencies.
Guidance, outlook, commentary and risks
Management expects 2013 growth to be driven by oil and gas, chemical and industrial pump demand, automotive share gains and emerging markets. Mining and defense are expected to remain headwinds. Management stated that key market recoveries in the second half of 2013 remained uncertain despite favorable order trends.
ITT expects additional repositioning costs of approximately $13 million to $23 million during the remainder of 2013 and approximately $10 million thereafter. Related cash outflows are expected to be approximately $20 million to $30 million during the remainder of 2013 and approximately $10 million thereafter. Management does not expect material global pension contributions during the remainder of 2013.
- Asbestos exposure is a significant contingency. At June 30, 2013, recorded asbestos liabilities were $1.336 billion and estimated insurance recoveries were $576.0 million, resulting in net exposure of $759.7 million. The estimates cover pending claims and claims projected through 2023; costs beyond that period are not recorded.
- There were approximately 77,000 pending asbestos claims, including 59,000 active claims. Management states that many claims have little or no value, but acknowledges that ultimate costs cannot be predicted and could materially affect financial position, results and cash flows.
- Expected asbestos insurance recovery was 43% of projected indemnity and defense costs over the modeled period and is projected to decline to 24% in the tenth year. Net asbestos cash outflows are projected to average $10 million to $20 million annually over the next five years.
- Environmental liabilities were $95.9 million gross and $84.0 million net of related assets. The reasonably possible liability range was $76.7 million to $165.7 million across 62 active sites.
- ITT continues to maintain a full valuation allowance against U.S. net deferred tax assets and certain foreign deferred tax assets. Future changes in the cumulative loss position could affect tax expense.
- The filing identifies risks from foreign exchange, including a $1.2 million Venezuela remeasurement charge and an estimated approximately $1.0 million operating-income impact from a further hypothetical 10% bolivar decline.
- Management stated that there were no material changes to previously disclosed risk factors, market-risk information or internal control effectiveness.
Important facts for investors to verify
- Whether organic growth and order growth convert into sustained revenue and margin improvement, particularly in Industrial Process and Motion Technologies.
- The profitability and final purchase-price accounting of Bornemann, including acquisition-related amortization and integration costs.
- The trajectory of corporate costs, repositioning and restructuring spending, and whether Lean and sourcing savings offset these charges.
- Changes in asbestos claims, insurance recoveries, liabilities and cash payments, including risks from claims beyond the current ten-year estimate.
- The range and development of environmental liabilities and the outcome of insurance-coverage litigation.
- Operating cash conversion, working-capital needs, capital expenditures and the effect of share repurchases on liquidity.
- The company’s continuing valuation allowance, unrecognized tax benefits and the potential effect of future tax changes on earnings.