ITT Corporation 2013 Form 10-K Summary
Business context and reporting period
ITT Corporation filed its Form 10-K for the fiscal year ended December 31, 2013. ITT is a diversified manufacturer of engineered components and technology solutions serving energy, transportation and industrial markets through four segments: Industrial Process, Motion Technologies, Interconnect Solutions and Control Technologies. The filing presents continuing operations after the 2011 spin-offs of Exelis and Xylem.
ITT had approximately 9,400 employees, operated in more than 35 countries and generated 64% of 2013 revenue outside the United States. Approximately 30% of revenue came from aftermarket products and services.
Key financial metrics
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Revenue | $2,496.9 million | $2,227.8 million | 12.1% |
| Gross profit | $799.8 million | $680.2 million | 17.6% |
| Gross margin | 32.0% | 30.5% | Up 150 basis points |
| Operating income | $183.6 million | $151.5 million | 21.2% |
| Operating margin | 7.4% | 6.8% | Up 60 basis points |
| Income from continuing operations attributable to ITT | $487.7 million | $109.5 million | 345.4% |
| Diluted EPS from continuing operations | $5.28 | $1.16 | 355.2% |
| Net income attributable to ITT | $488.5 million | $125.4 million | 289.6% |
| Cash flow from operating activities | $226.6 million | $247.1 million | Down $20.5 million |
| Capital expenditures | $122.9 million | $83.8 million | Up $39.1 million |
| Adjusted free cash flow | $164.5 million | $271.0 million | Down 39.3% |
| Adjusted free cash flow conversion | 88.3% | 171.5% | Down 83.2 percentage points |
The 2013 effective tax rate was negative 171.5%, primarily because ITT released a $374.6 million U.S. deferred-tax valuation allowance. This nonrecurring tax benefit materially increased reported earnings. Adjusted income from continuing operations was $186.3 million, or $2.02 per diluted share, compared with $158.0 million, or $1.68 per diluted share, in 2012.
Cash and cash equivalents were $507.3 million at year-end, compared with $544.5 million in 2012. Total debt and capital leases were $48.9 million, including $38.0 million of commercial paper. ITT had no borrowings under its $500 million revolving credit facility and reported compliance with its leverage and interest-coverage covenants.
Segment performance and changes versus the prior period
| Segment | 2013 revenue | Revenue change | 2013 operating margin |
|---|---|---|---|
| Industrial Process | $1,107.4 million | 15.9% | 10.1% |
| Motion Technologies | $721.8 million | 15.3% | 13.9% |
| Interconnect Solutions | $395.5 million | 5.3% | 3.6% |
| Control Technologies | $278.2 million | 0.4% | 19.9% |
- Consolidated organic revenue increased 6.3%, while organic orders increased 6.9%.
- Industrial Process benefited from the full-year contribution of the 2012 Bornemann acquisition, oil and gas growth and aftermarket demand. Revenue increased $151.6 million, including $136.0 million from Bornemann.
- Motion Technologies gained automotive brake-pad share in China and Europe and increased aftermarket demand. Organic revenue grew 12.7%.
- Interconnect Solutions returned to revenue growth and expanded operating margin by 180 basis points, supported by higher sales and restructuring, sourcing and lean initiatives, although profitability remained low.
- Control Technologies was broadly flat as commercial aerospace growth was offset by lower defense, industrial and aerospace aftermarket activity.
- Gross-margin improvement reflected higher volume, Bornemann contributions and approximately $42 million of net savings from sourcing, VBLSS and restructuring initiatives.
- Operating expenses increased 16.6%, primarily because of Bornemann, higher general and administrative spending, $28.4 million of restructuring costs and $23.0 million of repositioning costs related to the post-spin separation.
Fourth-quarter information
For the fourth quarter of 2013, revenue was $645.5 million and gross profit was $208.6 million. Income from continuing operations attributable to ITT was $10.9 million, or $0.12 per diluted share. Fourth-quarter results were affected by the timing and seasonality of operations and do not represent the full-year earnings profile.
Guidance, outlook and management commentary
- Management’s long-term objectives are approximately 5% to 7% average annual organic revenue growth, 50 to 70 basis points of annual operating-margin expansion, adjusted free-cash-flow conversion above 105% and adjusted EPS growth of 10% to 15% annually.
- For 2014, management expected Industrial Process revenue to exceed 2013 levels, supported by oil and gas and aftermarket investments, although complex project shipments and weaker baseline pump orders could pressure margins in the first half.
- Management expected Motion Technologies growth to be driven by higher OEM production in China and Europe.
- ITT expected approximately $10 million of additional repositioning costs in 2014 and approximately $20 million of further Interconnect Solutions restructuring costs, primarily for geographic footprint consolidation.
- Capital spending rose to $122.9 million in 2013 for capacity and technology investments in South Korea, Seneca Falls, New York and Wuxi, China.
Risks, contingencies and unusual items
- Asbestos liability for pending claims and claims estimated over the next ten years was $1,264.7 million, with estimated insurance recoveries of $517.8 million and net exposure of $746.9 million. Claims beyond the ten-year projection are probable but not reasonably estimable.
- Management projected net asbestos cash outflows of approximately $10 million to $20 million annually over the next five years, increasing to approximately $35 million to $45 million annually thereafter. Cash payments related to the current estimate may extend through approximately 2029.
- Primary insurance coverage-in-place agreements were exhausted or expected to be exhausted in the near term, potentially increasing interim net cash outflows. Insurance recoveries are subject to insurer solvency, policy interpretation and litigation risk.
- Environmental liabilities were $94.6 million, with a reasonably possible range of $73.3 million to $168.0 million across approximately 60 active sites.
- Postretirement plans had a combined funded deficit of $254.6 million. ITT estimated 2014 contributions of approximately $15.0 million.
- ITT remains exposed to global economic cycles, foreign currency, commodity prices, raw-material availability, customer concentration, product liability, regulatory compliance, cybersecurity and execution risks associated with restructuring and enterprise-system initiatives.
- The company reported $131.7 million of guarantees, letters of credit and similar arrangements, while stating that material loss contingencies were not expected.
- Bornemann’s Iranian activities were wound down by March 8, 2013. The filing reports 2013 Iranian-related revenue and operating income of zero after the wind-down, but a €1.3 million performance bond remained outstanding.
Most important facts for investors to verify
- Separate recurring operating performance from the $374.6 million deferred-tax valuation-allowance release and other adjusted items.
- Reconcile reported operating cash flow and adjusted free cash flow with capital spending, asbestos payments, restructuring and repositioning cash costs.
- Monitor asbestos claims, insurer recoveries, coverage exhaustion and the unrecorded exposure for claims filed after 2023.
- Assess whether Industrial Process backlog of $681.7 million and total company backlog of $1,093 million convert to revenue and margin as expected; nearly all year-end backlog was expected to ship in 2014.
- Evaluate Interconnect Solutions’ turnaround, including the planned additional restructuring costs and whether margin improvement is sustained.
- Review customer concentration: one customer represented 10.1% of consolidated 2013 revenue and approximately 46% of Motion Technologies revenue was sold to two major brake-system customers.
- Confirm the sustainability of the company’s long-term growth, margin-expansion and cash-conversion targets given higher investment levels and ongoing legacy liabilities.