Business Context and Reporting Period
ITT Corporation is a diversified manufacturer of engineered components and technology solutions serving energy, transportation and industrial markets through Industrial Process, Motion Technologies, Interconnect Solutions and Control Technologies. This unaudited Form 10-Q covers the three and nine months ended September 30, 2013, compared with the corresponding 2012 periods.
Financial Performance and Position
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Revenue | $634.0 million | $547.5 million | $1,851.4 million | $1,673.5 million |
| Gross profit | $202.9 million | $166.2 million | $591.2 million | $506.8 million |
| Gross margin | 32.0% | 30.4% | 31.9% | 30.3% |
| Operating income | $77.0 million | $36.7 million | $155.6 million | $130.4 million |
| Operating margin | 12.1% | 6.7% | 8.4% | 7.8% |
| Net income attributable to ITT | $430.7 million | $73.0 million | $477.3 million | $93.0 million |
| Diluted EPS | $4.69 | $0.78 | $5.17 | $0.99 |
Revenue increased 15.8% in the quarter and 10.6% year to date. Q3 organic revenue growth was 9.1%, with total orders up 23.0% and organic orders up 10.3%. The Bornemann acquisition contributed $33.1 million of Q3 revenue and $102.7 million for the first nine months.
- Industrial Process: Q3 revenue rose 18.8% to $285.0 million, but operating income declined 9.5% to $27.7 million; margin fell to 9.7% from 12.8% because of mix, project pricing, acquisition-related amortization and investment costs.
- Motion Technologies: Q3 revenue increased 17.0% to $176.8 million and operating income rose 33.3% to $24.8 million, supported by automotive brake-pad volume and cost savings.
- Interconnect Solutions: Q3 revenue increased 14.4% to $103.9 million and operating income improved to $10.8 million from a $0.9 million loss, reflecting higher volume, favorable mix and efficiency initiatives.
- Control Technologies: Q3 revenue increased 3.4% to $69.9 million, while operating income declined 8.1% to $13.7 million due to mix and strategic investment costs.
Reported earnings were heavily affected by a $374.6 million release of the U.S. deferred-tax-asset valuation allowance. Adjusted income from continuing operations was $49.9 million, or $0.54 per diluted share, versus $40.7 million, or $0.44, in Q3 2012. Nine-month adjusted income was $141.1 million, or $1.53 per diluted share, versus $123.5 million, or $1.31.
Cash Flow, Liquidity and Capital Structure
- Cash provided by operating activities was $98.6 million for the first nine months, down from $175.3 million, primarily because 2012 benefited from a significant income-tax refund.
- Adjusted free cash flow was $88.8 million, compared with $219.4 million in the prior-year period.
- Investing cash flow was $(118.8) million, including $58.2 million of capital expenditures and net purchases of short-term investments.
- Financing cash flow was $(24.2) million, including $87.9 million of share repurchases and $18.3 million of dividends paid.
- Cash and cash equivalents were $480.6 million at September 30, 2013, compared with $544.5 million at December 31, 2012.
- Total debt and capital leases were $77.3 million, including $66.0 million of commercial paper. The $500 million revolving credit facility was undrawn, and leverage and interest-coverage covenants were satisfied.
- Accounts receivable increased to $543.3 million from $440.3 million at year-end, while total current assets were $1,691.5 million versus current liabilities of $862.1 million.
Material Changes Versus the Prior Comparable Period
- Operating income increased 109.8% in Q3 and 19.3% year to date; reported operating margin improved by 540 basis points in Q3 and 60 basis points year to date.
- Gross margin improved 160 basis points in both the quarter and nine-month period, reflecting volume, sourcing and Lean transformation savings, partly offset by unfavorable mix.
- Asbestos-related operating results changed from a $12.8 million cost in Q3 2012 to a $15.4 million benefit in Q3 2013, primarily due to a $31.0 million insurer settlement and updated liability assumptions.
- Share count declined: diluted weighted-average shares were 91.9 million in Q3 and 92.3 million year to date, versus 93.5 million and 94.3 million, respectively, in 2012.
- Debt increased from $26.9 million at December 31, 2012 to $77.3 million at September 30, 2013, primarily reflecting commercial paper borrowings.
- Discontinued operations produced a Q3 loss of $2.3 million, versus income of $12.3 million in Q3 2012, including a $15.3 million cash payment to settle legacy receivables and payables.
Outlook, Commentary, Risks and Unusual Items
Management reported encouraging order and organic-revenue trends but remained cautious about the pace and timing of market recoveries, particularly weak baseline pump orders. No specific full-year earnings or revenue guidance is provided in the filing text.
- Management expects current restructuring actions to be completed during 2014 and estimates approximately $17.0 million of additional restructuring costs.
- Additional repositioning costs of approximately $5 million to $15 million were expected during the remainder of 2013, with approximately $10 million thereafter.
- Industrial Process capacity expansions in South Korea and Seneca Falls, New York are intended to support oil and gas growth; the Seneca Falls expansion was expected to be completed in mid-2014.
- Asbestos liabilities were $1,269.9 million and related recovery assets were $533.1 million, producing net exposure of $736.8 million. Approximately 59,000 active asbestos claims were pending at September 30.
- Management estimates recovery of 42% of asbestos indemnity and defense costs over the next 10 years, declining to approximately 30% in the tenth year. Net asbestos cash payments are expected to continue through approximately 2029.
- Environmental liabilities were $93.5 million, net of $11.7 million of related assets. The reasonably possible environmental liability range was $73.0 million to $166.0 million across 63 active sites.
- Tax examinations were ongoing in the Czech Republic, Germany, Italy, Korea and the United States. The company stated that potential changes in unrecognized tax benefits could not reasonably be estimated.
- Key operating risks include macroeconomic weakness, mining and industrial demand, automotive pricing and mix, defense sequestration, foreign exchange, acquisition integration, asbestos litigation and insurance recoveries, environmental matters and tax contingencies.
Investor Verification Checklist
- Verify the sustainability of adjusted earnings excluding the $374.6 million tax valuation-allowance release and asbestos-related benefits.
- Assess operating performance by segment, especially the Industrial Process margin decline and the turnaround progress at Interconnect Solutions.
- Monitor operating cash conversion, working-capital requirements, capital expenditures and the decline in adjusted free cash flow.
- Review asbestos claim activity, insurer solvency, coverage exhaustion risk and the sensitivity of the $736.8 million net exposure.
- Confirm the timing and total cost of restructuring, repositioning and facility-expansion programs.
- Evaluate commercial paper reliance, cash deployment through share repurchases and the availability of the undrawn revolving credit facility.