ITT Inc. Form 10-Q Summary
Business Context and Reporting Period
ITT Inc. is a diversified manufacturer of engineered components and technology solutions serving transportation, industrial, oil and gas, aerospace and defense, and related markets. Reportable segments are Industrial Process, Motion Technologies, and Connect & Control Technologies. This unaudited Form 10-Q covers the three and six months ended June 30, 2018, compared with the corresponding 2017 periods.
Financial Results and Key Metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $696.8 million | $630.9 million | $1,386.1 million | $1,256.7 million |
| Gross profit | $226.0 million | $205.0 million | $450.2 million | $408.1 million |
| Gross margin | 32.4% | 32.5% | 32.5% | 32.5% |
| Operating income | $80.3 million | $59.1 million | $190.9 million | $116.1 million |
| Operating margin | 11.5% | 9.4% | 13.8% | 9.2% |
| Net income attributable to ITT | $69.7 million | $47.8 million | $170.9 million | $93.8 million |
| Diluted EPS | $0.79 | $0.54 | $1.93 | $1.05 |
| Operating cash flow | Not separately provided | Not separately provided | $119.3 million | $92.6 million |
| Adjusted free cash flow | Not separately provided | Not separately provided | $91.0 million | $85.0 million |
- Q2 revenue increased 10.4%, while six-month revenue increased 10.3%. Organic revenue growth was 6.9% in Q2 and 4.5% year to date.
- Q2 segment operating margin was 15.2%, up 230 basis points, driven by volume, productivity, project execution and foreign exchange. Consolidated margin also benefited from lower asbestos-related costs and favorable tax items.
- Six-month income tax expense was $16.5 million versus $19.7 million in 2017. The effective tax rate declined to 8.8% from 17.4%, primarily because of a $21.6 million German deferred-tax valuation allowance reversal and a $4.5 million reduction in the provisional Tax Act charge.
- Orders were $741.7 million in Q2, up 18.4%, and $1,502.9 million for the first six months, up 15.9%. Organic order growth was 14.7% and 9.2%, respectively. Industrial Process backlog was $427.8 million at June 30, up 27.1% from December 31, 2017.
Liquidity, Capital Structure and Cash Flow
- Cash and cash equivalents were $449.6 million at June 30, 2018, compared with $389.8 million at December 31, 2017. Cash flow statements include $1.2 million of restricted cash, producing ending cash and cash equivalents of $450.8 million.
- Total debt and capital leases were $217.9 million, including $209.6 million drawn under the $500 million revolving credit agreement and $7.2 million of long-term debt and capital leases. There was no commercial paper outstanding at quarter-end.
- The revolving facility matures in November 2021 and includes a potential $200 million expansion. ITT remained within its minimum 3.0 interest-coverage and maximum 3.0 leverage covenants.
- Six-month investing cash outflow was $45.4 million, including $46.3 million of capital expenditures; the prior year included $113.7 million for the Axtone acquisition. Financing cash outflow was $4.1 million and included $55.4 million of share repurchases and $12.0 million of dividends paid.
- ITT declared a quarterly dividend of $0.134 per share, a 4.7% increase from the comparable 2017 quarter. The company repurchased $50.0 million of shares under its repurchase program during the first six months and had $90.6 million remaining under the program at June 30.
Material Changes Versus the Prior Comparable Period
- Industrial Process revenue increased 5.7% in Q2 and 3.9% year to date; operating margin expanded to 11.5% and 10.3%, respectively, primarily from volume, mix, pricing, project execution, productivity and sourcing.
- Motion Technologies revenue increased 13.9% in Q2 and 16.5% year to date, but margins declined to 16.8% and 17.5% because of commodity costs, pricing pressure, unfavorable aftermarket mix and growth investments.
- Connect & Control Technologies revenue increased 9.7% in Q2 and 6.3% year to date; margins expanded substantially to 16.6% and 15.6%, aided by productivity and higher volume and by prior-year legal and military-connector items.
- Six-month operating results benefited from a $32.1 million insurance settlement related to asbestos coverage, resulting in a $6.2 million net asbestos benefit versus $29.8 million of net asbestos costs in 2017.
- ITT adopted the new revenue standard using the modified retrospective method. Adoption produced a $4.1 million reduction to opening retained earnings and changed the timing and presentation of certain design-and-build contract revenue and related balances.
- ITT also adopted new postretirement-benefit and restricted-cash presentation requirements; 2017 operating results were retrospectively restated for the benefit-cost presentation change.
Outlook, Commentary, Risks and Unusual Items
- Management cited broad-based end-market strength, operational execution, productivity gains, automotive platform wins, aerospace and defense demand, and stronger oil and gas and chemical orders. The filing does not provide a clear quantitative full-year revenue or earnings guidance figure.
- Management expects to mitigate commodity and tariff pressure through pricing, supply-chain actions, manufacturing-footprint optimization, supplier negotiations and diversification. The ultimate impact of tariffs remains uncertain.
- Removal of six military-specification connector products from the Defense Logistics Agency Qualified Products List remains unresolved. Estimated annual sales associated with those products were $8 million to $10 million, and the timing of reinstatement is uncertain.
- Asbestos liabilities were $858.8 million and related insurance assets were $387.3 million at June 30, producing net exposure of $471.5 million. Approximately 25,000 claims were pending. Management cannot reasonably estimate exposure beyond the next ten years and states that future asbestos costs could materially adversely affect results.
- Management projects net asbestos cash outflows of approximately $20 million to $30 million annually over the next five years, increasing to approximately $35 million to $45 million annually over the remainder of the projection period. Payments related to currently estimated claims may extend through approximately 2031.
- Environmental liabilities were $67.1 million, with 33 active investigation or remediation sites and a potential high-end liability estimate of $116.5 million.
- A Department of Justice investigation involving certain government connector products remains active. ITT accrued $5 million as its current best estimate of probable loss, but actual loss could be higher and an excess range cannot presently be estimated.
- Tax accounting under the 2017 Tax Cuts and Jobs Act remains provisional in certain respects, including GILTI. ITT has not selected a GILTI deferred-tax accounting policy. Tax examinations are ongoing in multiple jurisdictions.
- On July 27, 2018, after quarter-end, ITT sold excess property for $41.0 million in cash and recorded an estimated $40 million pretax gain.
Investor Verification Checklist
- Verify the sustainability of operating-margin expansion after excluding asbestos, tax benefits, foreign exchange and other unusual items.
- Assess whether order growth and the Industrial Process backlog convert into revenue and cash flow, particularly in project pumps and oil and gas markets.
- Monitor commodity costs, automotive pricing and aftermarket mix in Motion Technologies, as well as tariff exposure and mitigation effectiveness.
- Track resolution of the military-connector Qualified Products List removal and the related DOJ investigation.
- Reassess asbestos liabilities, insurer recoveries and projected cash outflows, including potential exposure beyond the recorded ten-year forecast.
- Evaluate environmental remediation exposure, tax-law measurement changes and the effect of the planned 2019 lease-accounting adoption.