ITT Inc. 2017 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
ITT Inc. is a diversified manufacturer of highly engineered components and technology solutions serving transportation, industrial, oil and gas, aerospace, defense, and related markets. Reported segments are Industrial Process, Motion Technologies, and Connect & Control Technologies. The filing covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016. In 2017, ITT combined its former Interconnect Solutions and Control Technologies segments into Connect & Control Technologies, with prior-period segment data reclassified.
Financial Performance and Liquidity
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $625.8 million | $609.1 million | 2.7% |
| Gross profit | $202.3 million | $195.3 million | 3.6% |
| Gross margin | 32.3% | 32.1% | +20 bps |
| Operating income | $55.6 million | $51.0 million | 9.0% |
| Operating margin | 8.9% | 8.4% | +50 bps |
| Income from continuing operations attributable to ITT | $46.1 million | $37.7 million | 22.3% |
| Net income attributable to ITT | $46.0 million | $37.4 million | 23.0% |
| Diluted EPS | $0.52 | $0.41 | Increase of $0.11 |
| Operating cash flow | $27.1 million | $5.7 million | Increase of $21.4 million |
The effective tax rate declined to 16.6% from 23.7%, primarily due to tax benefits from the adoption of ASU 2016-09, a Korea deferred-tax-asset rate change, and a favorable mix of non-U.S. earnings. Adjusted income from continuing operations was $57.4 million, or $0.64 per diluted share, compared with $53.3 million, or $0.59 per diluted share, in the prior year.
- Segment revenue: Industrial Process declined 10.9% to $186.1 million; Motion Technologies increased 11.8% to $287.3 million; Connect & Control Technologies increased 6.2% to $153.3 million.
- Segment operating margin: Industrial Process was 3.9%, Motion Technologies 19.1%, and Connect & Control Technologies 10.6%. Connect & Control improved 200 basis points, while Industrial Process and Motion Technologies declined 40 and 60 basis points, respectively.
- Orders and backlog: Orders were $670.6 million, up 7.6%, with a 1.07x book-to-bill ratio. Organic orders increased 7.0%. Industrial Process backlog was $385 million at March 31, 2017, up 10.9% from year-end.
- Cash flow and investment: Capital expenditures were $36.7 million versus $21.0 million. ITT paid $113.7 million, net of cash acquired, for Axtone Railway Components. Adjusted free cash flow was $13.3 million versus negative $4.5 million.
- Cash and debt: Cash and cash equivalents were $348.5 million, down from $460.7 million at December 31, 2016. Total debt and capital leases were $217.1 million, including $112.0 million of commercial paper and $100.0 million outstanding under the revolving credit agreement.
- Dividend and repurchases: The quarterly dividend declared was $0.128 per share, up 3.2% year over year. No shares were repurchased under the public repurchase program; $2.3 million of shares were acquired for employee tax-withholding obligations.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by transportation market share gains, automotive brake-pad demand, aerospace and defense strength, the Axtone acquisition, and Connect & Control operational improvements. These benefits offset continued oil and gas project weakness.
- Operating income improved despite higher commodity costs, unfavorable pricing and mix, foreign-exchange pressure, and increased strategic investment. Restructuring benefits and productivity savings were important contributors.
- Research and development expense increased 17.2% to $22.5 million, primarily from increased Motion Technologies product-development activity.
- Net asbestos-related costs increased to $14.9 million from $12.8 million; the prior-year period included a $2.6 million insurance settlement benefit.
- Industrial Process revenue and operating income fell because of a 39% decline in project-pump revenue, weak beginning-of-year backlog, slow parts activity, and cost overruns on complex pump projects.
- Motion Technologies benefited from automotive friction-material growth and Axtone, but margin declined because of higher material and labor costs, pricing and mix pressure, strategic investment, and foreign exchange.
- Cash declined primarily because of the Axtone acquisition, higher capital expenditures, and working-capital requirements.
- ITT adopted ASU 2016-09, recording a $1.1 million tax benefit in the quarter and cumulative-effect adjustments that increased retained earnings by $2.1 million and reduced retained earnings by $1.6 million for separate adoption provisions.
Guidance, Outlook, Risks, Contingencies and Unusual Items
- Management planned approximately $30 million of restructuring and realignment actions during 2017 and expected prior restructuring and productivity actions to provide additional benefits.
- Management expected continued strength in Automotive and Rail, while identifying uncertainty in oil and gas markets and currencies, pricing pressure, rising commodity costs, and uncertainty regarding U.S. Administration policies as challenges.
- The Defense and Logistics Agency issued a temporary stop-shipment and stop-production order affecting certain military connectors. Annual sales for affected products were approximately $8 million to $10 million; the ultimate impact was not estimable.
- Asbestos liabilities were $942.9 million and related insurance-recovery assets were $367.3 million, resulting in net estimated exposure of $575.6 million for pending claims and claims estimated through 2027. Approximately 27,000 claims were pending at March 31, 2017. Management stated that ultimate exposure, including claims beyond the next 10 years, cannot reasonably be estimated and could materially affect results.
- Projected net asbestos cash outflows were $15 million to $25 million annually over the next five years and approximately $30 million to $40 million annually over the remainder of the projection period. Payments related to the current estimate were expected to extend through approximately 2030.
- ITT had 35 active environmental investigation or remediation sites. Recorded environmental liabilities were $72.5 million, and management estimated a potential high-end liability of $121.0 million.
- ITT is responding to a Department of Defense Inspector General subpoena concerning products sold to or used by the U.S. government. The company is cooperating, but the timing and outcome are uncertain.
- ITT agreed to sell excess property for approximately $41 million in cash, subject to remaining closing conditions. The transaction was expected to close in the first half of 2018 and could generate an estimated gain of approximately $38 million to $40 million.
- Unrecognized tax benefits could change by approximately $19 million over the following 12 months because of audits, statute expirations, and other events.
Investor Verification Items
- Verify the sustainability of revenue and order growth, particularly whether Industrial Process project-pump weakness improves and whether the 1.07x company-wide book-to-bill converts to shipments.
- Assess the contribution, purchase-price allocation, and integration performance of Axtone, including the preliminary $89.0 million goodwill amount.
- Monitor margin effects from commodity inflation, pricing, mix, foreign exchange, and Motion Technologies strategic investments.
- Reconcile GAAP earnings and cash flow with management’s adjusted metrics, including the effects of asbestos, restructuring, realignment, acquisition, and tax-related items.
- Track asbestos claims, insurance recoveries, projected cash outflows, and the risk of costs beyond the recorded 10-year estimate.
- Monitor the defense connector stop-shipment order and the unresolved Department of Defense investigation.
- Confirm completion and proceeds from the planned excess-property sale and whether the expected gain is realized.
- Review liquidity under the $500 million revolving credit agreement, commercial-paper access, covenant compliance, and the decline in cash following the acquisition and capital spending.