ITT Corporation 2014 Form 10-K Summary
Business context and reporting period
ITT Corporation filed its annual report for the fiscal year ended December 31, 2014. 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 company had approximately 9,400 employees, operated in more than 35 countries and generated 65% of sales outside the United States.
For the fourth quarter of 2014, revenue was $660.0 million, income from continuing operations attributable to ITT was $33.4 million and diluted earnings per share from continuing operations were $0.36.
Financial performance and condition
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Revenue | $2,654.6 million | $2,496.9 million | 6.3% increase |
| Gross profit | $866.4 million | $799.8 million | 8.3% increase |
| Gross margin | 32.6% | 32.0% | 60 basis-point increase |
| Operating income | $266.4 million | $183.6 million | 45.1% increase |
| Operating margin | 10.0% | 7.4% | 260 basis-point increase |
| Income from continuing operations attributable to ITT | $188.4 million | $487.7 million | 61.4% decrease |
| Net income attributable to ITT | $184.5 million | $488.5 million | 62.2% decrease |
| Diluted EPS from continuing operations | $2.03 | $5.28 | Decrease |
| Operating cash flow from continuing operations | $244.7 million | $226.6 million | 8.0% increase |
| Adjusted free cash flow | $173.0 million | $181.6 million | 4.7% decrease |
| Adjusted free cash flow conversion | 75.6% | 97.5% | Decrease |
Segment revenue was $1,208.3 million for Industrial Process, $769.4 million for Motion Technologies, $392.8 million for Interconnect Solutions and $290.5 million for Control Technologies. Segment operating margins were 10.3%, 17.0%, 5.7% and 21.9%, respectively.
At December 31, 2014, cash and cash equivalents were $584.0 million, total assets were $3.63 billion and total debt and capital leases were $8.5 million. ITT had no commercial paper outstanding and no borrowings under its $500 million revolving credit facility. The facility permits total commitments of up to $700 million if expanded with lender consent. The company reported compliance with its 3.0 times minimum interest coverage ratio and 3.0 times maximum leverage ratio.
Capital expenditures were $118.8 million. ITT paid $40.7 million in dividends and repurchased $50.0 million of common stock under its repurchase program. The quarterly dividend was $0.11 per share throughout 2014, compared with $0.10 in 2013.
Material changes versus the prior comparable period
- Revenue increased 6.3%, including 6.9% organic growth. Emerging-market revenue increased 11.4%, while oil and gas represented approximately 20% of total revenue.
- Operating income increased primarily because of stronger segment performance, approximately $60 million of productivity, sourcing and restructuring savings, and a $28.9 million reduction in net asbestos-related costs.
- Motion Technologies delivered the largest segment operating improvement, with operating income up 30.5% and margin up 310 basis points, driven by automotive, rail, Lean initiatives and manufacturing improvements.
- Interconnect Solutions revenue declined 0.7% because of weakness in defense and communications connectors and the phase-out of non-strategic product lines, although operating income increased 56.3%.
- Research and development expense increased 13.8% to $76.6 million, or 2.9% of revenue.
- Net income and reported EPS fell sharply because 2013 included a $374.6 million release of a U.S. deferred-tax valuation allowance. The 2014 effective tax rate was 27.2%, compared with a tax benefit and effective rate of negative 171.5% in 2013.
- Backlog declined to $1.025 billion from $1.093 billion, principally due to foreign-currency translation; management expected nearly all year-end backlog to be delivered during 2015.
- Cash increased by $76.7 million during 2014, compared with a $37.2 million decrease in 2013, helped by higher operating cash flow and investment maturities.
Guidance, outlook, commentary and risks
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. The filing does not provide a specific 2015 revenue or EPS forecast.
Management identified the decline in oil prices as a significant 2015 uncertainty. ITT expected customer project delays and potential order cancellations in oil and gas, particularly affecting Industrial Process and Interconnect Solutions. Other cited uncertainties included foreign-currency movements, instability in Venezuela and Russia, emerging-market deceleration and modest global GDP growth. A Venezuelan currency remeasurement produced a $1.1 million charge in the fourth quarter.
- Asbestos liability was $1.223 billion for pending claims and claims estimated over the next ten years, offset by $476.4 million of estimated insurance recoveries, resulting in net exposure of $746.8 million. Claims beyond 2024 are not accrued and could be material.
- Projected net asbestos cash outflows were $15 million to $25 million annually over the next five years and approximately $40 million to $50 million annually over the remaining projection period, subject to substantial uncertainty.
- Environmental liabilities were $89.9 million, with a reasonably possible high-end estimate of $160.3 million. Management estimated annual environmental spending of $10 million to $15 million.
- Postretirement benefit plans were underfunded by $262.7 million at year-end. Estimated 2015 contributions were approximately $5.0 million for global pension plans and $11.0 million for other employee-related benefit plans.
- International operations expose ITT to foreign-exchange, geopolitical, regulatory, tax, repatriation and political risks. A hypothetical 10% currency movement would have affected pretax earnings by approximately $20 million, based on the filing’s sensitivity analysis.
- Additional risks include commodity-price volatility, supply-chain disruptions, product liability, customer and distributor concentration, cybersecurity, tax audits, pension assumptions, environmental matters and the execution of restructuring and ERP implementation initiatives.
Management reported effective disclosure controls and effective internal control over financial reporting. Deloitte & Touche LLP issued unqualified opinions on the consolidated financial statements and internal controls.
Important facts for investors to verify
- Reconcile reported 2014 earnings with adjusted income of $228.8 million and adjusted diluted EPS of $2.47, particularly the effects of asbestos, restructuring, Venezuela, ERP costs and tax items.
- Assess the sustainability of operating-margin gains after restructuring savings and favorable asbestos-related remeasurement effects.
- Monitor oil and gas exposure, Industrial Process orders and backlog, and the effect of depressed oil prices on 2015 capital projects.
- Review asbestos claim assumptions, insurer solvency and coverage-in-place agreements, including liabilities not recorded for claims after 2024.
- Evaluate cash conversion, with adjusted free-cash-flow conversion of 75.6% versus the company’s long-term target above 105%.
- Consider foreign-currency and geopolitical exposure, particularly Venezuela, Russia, the euro and emerging markets.
- Review tax-audit contingencies, including $160.1 million of unrecognized tax benefits and a potential change of approximately $86.5 million over the following twelve months.