ITT Corporation — Q3 2014 Form 10-Q Summary
Business context and reporting period
ITT is a diversified manufacturer of engineered components and technology solutions serving energy, transportation, industrial, aerospace and defense markets. Reportable segments are Industrial Process, Motion Technologies, Interconnect Solutions and Control Technologies. This filing covers the quarter and nine months ended September 30, 2014, compared with the corresponding 2013 periods.
Financial performance and liquidity
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|
| Revenue | $657.1 million | $634.0 million | $1,994.6 million | $1,851.4 million |
| Gross profit | $219.9 million | $202.9 million | $649.5 million | $591.2 million |
| Gross margin | 33.5% | 32.0% | 32.6% | 31.9% |
| Operating income | $119.7 million | $77.0 million | $222.5 million | $155.6 million |
| Operating margin | 18.2% | 12.1% | 11.2% | 8.4% |
| Net income attributable to ITT | $80.3 million | $430.7 million | $150.8 million | $477.3 million |
| Diluted EPS | $0.86 | $4.69 | $1.62 | $5.17 |
- Revenue increased 3.6% in the quarter and 7.7% year to date. Organic revenue growth was 3.9% and 7.2%, respectively.
- Gross margin improved 150 basis points in the quarter and 70 basis points year to date. Segment operating income increased 22.6% in the quarter and 18.7% year to date, supported by volume, productivity and restructuring savings.
- Reported earnings declined sharply because third-quarter and year-to-date 2013 results benefited from a $374.6 million release of the U.S. deferred-tax-asset valuation allowance. The 2014 effective tax rates were 31.9% for the quarter and 28.8% year to date, versus negative rates in 2013.
- Adjusted income from continuing operations was $61.7 million, or $0.66 per diluted share, in Q3 2014, versus $49.9 million, or $0.54 per share, in Q3 2013. Year-to-date adjusted income was $174.5 million, or $1.88 per share.
- Orders increased 1.7% in the quarter to $688.7 million and 4.2% year to date to $2,060.8 million. Industrial Process backlog was $718.5 million at September 30, up 5.4% from December 31, 2013.
- Net cash provided by operating activities was $131.9 million for the first nine months, up from $98.6 million. Capital expenditures were $74.4 million, resulting in reported operating cash flow less capital expenditures of approximately $57.5 million. Adjusted free cash flow was $88.2 million versus $102.0 million in 2013.
- Cash and cash equivalents were $522.6 million at September 30, 2014, compared with $507.3 million at year-end 2013. Total debt and capital leases were $9.3 million, down from $48.9 million, and no commercial paper or revolving-credit borrowings were outstanding.
- ITT had access to a $500 million revolving credit facility, was in compliance with its covenants, and stated that available liquidity was sufficient for short-term funding needs.
- Dividends declared were $0.11 per share in the quarter, a 10% increase from the prior year. The company repurchased $25.5 million of common stock during the first nine months.
Segment developments and changes versus the prior comparable period
| Segment | Q3 revenue change | Q3 operating margin | Key drivers |
|---|
| Industrial Process | +2.7% | 10.6% | Oil and gas project pumps; partly offset by weaker short-cycle pumps, mining and prior-year valve shipments. |
| Motion Technologies | +11.4% | 18.5% | Automotive brake-pad growth, aftermarket demand, rail strength and KONI turnaround improvements. |
| Interconnect Solutions | -5.3% | 11.4% | Declines in defense, communications and non-strategic connectors, partly offset by oil and gas and industrial demand. |
| Control Technologies | +1.1% | 22.2% | Commercial aerospace and energy-absorption growth, offset by defense weakness and an end-of-life aerospace program. |
- The $42.5 million Q3 net asbestos benefit was a major contributor to reported operating-income growth; it compared with a $15.4 million benefit in Q3 2013.
- The 2014 asbestos remeasurement reduced estimated liability by $42.8 million and increased estimated recoveries by $16.0 million, producing a net benefit of $58.8 million.
- Restructuring costs increased to $22.2 million for the first nine months from $10.6 million. The Interconnect Solutions turnaround included approximately 250 planned headcount reductions and was expected to incur approximately $1.0 million of additional costs over the following three months.
- Management estimated approximately $20 million of future annual net savings from 2014 restructuring actions.
- Capital spending increased, primarily for Motion Technologies production capacity and an Industrial Process testing and production facility.
Outlook, commentary, risks and unusual items
- The filing does not provide a clear formal full-year revenue or earnings guidance range. Management emphasized continued investment in automotive brake-pad capacity, Industrial Process aftermarket capabilities, Lean initiatives and productivity improvements.
- Management cited strength in oil and gas project pumps, automotive brakes, rail and the KONI business, but noted order delays in certain oil and gas projects, particularly in emerging markets.
- Asbestos exposure remained material. At September 30, recorded asbestos liabilities were $1,224.5 million and related insurance-recovery assets were $497.3 million, for net estimated exposure of $727.2 million. Approximately 50,000 active claims were pending.
- Management estimated insurance recovery of 41% of asbestos indemnity and defense costs over the next ten years, declining to 25% in the tenth year. Net asbestos cash outflows were projected at $15 million to $25 million annually over the next five years and approximately $40 million to $50 million annually thereafter, with cash payments expected through approximately 2028.
- The company cannot reasonably estimate asbestos costs for claims arising after the next ten years; actual costs and recoveries could materially differ from recorded estimates.
- Environmental liabilities, net of related assets, were $81.2 million, with a reasonably possible gross liability range of $68.5 million to $156.5 million across 54 active sites.
- Tax authorities were examining ITT in several jurisdictions. The company estimated that unrecognized tax benefits could change by approximately $84.1 million over the next twelve months.
- Additional risks include geopolitical instability in Russia, Venezuela and other emerging markets; Venezuelan currency restrictions; defense-market weakness; complex long-term contracts recognized using percentage-of-completion accounting; and potential cost or margin effects from restructuring and strategic investments.
- A trial concerning whether certain insurer primary policies were properly exhausted was scheduled for November 2014. ITT also expected to make approximately €770,000 in settlement payments related to previously wound-down Iranian activities by year-end 2014.
Most important facts for investors to verify
- Whether operating improvement continues after excluding the $58.8 million net asbestos remeasurement benefit and other special items.
- The sustainability of Motion Technologies and KONI growth, and the timing of expected Industrial Process project-pump orders.
- Progress and remaining costs of the Interconnect Solutions turnaround and other restructuring actions.
- Actual asbestos claims, insurance recoveries, litigation outcomes and cash payments compared with management’s estimates.
- Tax-audit developments, changes in unrecognized tax benefits and the sustainability of the 2014 effective tax rate.
- Conversion of backlog and orders into revenue and cash flow, including risks from emerging-market delays, defense weakness and Venezuela’s exchange-rate regime.
