ITT (ITT) - 2018 Q4 - Annual Report

PART I Business Description ITT Inc. is a diversified manufacturer of highly engineered components and technology solutions for transportation, industrial, and oil and gas markets Company Snapshot (2018) | Metric | Value | | :--- | :--- | | 2018 Revenue | $2.75 Billion | | Employees | Approx. 10,000 in 35 Countries | | Revenue Outside U.S. | 68% | | Sales Presence | Over 100 Countries | - The company's business is organized into three primary segments: - Motion Technologies (MT): Produces friction, shock, and vibration equipment - Industrial Process (IP): Delivers industrial flow equipment and services - Connect & Control Technologies (CCT): Manufactures electronic connectors and various control products[21] - ITT's operating strategy is centered on disciplined organic growth through market expansion and new product development, combined with operational improvements using Lean Six Sigma principles to enhance productivity and reduce costs[26] Backlog by Segment (in millions) | Segment | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Motion Technologies | $303.1 | $299.7 | $201.2 | | Industrial Process | $444.2 | $385.5 | $347.2 | | Connect & Control Technologies | $273.7 | $233.5 | $236.7 | | Total ITT Inc. | $1,021.0 | $918.7 | $785.1 | Motion Technologies (MT) The MT segment manufactures brake pads, shock absorbers, and energy absorption components for the global transportation industry - MT's primary products include brake pads, shims, shock absorbers, and sealing technologies for the transportation sector[29] - Sales to Continental, MT's largest customer, accounted for 23% of the segment's 2018 revenue, largely driven by OEM specifications for ITT brake pads within Continental's systems[32] Industrial Process (IP) The IP segment manufactures and services industrial pumps, valves, and plant optimization systems for diverse markets - IP's portfolio includes industrial pumps (Goulds Pumps, Bornemann), valves (Engineered Valves), and aftermarket services (PRO Services, i-ALERT)[39] - Independent industrial distributors contribute to approximately one-third of the segment's revenue through an extensive global network[43] Connect & Control Technologies (CCT) The CCT segment designs and manufactures highly engineered connectors and control products for critical applications - CCT's product portfolio includes high-performance electrical connectors (Cannon, VEAM, BIW) and control products like actuators, pumps, and switches for various critical applications[47][51] - Distributors accounted for about 30% of the segment's 2018 revenue, with products sold both directly and through numerous channels[46] Risk Factors ITT faces significant risks from asbestos claims, global economic conditions, international operations, tariffs, and customer concentration - The company faces significant uncertainty from pending and future asbestos claims, with potential material adverse effects on financial condition, and has indemnified its 2011 spin-offs for certain pre-spin-off asbestos claims[76][78][79] - International operations, accounting for 68% of total sales in 2018, expose the company to various risks including unfavorable laws, currency repatriation restrictions, political instability, and changes in tariffs[83] - Recently announced U.S. tariffs have negatively impacted the price of certain parts and materials, and continued trade disputes could adversely affect demand, costs, customers, and suppliers[87] - Sales to Continental, ITT's largest customer, accounted for approximately 11% of total revenue in 2018, posing a material adverse risk if this customer relationship is lost[102] Unresolved Staff Comments The company reported no unresolved staff comments from the SEC - None[127] Properties ITT operates 24 owned and 29 leased manufacturing facilities globally, totaling 7.3 million square feet, deemed adequate for its needs Owned Manufacturing Facilities by Region (as of Dec 31, 2018) | Region | Number of Facilities | Area (sq. ft. in thousands) | | :--- | :--- | :--- | | North America | 10 | 2,438.0 | | Europe | 11 | 2,169.2 | | Asia | 2 | 704.4 | | South America | 1 | 42.7 | | Total | 24 | 5,354.3 | Leased Manufacturing Facilities by Region (as of Dec 31, 2018) | Region | Number of Facilities | Area (sq. ft. in thousands) | | :--- | :--- | :--- | | North America | 12 | 534.6 | | Europe | 9 | 459.5 | | Asia | 6 | 807.7 | | South America | 2 | 49.6 | | Total | 29 | 1,851.4 | Legal Proceedings ITT faces significant legal proceedings, primarily asbestos claims with a net liability of $472.6 million, and a $10 million accrual for a DOJ investigation - As of December 31, 2018, the company recorded an undiscounted asbestos-related liability of $849.3 million and an associated insurance recovery asset of $376.7 million, resulting in a net exposure of $472.6 million for claims estimated over the next 10 years[133] - The company is cooperating with a U.S. Department of Justice (DOJ) civil investigation into certain connector products, with a $10 million accrual recorded as the best estimate of probable loss, and the Criminal Division of the DOJ has declined to prosecute[135] Mine Safety Disclosures This item is not applicable to the company - Not applicable[136] Executive Officers This section lists the executive officers, including Luca Savi who became CEO and President in January 2019 - Luca Savi was appointed Chief Executive Officer and President, effective January 2019[138] - On December 31, 2018, Denise L. Ramos retired from her role as Chief Executive Officer and Director[69] PART II Market for Common Equity and Related Matters ITT's common stock trades on the NYSE, with no open-market share repurchases in Q4 2018, and a $100 investment yielding $117.74 by 2018 - The company's common stock is traded on the NYSE under the symbol "ITT"[141] - No open-market share repurchases of common stock were made during the quarter ended December 31, 2018[144] Cumulative Total Return (Based on $100 investment on 12/31/2013) | Index | 12/31/2013 | 12/31/2018 | | :--- | :--- | :--- | | ITT Inc. | $100.00 | $117.74 | | S&P 400 Mid-Cap | $100.00 | $133.91 | | S&P 400 Capital Goods | $100.00 | $134.00 | Selected Financial Data This section summarizes five-year financial data, showing 2018 revenue of $2,745.1 million and net income of $333.7 million Selected Financial Data (in millions, except per share amounts) | Metric | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Revenue | $2,745.1 | $2,585.3 | $2,405.4 | | Gross Profit | $887.2 | $819.9 | $760.9 | | Operating Income | $397.3 | $319.3 | $276.6 | | Net Income attributable to ITT Inc. | $333.7 | $113.5 | $186.1 | | Diluted EPS | $3.76 | $1.28 | $2.07 | | Dividends declared per share | $0.536 | $0.512 | $0.496 | Management's Discussion and Analysis (MD&A) ITT achieved record revenue and orders in 2018, driven by strong operational performance and organic growth, while maintaining robust liquidity and managing key risks Executive Summary In 2018, ITT delivered strong financial results with record revenue and orders, driven by organic growth and strategic capital deployment 2018 Key Performance Indicators vs. 2017 | Metric | 2018 Value | YoY Change | | :--- | :--- | :--- | | Revenue | $2,745M | +6% | | Orders | $2,892M | +10% | | Segment Operating Income | $411M | +27% | | EPS | $3.75 | +$2.46 | | Operating Cash Flow | $372M | +50% | - Organic revenue increased 4.2%, driven by growth in industrial and transportation markets, including market share gains in automotive and strength in rail and commercial aerospace[159] - Capital deployment in 2018 included returning $97 million to shareholders, comprising $47 million in dividends and $50 million through share repurchases[160] Financial Results: 2018 vs. 2017 In 2018, revenue increased 6.2% to $2,745.1 million, with operating income up 24.4% and a significantly lower effective tax rate due to prior-year tax reform impact Financial Performance Comparison (2018 vs. 2017) | Metric | 2018 | 2017 | Change | | :--- | :--- | :--- | :--- | | Revenue | $2,745.1M | $2,585.3M | +6.2% | | Gross Profit | $887.2M | $819.9M | +8.2% | | Operating Income | $397.3M | $319.3M | +24.4% | | Operating Margin | 14.5% | 12.4% | +210bp | | Net Income | $333.7M | $113.5M | +194.0% | Segment Revenue Growth (2018 vs. 2017) | Segment | Total Growth | Organic Growth | | :--- | :--- | :--- | | Motion Technologies | 8.3% | 4.2% | | Industrial Process | 2.5% | 2.7% | | Connect & Control Technologies | 6.8% | 5.9% | - The increase in operating income includes a net gain of $38.5 million from the sale of a former operating location[181][185] - The effective tax rate decreased from 62.9% in 2017 to 14.8% in 2018, primarily due to the 2017 rate including a $129.2 million provisional charge related to the U.S. Tax Cuts and Jobs Act[194][195] Financial Results: 2017 vs. 2016 In 2017, revenue grew 7.5% to $2,585.3 million, with operating income up 15.4%, but income from continuing operations fell 36.8% due to a $129.2 million provisional tax expense from U.S. tax reform Financial Performance Comparison (2017 vs. 2016) | Metric | 2017 | 2016 | Change | | :--- | :--- | :--- | :--- | | Revenue | $2,585.3M | $2,405.4M | +7.5% | | Operating Income | $319.3M | $276.6M | +15.4% | | Operating Margin | 12.4% | 11.5% | +90bp | | Income from Continuing Ops | $115.0M | $181.9M | -36.8% | | Effective Tax Rate | 62.9% | 29.4% | +3,350bp | - Motion Technologies revenue grew 19.6%, including $74.0 million from the Axtone acquisition, with organic revenue for the segment growing 9.8%[202] - The effective tax rate surged to 62.9% in 2017, primarily due to a $129.2 million provisional tax expense related to the U.S. Tax Act[224] Liquidity and Capital Resources ITT maintains strong liquidity through operating cash flows and credit facilities, with net cash from operations increasing to $371.8 million in 2018, and projected asbestos outflows of $20-$30 million annually Summary of Cash Flows (in millions) | Activity | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Operating | $371.8 | $247.2 | $240.7 | | Investing | $(52.3) | $(223.2) | $(54.4) | | Financing | $(128.8) | $(112.5) | $(141.9) | - The company has access to a $500 million revolving credit agreement, which matures in November 2021 and had no outstanding borrowings as of December 31, 2018[232] - In 2018, the company repurchased 1.0 million shares for $50.0 million under its share repurchase program[229] - Projected net cash outflows for asbestos defense and indemnity are expected to average $20 to $30 million annually over the next five years[247] Key Performance Indicators and Non-GAAP Measures This section defines and reconciles non-GAAP measures, showing 2018 organic revenue growth of 4.2%, adjusted segment operating income of $414.2 million, and adjusted free cash flow of $308.9 million Reconciliation of Revenue to Organic Revenue (2018) | (in millions) | Amount | | :--- | :--- | | 2018 Revenue | $2,745.1 | | Less: Acquisitions | $(5.5) | | Less: Foreign currency translation | $(45.7) | | 2018 Organic Revenue | $2,693.9 | | 2017 Revenue | $2,585.3 | | Organic Revenue Growth | 4.2% | Reconciliation of Net Income to Adjusted EPS (2018) | (in millions, except per share) | Amount | | :--- | :--- | | Income from continuing operations | $332.4 | | After-tax special items adjustments | $(45.5) | | Adjusted income from continuing operations | $286.9 | | Diluted EPS | $3.75 | | Adjusted Diluted EPS | $3.23 | Adjusted Free Cash Flow Reconciliation (2018) | (in millions) | Amount | | :--- | :--- | | Net cash - Operating activities | $371.8 | | Capital expenditures | $(95.5) | | Adjustments (Insurance, Asbestos, Restructuring, etc.) | $32.6 | | Adjusted free cash flow | $308.9 | | Adjusted free cash flow conversion | 107.7% | Critical Accounting Estimates The company's critical accounting estimates involve significant judgment, particularly for asbestos matters, revenue recognition, goodwill impairment, and environmental liabilities - Asbestos Matters: The liability estimate is based on a 10-year forecast of claims and is highly sensitive to assumptions about mesothelioma and lung cancer claims, which represent approximately 99% of the indemnity liability[279][280] - Revenue Recognition: For certain highly customized long-term projects, revenue is recognized over time using a cost-to-cost method, which requires significant estimates of total contract revenues and costs[290] - Goodwill Impairment: Goodwill is tested for impairment annually using an income approach, which involves significant estimates of future cash flows, growth rates, and discount rates[301][304] - Environmental Liabilities: Accruals for environmental remediation are recorded when a liability is probable and reasonably estimable, with a recorded liability of $66.8 million and a reasonably possible high-end range of $115.9 million as of December 31, 2018[306][308] Market Risk Disclosures ITT is exposed to market risks from foreign currency, interest rates, and commodity prices, with a 10% adverse currency change impacting pre-tax earnings by $30 million - A hypothetical 10% change in foreign currency exchange rates would have resulted in a translation impact to pre-tax earnings of approximately $30 million for 2018[311] - A hypothetical 100 basis point increase in interest rates would result in approximately $1 million of additional annual interest expense based on current variable rate debt levels[313] - A hypothetical 10% change in steel prices would impact pre-tax earnings by approximately $6 to $8 million[314] Financial Statements and Supplementary Data This section contains the company's audited consolidated financial statements for 2016-2018, including statements of operations, balance sheets, cash flows, and accompanying notes - This section includes the full consolidated financial statements and supplementary data as indexed on page 59 of the report[315][351] Changes in and Disagreements with Accountants The company reported no changes in or disagreements with its accountants on accounting and financial disclosure - None[316] Controls and Procedures Management concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2018 - Based on an evaluation as of December 31, 2018, the CEO and CFO concluded that the company's disclosure controls and procedures are effective[319] - Management assessed internal control over financial reporting based on the 2013 COSO framework and determined that it was effective as of December 31, 2018[323][324] Other Information This section includes a disclosure regarding a €1.3 million performance bond related to a former Iranian customer of the acquired Bornemann subsidiary - A performance bond of €1.3 million related to a former Iranian customer of the acquired Bornemann subsidiary remains outstanding, with annual fees of approximately €11 thousand paid in 2018[329] PART III Directors, Executive Officers and Corporate Governance Information on directors, executive officers, and corporate governance is incorporated by reference from the company's 2019 Proxy Statement - Information is incorporated by reference from the 2019 Proxy Statement[338] Executive Compensation Information on executive compensation, including discussion and analysis, is incorporated by reference from the company's 2019 Proxy Statement - Information is incorporated by reference from the 2019 Proxy Statement[343] Security Ownership and Related Matters Information on security ownership of beneficial owners and management is incorporated by reference from the company's 2019 Proxy Statement - Information is incorporated by reference from the 2019 Proxy Statement[344] Certain Relationships, Related Transactions, and Director Independence Information on related party transactions and director independence is incorporated by reference from the company's 2019 Proxy Statement - Information is incorporated by reference from the 2019 Proxy Statement[345] Principal Accounting Fees and Services Information on principal accounting fees and services is incorporated by reference from the company's 2019 Proxy Statement - Information is incorporated by reference from the 2019 Proxy Statement[346] PART IV Exhibits and Financial Statement Schedules This section lists the financial statements, financial statement schedules, and exhibits filed as part of the Form 10-K report - This section lists the documents filed as part of the report, including financial statements and exhibits[347] Form 10-K Summary This item is not applicable - Not Applicable[348]