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ITT > SEC Filings for ITT > Form 10-K on 21-Feb-2014All Recent SEC Filings

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Form 10-K for ITT CORP


21-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As we noted earlier on page 3 of this Annual Report on Form 10-K, this Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Part II, Item 7A, "Quantitative and Qualitative Disclosures about Market Risk" (along with other sections of this Annual Report), may contain forward-looking statements. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about the business and future financial results of the industry in which we operate, and other legal, regulatory and economic developments. These forward-looking statements include, but are not limited to, future strategic plans and other statements that describe the company's business strategy, outlook, objectives, plans, intentions or goals, and any discussion of future operating or financial performance.
We use words such as "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," "target," "future," "may," "will," "could," "should," "potential," "continue," "guidance" and other similar expressions to identify such forward-looking statements. Forward-looking statements are uncertain and to some extent unpredictable, and involve known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from those expressed or implied in, or reasonably inferred from, such forward-looking statements.
The risk factors discussed in Part I, Item 1A, "Risk Factors," and other risks identified in this Annual Report on Form 10-K could cause our actual results to differ materially from those expressed in forward-looking statements. There may be other risks and uncertainties that we are unable to predict at this time or that we currently do not expect to have a material adverse effect on our business.
OVERVIEW
ITT Corporation is a diversified manufacturer of highly engineered critical components and customized technology solutions for growing industrial markets. Building on its heritage of innovation, ITT partners with its customers to deliver enduring solutions to the key industries that underpin our modern way of life. We manufacture key components that are integral to the operation of systems and manufacturing processes in the energy, transportation and industrial markets. Our products provide enabling functionality for applications where reliability and performance are critically important to our customers and the users of their products.
Our businesses share a common, repeatable operating model. Each business applies technology and engineering expertise to solve our customer's most pressing challenges. Our applied engineering aptitude provides a superior business fit with our customers given the critical nature of their applications. This in turn provides us with a unique insight to our customer's requirements and enables us to develop solutions to assist our customers achieve their business goals. Our technology and customer intimacy in tandem produce opportunities to capture recurring revenue streams, aftermarket opportunities, and long lived original equipment manufacturer (OEM) platforms.
Our product and service offerings are organized into four segments: Industrial Process, Motion Technologies, Interconnect Solutions, and Control Technologies. These businesses generally operate within niche positions in large, attractive markets where specialized engineered solutions are required to support the needs of large industrial, transportation, and energy customers.
Industrial Process manufactures engineered fluid process equipment serving a diversified mix of customers in global infrastructure industries such as oil & gas, mining, power generation, chemical and other process markets and is a provider of plant optimization and efficiency solutions and aftermarket services and parts.
Motion Technologies manufactures brake pads, shock absorbers and damping technologies for the global automotive, truck, trailer and public bus and rail transportation markets.
Interconnect Solutions manufactures a wide range of highly specialized connector products that make it possible to transfer signal and power in various electronic devices that are utilized in the aerospace and defense, industrial and transportation, oil & gas markets, and medical markets.
Control Technologies manufactures specialized equipment, including actuation, valves, switches, vibration isolation, custom-energy absorption, and regulators for the aerospace and defense, and industrial markets.


EXECUTIVE SUMMARY
During 2013, we continued on our strategic growth path emphasizing on our key growth areas; Market Expansion, Differentiated Customer Experience, Operational Excellence, and Effective Capital Deployment. We geared towards margin improvement through various operational initiatives, while leveraging our strengths to further expand our global capabilities and reach. We invested in capacity expansion, technology, and R&D projects to drive organic growth and continued to advance our acquisition pipeline. We implemented a series of strategic objectives, including front-end realignment and on-time delivery initiatives, to grow the top-line in Interconnect Solutions' core markets, while improving the overall cost structure of the segment.
One of our key operational priorities is to execute VBLSS transformations at each of our significant revenue-producing facilities in the next three to five years, with the goal of improving the overall depth and breadth across all elements of process efficiency. VBLSS encompasses lean enterprise as well as continuous process improvement in other critical areas such as customer service and order entry and fulfillment. Our intent is to drive ever increasing levels of quality, speed, and efficiency throughout the organization to help drive margin improvement and customer performance. We are still in the early stages of our five-year lean transformation initiative but we are already seeing significant improvements on numerous key performance indicators. One such indicator, on-time delivery which helps us deliver a premier customer experience, has improved at a majority of our businesses during the year. At ITT, we are extending the lean concept beyond manufacturing to deliver a differentiated value to our customers by improving overall service and responsiveness. We have also engaged in sourcing initiatives that have delivered supply chain savings that exceeded our expectations and reflect the increased leverage our global strategic sourcing council has provided.
Our Industrial Process segment pursued opportunities in the growing global oil & gas markets and looked for opportunities to expand their aftermarket business, while integrating Bornemann to fully leverage its technology and our distribution network. Our Motion Technologies segment continues to expand our share of the automotive market with our advanced braking technologies by further penetrating the Asia-Pacific and North American regions. Control Technologies is focused on expanding their customer base, especially internationally, and to increase our direct customer contact to complement our extensive distributor network.
During 2013, we increased capital spending by $39.1 to $122.9 on expanding capacity through the construction of a new South Korea oil & gas production facility that will play a key role in advancing our energy strategy by becoming our Energy Center of Excellence for the Eastern Hemisphere. We have also committed to and began construction on the expansion of our Seneca Falls, New York facility, which is our Energy Center of Excellence for the Western Hemisphere and Global R&D Center of Excellence. Additionally, we completed an expansion of our research and development and testing capabilities and will be adding capacity and reorganizing our existing facility to accommodate larger, more complex industrial pumps and to meet the growing demands of our customers. We also returned $124.3 to shareholders in 2013 through a combination of share repurchases and dividends and invested $28.4 in restructuring initiatives. The restructuring initiatives focused on accelerating the turnaround efforts in certain businesses and we are implementing restructuring actions accordingly. Interconnect Solutions is one of those turnaround businesses, for which we have taken a holistic approach to deliver sustainable performance enhancements to our customers. We have focused on the front end and better coordination of connecting our engineering, marketing and sales directly with our key strategic channel partners and customers. We are also working to better align the manufacturing and overhead cost structure with the future strategy of the business. We are dedicated to reclaiming our leading position with our customers by providing innovative, high quality, reliable, highly engineered harsh environment connectors when the customer needs them. As a result of this focus, our Interconnect Solutions business illustrated preliminary benefits of this strategy, expanding its operating margin by 180 basis points from 2012. From a results standpoint, 2013 was a strong year as we experienced positive results from each of our four segments. On a consolidated basis, we delivered revenue growth of 12.1% and organic revenue growth of 6.3%. The organic revenue growth was primarily driven by share gains in the automotive brake pad markets in China and Western Europe and by global sales of oil and gas pumps. Offsetting this growth were declines from pump equipment destined for the mining market and baseline pumps for the chemical and industrial markets. In addition, we won numerous positions on key strategic contracts and orders during 2013, which drove a 6.9% increase in organic orders received. Consolidated operating income was $183.6 for the year, representing a $32.1 or 21.2% increase from the prior year, due to improved segment operating performance reflecting higher sales volume and net savings of approximately $42 from our VBLSS, sourcing, and restructuring initiatives and a year-over-year reduction in asbestos-related costs of $18.1 primarily related to a settlement agreement in 2013. We also continued our repositioning of the organization following the 2011 spin-offs of Exelis and Xylem, incurring costs of $23.0 (repositioning costs) during 2013, primarily related to the exit transition service agreements and creating IT infrastructure modifications. Net income from continuing


operations was $487.7 during 2013, which included a $374.6 release of a U.S. deferred tax valuation allowance, resulting in earnings of $5.28 per diluted share, reflecting growth of 355.2% over the prior year.
Adjusted income from continuing operations was $186.3 for 2013, reflecting an increase of $28.3, or 17.9%, over the prior year. Our adjusted income from continuing operations translated into $2.02 per diluted share, a $0.34 per share, or 20.2%, increase over the prior year. See the "Key Performance Indicators and Non-GAAP Measures," for reconciliation of non-GAAP measures.

DISCUSSION OF FINANCIAL RESULTS
2013 VERSUS 2012
                                                       2013            2012        Change
Revenue                                          $  2,496.9      $  2,227.8          12.1  %
Gross profit                                          799.8           680.2          17.6  %
Gross margin                                           32.0  %         30.5 %         150 bp
Operating expenses                                    616.2           528.7          16.6  %
Operating expense to revenue ratio                     24.7  %         23.7 %         100 bp
Operating income                                      183.6           151.5          21.2  %
Operating margin                                        7.4  %          6.8 %          60 bp
Interest and non-operating expenses, net                3.1             2.4          29.2  %
Income tax (benefit) expense                         (309.6 )          39.6        (881.8 )%
Effective tax rate                                   (171.5 )%         26.6 %     (19,810 )bp
Income from continuing operations attributable
to ITT Corporation                                    487.7           109.5         345.4  %
Earnings from discontinued operations, net of
tax                                                     0.8            15.9         (95.0 )%
Net income attributable to ITT Corporation       $    488.5      $    125.4         289.6  %

REVENUE
Revenue for the year ended December 31, 2013 increased $269.1, or 12.1%, over the prior year, primarily driven by our fourth quarter 2012 acquisition of Bornemann, which represented $136.0 of the increase. The Industrial Process segment saw organic revenue gains during the year from global expansion in the oil & gas market. In addition, we experienced growth of $95.6, or 15.3%, from our Motion Technologies segment primarily due to year-over-year OEM volume growth from expanded global brake pad market share gains and increased aftermarket demand. Our Interconnect Solutions segment also generated sales growth of $19.8, or 5.3%, with increased sales in all core market categories. The following table illustrates revenue generated with a specific country or region for the years ended December 31, 2013 and 2012, the corresponding percentage change, and the organic growth. See below for further discussion of year-over-year revenue activity at the segment level. See the section titled "Key Performance Indicators and Non-GAAP Measures" for a definition and reconciliation of organic revenue growth.

                                                                   Organic
                                   2013         2012    Change      Growth
United States                 $   896.2    $   869.3       3.1 %       0.9  %
Germany                           266.7        200.5      33.0 %      19.7  %
France                            144.7        118.2      22.4 %      17.2  %
Other developed markets           438.7        401.1       9.4 %       1.7  %
Total developed markets         1,746.3      1,589.1       9.9 %       4.7  %
South and Central America(a)      200.2        198.3       1.0 %      (8.5 )%
Eastern Europe and Russia         124.3        103.1      20.6 %      11.2  %
Middle East and Africa            144.1        114.3      26.1 %      19.8  %
China and Hong Kong               140.5        113.6      23.7 %      17.8  %
Other emerging growth markets     141.5        109.4      29.3 %      24.8  %
Total emerging growth markets     750.6        638.7      17.5 %      10.2  %
Total Revenue                 $ 2,496.9    $ 2,227.8      12.1 %       6.3  %

(a) Includes Mexico


The following table illustrates the year-over-year revenue results from each of our segments for the years ended December 31, 2013 and 2012.

                                                               Organic
                            2013          2012     Change       Growth
Industrial Process     $ 1,107.4     $   955.8       15.9  %       3.7 %
Motion Technologies        721.8         626.2       15.3  %      12.7 %
Interconnect Solutions     395.5         375.7        5.3  %       5.9 %
Control Technologies       278.2         277.1        0.4  %       0.7 %
Eliminations                (6.0 )        (7.0 )    (14.3 )%         -
Total Revenue          $ 2,496.9     $ 2,227.8       12.1  %       6.3 %

Industrial Process
Industrial Process revenue for the year ended December 31, 2013 increased $151.6, or 15.9%, year-over-year, primarily related to our fourth quarter 2012 acquisition of Bornemann. This acquisition provided $136.0 of incremental year-over-year revenue during 2013. Organic revenue increased 3.7% primarily due to gains in the global oil & gas market of approximately 21%, as well as increased shipments of project pumps in the North American chemical market. In addition, organic revenue growth reflected strength in aftermarket sales of approximately 15% as compared to the prior year. The growth in these areas during 2013 was partially offset by year-over-year weakness for North American baseline pumps and valves, delays in large global project shipments, as well as lower activity in the global mining and general industrial markets. Orders for the year ended December 31, 2013 increased $207.1, or 21.7%, as compared to the prior year, primarily reflecting Bornemann orders of $170.6. Organic orders increased $39.6, or 4.1%, due to an increase in parts orders and increased project business globally, partially offset by lower baseline business and valves orders in North America. The level of order and shipment activity related to engineered pumps can vary from period to period, which may impact year-over-year comparisons.
Backlog as of December 31, 2013 was $681.7 an increase of $53.2, or 8.5%, over December 31, 2012, with a significant portion related to complex project business expected to ship in the first half of 2014. This expectation coupled with the potential for lower levels of baseline pump shipments due to the order declines experienced during the fourth quarter of 2013 may have an unfavorable impact on margins during the first half of 2014. For the full year of 2014, we expect revenue to exceed 2013 levels stemming from anticipated growth in the oil & gas market and benefits from our aftermarket-related growth investments. Motion Technologies
Motion Technologies revenue for the year ended December 31, 2013 increased $95.6, or 15.3%, compared to the prior year, reflecting significant gains in both OEM and aftermarket within the Friction Technologies business. Foreign currency translation favorably impacted revenue growth by $16.1, resulting in organic revenue growth of 12.7%, over the prior year.
Our aftermarket revenues, which are predominately generated within Europe and include OES and independent aftermarket channels, grew by approximately 15% during 2013 reflecting the benefits from a number of new business awards and campaigns from automakers. Additionally, during 2013, we began to generate OES volumes from OE platforms in China.
The strong growth in OEM automotive brake pad volume was driven by Europe and China. The growth in Europe resulted from of our increasing number of automotive platforms and share gains, despite continued economic challenges. According to the European Automobile Manufacturers' Association (ACEA), car sales in Europe were 11.9 units in 2013, a year-over-year decrease of 1.7%.
The Chinese automotive market saw a significant increase in car sales during 2013, approximately 14% according to China Association of Automobile Manufacturers (CAAM). Our investments and strategic focus to gain market share in the region led to growth of approximately 54% in China.
Motion Technologies 2013 revenue growth was partially offset by a decline in revenue from the KONI business primarily related to the delay of various rail infrastructure projects in China and lower orders of military-related shock absorbers in the U.S.
Orders increased during 2013 by 18.8% year-over-year to $743.9, including a favorable impact from foreign currency of $16.1, reflecting significant fourth quarter order growth from Friction Technologies and KONI. We are anticipating revenue growth throughout 2014 primarily fueled by further year-over-year OE production increases in China and Europe.


Interconnect Solutions
Interconnect Solutions revenue for the year ended December 31, 2013 increased by $19.8, or 5.3%, compared to the prior year, due to growth in each of our served core markets, attributable to improving macro-economic conditions affecting the connector industry and by increased operational execution. Our growth in the aerospace and defense market of 11.9%, was driven by benefits from funded U.S. programs unaffected by the U.S. sequestration and by strong demand from commercial airline manufacturers. Growth in the communications market of 6.0% was driven by a recent position win with a major Smartphone manufacturer and a corresponding production ramp-up during 2013. Growth in the industrial and transportation market of 3.0% reflected increases in North America and Europe as well as growth from sales of medical-related connector equipment. Growth in the oil & gas market of 7.0% primarily reflects increased distribution activity in North and South America.
Orders increased during 2013 by 4.3% to $400.3, primarily reflecting year-over-year gains from the aerospace and defense and industrial markets. Control Technologies
Control Technologies revenue for the year ended December 31, 2013 increased by $1.1, or 0.4% as compared to the prior year reflecting growth in our aerospace commercial OEM products of approximately 20%, offset by a decline in revenue from our defense and industrial market product applications and an aerospace aftermarket program that is nearing its end of life in 2014. Our defense products applications revenue is down approximately 12% for the year, mainly due to programs impacted by the U.S. government sequestration. Revenue from industrial product applications declined approximately 5%, primarily driven by a decline in energy absorption equipment sales due to the completion of two large infrastructure projects during the prior year and lower sales of precision motion control products.
Orders decreased during 2013 by 2.7% to $276.0, primarily due to large orders received during the fourth quarter of 2012 related to our seat actuation systems. Orders received during 2013 were also impacted by lower defense-related orders and the aerospace aftermarket program that is nearing its end of life. These declines were partially offset by order growth of approximately 30% from commercial OEM product applications driven by improved content levels and higher aircraft production rates.

GROSS PROFIT
Gross profit for the year ended December 31, 2013 was $799.8, an increase of
$119.6 primarily from net savings related to global sourcing and VBLSS
initiatives combined with contributions from our Bornemann acquisition. In
addition, increased sales volumes were partially offset by an unfavorable change
in price and sales mix across segments. The table below provides gross profit
and gross margin by segment for the year ended December 31, 2013 and 2012.
                          2013        2012     Change
Industrial Process     $ 361.7     $ 294.8       22.7  %
Motion Technologies      193.4       160.4       20.6  %
Interconnect Solutions   129.7       111.8       16.0  %
Control Technologies     113.7       111.8        1.7  %
Corporate and Other        1.3         1.4       (7.1 )%
Total gross profit     $ 799.8     $ 680.2       17.6  %
Gross margin:
Industrial Process        32.7 %      30.8 %      190 bp
Motion Technologies       26.8 %      25.6 %      120 bp
Interconnect Solutions    32.8 %      29.8 %      300 bp
Control Technologies      40.9 %      40.3 %       60 bp
Consolidated              32.0 %      30.5 %      150 bp


OPERATING EXPENSES
Operating expenses for the year ended December 31, 2013 increased $87.5 compared
to the prior year, primarily driven by increased costs from the Bornemann
business and costs to restructure and reposition the Company following the 2011
spin-offs, partially offset by lower asbestos-related costs. The following table
provides further information by expense type, as well as a breakdown of
operating expense by segment.
                                       2013       2012    Change
Sales and marketing expenses        $ 216.2    $ 180.4      19.8  %
General and administrative expenses   297.7      221.7      34.3  %
Research and development expenses      67.3       62.7       7.3  %
Asbestos-related costs, net            32.8       50.9     (35.6 )%
Transformation costs                    2.2       13.0     (83.1 )%
Total operating expenses            $ 616.2    $ 528.7      16.6  %
By Segment:
Industrial Process                  $ 249.7    $ 195.5      27.7  %
Motion Technologies                    93.1       77.3      20.4  %
Interconnect Solutions                115.5      104.9      10.1  %
Control Technologies                   58.4       53.5       9.2  %
Corporate & Other                      99.5       97.5       2.1  %

Sales and marketing expenses for the year ended December 31, 2013 increased $35.8 primarily due to costs from the Bornemann business.
General and administrative (G&A) expenses for the year ended December 31, 2013 increased $76.0, including incremental year-over-year 2013 expenses of $18.6 associated with the Bornemann business. In addition, during 2013 we recorded restructuring charges of $28.4, an increase of $14.4, primarily related to the Interconnect Solutions turnaround strategy. We estimate our 2013 restructuring actions will yield approximately $18 in annual net savings. Additionally, during 2013 we incurred costs to reposition the organization (repositioning costs) of $23.0 following the 2011 spin-offs of Exelis and Xylem. Repositioning costs primarily consisted of costs to exit transition services agreements, IT infrastructure modifications, and other various actions and resulted in an increase to G&A expenses of $14.3. The Company expects to incur additional repositioning costs and payments of approximately $10 during 2014 primarily related to the continued expansion of our human resources capabilities. In addition, 2013 was unfavorably impacted by higher corporate G&A expenses following the 2012 recognition of an insurance-related asset on environmental exposures and higher prior year environmental insurance recoveries. R&D costs increased 7.3% year-over-year, as we continued to invest in new product developments in targeted growth markets at each segment. As a percentage of revenue, R&D costs declined to 2.7% in 2013 from 2.8% in 2012, primarily as a function of our year-over-year revenue growth. We anticipate our investments in future R&D activities will moderately increase from current spending levels to ensure a continuing flow of innovative, high quality products and maintain our competitive position in the markets we serve.
We recognized transformation costs of $2.2 and $13.0, including $1.3 and $4.3 that was reflected in results of our business segments, during 2013 and 2012, respectively. Transformation costs reflect expenses incurred in connection with activities taken to complete the separation following the Distribution. As of December 31, 2013, activities related to the Distribution are substantially complete. See Note 6, "Company Transformation" in our Notes to the Consolidated Financial Statements for further information. Asbestos-Related Costs, Net
During 2013, we recognized net asbestos-related costs of $32.8, reflecting a decrease of $18.1 compared to the prior year, primarily related to a $31.0 benefit recognized in connection with a settlement agreement with an insurer in 2013 compared to a $5.8 benefit due to a settlement in 2012. Additionally, a distribution received from an insolvent insurer resulted in a separate $5.8 benefit in 2012. We experienced $2.4 favorability compared to the prior year in connection with our annual remeasurement. Based on the results of our 2013 remeasurement, performed in the third quarter of each year, we decreased our estimated undiscounted asbestos liability, including legal fees, by $65.0 which is a result of several developments, including an expectation of lower defense costs relative to indemnities paid over the projection period and favorable experience in the ratio of cases dismissed versus settled. These favorable . . .

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