UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-K
ANNUAL REPORT
(Mark One)
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2017
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition period from to
Commission File No. 001-05672
Incorporated in the State of Indiana | 81-1197930 | |
(I.R.S. Employer Identification No.) | ||
1133 Westchester Avenue, White Plains, NY 10604
(Principal Executive Office)
Telephone Number: (914) 641-2000
Securities registered pursuant to Section 12(b) of the Act, all of which are registered on The New York Stock Exchange, Inc.:
COMMON STOCK, $1 PAR VALUE
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files. Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer" "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ | Accelerated filer ¨ | Non-accelerated filer ¨ | ||
Smaller reporting company ¨ (Do not check if a smaller reporting company) | Emerging growth company ¨ | |||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ
The aggregate market value of the common stock of the registrant held by non-affiliates of the registrant on June 30, 2017 was approximately $3.5 billion. As of February 14, 2018, there were outstanding 88.2 million shares of common stock, $1 par value, of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A for its 2018 Annual Meeting of Shareholders are incorporated by reference in Part II and Part III of this Form 10-K.
TABLE OF CONTENTS
FORWARD-LOOKING AND CAUTIONARY STATEMENTS
Some of the information included herein includes forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our business, future financial results and 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.
Where in any forward-looking statement we express an expectation or belief as to future results or events, such expectation or belief is based on current plans and expectations of our management, expressed in good faith and believed to have a reasonable basis. However, there can be no assurance that the expectation or belief will occur or that anticipated results will be achieved or accomplished. More information on factors that could cause actual results or events to differ materially from those anticipated is included in this Annual Report on Form 10-K under the caption "Risk Factors," and in other documents we file from time to time with the U.S. Securities and Exchange Commission (SEC).
The forward-looking statements included in this report speak only as of the date of this report. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports, proxy statements and other information with the SEC. You can inspect, read and copy these reports, proxy statements and other information at the SEC's Public Reference Room, which is located at 100 F Street, N.E., Washington, D.C. 20549. You can obtain information regarding the operation of the SEC's Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at www.sec.gov on which you may access electronic copies of our SEC filings.
We make available free of charge at www.itt.com/investors copies of materials we file with, or furnish to, the SEC as well as other important information that we disclose from time to time. Information contained on our website, or that can be accessed through our website, does not constitute a part of this Annual Report on Form 10-K. We have included our website address only as an inactive textual reference and do not intend it to be an active link to our website.
Our corporate headquarters are located at 1133 Westchester Avenue, White Plains, NY 10604 and the telephone number of this location is (914) 641-2000.
PART I
ITEM 1. | DESCRIPTION OF BUSINESS |
COMPANY OVERVIEW
Unless the context otherwise indicates, references herein to "ITT," "the Company," and such words as "we," "us," and "our" include ITT Inc. and its subsidiaries.
ITT is a diversified manufacturer of highly engineered critical components and customized technology solutions for the transportation, industrial, and oil and gas markets. We manufacture components that are integral to the operation of systems and manufacturing processes in these key markets. Our products provide enabling functionality for applications where reliability and performance are critically important to our customers and the users of their products.
We are a global company with approximately 10,000 employees in approximately 35 countries and 2017 revenue of $2.6 billion, which we derived from sales in more than 100 countries. In 2017, 67% of our sales were outside the U.S., including 33% from emerging markets. Accordingly, approximately half of our manufacturing facilities are outside of the U.S. in order to achieve strategic proximity to customers, further increase global sales and market share, and lower costs.
We have a balanced and diversified portfolio of businesses, which are organized in three segments – Industrial Process, Motion Technologies, and Connect & Control Technologies. Our businesses share a common, repeatable operating model centered on our engineering aptitude. Each business applies its technology and engineering expertise to solve some of the most pressing challenges of our customers. Our applied engineering provides a special business fit with our customers given the critical nature of their applications. This in turn provides us with unique insight into our customers' requirements and enables us to develop solutions to better assist our customers to achieve their business goals. Our technology and customer intimacy together produce opportunities to capture recurring revenue streams, aftermarket opportunities and long-lived platforms from original equipment manufacturers (OEMs).
We possess strong leading brands, such as Goulds Pumps, Bornemann, Engineered Valves, Cannon, VEAM, BIW Connector Systems, KONI, Axtone, Wolverine, Enidine, Aerospace Controls, and ITT, in many of our niche markets. These brands are associated with quality, reliability, durability, and engineering excellence. Our brands extend internationally and participate in emerging markets including China, Mexico, Brazil, Saudi Arabia, and Russia.
We are committed to creating long-term sustainable value for all of our stakeholders, supported by our balanced operating strategy designed to achieve long-term profitable growth. The elements of this strategy are disciplined organic growth through global market expansion and new product development, combined with operational improvements that focus on the principles of Lean Six Sigma (herein referred to as Lean) to reduce costs and cycle times while improving overall productivity, quality, and safety on a continuing basis. We have also moved beyond the factory floor to improve the efficiency of other critical processes in the value chain to become a truly lean enterprise. This initiative encompasses not only core Lean problem solving and continuous improvement principles, but also leadership, talent and cultural aspects.
Given these dynamics and our technology investments, global reach and vibrant brands, we believe we have the opportunity to continue to expand geographically, broaden our product lines, improve our market position, and increase earnings through organic revenue growth, and operational efficiencies and through targeted acquisitions. We continue to prioritize deploying capital for organic growth before acquisitive growth. Our acquisition strategy generally targets firms in similar businesses and end-markets that have unique and differentiated products, services, and technologies. Effective capital deployment, including resource optimization and a disciplined focus on liquidity and cash management, is a major part of how we plan to achieve our financial performance goals.
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Segment Information
See Note 3, Segment Information, to the Consolidated Financial Statements for financial information about each of our segments.
Industrial Process
The Industrial Process segment, commonly referred to as IP, is an original equipment manufacturer and aftermarket parts and service provider offering an extensive portfolio of industrial pumps, valves, plant optimization systems, and related services. IP is aligned around three product categories – Industrial Products, Engineered Systems, and Aftermarket Solutions – serving an extensive base of customers from large multi-national companies and engineering, procurement and construction (EPC) firms to regional distributors and end-user customers. IP has a global manufacturing footprint with significant operations located in the United States, South Korea, and Germany. IP's customers operate in global infrastructure and natural resource markets such as oil and gas, chemical and petrochemical, pharmaceutical, general industrial, mining, pulp and paper, food and beverage, and power generation. Brands include Goulds Pumps, Bornemann, Engineered Valves, PRO Services, and C'treat.
Industrial Products
Industrial Products designs and manufactures configured-to-order industry standards-based industrial pumps, valves, and equipment for both original equipment installations and replacement parts and pumps. These products include a broad portfolio of centrifugal process pumps and engineered industrial and sanitary valves.
Engineered Systems
Engineered Systems provides highly engineered and customized pumping systems typically used in severe service conditions via both original equipment installations and replacement parts and pumps. Products include API (American Petroleum Institute) centrifugal pumps, vertical centrifugal pumps, twin screw and positive displacement pumps, and water systems. Our pumping systems are generally part of larger capital projects, which have longer lead times and are generally managed by EPC firms.
Aftermarket Solutions
Aftermarket Solutions provides customers with parts, services, and plant optimization solutions that reduce total cost of ownership for pumps and rotating equipment. In addition to providing standard repairs and upgrades, the business also develops engineered solutions for specific customer process issues. Examples include innovative technologies like PumpSmart Controllers and i-ALERT2 Equipment Health Monitoring Devices to control and monitor pumps and other rotating equipment in an industrial environment.
IP goes to market via a global and diversified sales channel structure. End-users are serviced by an extensive network of independent industrial distributors, which account for approximately one-third of revenue, and representatives which complement our customer-focused direct sales and service organization. We also have focused channels dedicated to supporting EPC firms as their needs are often distinct from those of other distributors and end-user customers.
The pump and valve markets served are highly competitive, especially in the last few years, due to uncertainty and volatility in the oil and gas market. For most of our products there are hundreds of regional competitors and a limited number of larger global peers. Primary customer purchase decision drivers include price, delivery terms, and on-time performance, brand recognition and reputation, perceived quality, breadth of product and service offerings, commercial terms, technical support and localization. Pricing can be very competitive for large projects because of overcapacity, fewer investment projects, and aftermarket opportunities for the original equipment provider.
Motion Technologies
The Motion Technologies segment, commonly referred to as MT, is a manufacturer of braking pads, shims, shock absorbers, and energy absorption components, and sealing technologies primarily for the transportation industry, including passenger cars, light- and heavy-duty commercial and military vehicles, buses, and rail. MT consists of three business units, Friction Technologies, Wolverine, and KONI.
Friction Technologies
Our Friction Technologies business manufactures a range of brake pads installed as original equipment (OE) pads on passenger cars and light- and heavy-duty commercial vehicles. Demand for MT's products stem from a variety of end customers and automotive platforms around the world. OE pads are sold either directly to original equipment manufacturers (OEMs) or to Tier-1 brake manufacturers. Our OE pads are designed to meet customer specifications and environmental regulations, and to satisfy an array of performance standards and geographic applications. Most automobile OEM platforms (car model) require specific brake pad formulations and have demanding delivery and volume schedules.
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Friction Technologies also manufactures aftermarket brake pads designed for the automotive service and repairs market. This market consists of both OE dealers, also referred to as original equipment spares (OES) networks, and independent aftermarket (AM) networks. Brake pads sold within the OES network generally match the specifications of an original auto platform OE brake pad, while our catalog of AM pads feature technology designed to provide a range of braking performance levels. Within the service and repairs market, pads are sold either directly to OE manufacturers or Tier-1 brake manufacturers (such as Continental or TRW) or indirectly through independent distributor channels.
Combined sales to Continental and TRW, MT's two largest customers, were 35% of 2017 MT revenue, however, 43% of the Continental and TRW derived revenue is directly attributable to OES supply agreements signed directly with OEMs. Also, in many cases OEMs specify the use of our pads in a braking system with brake manufacturers, such as Continental and TRW.
Wolverine
Wolverine is a manufacturer of customized damping technologies for automotive braking systems and specialized gasket sealing solutions for harsh operating environments across a range of industries. Brake shims are thin metal and rubber adhesive dampeners that fit onto the brake pad and against the brake caliper to prevent excessive noise and vibration. Gaskets are an anti-vibration solution and a sealing solution that prevent fluid spillage with applications to engines, transmissions, exhaust systems, fuel systems, and a variety of pneumatic systems.
KONI & Axtone
The KONI and Axtone businesses are organized into three main product groups: railway rolling stock; car & racing; and bus, truck & trailer.
Railway Rolling Stock provides a wide range of equipment for passenger rail, locomotives, freight cars, high speed trains and light rail. Offerings include customized energy absorption solutions, hydraulic shock absorbers (primary, lateral, and inter-car), yaw dampers, springs, visco-elastic and hydraulic buffers, and coupler components. Revenue opportunities for our rail damping systems are balanced between OE and AM customers. Sales are either directly to train manufacturers, train operators carrying out scheduled train maintenance programs, or indirectly through distributors.
Car & Racing features performance shock absorbers often using our Frequency Selective Damping (FSD) technology. FSD products generally have been used by car and racing enthusiasts who desire to modify their cars for increased handling performance and comfort, and are now also being incorporated into OEM platform designs. KONI car shock absorbers are sold all over the world, through a distribution network that markets KONI products into specific geographies or customer groups.
Bus, Truck & Trailer manufactures shock absorbers and bus dampers, for sale to both OEM and AM customers.
MT has a market reputation, derived from many years of mutual collaboration with major OEMs, of customer satisfaction, quality and on-time delivery. MT has a global manufacturing footprint, with production facilities in Western Europe, Eastern Europe, China, and North America.
MT competes in markets primarily served by large, well-established national and global companies. Key competitive drivers within the brake pad business include technical expertise, formulation development capabilities, scale production, product performance, high-quality standards, customer intimacy, reputation, and the ability to meet demanding delivery and volume schedules in a reduced amount of time. OE and OES customers usually require long-lasting and well-established relationships, based on mutual trust, local proximity and a wide range of cooperative activities, starting from the design to the sampling, prototyping and testing phases of brake pads. Within the independent AM pads market, MT is a leading European provider in a highly fragmented global market.
Competitive drivers in the rail damping systems business include price, technical expertise and product performance. Rail damping systems are considered critical components because of safety requirements and thus they have to be specifically designed according to many different train applications, and must satisfy strict compliance requirements. MT is a leader in the rail dampers component of the complete rail damper system in Europe and continues to gain market share in China.
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Connect & Control Technologies
During the first quarter of 2017, we combined our former Interconnect Solutions and Control Technologies segments to form Connect & Control Technologies. The Connect & Control Technologies segment, commonly referred to as CCT, designs and manufactures a range of highly engineered connectors and specialized control components for critical applications supporting various markets including aerospace, defense, industrial, transportation, medical, and oil and gas. CCT’s products are often part of long-lived platforms that provide for recurring aftermarket and replacement opportunities. CCT has organized its business around product offerings and end-user markets, with dedicated teams that specialize in solutions for their specific markets, providing focused customer support and expertise.
CCT has a global production footprint, including major facilities in the United States, Mexico, Germany, and China, which provides close geographic proximity to key customers. CCT competes with a large number of competitors in highly fragmented industries. CCT’s competitors can range from large public multi-national corporations to small privately held local firms, depending on the product line and region. CCT's ability to compete successfully depends upon numerous factors, including quality, price, availability, performance, brand recognition, customer service, innovation, application expertise and previous installation history. In addition, collaboration with customers to deliver a wide range of product offerings has allowed CCT to compete effectively, to cultivate and maintain customer relationships, and to expand into new markets. CCT products are sold directly and through numerous channels including distributors. CCT has long-lasting relationships with distributors, as many have been selling certain CCT products for over 70 years. Sales to distributors represented approximately 30% of 2017 CCT revenue.
Connector Products
The connector product portfolio includes high performance electrical connectors of the following types: Circular, Rectangular, Radio Frequency, Fiber Optic, D-sub Miniature, Micro-Miniature and cable assemblies. Brands include Cannon, VEAM and BIW Connector Systems, which deliver solutions to enable the transfer of data, signal, and power into various end-user markets including aerospace, defense, industrial, transportation, medical, and oil and gas. These brands are known for high-performance, high-reliability solutions which withstand high vibrations and are resistant to dirt and fluids. In certain harsh environment niche markets, our connector products are considered market leaders because of their technological capabilities, cost performance, and global footprint.
Products for the aerospace and defense markets include industry standards-based connectors and customized solutions for most segments of the commercial aviation and defense industries. These products are designed to withstand the extreme shock, exposure, and vibration environments that are typical in aviation and military applications and where reliability and safety are critical factors.
Products for the industrial markets include connectors for industrial production equipment, industrial electronics and instruments, and other industrial and medical applications. Products for the transportation markets include connectors for high-speed, mainline, metro and light passenger rail, heavy-duty vehicles, and electric vehicle applications.
Products for the oil and gas markets include connectors that provide power for electric submersible pumps in oil and gas wells, reservoir monitoring instruments, and electrical downhole heaters. Oil and gas product applications include electrical power penetrations for wellheads, packers, and pods that are able to accommodate any size and provide for multiple sealing strategies and ratings.
Control Products
The control product portfolio provides actuation, fuel management, noise and energy absorption, and environmental control system applications, with a specialized set of design and application engineering skills and capabilities that enables CCT to engineer differentiated custom solutions for unique applications for the aerospace and defense, and industrial markets.
Control products for the aerospace and defense markets consist of fuel and water pumps, valves, electro-mechanical rotary and linear actuators, and pressure, temperature, limit, and flow switches for various aircraft systems. These products also include stowage bin rate controls, rotary hinge dampers and actuators, seat recline locks and control cables, electromechanical seat actuation, a variety of engineered elastomer isolators to protect equipment and keep the interior of the aircraft quiet, certain energy absorption products and other aerospace components. Other control products for this market include environmental control systems such as climate control and ice protection heaters, composite conveyance ducting and acoustically engineered inlets and exhausts for auxiliary power units.
Control products for the industrial markets include large and small bore shock absorbers, linear and rotary actuators, and process control instrumentation, such as high and low pressure regulators and flow, temperature, and pressure switches. The shock absorbers and actuators serve a wide range of applications in a diverse set of end-markets including production, packaging, and factory automation. The process control products primarily serve the chemical, petrochemical, and energy segments of the industrial market.
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Other Company Information
Materials
All of our businesses require various OEM products, manufactured components, and raw materials; the availability and prices of which may fluctuate. The principal OEM products and manufactured components assembled into our products include motors, castings, mechanical seals, machined castings, metal fabrications and miscellaneous metal, plastic, or electronic components. The primary raw materials used in manufacturing our products include steel, gold, copper, nickel, iron, aluminum, tin, and rubber, as well as specialty alloys, including titanium. Materials are purchased in various forms, such as sheet, bar, rod and wire stock, pellets, and metal powders.
Raw materials, supplies and product subassemblies are purchased from third-party suppliers, contract manufacturers, and commodity dealers. For most of our products, we have existing alternate sources of supply, or such materials are readily available. In some instances we depend on a single source of supply, manufacturing or assembly, or participate in commodity markets that may be subject to a limited number of suppliers.
We continually monitor the business conditions of our supply chain to maintain our market position and to avoid potential supply disruptions. There have been no raw material shortages that have had a material adverse impact on our business as a whole, and we have been able to develop a robust supply chain such that we do not anticipate shortages of such materials in the future.
Although some cost increases may be recovered through increased prices to customers, our operating results are generally exposed to fluctuations due to inflation of prices for raw materials and commodities. When practical, we attempt to control such costs through fixed-priced contracts with suppliers. We typically acquire materials and components through a combination of blanket and scheduled purchase orders to support our materials requirements for an average of four to eight weeks, with the exception of some specialty materials. From time to time, we experience price volatility or supply constraints for raw materials based on market supply and demand dynamics. In limited circumstances, we may have to obtain scarce components for higher prices on the spot market, which may have a negative impact on gross margin and can periodically create a disruption to production and delivery. We also acquire certain inventory in anticipation of supply constraints or enter into longer-term pricing commitments with vendors to improve the priority, price, and availability of supply. We evaluate hedging opportunities to mitigate or minimize the risk of operating margin erosion resulting from the volatility of commodity prices.
Manufacturing Methods
We utilize two primary methods of fulfilling demand for products: build-to-order and engineer-to-order. Build-to-order consists of assembling a group of products with the same pre-defined specifications, generally for our OEM customers. Engineer-to-order consists of assembling a customized system according to a customer’s individual order specifications. In both cases, we offer design, integration, test and other production value-added services. We employ build-to-order capabilities to maximize manufacturing and logistics efficiencies by producing high volumes of basic product configurations. Engineering products-to-order permits the configuration of units to meet the customized requirements of our customers. Our inventory management and distribution practices in both build-to-order and engineer-to-order seek to minimize inventory holding periods, and improve customer delivery performance.
Backlog
Our backlog represents firm orders that have been received, acknowledged and entered into our production systems. Our backlog may vary due to market volatility or other changes in macroeconomic conditions. In addition, delivery schedules vary from customer to customer based on their requirements. For example, large complex projects in specialized markets such as oil and gas, chemical, and mining at IP require longer lead times and production cycles. Delivery delays could arise from supply chain limitations, internal production challenges, changes in the customer’s requirements, or technical difficulties. Total backlog as of December 31, 2017 and 2016 was $869.7 and $785.1, respectively. Total backlog by segment as of December 31, 2017 and 2016 was: IP - $336.5 and $347.2; MT - $299.7 and $201.2; and CCT - $233.5 and $236.7. We expect to satisfy nearly all December 31, 2017 backlog commitments during 2018.
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Intellectual Property
We generally seek patent protection for certain inventions and improvements that are likely to be incorporated into our products or where proprietary rights are expected to improve our competitive position. The highly customized application engineering embedded within our products, our proprietary rights, and our knowledge capabilities all contribute to enhancing our competitive position.
While we own and control a significant number of patents, trade secrets, confidential information, trademarks, trade names, copyrights, and other intellectual property rights which, in the aggregate, are of material importance to our business, management believes that our Company, as a whole, as well as each of our core segments, is not materially dependent on any one intellectual property right or related group of such rights. Patents, patent applications, and license agreements will expire or terminate over time by operation of law, in accordance with their terms or otherwise. As the portfolio of our patents, patent applications, and license agreements has evolved over a long period of time, we do not expect the expiration of any specific patent or other intellectual property right to have a material adverse effect on our financial statements.
Research and Development
Research and Development (R&D) is a key element of our engineering culture and is generally focused on the design and development of products and solutions that anticipate customer needs and emerging trends. Our approach to R&D often begins by working with our customers to address a problem, then engineering a solution to the particular customer need. As a result, our R&D is based on taking technology quickly to the tangible phase, increasing the competitive offering, and increasing the customer service experience through engineered application solutions. During 2017, 2016 and 2015, we recognized R&D expenses of $93.7, $80.8, and $78.9, respectively, which were 3.6%, 3.4%, and 3.2%, of revenues, respectively.
Cyclicality and Seasonality
Many of the businesses in which we operate are subject to specific industry and general economic cycles. We consider our connector products in our CCT segment to be an early cycle business, meaning it generally is impacted more in the early portion of an economic cycle, while the automotive and aerospace components businesses tend to be impacted in the middle portion of the cycle and the industrial pump business typically is impacted late in the economic cycle.
Our businesses experience limited seasonal variations, with demand generally lower during summer months (our third quarter) mainly attributable to manufacturing shutdowns and the planned industrial maintenance activities of our customers. Revenue impacts from the limited seasonal variations are typically mitigated by our backlog of orders that allow us to adjust levels of production across the summer months.
Environmental Matters
We are subject to stringent federal, state, local, and foreign environmental laws and regulations concerning air emissions, water discharges and waste disposal. In the U.S., these include, but are not limited to, the Federal Clean Air Act, the Clean Water Act, the Resource, Conservation and Recovery Act, and the Comprehensive Environmental Response, Compensation and Liability Act. Environmental requirements are significant factors affecting our operations. We have established an internal program to assess compliance with applicable environmental requirements at our facilities. The program, which includes periodic audits of many of our locations, including our major operating facilities, is designed to identify problems in a timely manner, correct deficiencies and prevent future noncompliance.
We closely monitor our environmental responsibilities, together with trends in environmental laws. In addition, we have purchased insurance protection against certain environmental risks arising from our business activities. Environmental laws and regulations are subject to change, however, and the nature and timing of such changes, if any, is difficult to predict. As actual costs incurred at identified sites in future periods may vary from our current estimates given the inherent uncertainties in evaluating environmental exposures, management believes it is possible that the outcome of these uncertainties may have a material adverse effect on our financial statements. See "Critical Accounting Estimates" within Item 7, Management's Discussion and Analysis, as well as Note 18, Commitments and Contingencies, to the Consolidated Financial Statements for additional information regarding environmental matters.
Employees
As of December 31, 2017, we had approximately 10,000 employees, of which approximately 3,100 were located in the U.S. Approximately 20% of our U.S. employees are represented by unions. We also have unionized employees in Italy, Germany, and Brazil. No one unionized facility accounts for more than 11% of ITT's total revenues. Although our relations with our employees are strong and we have not experienced any material strikes or work stoppages recently, we can provide no assurance that we will not experience these or other types of conflict with labor unions, works councils, other groups representing employees or our employees generally, or that any future negotiations with our labor unions will not result in significant increases in our cost of labor.
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General Developments of the Business
On October 31, 2011, ITT completed the tax-free spin-off (referred to herein as the 2011 spin-off) of its Defense and Information Solutions business, Exelis Inc. (Exelis), and its water-related businesses, Xylem Inc. (Xylem) by way of a distribution of all of the issued and outstanding shares of Exelis common stock and Xylem common stock, on a pro rata basis, to ITT shareholders of record on October 17, 2011. The 2011 spin-off was made pursuant to a Distribution Agreement, dated October 25, 2011, among ITT, Exelis and Xylem (the Distribution Agreement). Following the 2011 spin-off, ITT did not own any shares of common stock of Exelis or Xylem. On May 29, 2015, Exelis was acquired by Harris Corporation (Harris).
On May 16, 2016, we consummated a corporate reorganization into a holding company structure. As a result of the reorganization ITT Inc., an Indiana corporation formed in 2016 that was previously a wholly owned subsidiary of ITT Corporation, became the publicly traded holding company of ITT Corporation and its subsidiaries and the successor issuer to ITT Corporation under Rule 12g-3(a) under the Securities Exchange Act of 1934 (Exchange Act). As the successor issuer, ITT Inc. common stock was deemed to be registered under Section 12(b) of the Exchange Act and ITT Inc. succeeded to ITT Corporation’s obligation to file reports, proxy statements and other information required by the Exchange Act with the SEC. For additional information regarding the holding company reorganization, please refer to the Current Report on Form 8-K that we filed with the SEC on May 16, 2016.
Acquisitions
On March 31, 2015, we completed the acquisition of Environmental Control Systems (f/k/a Hartzell Aerospace), a designer and manufacturer of products to support aerospace applications. Environmental Control Systems is included as part of our Connect & Control Technologies segment.
On October 5, 2015, we completed the acquisition of Wolverine Automotive Holdings Inc., the parent company of Wolverine Advanced Materials LLC (Wolverine). Wolverine is a manufacturer of customized technologies for automotive braking systems and specialized sealing solutions. Wolverine is included as part of our Motion Technologies segment.
On January 26, 2017, we completed the acquisition of Axtone Railway Components (Axtone), a leading manufacturer of highly engineered and customized components for railway and other harsh-environment industrial markets. Axtone is included as part of our Motion Technologies segment.
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ITEM 1A. | RISK FACTORS |
We are subject to a wide range of factors that could materially affect future developments and performance. Because of these factors, past performance may not be a reliable indicator of future results. Set forth below and elsewhere in this document are descriptions of the risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this document. The most significant factors affecting our business and operations include the following:
Business and Operating Risks
Our exposure to pending and future asbestos claims and related liabilities, assets, and cash flows is subject to significant uncertainties.
Subsidiaries of ITT, including ITT LLC (f/k/a ITT Corporation) and Goulds Pumps LLC (f/k/a Goulds Pumps, Inc.), have been sued, along with many other companies, in numerous lawsuits in which the plaintiffs claim damages for personal injury arising from exposure to asbestos from component parts of certain products sold or distributed by various defendants, including certain ITT subsidiaries. We expect they will be sued in similar actions in the future. As such, we record an estimated liability related to pending claims and claims estimated to be filed over the next 10 years based on a number of key assumptions, including the plaintiffs’ propensity to sue, claim acceptance rates, disease type, settlement values and defense costs. These assumptions are derived from ITT’s recent experience and reflect the Company’s expectations about future claim activities. Although it is probable that the Company will incur additional costs for asbestos claims filed beyond the next 10 years, we do not believe that there is a reasonable basis for estimating those costs at this time.
In addition, we record an asset that represents our best estimate of probable recoveries from our insurers for the estimated asbestos liabilities. There are significant assumptions made in developing estimates of asbestos-related recoveries, such as policy triggers, policy or contract interpretation, the methodology for allocating claims to policies, and the continued solvency of the Company’s insurers. Certain of our primary coverage-in-place agreements are exhausted which may result in higher net cash outflows until excess carriers begin accepting claims for reimbursement. Performance by our insurers could differ from the assumptions underlying the recognized asset and could result in lower collections of receivables than are currently expected to reduce the Company’s asbestos costs.
Due to these uncertainties, as well as our inability to reasonably estimate any additional asbestos liability for claims that may be filed beyond the next 10 years, it is difficult to predict the ultimate cost, including potential recoveries, of resolving pending and unasserted asbestos claims. Changes in estimates related to these uncertainties may result in increases or decreases to the net asbestos liability, particularly if the quality, number of claims, or settlement or defense costs change significantly, if there are significant developments in the trend of case law or court procedures, or if legislation or another alternative solution is implemented. The resolution of asbestos claims may take many years. We believe it is possible that the future events affecting the key factors and other variables within the next 10 years, as well as the cost of asbestos claims filed beyond the next 10 years, net of expected recoveries, could have a material adverse effect on our financial condition, results of operations, or cash flows in any given period.
As part of the 2011 spin-off, ITT Corporation (n/k/a ITT LLC) indemnified Exelis and Xylem with respect to asserted and unasserted asbestos claims that relate to the presence or alleged presence of asbestos in products manufactured, repaired or sold prior to the 2011 spin-off, subject to limited exceptions.
Our operating results and our ability to maintain liquidity or procure capital may be adversely affected by unfavorable or uncertain global economic and capital market conditions.
We have experienced and expect to continue to experience volatility in revenues, operating results and profitability. We have undertaken measures to reduce the impact of this volatility through diversification of markets and expansion of geographic regions in which we operate. The end markets we serve include automotive, aerospace, oil and gas, industrial, mining, chemical, and defense, each of which is impacted by specific industry and general economic cycles. Important factors impacting our businesses include, but are not limited to, the overall strength of the global economy and our customers’ confidence in local and global macroeconomic conditions, industrial spending, tax rates, interest rates, the availability of commercial financing, and regulations in the jurisdictions in which we operate. Instability in the global credit markets and geopolitical environment in many parts of the world may put pressure on global economic conditions. If global economic and market conditions, or economic conditions in key markets or regions deteriorate, we may experience material impacts on our financial statements.
We closely monitor the credit worthiness of our insurers and customers and evaluate their ability to service their obligations to us. However, adverse changes to financial conditions could jeopardize these counterparty obligations. A tightening of credit markets may reduce funds available to our customers to pay for our products and services for a
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prolonged and perhaps unknown period of time. Restrictive credit markets may also result in customers extending terms for payment and may result in our having higher customer receivables with increased risk of default.
Should market conditions deteriorate, this may also adversely affect our ability to manage inventory levels and maintain current levels of profitability. If, for any reason, we lose access to our currently available lines of credit, or if we are required to raise additional capital, we may be unable to do so, or we may be able to do so only on unfavorable terms. Deteriorating market conditions could also indicate an impairment in the value of our goodwill and intangible assets in one or more of our reporting units which would require us to recognize a non-cash charge to our Statement of Operations. We test both goodwill and intangible assets for impairment on an annual basis and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable.
We are subject to inherent business risks due to our operations and sales outside the U.S. and in emerging markets.
Our international operations, including U.S. exports, comprise a growing portion of our operations and are a strategic focus for continued future growth. Our strategy calls for increasing sales in overseas markets, including emerging markets such as Mexico, South America, China, Russia, and the Middle East. In 2017, 67% of our total sales were to customers operating outside of the United States. Our sales from international operations and export sales are subject in varying degrees to risks inherent to doing business outside of the United States. These risks include the following, some of which could be impacted by changes in international trade agreements between the United States and other countries:
• | possibility of unfavorable circumstances arising from host country laws or regulations; |
• | restrictions, regulations, or tax liabilities on currency repatriation; |
• | potential negative consequences from changes to taxation policies; |
• | the disruption of operations from labor and political disturbances; |
• | our ability to hire and maintain qualified staff in these regions; and |
• | changes in tariff and trade barriers and import and export licensing requirements. |
In addition to the general risks that we face outside the U.S., we now conduct more of our operations in emerging markets than we have in the past, which could involve additional uncertainties, including risks that governments may impose limitations on our ability to repatriate funds, impose or increase withholding or other taxes on remittances and other payments to us, seek to nationalize our assets, or impose or increase investment barriers or other restrictions that may adversely affect our business. In addition, emerging markets pose other uncertainties, including challenges to our ability to protect our intellectual property, pressure on the pricing of our products, and risks of political instability.
The cost of compliance with increasingly complex and often conflicting regulations worldwide can also impair our flexibility in modifying product, marketing, pricing, or other strategies for growing our businesses, as well as our ability to improve productivity and maintain acceptable profit margins.
Our business is impacted by our customers' levels of capital investment and maintenance expenditures, particularly in the oil and gas, chemical, and mining markets.
Demand for our industrial products and services depend on the level of capital investment and planned maintenance expenditures of our customers. Our customers' levels of capital expenditures depends, in turn, on general economic conditions, availability of credit, economic conditions within their respective industries and expectations of future market behavior. Additionally, volatility in commodity prices can negatively affect the level of these activities and can result in postponement of capital spending decisions or the delay or cancellation of existing orders. The ability of our customers to finance capital investment and maintenance may also be affected by factors independent of the conditions in their industries, such as the condition of global credit and capital markets.
The businesses of many of our customers, particularly those in the oil and gas, chemical, and mining industries, which represent approximately 10%, 6%, and 3%, respectively, of our 2017 revenue, are to varying degrees cyclical and have experienced, or may experience, periodic downturns of varying severity. Our customers in these industries, particularly those whose demand for our products and services is primarily profit-driven, historically have tended to delay large capital projects, including expensive maintenance and upgrades, during economic downturns. Additionally, fluctuating energy demand forecasts and lingering uncertainty concerning commodity pricing and other macroeconomic factors can cause our customers to be more conservative in their capital planning, which may reduce demand for our products and services. Reduced demand for our products and services could result in the delay or cancellation of existing orders or lead to excess manufacturing capacity, which unfavorably impacts our absorption of fixed manufacturing costs. This reduced demand may also erode average selling prices in our industry. Any of these results could adversely affect our business and financial results.
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Additionally, some of our industrial products customers may choose to delay capital investment and maintenance, even during favorable conditions in their industries or markets. Despite these favorable conditions, the general health of global credit and capital markets and our customers' ability to access such markets may significantly impact investments in large capital projects, as well as necessary maintenance and upgrades. In addition, the liquidity and financial position of our customers, which is typically directly linked to the economies in which they operate, could impact capital investment decisions and their ability to pay in full and/or on a timely basis. Any of these factors, whether individually or in the aggregate, could have a material adverse effect on our customers and, in turn, our business and financial results.
Significant movements in foreign currency exchange rates may adversely affect our financial statements.
A significant portion of our sales are to customers operating outside the U.S., therefore, we are exposed to fluctuations in foreign currency exchange rates. The primary currencies to which we have exposure are the Euro, Chinese renminbi, Czech koruna, South Korean won, Polish zloty, British pound, and Mexican peso. From time to time, we may enter into derivative contracts to hedge some of these foreign currency exposures. However, our hedging strategy may fail to reduce our exposure or could result in unfavorable impact to our operating results.
As we continue to grow our business internationally, our operating results could be affected by the relative strength or weakness of global economies and the impact of foreign currency exchange rate fluctuations. Any significant change in the value of currencies of the countries in which we do business relative to the value of the U.S. dollar could affect our ability to sell products competitively and control our cost structure, which could have a material adverse effect on our financial statements. Accordingly, fluctuations in foreign currency exchange rates may also impact our results when the currency of a transaction differs from the functional currency of our operating unit, or when financial statements in the functional currency of non-U.S. operating units are translated into U.S. dollars. Given that the majority of our sales are non-U.S. based, a strengthening or weakening of the U.S. dollar against other major foreign currencies could adversely affect our results of operations.
Failure to compete successfully in our markets could adversely affect our business.
We provide products and services to competitive markets. We believe the principal points of competition in our markets are product performance, reliability and innovation, application expertise, brand reputation, energy efficiency, product life cycle cost, timeliness of delivery, proximity of service centers, effectiveness of our distribution channels and price.
Maintaining and improving our competitive position will require continued investment by us in manufacturing, research and development, engineering, marketing, customer service and support, and our distribution networks. We may not be successful in maintaining our competitive position. Our competitors may develop products that are superior to our products, or may develop more efficient or effective methods of providing products and services or may adapt more quickly than we do to new technologies or evolving customer requirements. Pricing pressures also could cause us to adjust the prices of certain products to stay competitive. We may not be able to compete successfully with existing or new competitors.
Our operating costs are subject to fluctuations, particularly due to changes in commodity prices, raw materials, energy and related utilities, freight, and cost of labor. In order to remain competitive, we may not be able to recoup all or a portion of these higher costs from our customers through product price increases. Further, our ability to realize financial benefits from Lean activities may not be able to mitigate fully or in part these manufacturing and operating cost increases and, as a result, could negatively impact our profitability.
Quality problems with our manufacturing processes or finished goods could harm our reputation for producing high-quality products and erode our competitive advantage, sales, and market share.
We manufacture key components that are integral to the operation of systems and manufacturing processes in the energy, transportation, defense, aerospace, and industrial markets. Our products provide enabling functionality for applications for which reliability and performance are critically important to our customers and the users of their products. As such, quality is extremely important to us and our customers due to the potentially costly consequences of product failure. Our quality certifications, including products manufactured to military specifications, are critical to the marketing success of our goods and services. If we fail to meet these standards, our reputation could be damaged, we could lose customers or the ability to sell certain products, and our revenue and results of operations could be materially adversely affected. Aside from specific customer standards, our success in part depends on our ability to manufacture to exact tolerances precision-engineered components, subassemblies, and finished devices from multiple materials. If our components fail to meet these standards or fail to adapt to evolving standards, our reputation as a manufacturer of high-quality components will be harmed, our competitive advantage could be damaged, and we could lose customers, market share or our ability to sell certain products.
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We are subject to risks related to government contracting, including changes in levels of government spending and regulatory and contractual requirements applicable to sales to the U.S. government.
Our Connect & Control Technologies and Motion Technologies segments derive a portion of their revenue from sales to U.S. government customers and higher tier contractors who sell to the U.S. government. Government expenditures are subject to political and budgetary fluctuations and constraints, which may result in significant unexpected changes in levels of demand for our products. In addition, the award, administration and performance of government contracts are subject to regulatory and contractual requirements that differ significantly from the terms and conditions that apply to contracts with our non-governmental customers. We may be subject to audits and investigations to evaluate our compliance with these requirements. If we are found to have failed to comply with requirements applicable to government contractors, we may be subject to various actions, including but not limited to fines or penalties, reductions in the value of our government contracts, or suspension or debarment from government contracting. Failure to comply with applicable requirements also could harm our reputation and our ability to compete for future government contracts or sell commercial equivalent products. Any of these outcomes could have a material adverse effect on our business, results of operations and financial condition.
Our business could be adversely affected by raw material price volatility and the inability of suppliers to meet quality and delivery requirements.
Our business relies on third-party suppliers for raw materials, components, and contract manufacturing services to produce our products. The supply of raw materials to the Company and to its component parts suppliers and the supply of castings, motors, and other critical components could be interrupted for a variety of reasons, including availability and pricing. Prices for raw materials necessary for production have fluctuated significantly in the past and significant increases could adversely affect the Company’s results of operations and profit margins. Due to pricing pressure or other factors, the Company may not be able to pass along increased raw material and components parts prices to its customers in the form of price increases or its ability to do so could be delayed. Consequently, our results of operations and financial condition may be adversely affected.
For most of our products, we have existing alternate sources of supply, or such materials are readily available. In limited instances we depend on a single source of supply, manufacturing or assembly or participate in commodity markets that may be subject to a limited number of suppliers. Delays in obtaining supplies may result from a number of factors affecting our suppliers, including production interruptions at suppliers, capacity constraints, labor disputes, the impaired financial condition of a particular supplier, the ability of suppliers to meet regulatory requirements, and suppliers’ allocations to other purchasers. Any delay in our suppliers’ abilities to provide us with sufficient quality and flow of materials, price increases, or decreased availability of raw materials or commodities could impair our ability to deliver products to our customers and, accordingly, could have an adverse effect on our business, results of operations and financial position.
If we fail to manage the distribution of our products and services effectively, our revenue, gross margin and profitability could suffer. A significant portion of our revenue is derived from a single customer.
We use a variety of sales channels to sell our products and services. Successfully managing these sales channels is a complex process as we sell a broad mix of products through a network of approximately 700 distributors, agents, and value-added resellers. Moreover, since each distribution method has distinct risks and profit margins, our failure to implement the most advantageous balance in the delivery model for our products and services could adversely affect our revenue and profit margins. In addition, changes to the sales channels could introduce additional complexity to the sales and inventory management processes and could cause disruptions to customer service or create channel conflicts.
Further, we must manage inventory effectively, particularly with respect to sales to distributors, which involves forecasting demand and potential pricing issues. Distributors may increase orders during periods of product shortages, cancel orders if their inventory is too high or delay orders in anticipation of new products. Our reliance on indirect distribution methods may reduce visibility to end-customer demand, generating a time lag to the market trend with potential negative impacts on inventory levels and strategic decisions, including pricing, capital deployment, and operational decisions.
Our financial results could be adversely affected by the loss of a distributor, the loss or deterioration of some distribution or reseller arrangements, channel conflicts, including the consolidation of third-party distributors, or if the financial conditions of our channel partners were to weaken. It is not unreasonable to suspect that some of our distributors may have insufficient financial resources and may not be able to withstand changes in business conditions, including economic weakness, leading to a slowness or difficulty in the cash collection process.
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Approximately 11% of our total revenue is derived from a single customer, Continental ATE, whom we sell to through OE brake pad contracts and OES supply agreements with automakers, and which is also a third-party distributor for us in the independent aftermarket channel. The loss of this customer could have a material adverse effect on our business, results of operations, or financial condition.
Changes in our effective tax rates as a result of changes in the realizability of our deferred tax assets, the geographic mix of earnings, tax examinations or disputes, tax authority rulings, or changes in the tax laws, may adversely affect our financial results.
The Company is subject to income taxes in the U.S. and in various foreign jurisdictions. We exercise significant judgment in calculating our provision for income taxes and other tax liabilities. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Furthermore, changes in domestic or foreign income tax laws and regulations, or their interpretation, could result in higher or lower income tax rates assessed or changes in the taxability of certain income or the deductibility of certain expenses, thereby affecting our income tax expense and profitability.
Any significant increase in our future effective tax rates could reduce net income in future periods. Given the global nature of our business, a number of factors may increase our future effective tax rates, including:
• | decisions to repatriate non-U.S. earnings for which we have not previously provided for withholding or other income taxes; |
• | changes in the geographic mix of our profits among jurisdictions with differing statutory income tax rates; |
• | sustainability of historical income tax rates in the jurisdictions in which we conduct business; |
• | changes in tax laws applicable to us; |
• | expiration, renewal, or application of tax holidays; |
• | the resolution of issues arising from tax audits with various tax authorities; or |
• | changes in the valuation of our deferred tax assets, deferred tax liabilities, and deferred tax asset valuation allowances. |
The amount of income taxes and other taxes we have paid are subject to ongoing audits by U.S. federal, state and local tax authorities and by non-U.S. authorities. If these audits result in assessments different from amounts paid or reserved, future financial results may include unfavorable tax adjustments. We are currently under routine examination by the U.S. Internal Revenue Service and other tax authorities, and we may be subject to additional examinations in the future. The tax authorities may disagree with our tax treatment of certain material items and thereby increase our tax liability. Failure to sustain our position in these matters could result in a material adverse effect on our financial statements.
Failure to retain our existing senior management, engineering and other key personnel or the inability to attract and retain new qualified personnel could negatively impact our ability to operate or grow our business.
Our success will continue to depend to a significant extent on our ability to retain or attract a significant number of employees in senior management, engineering and other key personnel. The ability to attract or retain employees will depend on our ability to offer competitive compensation, training and cultural benefits. We will need to continue to develop a roster of qualified talent to support business growth and replace departing employees. A failure to retain or attract highly skilled personnel could adversely affect our operating results or ability to operate or grow our business.
A material business interruption, particularly at one of our manufacturing facilities, could negatively impact our ability to generate sales and meet customer demand.
If operations at one of our manufacturing facilities were to be disrupted as a result of a significant equipment failure, natural disaster, power outage, fire, explosion, terrorism, IT system failure, cyber-based attack, adverse weather conditions, labor disputes, relocation of production location, or any other reason, our financial performance could be adversely affected as a result of our inability to meet customer demand for our products. A significant interruption in production capability could also require us to make substantial payments due to non-performance, which could negatively affect our results of operations. We have insurance for certain covered losses which we believe to be adequate to provide for reconstruction of facilities and equipment, as well as certain financial losses resulting from any production interruption or shutdown. However, any recovery under our insurance policies may not offset the lost revenues or increased expenses that may be experienced during the disruption of operations.
Additionally, we have intentions to upgrade or replace existing Enterprise Resource Planning (ERP) systems over the next several years. Implementing new ERP systems may result in unintended changes to the way in which production is performed and transactions are processed. Our ability to execute these ERP systems implementations will directly impact our potential risk exposure during this implementation period.
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Information technology security breaches and changes in laws relating to the use and transfer of personal information could adversely affect our business and results of operations.
The efficient operation of our business is dependent on computer hardware and software systems. While we believe we have taken many steps to protect our information systems, even the most well-protected information systems are vulnerable to internal and external security breaches including, but not limited to, those by computer hackers and cyber terrorists utilizing techniques such as phishing, ransomware or denial of service attacks. Furthermore, information technology security threats are increasing in sophistication and frequency. While we actively manage the risks to our information systems that are within our control, we can provide no assurance that our actions will be successful in eliminating or mitigating risks to our systems, networks or data. The unavailability of our information systems, the failure of these systems to perform as anticipated for any reason or any significant breach of security could cause significant disruption to our business or could result in decreased performance and increased overhead costs, causing an adverse effect on our reputation, business, financial condition and results of operations. A breach could also result in the loss of our intellectual property, potentially impacting our long-term capability to compete on sales for affected products. In addition, a breach of security of our information systems could result in litigation, regulatory action and potential liability, as well as increased costs to implement further information security measures.
The regulatory environment surrounding information security and privacy is increasingly demanding, with frequent imposition of new and changing requirements. For example, the European Union's General Data Protection Regulation (GDPR), which will become effective in May 2018, imposes significant new requirements on how we collect, process and transfer personal data, as well as significant fines for non-compliance. The costs of compliance with the GDPR and the potential for fines and other related costs in the event of a breach of the GDPR or other information security or privacy requirements may have an adverse effect on our financial results.
Portfolio management strategies for growth, including cost-saving initiatives, may not meet expectations.
We regularly review our portfolio of businesses and pursue growth through the acquisition of other companies, assets and product lines that either complement or expand our existing business. Although we conduct what we believe to be a prudent level of investigation regarding the operating and financial condition of the businesses we purchase, a level of risk remains regarding the actual operating condition of these businesses. Until we actually assume operating control of these business assets and their operations, we may not be able to ascertain the actual value or understand the potential liabilities of the acquired entities and their operations. Acquisitions involve a number of risks and present financial, managerial and operational challenges that could have a material adverse effect on our reputation and business, including that an acquired business could under-perform relative to our expectations, the failure to realize expected synergies, integration of technology, operations, personnel and financial and other systems, the possibility that we have acquired substantial undisclosed liabilities, potentially insufficient internal controls over financial activities or financial reporting at an acquired company that could impact us on a consolidated basis, diversion of management attention from other businesses, loss of key employees of the acquired businesses, and customer dissatisfaction or performance.
Our portfolio reviews also include the potential for cost-saving initiatives through restructuring and other initiatives. We strive for and expect to achieve cost savings in connection with certain initiatives, including: (i) manufacturing process and supply chain rationalization; (ii) streamlining redundant administrative overhead and support activities; and (iii) restructuring and repositioning actions. Cost savings expectations are inherently estimates that are difficult to predict and we cannot provide assurance that we will achieve expected, or any, actual cost savings. Our restructuring activities may place substantial demands on our management, which could lead to the diversion of management’s attention from other business priorities and result in a reduced customer focus. In addition, restructuring activities may result in a loss of knowledge or expertise of existing products or business processes or could negatively impact employee performance and retention.
The level of returns on postretirement benefit plan assets, changes in interest rates and other factors could affect our earnings and cash flows in future periods.
A portion of our current and retired employee population is covered by pension and other employee-related defined benefit plans (collectively, postretirement benefit plans). We may experience significant fluctuations in costs related to postretirement benefit plans as a result of macroeconomic factors, such as interest rates, that are beyond our control. The cost of our postretirement plans is incurred over long periods of time and involves various factors and uncertainties during those periods, which can be volatile and unpredictable, including the rates of return on postretirement benefit plan assets and discount rates used to calculate liabilities and expenses. Management develops each assumption using relevant Company experience in conjunction with market-related data. Our liquidity, cash flows and financial statements could be materially affected by significant changes in key economic indicators, volatility in the financial markets, future legislation and other governmental regulatory actions.
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We make contributions to fund our postretirement benefit plans when considered necessary or advantageous to do so. The macro-economic factors discussed above, including the return on postretirement benefit plan assets and the minimum funding requirements established by local government funding or taxing authorities, or established by other agreements, may influence future funding requirements. A significant decline in the fair value of our plan assets, or other adverse changes to our overall pension and other employee-related benefit plans could require increased funding contributions and could adversely affect our financial statements. Future minimum funding requirements will depend primarily on the return on plan assets and discount rate. Depending on these factors, the level of future minimum contributions could be material.
Our business could be adversely affected by the inability of suppliers to provide us with certifications relating to conflict minerals.
Since our supply chain is complex, ultimately we may not be able to sufficiently discover the origin of the conflict minerals (generally defined as the minerals tin, tantalum, titanium and gold which have been extracted from the Democratic Republic of the Congo or adjoining countries) used in our products through the due diligence procedures that we implement, which may adversely affect our reputation with our customers, shareholders, and other stakeholders. We may also face difficulties in satisfying customers who require that all of our products are certified as conflict mineral free. If we are not able to meet such requirements, customers may choose not to purchase our products, which could adversely affect our sales and the value of portions of our inventory. Further, there may be only a limited number of suppliers offering conflict free minerals and, as a result, we cannot be sure that we will be able to obtain metals, if necessary, from such suppliers in sufficient quantities or at competitive prices. Any one or a combination of these various factors could harm our business, reduce market demand for our products, and adversely affect our financial results.
Other Risks, Including Litigation and Regulatory Risk
Changes in environmental laws or regulations, the discovery of previously unknown or more extensive contamination, or the failure of a potentially responsible party to perform may adversely affect our financial results.
Environmental laws and regulations allow for the assessment of substantial fines and criminal sanctions as well as facility shutdowns to address violations, and may require the installation of costly pollution control equipment or operational changes to limit emissions or discharges. We also could be affected by changes in environmental laws or regulations, including, for example, those imposed in response to vapor intrusion or climate change concerns.
Accruals for environmental liabilities are recorded on a site-by-site basis when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on current law and existing technologies. Our estimated liability is undiscounted and is reduced to reflect the participation of other potentially responsible parties in those instances where it is probable that such parties are legally responsible and financially capable of paying their respective share of the relevant costs. Such estimates are subject to change and may be affected by many factors, such as new information about a site, evolving scientific knowledge about risk associated with any contamination involved, developments affecting remediation technology, and enforcement by regulatory authorities.
Developments such as the adoption of new environmental laws and regulations, violations by us of such laws and regulations, discovery of previously unknown or more extensive contamination, litigation involving environmental impacts, the adequacy of insurance policies, our inability to recover costs associated with any such developments, or financial insolvency of other potentially responsible parties could have a material adverse effect on our financial statements.
Failure to comply with the U.S. Foreign Corrupt Practices Act or other applicable anti-corruption legislation, as well as export controls and trade sanctions, could result in fines or criminal penalties.
We operate in a number of countries throughout the world, including countries known to have a reputation for corruption. We are committed to doing business in accordance with applicable anti-corruption laws. We are subject, however, to the risk that we, our affiliated entities, or the respective officers, directors, employees and agents of ITT, may take action determined to be in violation of such anti-corruption laws, including but not limited to, the U.S. Foreign Corrupt Practices Act of 1977 and the U.K. Bribery Act of 2010, as well as trade sanctions administered by the Office of Foreign Assets Control (OFAC), the U.S. Department of State and the U.S. Department of Commerce. Any such violation could result in substantial fines, sanctions, civil and/or criminal penalties, suspension or debarment from government contracts, or curtailment of operations in certain jurisdictions, and might adversely affect our business, results of operations or financial position. In addition, actual or alleged violations could damage our reputation and ability to do business. Furthermore, detecting, investigating, and resolving actual or alleged violations is expensive and can consume significant time and attention of our senior management.
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We are subject to laws, regulations and potential liability relating to claims, complaints and proceedings, including those related to product and other matters.
We are subject to various laws, ordinances, regulations and other requirements of government authorities in the U.S. and in foreign countries. Any violations or failure to comply with securities laws, trade or tax rules or similar regulations could create a substantial liability for us, and also could cause harm to our reputation. Changes in laws, ordinances, regulations or other government policies, the nature, timing, and effect of which are uncertain, may significantly increase our expenses and liabilities.
Our business exposes us to potential product liability risks that are inherent in the design, manufacture, and marketing of products for the markets we serve. In addition, many of the devices we manufacture and sell are designed to be used in harsh environments for long periods of time where the cost of failure is high. Component failures, manufacturing defects, design flaws, or inadequate disclosure of product-related risks or product-related information could result in an unsafe condition or injury to, or death of, an end-user of our products. The occurrence of such a problem could result in product liability claims or a recall of, or safety alert relating to, one or more of our products which could ultimately result, in certain cases, in the removal of such products from the marketplace and claims regarding costs associated therewith. Product liability claims or product recalls in the future, regardless of their ultimate outcome, could have a material adverse effect on our business and reputation and on our ability to attract and retain customers for our products.
From time to time we are involved in legal proceedings that are incidental to the operation of our businesses. Some of these proceedings allege damages relating to personal injury claims, employment and employee benefit matters and commercial or contractual disputes, sometimes related to acquisitions or divestitures. Additionally, we may become subject to significant claims of which we are currently unaware or the claims of which we are aware may result in our incurring a significantly greater liability than we anticipate or can estimate.
Past divestitures and spin-offs may expose us to potential liabilities.
Over our more than 100 year history, we have divested a number of businesses, including as part of spin-offs in 1995 and 2011. With respect to some of these former businesses, we have contractually agreed to indemnify the counterparties against, or otherwise retain, certain liabilities, including, for example certain lawsuits, tax liabilities, product liability claims, asbestos claims or environmental matters. Even without ongoing contractual indemnification obligations, we could be exposed to liabilities arising out of such divestitures. In addition, the counterparties to those divestitures may have agreed to indemnify us or assume certain liabilities relating to those divestitures. Similarly, there can be no assurance that the indemnity or assumption of liability by the counterparties will be sufficient to protect us against the full amount of these liabilities, or that a counterparty will be able to fully satisfy its obligations. Third parties also could seek to hold us responsible for any of the liabilities that a counterparty agreed to assume. Even if we ultimately succeed in recovering any amounts for which we were initially held liable, we may be temporarily required to bear these losses ourselves. For example, as part of the Distribution Agreement that we signed in 2011, ITT LLC, Exelis, and Xylem indemnified each other with respect to such parties' assumed or retained liabilities pursuant to the Distribution Agreement and breaches of the Distribution Agreement or related spin agreements. As a result of these types of arrangements, conditions outside our control could have a material adverse effect on our future financial results.
Anti-takeover provisions in our organizational documents and Indiana law could delay or prevent a change in control.
Certain provisions of our articles of incorporation and by-laws may delay or prevent a merger or acquisition that a shareholder may consider favorable. For example, the articles of incorporation authorize our Board of Directors to issue one or more series of preferred stock. In addition, the articles of incorporation and by-laws, among other things, do not permit action by written consent of the shareholders. These provisions may also discourage acquisition proposals or delay or prevent a change in control, which could harm our stock price. Indiana law also imposes some restrictions on mergers and other business combinations between any holder of 10% or more of our outstanding common stock and us as well as certain restrictions on the voting rights of "control shares" of an "issuing public corporation."
ITEM 1B. | UNRESOLVED STAFF COMMENTS |
None.
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ITEM 2. | PROPERTIES |
We consider the offices, plants, warehouses, and other properties that we own or lease to be in good condition and generally suitable for their intended purpose. We believe these properties are adequate for the Company’s needs and will generally allow for expansion of capacity if needed. The following table summarizes the number and area (in thousands of square feet) of our properties by region and business segment as of December 31, 2017.
Number of Facilities - Owned | |||||||||||||||||||||||||
Industrial Process | Motion Technologies | Connect & Control Technologies | Other | Total | |||||||||||||||||||||
Location | # | Area | # | Area | # | Area | # | Area | # | Area | |||||||||||||||
Manufacturing: | |||||||||||||||||||||||||
North America | 3 | 1,109.0 | 4 | 813.6 | 4 | 540.4 | — | — | 11 | 2,463.0 | |||||||||||||||
Europe | 1 | 356.8 | 10 | 1,609.1 | 1 | 231.3 | — | — | 12 | 2,197.2 | |||||||||||||||
Asia | 1 | 670.9 | 1 | 8.8 | 1 | 13.4 | — | — | 3 | 693.1 | |||||||||||||||
South America | 1 | 68.0 | — | — | — | — | — | — | 1 | 68.0 | |||||||||||||||
6 | 2,204.7 | 15 | 2,431.5 | 6 | 785.1 | — | — | 27 | 5,421.3 | ||||||||||||||||
Non-Manufacturing: | |||||||||||||||||||||||||
North America | 3 | 112.5 | — | — | — | — | — | — | 3 | 112.5 | |||||||||||||||
Europe | — | — | 1 | 38.5 | — | — | — | — | 1 | 38.5 | |||||||||||||||
3 | 112.5 | 1 | 38.5 | — | — | — | — | 4 | 151.0 | ||||||||||||||||
Number of Facilities - Leased | |||||||||||||||||||||||||
Industrial Process | Motion Technologies | Connect & Control Technologies | Other | Total | |||||||||||||||||||||
Location | # | Area | # | Area | # | Area | # | Area | # | Area | |||||||||||||||
Manufacturing: | |||||||||||||||||||||||||
North America | 3 | 156.0 | 3 | 56.6 | 9 | 442.1 | — | — | 15 | 654.7 | |||||||||||||||
Europe | — | — | 4 | 350.7 | 3 | 69.0 | — | — | 7 | 419.7 | |||||||||||||||
Asia | 2 | 221.5 | 2 | 348.6 | 1 | 294.4 | — | — | 5 | 864.5 | |||||||||||||||
South America | 1 | 31.8 | — | — | — | — | — | — | 1 | 31.8 | |||||||||||||||
6 | 409.3 | 9 | 755.9 | 13 | 805.5 | — | — | 28 | 1,970.7 | ||||||||||||||||
Non-Manufacturing: | |||||||||||||||||||||||||
North America | 16 | 421.6 | 2 | 58.0 | — | — | 2 | 64.6 | 20 | 544.2 | |||||||||||||||
Europe | 10 | 133.0 | 1 | 28.0 | — | — | 1 | 3.2 | 12 | 164.2 | |||||||||||||||
Middle East | 2 | 14.8 | — | — | — | — | — | — | 2 | 14.8 | |||||||||||||||
Asia | 10 | 140.9 | 2 | 5.5 | 4 | 7.2 | 2 | 11.9 | 18 | 165.5 | |||||||||||||||
South America | 6 | 220.9 | — | — | — | — | — | — | 6 | 220.9 | |||||||||||||||
44 | 931.2 | 5 | 91.5 | 4 | 7.2 | 5 | 79.7 | 58 | 1,109.6 | ||||||||||||||||
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ITEM 3. | LEGAL PROCEEDINGS |
From time to time, we are involved in litigation, claims, government inquiries, investigations and proceedings, including but not limited to those relating to environmental exposures, intellectual property matters, personal injury claims, regulatory matters, commercial and government contract issues, employment and employee benefit matters, commercial or contractual disputes, and securities matters.
Asbestos Proceedings
Subsidiaries of ITT, including ITT LLC and Goulds Pumps LLC, have been joined as defendants with numerous other companies in product liability lawsuits alleging personal injury due to asbestos exposure. These claims allege that certain of their products sold prior to 1985 contained a part manufactured by a third party (e.g., a gasket) which contained asbestos. To the extent these third-party parts may have contained asbestos, it was encapsulated in the gasket (or other) material and was non-friable. Frequently, the plaintiffs are unable to identify any ITT LLC or Goulds Pumps LLC products as a source of asbestos exposure. In addition, a large majority of claims pending against the Company's subsidiaries have been placed on inactive dockets because the plaintiff cannot demonstrate a significant compensable loss. Our experience to date is that a substantial portion of resolved claims have been dismissed without payment by the Company's subsidiaries.
We have recorded a liability for pending asbestos claims and asbestos claims estimated to be filed over the next 10 years. While it is probable that we will incur additional costs for future claims to be filed against the Company, a liability for potential future claims beyond the next 10 years is not reasonably estimable due to the uncertainties and variables inherent in the long-term projection of the Company's asbestos exposures and potential recoveries. As of December 31, 2017, we have recorded an undiscounted asbestos-related liability for pending claims and unasserted claims estimated to be filed over the next 10 years of $877.2, which includes expected legal fees and we have recorded an associated asset of $368.7, which represents estimated recoveries from insurers, resulting in a net exposure of $508.5. See information provided in Note 18, Commitments and Contingencies, to the Consolidated Financial Statements for further information.
Environmental
In the ordinary course of business, we are subject to federal, state, local, and foreign environmental laws and regulations. We are responsible, or are alleged to be responsible, for ongoing environmental investigation and site remediation. These sites are in various stages of investigation and/or remediation and in many of these proceedings our liability is considered de minimis. We have received notification from the U.S. Environmental Protection Agency, and from similar state and foreign environmental agencies, that a number of sites formerly or currently owned and/or operated by ITT, and other properties or water supplies that may be or have been impacted from those operations, contain disposed or recycled materials or wastes and require environmental investigation and/or remediation. These sites include instances where we have been identified as a potentially responsible party under federal and state environmental laws and regulations. See information provided in Note 18, Commitments and Contingencies, to the Consolidated Financial Statements for further information.
Other Matters
The Company received a civil subpoena from the Department of Defense, Office of the Inspector General, in the second quarter of 2015 as part of an investigation being led by the Civil Division of the U.S. Department of Justice (DOJ). The subpoena and related investigation involve certain connector products manufactured by the Company’s Connect & Control Technologies segment that are purchased or used by the U.S. government. In addition, in the third quarter of 2017, the Company learned that the Criminal Division of DOJ is also investigating this matter. The Company is cooperating with the government and has produced documents responsive to the subpoena to the Civil Division. Based on its current analysis following discussions with DOJ to resolve the civil matter, the Company has accrued $5 as its current best estimate of the minimum amount of probable loss. It is reasonably possible that any actual loss related to this matter may be higher than this amount, but at this time management is unable to estimate a range of potential loss in excess of the amount accrued.
ITEM 4. | MINE SAFETY DISCLOSURES |
Not applicable.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The current executive officers of the Company, as of February 1, 2018, are listed below.
Name | Age | Current Title | |
Denise L. Ramos | 61 | Chief Executive Officer and President | |
Farrokh Batliwala | 42 | Senior Vice President and President, Connect & Control Technologies | |
Victoria L. Creamer | 48 | Senior Vice President Human Resources | |
Steven C. Giuliano | 48 | Vice President and Chief Accounting Officer | |
Mary Beth Gustafsson | 58 | Senior Vice President, General Counsel and Chief Compliance Officer | |
David Malinas | 43 | Senior Vice President and President, Industrial Process | |
Luca Savi | 52 | Executive Vice President and Chief Operating Officer | |
Thomas M. Scalera | 46 | Executive Vice President and Chief Financial Officer | |
Denise L. Ramos was appointed Chief Executive Officer, President and a director of the Company in October 2011. She previously served as Senior Vice President and Chief Financial Officer of the Company since 2007. Prior to joining the Company, Ms. Ramos served as Chief Financial Officer for Furniture Brands International from 2005 to 2007. From 2000 to 2005, Ms. Ramos served as Senior Vice President and Corporate Treasurer at Yum! Brands, Inc. and Chief Financial Officer for the U.S. division of KFC Corporation. Ms. Ramos began her career in 1979 at Atlantic Richfield Company (ARCO), where she had more than 20 years of business and financial experience serving in a number of increasingly responsible finance positions, including Corporate General Auditor and Assistant Treasurer. Ms. Ramos is currently a director of the following public company: Phillips 66, since 2016 (Audit and Finance Committee, Nominating and Governance Committee and Public Policy Committee). She serves on the Board of Trustees for the Manufacturers Alliance for Productivity and Innovation and is also a member of the Business Council. Ms. Ramos was included in the Top 100 CEO Leaders in Science, Technology, Engineering and Math publication by STEMconnector, she received a Distinguished Leadership Award from the New York Hall of Science and she was named to Fortune magazine’s 2014 Top People in Business. She also served on the board of the following public company within the last five years: Praxair, Inc. from 2014 to 2016.
Farrokh Batliwala has served as our Senior Vice President and President, Connect & Control Technologies since May 2017. Prior to the consolidation of ITT's Control Technologies and Interconnect Solutions segments, Mr. Batliwala served as the Senior Vice President and President of Control Technologies and Interconnect Solutions, from November 2016 to May 2017, and previously served as Senior Vice President and President, Control Technologies from October 2015 to November 2016. Prior to joining us, Mr. Batliwala served as Vice President and General Manager, Hydraulics, Power and Motion Control Division for Eaton Corporation (Eaton), a diversified global power management technology company, from 2013 to 2015. Mr. Batliwala held various other positions of increasing levels of responsibility at Eaton since 2004.
Victoria L. Creamer has served as our Senior Vice President, Human Resources since February 2015. Prior to joining ITT, Ms. Creamer served as Vice President, Global Compensation and Recognition of International Business Machines Corporation (IBM), a global technology and consulting company, from April 2013 to January 2015. Ms. Creamer held various other positions of increasing levels of responsibility at IBM since 1991.
Steven C. Giuliano has served as our Vice President and Chief Accounting Officer since January 2014. Prior to joining, Mr. Giuliano served as Senior Vice President and Chief Financial Officer from 2009 to 2011, and was Vice President and Chief Financial Officer from 2007 to 2009, of Arch Chemicals, Inc. Mr. Giuliano was Controller of Arch Chemicals from 1999 through 2007, while assuming increasing levels of responsibility.
Mary Beth Gustafsson has served as our Senior Vice President and General Counsel since February 2014 and as our Chief Compliance Officer since August 2014. Prior to joining us, Ms. Gustafsson served as Executive Vice President, General Counsel and Corporate Secretary of First Solar Inc., a global provider of comprehensive photovoltaic solar systems, from 2009 to 2013 and from 2008 to 2009 as Vice President, General Counsel. Ms. Gustafsson was previously Senior Vice President, General Counsel and Secretary of American Standard Companies, Inc. (American Standard) from 2005 to 2008, and held various other positions of increasing levels of responsibility at American Standard since 2001.
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David Malinas has served as our Senior Vice President and President, Industrial Process since June 2017. He previously served as Vice President and General Manager of Thermo Fisher Scientific, a leading provider of scientific tools and services, from April 2008 through June 2017. In addition, while at Thermo Fisher Scientific, he held a variety of leadership roles across the United States and Japan. Mr. Malinas also previously held a variety of management roles at Danaher Corporation in the Environmental and Motion platforms in the USA, England, Germany and Mexico.
Luca Savi has served as our Executive Vice President and Chief Operating Officer since January 2017 and previously as Executive Vice President, Motion Technologies since February 2016. He joined ITT in November 2011 as Senior Vice President and President, Motion Technologies. Prior to joining us, Mr. Savi served as Chief Operating Officer, Comau Body Welding at Comau, a subsidiary of the Fiat Group responsible for producing and serving advanced manufacturing systems, from 2009 to 2011 and prior to that as Chief Executive Officer, Comau North America from 2007 to 2009 and Chief Executive Officer, Comau China from 2004 to 2007. Mr. Savi previously held senior leadership roles at Honeywell International, Royal Dutch Shell and Ferruzzi-Montedison Group.
Thomas M. Scalera has served as our Executive Vice President and Chief Financial Officer since February 2016 and previously as our Senior Vice President, Chief Financial Officer and Strategy and IT Leader since August 2014 and prior to that as Senior Vice President and Chief Financial Officer since October 2011. He previously served as Vice President, Corporate Finance from 2010 to 2011 and Director, Investor Relations from 2008 to 2010. Prior to joining ITT in 2006, Mr. Scalera held senior financial roles with R.R. Donnelley, Dover Corp., and PricewaterhouseCoopers, LLP.
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PART II
ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
COMMON STOCK – MARKET PRICES AND DIVIDENDS
The table below reflects the range of market prices of our common stock as reported in the consolidated transaction reporting system of the New York Stock Exchange (NYSE), the principal market in which this security is traded (under the trading symbol "ITT").
2017 | 2016 | ||||||||||||||
High | Low | High | Low | ||||||||||||
Three Months Ended: | |||||||||||||||
March 31 | $ | 44.00 | $ | 38.52 | $ | 38.96 | $ | 29.15 | |||||||
June 30 | 42.73 | 36.93 | 39.70 | 30.31 | |||||||||||
September 30 | 44.95 | 38.66 | 36.98 | 30.06 | |||||||||||
December 31 | 54.79 | 44.06 | 43.07 | 32.46 | |||||||||||
We declared dividends of $0.128 and $0.124 per share of common stock in each of the four quarters of 2017 and 2016, respectively. In the first quarter of 2018, we declared a dividend of $0.134 per share for shareholders of record on March 12, 2018. The amount and timing of dividends payable on our common stock are within the sole discretion of our Board of Directors and will be based on, and affected by, a number of factors, including our financial position and results of operations, available cash, expected capital spending plans, prevailing business conditions, and other factors the Board deems relevant. Therefore, there can be no assurance as to what level of dividends, if any, will be paid in the future.
There were approximately 9,136 holders of record of our common stock on February 14, 2018.
EQUITY COMPENSATION PLAN INFORMATION
The equity compensation plan information called for by Item 5(a) is set forth under the caption "Equity Compensation Plan Information" in our Proxy Statement for the 2018 Annual Meeting of Shareholders.
During the fiscal year ended December 31, 2017, no equity securities of the Company were sold by the Company that were not registered under the Securities Act.
ISSUER PURCHASES OF EQUITY SECURITIES
The following table summarizes our purchases of our common stock for the quarter ended December 31, 2017.
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS) PERIOD | TOTAL NUMBER OF SHARES PURCHASED | AVERAGE PRICE PAID PER SHARE(1) | TOTAL NUMBER OF SHARES PURCHASED AS PART OF PUBLICLY ANNOUNCED PLANS OR PROGRAMS(2) | MAXIMUM DOLLAR VALUE OF SHARES THAT MAY YET BE PURCHASED UNDER THE PLANS OR PROGRAMS(2) | ||||||||||
10/1/2017 - 10/31/2017 | — | — | — | $ | 140.6 | |||||||||
11/1/2017 - 11/30/2017 | — | — | — | $ | 140.6 | |||||||||
12/1/2017 - 12/31/2017 | — | — | — | $ | 140.6 | |||||||||
(1) | Average price paid per share is calculated on a settlement basis and includes commissions. |
(2) | On October 27, 2006, our Board of Directors approved a three-year $1 billion Share Repurchase Program. On December 16, 2008, our Board of Directors modified the provisions of the Share Repurchase Program to replace the original three-year term with an indefinite term. As of December 31, 2017, we had repurchased 21.2 shares for $859.4, including commissions, under the Share Repurchase Program. The program is consistent with our capital allocation process, which has centered on those investments necessary to grow our businesses organically and through acquisitions, while also providing returns to shareholders. Our strategy for cash flow utilization is to invest in our business, execute strategic acquisitions, pay dividends, and repurchase common stock. |
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PERFORMANCE GRAPH
CUMULATIVE TOTAL RETURN
Based upon an initial investment on December 31, 2012 of $100 with dividends reinvested
12/31/2012 | 12/31/2013 | 12/31/2014 | 12/31/2015 | 12/31/2016 | 12/31/2017 | ||||||||||||||||||
ITT Inc. | $ | 100.00 | $ | 187.38 | $ | 176.37 | $ | 160.26 | $ | 172.46 | $ | 241.55 | |||||||||||
S&P 400 Mid-Cap | $ | 100.00 | $ | 133.46 | $ | 146.45 | $ | 143.25 | $ | 172.95 | $ | 201.02 | |||||||||||
S&P 400 Capital Goods | $ | 100.00 | $ | 141.36 | $ | 141.71 | $ | 133.91 | $ | 176.66 | $ | 220.29 | |||||||||||
This graph is not, and is not intended to be, indicative of future performance of our common stock. This graph shall not be deemed "filed" with the SEC or subject to the liabilities of Section 18 of the Exchange Act, and should not be deemed to be incorporated by reference into any of our prior or subsequent filings under the Securities Act.
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ITEM 6. | SELECTED FINANCIAL DATA |
The following table presents selected historical financial data derived from the Consolidated Financial Statements for each of the five years presented. The selected financial data should be read in conjunction with, and is qualified in its entirety by reference to Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and the Notes thereto.
(In Millions, except per share amounts) | 2017(a) | 2016(b) | 2015 | 2014 | 2013 | ||||||||||||||
Results of Operations | |||||||||||||||||||
Revenue | $ | 2,585.3 | $ | 2,405.4 | $ | 2,485.6 | $ | 2,654.6 | $ | 2,496.9 | |||||||||
Gross profit | 817.2 | 758.2 | 809.1 | 866.4 | 799.8 | ||||||||||||||
Gross margin | 31.6 | % | 31.5 | % | 32.6 | % | 32.6 | % | 32.0 | % | |||||||||
Asbestos-related (benefit) costs, net(c) | (19.9 | ) | (25.6 | ) | (91.4 | ) | 3.9 | 32.8 | |||||||||||
Other operating costs | 527.4 | 524.9 | 520.4 | 596.1 | 583.4 | ||||||||||||||
Operating income | 309.7 | 258.9 | 380.1 | 266.4 | 183.6 | ||||||||||||||
Operating margin | 12.0 | % | 10.8 | % | 15.3 | % | 10.0 | % | 7.4 | % | |||||||||
Income tax expense (benefit)(d) | 194.6 | 76.0 | 70.1 | 71.3 | (309.6 | ) | |||||||||||||
Income from continuing operations attributable to ITT Inc. | 115.0 | 181.9 | 312.4 | 188.4 | 487.7 | ||||||||||||||
(Loss) income from discontinued operations, net of tax(e) | (1.5 | ) | 4.2 | 39.4 | (3.9 | ) | 0.8 | ||||||||||||
Net income attributable to ITT Inc. | $ | 113.5 | $ | 186.1 | $ | 351.8 | $ | 184.5 | $ | 488.5 | |||||||||
Income from continuing operations per basic share | $ | 1.30 | $ | 2.04 | $ | 3.48 | $ | 2.06 | $ | 5.36 | |||||||||
(Loss) income from discontinued operations per basic share | $ | (0.01 | ) | $ | 0.05 | $ | 0.44 | $ | (0.04 | ) | $ | 0.01 | |||||||
Net income per basic share | $ | 1.29 | $ | 2.09 | $ | 3.92 | $ | 2.02 | $ | 5.37 | |||||||||
Income from continuing operations per diluted share | $ | 1.29 | $ | 2.02 | $ | 3.44 | $ | 2.03 | $ | 5.28 | |||||||||
(Loss) income from discontinued operations per diluted share | $ | (0.01 | ) | $ | 0.05 | $ | 0.44 | $ | (0.04 | ) | $ | 0.01 | |||||||
Net income per diluted share | $ | 1.28 | $ | 2.07 | $ | 3.88 | $ | 1.99 | $ | 5.29 | |||||||||
Dividends declared | $ | 0.512 | $ | 0.496 | $ | 0.4732 | $ | 0.44 | $ | 0.40 | |||||||||
Financial Position | |||||||||||||||||||
Cash and cash equivalents | $ | 389.8 | $ | 460.7 | $ | 415.7 | $ | 584.0 | $ | 507.3 | |||||||||
Total assets | 3,700.2 | 3,601.7 | 3,723.6 | 3,631.5 | 3,740.2 | ||||||||||||||
Total debt and capital leases | 171.9 | 216.3 | 248.5 | 8.5 | 48.9 | ||||||||||||||
(a) | On January 26, 2017, we acquired Axtone Railway Components (Axtone). Our 2017 Consolidated Financial Statements include an additional 11 months of operations compared to 2016 related to this acquisition. See Note 21, Acquisitions, in our Notes to Consolidated Financial Statements for further information. |
(b) | On October 5, 2015, we acquired Wolverine Automotive Holdings Inc. (Wolverine). Our 2016 Consolidated Financial Statements include an additional nine months of operations compared to 2015 related to this acquisition. See Note 21, Acquisitions, in our Notes to Consolidated Financial Statements for further information. |
(c) | The asbestos-related benefit in 2015 primarily reflects a $100.7 benefit recognized related to a new single firm defense strategy and streamlined case management that is expected to significantly reduce asbestos defense costs. See Note 18, Commitments and Contingencies, in our Notes to the Consolidated Financial Statements for further information. |
(d) | The 2017 income tax expense includes a $129.2 impact associated with the Tax Cuts and Jobs Act of 2017 that was signed into U.S. law in December 2017. See Note 5, Income Taxes, in our Notes to the Consolidated Financial Statements for further information. The 2013 income tax benefit of $309.6 includes the release of a U.S. deferred tax valuation allowance of $374.6. |
(e) | The 2015 income from discontinued operations of $39.4, principally related to the settlement of the U.S. income tax audit. |
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ITEM 7. | MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion should be read in conjunction with the consolidated financial statements and the notes related thereto. As we noted earlier in the Forward-Looking and Cautionary Statements 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. The risks 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 by such forward-looking statements.
OVERVIEW
ITT Inc., through its worldwide subsidiaries, is a diversified manufacturer of highly engineered critical components and customized technology solutions for the energy, transportation and industrial markets. We refer you to Part I, Item 1, "Description of Business" for a further overview of our company, segments, products and services offerings, and other information about our business.
EXECUTIVE SUMMARY
During 2017, we continued to focus on optimizing execution across the enterprise while advancing our long-term strategies and driving growth and share gains with key customers, end markets, and geographies. In early 2017, we created a new operating model and Chief Operating Officer structure, which has been successfully driving more robust processes and performance across the company. The benefits generated from increased volume, productivity improvements across our businesses, and proactive restructuring actions more than offset unfavorable headwinds experienced during the year.
Our 2017 results include:
• | Revenue of $2.6 billion, reflecting growth of $179.9, or 7.5%, and organic revenue growth of $76.4, or 3.2%, which excludes an incremental benefit of $74 from our acquisition of Axtone and $29.5 from favorable foreign exchange translation. Organic revenue growth was driven by a 7% increase to our transportation markets, led by automotive brake pads and KONI high speed rail, partially offset by lower aerospace revenues. Organic revenue to our industrial markets decreased 1% due to weaker chemical and industrial pumps, partially offset by strength in general industrial connectors and mining. Organic revenue to our oil & gas markets declined 4% amid project pump declines, partially offset by increased connector sales. |
• | Operating income of $309.7 and operating margin of 12.0%, reflecting growth of $50.8 and 120 basis points, respectively, as sales volume growth, lower restructuring costs coupled with the benefits from current and prior year actions, and productivity improvements at all three segments, were partially offset by higher commodity costs, unfavorable price and sales mix, incremental investments to support long-term growth, higher incentive compensation costs, and unfavorable impacts from foreign currency fluctuations. |
• | Income from continuing operations was $1.29 per diluted share that includes provisional tax expense impact of $129.2 ($1.45 per diluted share) from the Tax Cuts and Jobs Act of 2017 (herein referred to as the "Tax Act"). Adjusted income from continuing operations was $2.59 per diluted share for 2017, reflecting a 27 cent per share increase over the prior year. |
See the section titled "Key Performance Indicators and Non-GAAP Measures" for a definition and reconciliation of organic revenue, adjusted segment operating income, and adjusted income from continuing operations.
During 2017, we advanced our strategic goals to drive long-term growth and share gains. The following highlights a few examples of strategic actions that occurred during the year that will help position us well for continued value creation:
• | We aligned the operations and management of our connectors and control technologies businesses creating a new business segment, Connect & Control Technologies, to increase focus on aerospace and industrial markets, optimize operations, leverage shared infrastructure, and drive long-term growth. |
• | At our Industrial Process segment, we continued our strategic transformation led by our structural reset and focused heavily on optimizing our project execution, leading to operating margin expansion. |
• | Despite ongoing pricing and commodity cost headwinds, our Motion Technologies segment delivered exceptional operating results due to our World-Class Manufacturing Excellence Program, which began almost three years ago. |
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During the year, we drove market share gains by expanding in new and existing key end markets and geographies, including:
• | Advancing key strategies in rotorcraft, aerospace and defense, electric vehicle, and high speed rail markets. In all categories, we were awarded significant multi-year awards that may also generate attractive aftermarket opportunities. |
• | In the transportation market, we significantly outpaced global OEM production rates in China, North America and Europe. We were also awarded 75 new automotive platforms, including 42 in China and 15 for electric vehicles. |
• | We launched the innovative ITT SMART Pad and are working with customers on both development and on-board opportunities. |
In 2017, we continued to deploy our capital in balanced and effective ways, including:
• | Funding organic investments, such as our phased investments in Mexico, China, and the Czech Republic to efficiently align our friction footprint with the automotive platforms we have already secured. |
• | Completing our acquisition of Axtone Railway Components, which will expand and complement our existing capabilities in the global railway market. |
• | Returning $75 to shareholders; $45 in the form of quarterly dividends and $30 in share repurchases. |
As we enter 2018, we plan to build on our operational and strategic momentum by focusing heavily on execution under our new operating model, by driving innovation & growth strategies through our businesses, and by deploying capital in a balanced and efficient way. We will also continue to leverage the benefits of our global and end-market diversification. We expect our primary top-line drivers of growth in 2018 to include global friction and rail share gains and improved short-cycle industrial and chemical pump demand, and we are encouraged by indications of stabilization in our key end markets. While higher commodity costs, price pressures, and non-functional corporate costs are expected to provide challenges in the coming year, we will direct our focus to areas that are within our control by continuing to drive productivity across all three of our business segments and initiating proactive restructuring actions as necessary. In addition, we plan to focus more of our efforts on growth and innovation, increasing research and development activities in 2018 as part of our long-term growth strategy. Finally, we will continue our track record of balanced and effective capital deployment by funding major organic investments that extend our global reach, expand our production capabilities in key end-markets such automotive friction and rotorcraft, and by focusing on our acquisition pipeline. We also raised our first quarter 2018 quarterly dividend by 5%, which would represent our sixth consecutive year of dividend increases, and anticipate returning up to approximately $50 to shareholders in the form of share repurchases.
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DISCUSSION OF FINANCIAL RESULTS
2017 VERSUS 2016
2017 | 2016 | Change | ||||||||
Revenue | $ | 2,585.3 | $ | 2,405.4 | 7.5 | % | ||||
Gross profit | 817.2 | 758.2 | 7.8 | % | ||||||
Gross margin | 31.6 | % | 31.5 | % | 10 | bp | ||||
Operating expenses | 507.5 | 499.3 | 1.6 | % | ||||||
Operating expense to revenue ratio | 19.6 | % | 20.8 | % | (120 | )bp | ||||
Operating income | 309.7 | 258.9 | 19.6 | % | ||||||
Operating margin | 12.0 | % | 10.8 | % | 120 | bp | ||||
Income tax expense | 194.6 | 76.0 | 156.1 | % | ||||||
Effective tax rate | 62.9 | % | 29.4 | % | 3,350 | bp | ||||
Income from continuing operations attributable to ITT Inc. | 115.0 | 181.9 | (36.8 | )% | ||||||
(Loss) income from discontinued operations, net of tax | (1.5 | ) | 4.2 | (135.7 | )% | |||||
Net income attributable to ITT Inc. | $ | 113.5 | $ | 186.1 | (39.0 | )% | ||||
All comparisons included with the Discussion of Financial Results 2017 versus 2016 refer to results for the year ended December 31, 2017 compared to the year ended December 31, 2016, unless stated otherwise.
REVENUE
The following table illustrates the year-over-year revenue results from each of our segments for the years ended December 31, 2017 and 2016.
2017 | 2016 | Change | Organic (decline) growth(a) | ||||||||||
Industrial Process | $ | 807.2 | $ | 830.1 | (2.8 | )% | (3.4 | )% | |||||
Motion Technologies | 1,176.0 | 983.4 | 19.6 | % | 9.8 | % | |||||||
Connect & Control Technologies | 605.6 | 596.3 | 1.6 | % | 1.4 | % | |||||||
Eliminations | (3.5 | ) | (4.4 | ) | (20.5 | )% | — | % | |||||
Total Revenue | $ | 2,585.3 | $ | 2,405.4 | 7.5 | % | 3.2 | % | |||||
(a) | See the section titled "Key Performance Indicators and Non-GAAP Measures" for a definition and reconciliation of organic revenue and organic orders. |
Industrial Process
Industrial Process revenue for the year ended December 31, 2017 was $807.2, reflecting a decrease of $22.9, or 2.8%, including a favorable foreign currency translation impact of $5.7. Organic revenue decreased 3.4%, due to a 17% decline in project pump revenue primarily stemming from lower North American oil and gas projects in backlog entering the year and lower mining project revenue, but also reflected an 11% decline in revenue from valves partially related to a significant prior year contract. Partially offsetting this decline was organic revenue growth of 4% in short-cycle baseline pumps driven by stronger demand in the industrial and mining markets and growth of 3% from aftermarket parts driven by oil & gas in Europe and Middle East regions and growth of 6% from service due to strength in all North American markets.
Upon adoption of the new revenue standard in the first quarter of 2018, the timing of revenue recognition for certain projects in the Industrial Process business will vary and may be recorded upon shipment based on contract terms, when previously such projects were recorded over time. The impact to future revenue trends is uncertain as it will depend on future orders and contract terms. However, cash flows and overall profitability of a contract at completion are unchanged by the new standard.
Orders for the year ended December 31, 2017 were $799.8, reflecting an increase of $20.7, or 2.7% including favorable foreign currency translation impact of $4.6. Organic orders increased 2.1%, driven by an 8% increase in short-cycle baseline pumps stemming from higher distributor activity across all end markets in North America and in the paper and general industrial markets. Positive organic order growth of 5% from aftermarket parts and service was driven by increases in the North America pulp and paper, Europe and Middle East oil & gas, and Asia mining markets.
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Organic order growth was partially offset by an 8% decline in project activity reflecting the continued competitive and challenging conditions in chemical and oil and gas markets.
The level of order and shipment activity related to project pumps can vary significantly from period to period. Backlog as of December 31, 2017 was $336.5, reflecting a decrease of $10.7, or 3.1%, compared to December 31, 2016.
Motion Technologies
Motion Technologies revenue for the year ended December 31, 2017 was $1,176.0, reflecting an increase of $192.6, or 19.6%, including incremental revenue of $74.0 from the acquisition of Axtone, which was completed in the first quarter of 2017, and favorable foreign currency translation impact of $22.7. Organic revenue increased $95.9, or 9.8%, driven by a 12% increase from our Friction Technologies business. The increase was primarily driven by continued strength in automotive OEM sales channel due to market growth and share gains in China, Europe and North America. The OES and independent aftermarket channels were also strong as revenues grew approximately 8% and 13%, respectively. Wolverine contributed organic revenue growth of approximately 5% due to global share gains in sealing solutions. Organic revenue from our KONI business increased approximately 5% primarily in the rail market due to growth in Europe and higher demand in the high speed rail market in China. Activity on a U.S. defense program also contributed to the growth in KONI revenue.
Orders for the year ended December 31, 2017 were $1,198.8, reflecting an increase of $200.4, or 20.1%, including incremental orders of $70.2 from the acquisition of Axtone and favorable foreign currency translation impacts of $22.0. Organic orders grew $108.2, or 10.8%, primarily due to continued strength in our Friction Technologies business. KONI order activity grew approximately 16% due to a large multi-year order on a U.S. defense program and strength from new products in the China high speed rail market.
Connect & Control Technologies
Connect & Control Technologies revenue for the year ended December 31, 2017 was $605.6, reflecting an increase of $9.3, or 1.6%, including favorable foreign currency translation impacts of $1.0. The increase in revenue was primarily driven by strength in oil and gas connectors which increased approximately 31% due to stronger demand in North America and the Middle East upstream market. In addition, revenue from the general industrial market grew approximately 2% due to heavy vehicle and electric vehicle connector strength. Revenue from the aerospace and defense market decreased 1% due to weaker commercial aerospace demand and impacts from restrictions on the sales of certain military-specification connectors, but was partially offset by rotorcraft share gains and defense component strength.
Orders received during the year ended December 31, 2017 were $624.1, reflecting an increase of $21.7, or 3.6%, including favorable foreign currency translation impacts of $1. The increase was primarily driven by strong order activity in the aerospace and defense market due to defense component strength as well as rotorcraft share gains. Offsetting this increase were impacts from restrictions on the sales of certain military-specification connectors and weaker commercial aerospace demand. Orders for connectors associated with the oil and gas market grew 31%. In the general industrial markets, orders grew approximately 2% due energy absorption projects, actuation components, and heavy vehicle connectors in China.
On July 11, 2017, the U.S. Defense Logistics Agency, Land and Maritime (DLA) issued a notice that it has removed our connectors business from the Qualified Products List (QPL) with respect to six military-specification connector products. At the time of this notice, these products had been subject to a previously-disclosed stop shipment/stop production order issued by DLA earlier in 2017. Annual sales of these military-specification connectors are estimated to range from $8 to $10. The Company will seek to restore its status on the QPL as expeditiously as possible but is unable to estimate how long this process will take. At this time, there is uncertainty whether there will be any further negative impacts to our revenue and results of operations related to the QPL removal.
GROSS PROFIT
Gross profit for 2017 was $817.2, reflecting a gross margin of 31.6%. Gross profit for 2016 was $758.2, reflecting a gross margin of 31.5%. Higher automotive sales volumes, lower labor costs as a result of restructuring benefits from our structural cost reset at our Industrial Process segment, operational improvements at our Connect & Control Technologies segment, and incremental activity from our 2017 acquisition of Axtone were partially offset by unfavorable automotive and aerospace pricing and sales mix impacts, increased direct material costs due to higher commodity prices impacting our Motion Technologies segment, and unfavorable impacts from certain military-specification connectors.
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OPERATING EXPENSES
The following table provides further information by expense type, as well as a breakdown of operating expense by segment.
2017 | 2016 | Change | ||||||||
General and administrative expenses | $ | 264.0 | $ | 274.1 | (3.7 | )% | ||||
Sales and marketing expenses | 169.7 | 170.0 | (0.2 | )% | ||||||
Research and development expenses | 93.7 | 80.8 | 16.0 | % | ||||||
Asbestos-related benefit, net | (19.9 | ) | (25.6 | ) | (22.3 | )% | ||||
Total operating expenses | $ | 507.5 | $ | 499.3 | 1.6 | % | ||||
By Segment: | ||||||||||
Industrial Process | $ | 175.7 | $ | 212.3 | (17.2 | )% | ||||
Motion Technologies | 177.9 | 139.0 | 28.0 | % | ||||||
Connect & Control Technologies | 147.4 | 136.7 | 7.8 | % | ||||||
Corporate & Other | 6.5 | 11.3 | (42.5 | )% | ||||||
General and administrative ("G&A") expenses were $264.0 for the year ended December 31, 2017, reflecting a decrease of $10.1, or 3.7%. The year-over-year decrease was primarily due to an insurance related settlement of $16 received in the fourth quarter of 2017, lower restructuring costs of $13.2, and cost savings from our past restructuring actions. In addition, in the prior year we recorded pension settlement charges of $12.7 and a trade name impairment of $4.1. These items were partially offset by higher incentive compensation of approximately $20, unfavorable foreign currency impacts of approximately $13, a legal accrual of $5, and a pension curtailment of $3.7. In addition, G&A expenses increased $10.6 due to the Axtone acquisition in early 2017.
Sales and marketing expenses for the year ended December 31, 2017 were $169.7, reflecting a decrease of 0.2%, as lower personnel and commission costs at Industrial Process were partially offset by higher overall selling costs at Motion Technologies attributable to strong sales growth and incremental costs related to our acquisition of Axtone of $4.3.
Research and development ("R&D") expenses for the year ended December 31, 2017 were $93.7, reflecting an increase of $12.9, or 16.0%. The increase was primarily driven by increased product development activity at our Motion Technologies and Connect and Control segments. Incremental costs related to our acquisition of Axtone were $1.4 during 2017.
During 2017, we recognized a net asbestos-related benefit of $19.9, compared to a benefit of $25.6 in the prior year. The decrease was primarily due to a lower current year benefit from our annual remeasurement. See Note 18, Commitments and Contingencies, in our Notes to the Consolidated Financial Statements for further information on our asbestos-related liabilities and assets.
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OPERATING INCOME
The following table illustrates the 2017 and 2016 operating income and operating margin by segments and at the consolidated level.
2017 | 2016 | Change | ||||||||
Industrial Process | $ | 59.5 | $ | 33.5 | 77.6 | % | ||||
Motion Technologies | 190.0 | 171.4 | 10.9 | % | ||||||
Connect & Control Technologies | 66.7 | 65.2 | 2.3 | % | ||||||
Segment operating income | 316.2 | 270.1 | 17.1 | % | ||||||
Asbestos-related benefit, net | 19.9 | 25.6 | (22.3 | )% | ||||||
Other corporate costs | (26.4 | ) | (36.8 | ) | (28.3 | )% | ||||
Total corporate and other cost, net | (6.5 | ) | (11.2 | ) | (42.0 | )% | ||||
Total operating income | $ | 309.7 | $ | 258.9 | 19.6 | % | ||||
Operating margin: | ||||||||||
Industrial Process | 7.4 | % | 4.0 | % | 340 | bp | ||||
Motion Technologies | 16.2 | % | 17.4 | % | (120 | )bp | ||||
Connect & Control Technologies | 11.0 | % | 10.9 | % | 10 | bp | ||||
Segment operating margin | 12.2 | % | 11.2 | % | 100 | bp | ||||
Consolidated operating margin | 12.0 | % | 10.8 | % | 120 | bp | ||||
Industrial Process operating income for the year ended December 31, 2017 increased $26.0, or 77.6%, to $59.5. IP's operating margin of 7.4% reflected an increase of 340 basis points. The increase in operating income and margin was primarily driven by net savings of $15 due to restructuring benefits, productivity, and sourcing initiatives, a decrease in restructuring costs of $13.1, improved project performance, and a trade name impairment of $4.1 recorded in 2016. These items were partially offset by an unfavorable impact of approximately $9 from lower sales volume, higher incentive compensation of $6.4 and unfavorable foreign currency impacts of approximately $4. In addition, pension termination charges increased slightly as IP recorded curtailment charges of $3.7 in 2017, compared to a pension settlement charge of $3.4 in 2016.
Motion Technologies operating income for the year ended December 31, 2017 increased $18.6, or 10.9%, to $190.0, but MT's operating margin decreased 120 basis points to 16.2%. The increase in operating income was primarily driven by higher sales volume, which provided a benefit of approximately $44, and productivity improvements at our brake component facilities. These items were partially offset by unfavorable pricing and sales mix, higher material costs, and incremental investments to support recent long-term global automotive platform wins including startup costs for our new North American facility. Foreign currency fluctuations provided an unfavorable impact of approximately $4 during 2017. In addition, our acquisition of Axtone produced incremental operating income of $1.3 during 2017.
Connect & Control Technologies operating income for the year ended December 31, 2017 increased $1.5, or 2.3%, to $66.7 and resulted in an operating margin of 11.0%. Operating income was favorably impacted by net savings of approximately $23, due to restructuring benefits, productivity, and sourcing initiatives, primarily at our North American Connector facility, as well as higher sales volumes that provided a benefit of approximately $8. These items were offset by unfavorable sales mix and pricing of approximately $12, unfavorable impacts related to certain military-specification connectors and a $5 legal accrual. In addition, unfavorable foreign currency impacts of approximately $3 impacted operating income.
Other corporate costs for the year ended December 31, 2017 decreased $10.4, or 28.3%, to $26.4, primarily reflecting an insurance related settlement of $16, pension settlement costs of $9.3 in the prior year, and income of $3.8 related to an amendment to the environmental Qualified Settlement Fund (QSF) in the second quarter of 2017. These items were partially offset by higher incentive compensation, certain insurance related benefits recorded in 2016, and disposal costs associated with a pending sale of property.
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INCOME TAX EXPENSE
Income tax expense of $194.6 was recognized during the year ended December 31, 2017, representing an effective tax rate of 62.9%, which included a $129.2 provisional tax expense related to the Tax Act that was signed into U.S. law on December 22, 2017. The $129.2 provisional tax expense, includes $86.0 related to measuring our U.S. net deferred tax assets at the 21% rate (versus the prior 35% rate), and one-time provisional U.S. tax expenses of $57.9 on existing post-1986 foreign earnings and $37.6 for the future distribution of such earnings to the U.S., which were partially reduced by the reversal of a previously recorded $52.3 liability for foreign earnings that were not considered permanently reinvested. For further information on the Tax Act refer to Note 5, Income Taxes, to our Consolidated Financial Statement and the section titled "Critical Accounting Estimates" within Management's Discussion and Analysis. Excluding the impact of the U.S. Tax Act, income tax expense for 2017 was $65.4, representing an effective tax rate of 21.1%, compared to 2016 income tax expense of $76.0, and an effective tax rate of 29.4%. The lower effective tax rate in 2017, excluding the impact from the Tax Act, was due to tax benefits from an Italian patent box strategy, excess tax deduction on equity compensation, and a decrease in the deferred tax liability on foreign earnings which are not considered indefinitely reinvested.
The Tax Act limits deductibility of net interest expense and officer compensation, adopts certain additional rules to tax low-taxed foreign earnings and provides reduced tax rates for certain earnings from intangibles and export activities. These new rules are applicable to the tax year 2018 and forward and the Company is in the process of evaluating their impact on its financial statements. We anticipate that negative impacts of the Tax Act will reduce the tax benefit resulting from the reduced U.S. corporate income tax rate.
INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX
Results from discontinued operations for the year ended December 31, 2017 reflect a loss of $1.5, net of tax, primarily driven by environmental related liabilities. Results from discontinued operations for the year ended December 31, 2016 reflect a gain of $4.2, net of tax, primarily related to favorable resolutions of certain legacy liabilities in 2016.
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DISCUSSION OF FINANCIAL RESULTS
2016 VERSUS 2015
2016 | 2015 | Change | ||||||||
Revenue | $ | 2,405.4 | $ | 2,485.6 | (3.2 | )% | ||||
Gross profit | 758.2 | 809.1 | (6.3 | )% | ||||||
Gross margin | 31.5 | % | 32.6 | % | (110 | )bp | ||||
Operating expenses | 499.3 | 429.0 | 16.4 | % | ||||||
Operating expense to revenue ratio | 20.8 | % | 17.3 | % | 350 | bp | ||||
Operating income | 258.9 | 380.1 | (31.9 | )% | ||||||
Operating margin | 10.8 | % | 15.3 | % | (450 | )bp | ||||
Income tax expense | 76.0 | 70.1 | 8.4 | % | ||||||
Effective tax rate | 29.4 | % | 18.3 | % | 1,110 | bp | ||||
Income from continuing operations attributable to ITT Inc. | 181.9 | 312.4 | (41.8 | )% | ||||||
Income from discontinued operations, net of tax | 4.2 | 39.4 | (89.3 | )% | ||||||
Net income attributable to ITT Inc. | $ | 186.1 | $ | 351.8 | (47.1 | )% | ||||
All comparisons included with the Discussion of Financial Results 2016 versus 2015 refer to results for the year ended December 31, 2016 compared to the year ended December 31, 2015, unless stated otherwise.
REVENUE
The following table illustrates the year-over-year revenue results from each of our segments for the years ended December 31, 2016 and 2015.
2016 | 2015 | Change | Organic Revenue Growth(a) | ||||||||||
Industrial Process | $ | 830.1 | $ | 1,113.8 | (25.5 | )% | (22.9 | )% | |||||
Motion Technologies | 983.4 | 767.2 | 28.2 | % | 12.3 | % | |||||||
Connect & Control Technologies | 596.3 | 609.3 | (2.1 | )% | (3.3 | )% | |||||||
Eliminations | (4.4 | ) | (4.7 | ) | (6.4 | )% | — | ||||||
Total Revenue | $ | 2,405.4 | $ | 2,485.6 | (3.2 | )% | (7.3 | )% | |||||
(a) | See the section titled "Key Performance Indicators and Non-GAAP Measures" for a definition and reconciliation of organic revenue and organic orders. |
Industrial Process
Industrial Process revenue for the year ended December 31, 2016 was $830.1, reflecting a decrease of $283.7, or 25.5%, including an unfavorable foreign currency translation impact of $28.7. Organic revenue decreased 22.9%, reflecting challenging conditions within oil and gas, mining, and chemical and industrial markets that have driven lower demand for original equipment and replacement parts, as well as the postponement of customer maintenance activities. These challenging conditions resulted in a decline in revenue from project pumps, baseline pumps and aftermarket of 44%, 18% and 12%, respectively. Our revenues derived from the oil and gas market declined approximately 36%. Our revenue in the mining market was down approximately 41%, due to low metal prices as well as strong prior year bookings in Latin America. Revenue stemming from the chemical market declined approximately 15% globally, which reflects significant impacts within North America driven by a decline in large projects.
Orders for the year ended December 31, 2016 were $779.1, reflecting a decrease of $157.6, or 16.8% including unfavorable foreign currency translation impact of $23.6. Organic orders decreased 14.3%, from the prior year, primarily due to the challenging market conditions which drove delays and cancellations of capital projects and customer maintenance and replacement activities. Partially offsetting these declines was a 27% increase in orders from the chemical market due to weak orders activity in the prior year.
Backlog
The level of order and shipment activity related to engineered pumps can vary significantly from period to period. Backlog as of December 31, 2016 was $347.2, reflecting a decrease of $63.7, or 15.5%. The decrease reflects lower project order intake due to global capital project delays and lower oil and gas and mining activity due to market uncertainty and volatility.
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Motion Technologies
Motion Technologies revenue for the year ended December 31, 2016 was $983.4, reflecting an increase of $216.2, or 28.2% including incremental revenue of $126.4 from the acquisition of Wolverine, which was completed in the beginning of the fourth quarter of 2015, and unfavorable foreign currency translation impact of $4.7. Organic revenue increased $94.5, or 12.3%, driven primarily by strength in automotive brake pads due to OEM share gains in China, Europe, and North America that increased OEM revenue approximately 21%. Sales grew in OES approximately 10% while sales in independent aftermarket were flat compared to the prior year. Sales from our KONI business were also flat as growth in our automotive FSD (frequency selective damping) shock absorber product line was offset by a decline in the China rail market.
Orders for the year ended December 31, 2016 were $998.4, reflecting an increase of $218.4, or 28.0%, including incremental orders of $126.8 from the acquisition of Wolverine and unfavorable foreign currency translation impact of $4.5. Organic orders grew $96.1, or 12.3%, due to overall strength in Friction Technologies as recent automotive platform wins began to enter the production cycle as well as an expanding customer base. KONI orders increased approximately 5% due to strength in the U.S. defense market related to an existing position on a U.S. military platform as well as continued growth in the automotive FSD product line. This was slightly offset by a weaker China rail market.
Connect & Control Technologies
Connect & Control Technologies revenue for the year ended December 31, 2016 was $596.3, reflecting a decrease of $13.0, or 2.1%. Organic revenue decreased $20.4, or 3.3%, which excludes the first quarter 2016 incremental benefit from our 2015 acquisition of Hartzell Aerospace of $8.8, as well as revenue of $3.4 from the 2015 period generated by an industrial motors product line that was divested in May 2015 and favorable foreign currency translation impacts of $2. The decline in organic revenue was primarily driven by revenue derived from the oil and gas market which decreased approximately 34% due to weak demand for upstream connectors, and a 7% decline in revenue for commercial aerospace components due to difficult comparisons to the previous year. This was partially offset by connector revenues in the transportation and industrial markets which grew approximately 3% due to strength in applications for electric vehicles as well as medical products. Revenue from the defense market increased slightly as higher component revenue was slightly offset by weaker connectors.
Orders for the year ended December 31, 2016 were $602.4, reflecting a decrease of $16.2, or 2.6%. Organic orders decreased $26.7, or 4.3%, which excludes the first quarter 2016 incremental benefit from our 2015 acquisition of Hartzell Aerospace of $13.4, orders from the prior year of $4.6 associated with the industrial product line sold in May 2015 and favorable foreign currency translation of $1.7. The decline in orders was primarily due to weakness in the upstream oil and gas market, lower order activity in the defense market, and difficult comparisons to the prior year due to a large project.
GROSS PROFIT
Gross profit for 2016 was $758.2, reflecting a gross margin of 31.5%. Gross profit for 2015 was $809.1, reflecting a gross margin of 32.6%. Lower project pump sales volumes and unfavorable impacts from project pump performance at our Industrial Process segment and unfavorable automotive pricing were only partially offset by lower labor costs as a result of restructuring benefits from our structural rest at our Industrial Process segment.
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OPERATING EXPENSES
The following table provides further information by expense type, as well as a breakdown of operating expense by segment.
2016 | 2015 | Change | ||||||||
General and administrative expenses | $ | 274.1 | 258.3 | 6.1 | % | |||||
Sales and marketing expenses | 170.0 | 183.2 | (7.2 | )% | ||||||
Research and development expenses | 80.8 | 78.9 | 2.4 | % | ||||||
Asbestos-related benefit, net | (25.6 | ) | (91.4 | ) | (72.0 | )% | ||||
Total operating expenses | $ | 499.3 | $ | 429.0 | 16.4 | % | ||||
By Segment: | ||||||||||
Industrial Process | $ | 212.3 | $ | 221.6 | (4.2 | )% | ||||
Motion Technologies | 139.0 | 101.5 | 36.9 | % | ||||||
Connect & Control Technologies | 136.7 | 162.8 | (16.0 | )% | ||||||
Corporate & Other | 11.3 | (56.9 | ) | ** | ||||||
** Resulting percentage not considered meaningful.
G&A expenses were $274.1 for the year ended December 31, 2016, reflecting an increase of $15.8, or 6.1%. The year-over-year increase was primarily impacted by incremental costs from the 2015 acquisition of Wolverine of $14.6. In addition, a trade name impairment of $4.1 recorded in 2016 in our Industrial Process segment as the result of challenging conditions experienced within the upstream oil and gas market, unfavorable foreign currency impacts of $2.4 and a favorable warranty resolution in 2015 of approximately $5 were nearly offset by lower incentive based compensation of $5.7, as well as lower acquisition-related costs of $3.3.
Sales and marketing expenses for the year ended December 31, 2016 were $170.0, reflecting a decrease of $13.2, or 7.2%, mainly due to focused cost reductions and lower headcount from our structural reset at Industrial Process, partially offset by incremental sales and marketing costs of $3.7, related to our fourth quarter 2015 acquisition of Wolverine.
R&D expenses for the year ended December 31, 2016 were $80.8, reflecting an increase of $1.9, or 2.4%. The increase was primarily driven by incremental costs of $3.3 related to our acquisition of Wolverine in 2015. In addition, increased product development activities at Motion Technologies were offset by lower R&D spending at Connect & Control Technologies during 2016 due to the progress made on the development of a major aerospace program.
During 2016, we recognized a net asbestos-related benefit of $25.6, compared to a benefit of $91.4 in the prior year. The change was primarily due to a $100.7 benefit recognized in 2015, reflecting a new single firm defense strategy and streamlined case management to assist in reducing asbestos related defense costs. This was partially offset by our annual remeasurement which resulted in a benefit of $81.8 in 2016 compared to a benefit of $44.8 in 2015. See Note 18, Commitments and Contingencies, in our Notes to the Consolidated Financial Statements for further information on our asbestos-related liabilities and assets.
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OPERATING INCOME
The following table illustrates the 2016 and 2015 operating income and operating margin by segments and at the consolidated level.
2016 | 2015 | Change | ||||||||
Industrial Process | $ | 33.5 | $ | 141.2 | (76.3 | )% | ||||
Motion Technologies | 171.4 | 126.4 | 35.6 | % | ||||||
Connect & Control Technologies | 65.2 | 54.6 | 19.4 | % | ||||||
Segment operating income | 270.1 | 322.2 | (16.2 | )% | ||||||
Asbestos-related benefit, net | 25.6 | 91.4 | (72.0 | )% | ||||||
Other corporate costs | (36.8 | ) | (33.5 | ) | 9.9 | % | ||||
Total corporate and other (cost) benefit, net | (11.2 | ) | 57.9 | (119.3 | )% | |||||
Total operating income | $ | 258.9 | $ | 380.1 | (31.9 | )% | ||||
Operating margin: | ||||||||||
Industrial Process | 4.0 | % | 12.7 | % | (870 | )bp | ||||
Motion Technologies | 17.4 | % | 16.5 | % | 90 | bp | ||||
Connect & Control Technologies | 10.9 | % | 9.0 | % | 190 | bp | ||||
Segment operating margin | 11.2 | % | 13.0 | % | (180 | )bp | ||||
Consolidated operating margin | 10.8 | % | 15.3 | % | (450 | )bp | ||||
Industrial Process operating income for the year ended December 31, 2016 decreased $107.7, or 76.3%, to $33.5 and resulted in an operating margin of 4.0%, reflecting a decline of 870 basis points. The decrease in operating income and margin was primarily the result of lower volume which negatively impacted operating income and operating margin by approximately $132, or 1,150 basis points, respectively. Further impacting operating income were unfavorable foreign currency impacts of $9, lower contract profitability of approximately $8, a trade name impairment of $4.1 recorded during 2016 as the result of challenging conditions experienced within the upstream oil and gas market, favorable adjustments made in 2015 to reserves established in purchase accounting for a prior acquisition of $6.7, and a favorable product warranty resolution during 2015 of approximately $5. In addition, restructuring costs in 2016 increased $8.3 compared to the prior year and pension settlement charges of $3.4 were recorded in 2016. These items were partially offset by net savings from restructuring, Lean, sourcing, and cost control initiatives and lower incentive compensation of $3.3.
Motion Technologies operating income for the year ended December 31, 2016 increased $45.0, or 35.6%, to $171.4 and resulted in an operating margin of 17.4%, reflecting an increase of 90 basis points. The increase in operating income was primarily driven by higher sales volumes which provided approximately $48, and was partially offset by unfavorable pricing and mix, as well as a gain of $3 recorded in 2015 related to an insurance recovery and unfavorable foreign currency impacts of approximately $3. Net savings from Lean, sourcing, and cost control initiatives was approximately $26 and the 2015 acquisition of Wolverine provided a benefit of $13.4.
Connect & Control Technologies operating income for the year ended December 31, 2016 increased $10.6, or 19.4%, and resulted in an operating margin of 10.9%, reflecting an increase of 190 basis points. The result reflects net savings from restructuring, Lean, sourcing, and cost control initiatives of approximately $18 which reflected a reduced disruption impact from the relocation of certain North American operations. In addition, restructuring costs declined $10.1 while an unfavorable legal settlement impact of $2 and an impairment charge of $2, both associated with a non-core product line, were recorded in 2015 and further contributed to the increase in 2016 over the prior year. This was offset by a negative impact from sales volume, price and mix of approximately $12 as well as incremental costs in 2016 of approximately $5 associated with the relocation and consolidation of certain operations to an existing lower-cost facility. In addition, postretirement-related costs were higher primarily due to a $5 benefit recognized in 2015 from a plan curtailment.
Other corporate co