ITT Inc.: Form 10-Q for the period ended Jul 1, 2023

(In millions, except per share amounts, unless otherwise stated)

OVERVIEW

ITT Inc. is a diversified manufacturer of highly engineered critical components and customized technology solutions for the transportation, industrial, and energy markets. We manufacture components that are integral to the operation of systems and manufacturing processes in these key markets. Our products enable functionality for applications where reliability and performance are critically important to our customers and the users of their products.

Our businesses share a common, repeatable operating model centered on our engineering capabilities. Each business applies its technology and engineering expertise to solve our customers’ most pressing challenges. Our applied engineering provides a valuable business relationship with our customers given the critical nature of their applications. This in turn provides us with unique insight to our customers’ requirements and enables us to develop solutions to assist our customers in achieving their business goals. Our technology and customer intimacy produce opportunities to capture recurring revenue streams, aftermarket opportunities and long-lived platforms from original equipment manufacturers (OEMs).

Our product and service offerings are organized into three reportable segments: Motion Technologies (MT), Industrial Process (IP), and Connect & Control Technologies (CCT). See Note 3, Segment Information, in this Report for a summary description of each segment. Additional information is also available in our 2022 Annual Report within Part I, Item 1, “Description of Business.”

All comparisons included within Management’s Discussion and Analysis of Financial Condition and Results of Operations refer to the comparable three and six months ended July 2, 2022, unless stated otherwise.

Macroeconomic Conditions

During the second quarter of 2023, there has been continued uncertainty in the global economy, which has been, and will continue to be, influenced by a number of external factors, which are described below.

Russia-Ukraine War

In February 2022, the United States and other leading nations announced targeted economic sanctions on Russia and certain Russian citizens in response to Russia’s war with Ukraine, which has increased regional instability and global economic and political uncertainty.

During the six months ended July 1, 2023 and July 2, 2022, we recorded total pre-tax charges of $3.2 and $8.0, respectively, primarily related to accounts receivable and inventory write-downs due to the suspension of business in Russia stemming from the Russia-Ukraine war. For further discussion of risks stemming from the Russia-Ukraine war, see Part I, Item IA, “Risk Factors” in our 2022 Annual Report for the fiscal year ended December 31, 2022.

COVID-19 Pandemic

Challenges resulting from the COVID-19 pandemic have adversely impacted, and may continue to adversely impact, our business and financial results. For additional discussion of risks related to COVID-19, see Part I, Item IA, “Risk Factors” in our 2022 Annual Report.

Inflationary Pressures

Since 2020, the cost of energy and of raw materials we use in our production processes, including commodities such as steel, oil, copper, and tin, have significantly increased. The rising prices are mainly a result of reduced supply caused by supply chain disruptions primarily as a result of the COVID-19 pandemic and the Russia-Ukraine war.

Beginning in 2022, central banks around the world have been raising interest rates to counter inflation. Rising interest rates have increased our cost of debt and have contributed to instability in the global banking system, which may adversely impact consumer behavior, including demand for our products.

The manufacturing industry continues to experience a skilled labor shortage, which has created difficulties in attracting and retaining factory employees and has resulted in higher labor costs.

These global macroeconomic conditions have contributed to a strengthening of the U.S. dollar relative to foreign currencies, which has created volatility in our reported results stemming from unfavorable foreign currency translation impacts.

Global macroeconomic conditions have led and may continue to lead to decreased demand for our products, increased costs, and reduced operating margins. We have been able to offset most of these negative impacts through pricing actions and productivity savings, which we continue to pursue. Future impacts on our business and financial results as a result of these conditions are not estimable at this time, and depend, in part, on the extent to which these conditions improve or worsen, which remains uncertain. For additional discussion of the risks related to global macroeconomic conditions, see Part I, Item IA, “Risk Factors” in our 2022 Annual Report.

EXECUTIVE SUMMARY

The following table provides a summary of key performance indicators for the second quarter of 2023 as compared to the second quarter of 2022.

Further details related to these results are contained elsewhere in the Discussion of Financial Results section. Refer to the section titled “Key Performance Indicators and Non-GAAP Measures” for definitions and reconciliations between GAAP and non-GAAP metrics.

Our second quarter 2023 results are summarized below:

• Revenue of $833.9 increased by $100.6 due to higher sales volume and pricing actions, particularly within IP’s pump project, baseline pumps and aftermarket businesses, MT’s Friction business, and CCT’s components business. In addition, revenue was favorably impacted by foreign currency translation of $5.1 and by the acquisition of Micro-Mode, which contributed $3.9 to total revenue growth.
• Segment operating income of $152.5, increased by $38.2 despite unfavorable foreign currency impacts of $8.9. The increase was due to productivity savings, pricing actions, and higher sales volume. In addition, the current period benefited from a gain of $7.2 on the sale of a product line within our CCT segment and income of $3.7 from a recovery of costs associated with the 2020 lease termination of a legacy site. The increase in segment operating income was partially offset by higher raw material, labor and overhead costs stemming from continued supply chain challenges and cost inflation.
• Income from continuing operations was $1.31 per diluted share, an increase of $0.40 as compared to the prior year, primarily due to higher segment operating income, as discussed above. Adjusted income from continuing operations was $1.33 per diluted share, an increase of $0.35 as compared to the prior year.

With respect to capital deployment, on May 2, 2023, we acquired Micro-Mode Products, Inc. (Micro-Mode) for a purchase price of $79.3, net of cash acquired. See Note 18, Acquisitions and Investments, for more information. In addition, during the second quarter of 2023, we repurchased 0.4 shares of common stock on the open market for $30.5 and declared a dividend of $0.29 per share, which was a 10% increase from the quarterly dividend of $0.264 in 2022.

DISCUSSION OF FINANCIAL RESULTS

REVENUE

The following table illustrates the revenue derived from each of our segments.

(a) See the section titled “Key Performance Indicators and Non-GAAP Measures” for a definition and reconciliation of organic revenue.

Motion Technologies

MT revenue increased by $37.5 and $32.2 for the three and six months ended July 1, 2023, respectively, primarily driven by higher sales volume and pricing actions. Specifically, the increases in sales volume were driven by growth in our Friction business of 13% and 8%, respectively, due to strong OE growth, partially offset by declines in our Wolverine business of 11% and 9%, respectively, primarily attributable to sealing materials. In addition, the three-month period benefited from favorable foreign currency translation of $5.3, while the six-month period was negatively impacted by unfavorable foreign currency translation of $8.3 and impacts from the Russia-Ukraine war. Excluding the impact of foreign currency translation, organic revenue during the three- and six-month periods grew $32.2 and $40.5, respectively.

In March 2023, our Friction business signed a 10-year agreement, effective on January 1, 2024, for the supply of ITT aftermarket brake pads to Continental AG. The agreement is expected to generate over $1 billion in revenue over the term of the agreement.

Industrial Process

IP revenue for the three and six months ended July 1, 2023 increased by $54.0 and $118.3, respectively, primarily driven by higher sales volume and pricing actions. Specifically, the increases in both periods were driven by growth in pump project sales of 101% and 72%, respectively, primarily attributable to the energy market, and growth in baseline pumps, aftermarket parts and service. The six-month period also benefited by $15.0 from the acquisition of Habonim, which occurred in the second quarter of 2022. The increases in both periods were partially offset by unfavorable foreign currency translation of $0.2 and $2.4, respectively. Excluding the impact from Habonim and unfavorable foreign currency translation, organic revenue increased by $54.2 and $105.7, respectively.

The level of order and shipment activity at IP can vary significantly from period to period due to pump projects which are highly engineered, customized to customer needs, and have longer lead times. Total orders during the three and six months ended July 1, 2023 were $343.0 and $670.3, increases of 15% and 20%, respectively, versus the comparable prior year periods. Backlog as of July 1, 2023 was $688.8, an increase of $108.8, or 19%, as compared to December 31, 2022. Our backlog represents firm orders that have been received, acknowledged, and entered into our production systems.

Connect & Control Technologies

CCT revenue for the three and six months ended July 1, 2023 increased by $9.0 and $22.0, respectively, primarily driven by pricing actions and the second quarter acquisition of Micro-Mode, which had current period revenue of $3.9. The six-month period also benefited from higher sales volume, partially offset by unfavorable foreign currency translation of $2.0. Specifically, the increases in both periods were driven by growth in component sales of 26% and 21%, respectively, particularly within the aerospace and defense markets. Excluding the impact from acquisitions and foreign currency translation, organic revenue increased $5.0 and $20.1, respectively.

GROSS PROFIT

Gross profit for the three months ended July 1, 2023 and July 2, 2022 was $280.0 and $222.2, respectively, reflecting a gross margin of 33.6% and 30.3%. Gross profit for the six months ended July 1, 2023 and July 2, 2022 was $541.9 and $440.6, respectively, reflecting a gross margin of 33.2% and 30.2%. The increases in gross profit for both periods was primarily driven by increases in revenue, as described above, and productivity savings. In addition, the current six-month period benefited from lower charges related to the Russia-Ukraine war. The increases in gross profit for both periods were partially offset by increases in raw material and labor costs, which were driven by inflationary pressures as discussed above. See section titled, “Macroeconomic Conditions”, for further information.

OPERATING EXPENSES

The following table summarizes our operating expenses, including by segment.

General and administrative (G&A) expenses increased $11.4 and $19.3 for the three and six months ended July 1, 2023. The increases in both periods were primarily driven by unfavorable foreign currency impacts, higher personnel and incentive-based compensation costs, and higher strategic M&A-related costs to support the acquisition of Micro-Mode. The increases were partially offset by a gain of $7.2 resulting from the sale of a product line within our CCT segment, income of $3.7 from a recovery of costs associated with the 2020 lease termination of a legacy site, lower restructuring and asset impairment charges, and higher corporate-owned life insurance gains.

Sales and marketing expenses increased $3.5 and $8.0 for the three and six months ended July 1, 2023, primarily driven by higher personnel and other sales-related costs to support higher sales activity.

Research and development expenses increased $1.4 and $2.8 for the three and six months ended July 1, 2023, primarily driven by higher personnel costs and continued strategic investments in innovation and new product development to drive future growth.

OPERATING INCOME

The following table summarizes our operating income and margin by segment.

MT operating income for the three and six months ended July 1, 2023 increased $10.7 and $4.4, respectively, primarily due to productivity savings as well as from higher revenue, as discussed above. The six-month period also benefited from lower charges related to the Russia-Ukraine war.

The increases in operating income for both periods were partially offset by higher raw material and labor costs and unfavorable foreign currency impacts. The increase related to the six-month period was also partially offset by higher overhead costs and unfavorable sales mix.

IP operating income for the three and six months ended July 1, 2023 increased $27.3 and $62.2, respectively, primarily driven by higher revenue, as discussed above, and productivity savings. The six-month period also benefited from lower charges related to the Russia-Ukraine war. The increases in operating income for both periods were partially offset by higher raw material and labor costs, unfavorable sales mix, and unfavorable foreign currency impacts.

CCT operating income for the three and six months ended July 1, 2023 increased $0.2 and $3.9, respectively, primarily driven by higher revenue, as discussed above, productivity savings, and a gain of $7.2 resulting from the sale of a product line. The increase in operating income was partially offset by higher raw material, labor and overhead costs, higher strategic growth investment, and unfavorable foreign currency impacts.

Other corporate costs for the three and six months ended July 1, 2023 decreased $3.3 and $0.7, respectively, primarily driven by income of $3.7 from a recovery of costs associated with the 2020 lease termination of a legacy site as well as by higher corporate-owned life insurance gains, partially offset by higher personnel costs.

INTEREST AND NON-OPERATING EXPENSE (INCOME), NET

The following table summarizes our interest and non-operating expense (income), net.

The increases in interest and non-operating expense (income), net for the three and six months ended July 1, 2023 were primarily driven by higher interest expense associated with higher weighted average interest rates on our commercial paper borrowings. The six-month period also included interest expense of $1.4 related to a tax audit settlement in Italy, as discussed in the income tax expense section below.

INCOME TAX EXPENSE

The following table summarizes our income tax expense and effective tax rate.

ITT Inc. | Q2 2023 Form 10-Q | 28

The effective tax rate (ETR) for the three months ended July 1, 2023 was lower than the prior period primarily due to higher permanent tax benefits related to research and development incentives in both foreign and U.S. jurisdictions. For the six months ended July 1, 2023 the ETR was lower primarily due to benefits of $16.3 from valuation allowance reversals on deferred tax assets in Germany. ITT also recognized tax benefits of $4.9 as a result of filing an amended 2017 consolidated federal tax return, which were partially offset by an expense of $14.1 relating to an Italian tax audit settlement covering tax years 2016-2022.

We are closely monitoring the potential changes in tax laws resulting from the Organization for Economic Cooperation and Development’s (OECD) multi-jurisdictional plan of action to address base erosion and profit shifting, which could adversely impact our effective tax rate.

See Note 5, Income Taxes, to the Consolidated Condensed Financial Statements for further information.

LIQUIDITY AND CAPITAL RESOURCES

Funding and Liquidity Strategy

We monitor our funding needs and execute strategies to meet overall liquidity requirements, including the management of our capital structure, on both a short- and long-term basis. Significant factors that affect our overall management of liquidity include our cash flow from operations, credit ratings, the availability of commercial paper, access to bank lines of credit, term loans, and the ability to attract long-term capital on satisfactory terms. We assess these factors along with current market conditions on a continuous basis, and as a result, may alter the mix of our short- and long-term financing when it is advantageous to do so. We expect to have enough liquidity to fund operations for at least the next 12 months and beyond.

We manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct business and the cost effectiveness with which those funds can be accessed. We support our growth and expansion in markets outside of the U.S. through the enhancement of existing products and development of new products, increased capital spending, and potential foreign acquisitions. We look for opportunities to access cash balances in excess of local operating requirements to meet our global liquidity needs in a cost-efficient manner. We transfer cash between certain international subsidiaries and the U.S. when it is cost effective to do so. During the six months ended July 1, 2023, we had net cash distributions from foreign countries to the U.S. of $300.5. During the year ended December 31, 2022, we had net cash distributions from foreign countries to the U.S. of $74.0. The timing and amount of any additional future distributions will be evaluated based on our jurisdictional cash needs.

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, several factors, including our financial position and results of operations, available cash, expected capital spending plans, prevailing business conditions, and other factors the Board of Directors deems relevant. Therefore, we cannot provide any assurance as to what level of dividends, if any, will be paid in the future. In the second quarter of 2023, we declared a dividend of $0.290 per share for shareholders of record on June 9, 2023, which was a 10% increase from the quarterly dividends declared of $0.264 in 2022. Dividend payments during the six months ended July 1, 2023 amounted to $48.1.

During the six months ended July 1, 2023 and July 2, 2022, we spent $60.5 and $240.9, respectively, on open-market share repurchases under our share repurchase programs. All repurchased shares are retired immediately following the repurchases. See Part II, Item 2, Unregistered Sales of Equity Securities and Use of Proceeds, for additional information.

Commercial Paper

When available and economically feasible, we have accessed the commercial paper market through programs in place in the U.S. and Europe to supplement cash flows generated internally and to provide additional short-term funding.

The following table presents our outstanding commercial paper borrowings.

ITT Inc. | Q2 2023 Form 10-Q | 29

From December 31, 2022 to July 1, 2023, we substantially reduced our borrowings under the U.S. commercial paper program and increased our borrowings under the Euro program to reduce our cost of debt given the lower interest rates under the Euro program. See Note 13, Debt, to the Consolidated Condensed Financial Statements for further information.

All outstanding commercial paper for both periods had maturity terms of less than three months from the date of issuance.

Revolving Credit Agreement

On August 5, 2021, we entered into a revolving credit facility agreement with a syndicate of third party lenders including Bank of America, N.A., as administrative agent (the 2021 Revolving Credit Agreement). The 2021 Revolving Credit Agreement matures in August 2026 and provides for an aggregate principal amount of up to $700 of (i) revolving extensions of credit (the revolving loans) outstanding at any time, and (ii) letters of credit for a face amount of up to $100 at any time outstanding. Subject to certain conditions, we are permitted to terminate permanently the total commitments and reduce commitments by a minimum aggregate amount of $10 or any whole multiple of $1 in excess thereof. Borrowings under the credit facility are available in U.S. dollars, Euros, British pound sterling or any other currency that may be requested by us, subject to the approval of the administrative agent and each lender. We are permitted to request that lenders increase the commitments under the facility by up to $350 for a maximum aggregate principal amount of $1,050; however, this is subject to certain conditions and therefore may not be available to us. As of July 1, 2023 and December 31, 2022, we had no outstanding borrowings under the 2021 Revolving Credit Agreement.

On May 10, 2023, entered into the First Amendment (the Amendment) to the Company’s 2021 Revolving Credit Agreement. In connection with the phase out of LIBOR as a reference interest rate, the Amendment replaced LIBOR as a benchmark for United States Dollar revolving borrowings with the term secured overnight funding rate (Term SOFR), and replaced LIBOR as a benchmark for Euro swing line borrowings with the euro overnight short-term rate (ESTR). The Amendment did not have a significant impact on the Company’s consolidated financial statements.

See Note 13, Debt, to the Consolidated Condensed Financial Statements for further information.

Sources and Uses of Liquidity

Our principal source of liquidity is our cash flow generated from operating activities, which provides us with the ability to meet the majority of our short-term funding requirements. The following table summarizes net cash provided by or used in operating, investing, and financing activities from continuing operations, as well as net cash from discontinued operations.

Operating Activities

The increase in net cash from operating activities of $143.6 was primarily due to an increase in segment operating income, lower incentive-based compensation payments related to the prior year, and favorable year-over-year net working capital impacts primarily due to improved inventory management.

Investing Activities

The decrease in net cash used in investing activities of $98.6 is mainly driven by our acquisition and equity-method investment activity. On May 2, 2023, we completed the acquisition of Micro-Mode for a purchase price of $79.3, net of cash. In the prior year, we acquired Habonim for a purchase price of $139.9 and we purchased a minority investment in CRP Technology Srl and CRP USA LLC for $23.0. Refer to Note 18, Acquisitions and Investments, for further information. In addition, during the second quarter of 2023, we received proceeds of $10.5 from the sale of a product line within our CCT segment to a third party.

Financing Activities

The decline in net cash from financing activities of $246.8 was due to a decrease of $425.6 in cash flows related to commercial paper borrowings, partially offset by a decrease of $180.9 in open-market repurchases of ITT common stock.

KEY PERFORMANCE INDICATORS AND NON-GAAP MEASURES

Management reviews a variety of key performance indicators including revenue, segment operating income and margins, and earnings per share, some of which are calculated with accounting principles other than those generally accepted in the United States of America (GAAP). In addition, we consider certain measures to be useful to management and investors when evaluating our operating performance for the periods presented. These measures provide a tool for evaluating our ongoing operations and management of assets from period to period. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment among competing strategic alternatives and initiatives, including, but not limited to, acquisitions, dividends, and share repurchases. Some of these metrics, however, are not measures of financial performance under GAAP and should not be considered a substitute for measures determined in accordance with GAAP. We consider the following non-GAAP measures to be key performance indicators. These measures may not be comparable to similarly titled measures reported by other companies.

• “Organic revenue” is defined as revenue, excluding the impacts of foreign currency fluctuations and acquisitions. The period-over-period change resulting from foreign currency fluctuations is estimated using a fixed exchange rate for both the current and prior periods. We believe that reporting organic revenue provides useful information to investors by facilitating comparisons of our revenue performance with prior and future periods and to our peers.

The following tables include a reconciliation of revenue to organic revenue by segment.

ITT Inc. | Q2 2023 Form 10-Q | 32

• “Adjusted operating income” and “Adjusted segment operating income” are defined as operating income and segment operating income, adjusted to exclude special items that include, but are not limited to, restructuring, certain asset impairment charges, certain acquisition-related impacts and unusual or infrequent operating items. Special items represent charges or credits that impact current results, which management views as unrelated to the Company’s ongoing operations and performance. “Adjusted operating margin” and “Adjusted segment operating margin” are defined as adjusted operating income or adjusted segment operating income, respectively, divided by revenue. We believe that these financial measures are useful to investors and other users of our financial statements in evaluating ongoing operating profitability, as well as evaluating operating performance in relation to our competitors.

The following tables include a reconciliation of operating income to adjusted operating income by segment.

(a) Includes income from a recovery of costs associated with the 2020 lease termination of a legacy site.

(b) Includes severance charges and accelerated amortization of an intangible asset.

• “Adjusted income from continuing operations” is defined as income from continuing operations attributable to ITT Inc. adjusted to exclude special items that include, but are not limited to, restructuring, certain asset impairment charges, certain acquisition-related impacts, income tax settlements or adjustments and unusual or infrequent items. Special items represent charges or credits, on an after-tax basis, that impact current results, which management views as unrelated to the Company’s ongoing operations and performance. The after-tax basis of each special item is determined using the jurisdictional tax rate of where the expense or benefit occurred. “Adjusted income from continuing operations per diluted share” (adjusted EPS) is defined as adjusted income from continuing operations divided by diluted weighted average common shares outstanding. We believe that adjusted income from continuing operations and adjusted EPS are useful to investors and other users of our financial statements in evaluating ongoing operating profitability, as well as in evaluating operating performance in relation to our competitors.

The following table includes reconciliations of income from continuing operations to adjusted income from continuing operations.

(a) Year-to-date period of 2023 tax-related special items primarily reflect benefits from valuation allowance reversals ($17.5) and the amendment of our federal tax return ($4.9), partially offset by a settlement expense related to a tax audit in Italy ($14.3) and tax on future distribution of foreign earnings ($2.9). Year-to-date period of 2022 tax-related special items primarily reflect tax on future distribution of foreign earnings ($2.0) and the write-down of a tax receivable ($2.1) partially offset by a benefit from valuation allowance reversals ($1.9).

(b) 2023 other special items primarily consist of income from a recovery of costs associated with the 2020 lease termination of a legacy site. 2022 other special items primarily consist of severance costs.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 2, Recent Accounting Pronouncements, to the Consolidated Condensed Financial Statements for information on recent accounting pronouncements.

CRITICAL ACCOUNTING ESTIMATES

The preparation of the Company’s financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. The Company believes the most complex and sensitive judgments, because of their significance to the Consolidated Condensed Financial Statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2022 Annual Report describes the critical accounting estimates that are used in the preparation of the Consolidated Condensed Financial Statements. Actual results in these areas could differ from management’s estimates. There have been no material changes concerning the Company’s critical accounting estimates as described in our 2022 Annual Report.

There has been no material change in the information concerning market risk as stated in our 2022 Annual Report. See Note 17, Derivative Financial Instruments, to the Consolidated Condensed Financial Statements for information on the Company’s use of derivative financial instruments to mitigate exposure from foreign currency exchange rate fluctuations and commodity price fluctuations.

Evaluation of Disclosure Controls and Procedures

The Chief Executive Officer and Chief Financial Officer of the Company have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act) as of the end of the period covered by this Report. Based on such evaluation, such officers have concluded that, as of the end of the period covered by this Report, the Company’s disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during the period covered by this Report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Reference is made to the risk factors set forth in Part I, Item 1A, “Risk Factors”, of our 2022 Annual Report, which are incorporated by reference herein. Other than as set forth below, there have been no material changes with regard to the risk factors disclosed in such report.

Our operations could be disrupted and our business could be materially and adversely affected by cybersecurity incidents.

The efficient operation of our business is dependent on information technology (IT) systems, some of which are owned or managed by third parties. In the ordinary course of business, we collect and store confidential information, including proprietary business information belonging to us, our customers, suppliers, business partners and other third parties, as well as personally identifiable information of our employees and others.

Our information technology systems and those of third-party service providers may be susceptible to damage, disruptions or shutdowns due to power outages, hardware failures, telecommunication failures, cybersecurity incidents and user errors. Although we actively manage the risks to our information technology systems that are within our control, we can provide no assurance that our actions or those of our third-party service providers will always be successful in eliminating or mitigating risks to our systems, networks or data. Even the most well-protected information technology systems are vulnerable to internal and external cybersecurity incidents including, but not limited to, those by employees and by computer hackers and other threat actors utilizing techniques such as phishing, ransomware or denial of service attacks. If we experience a disruption in our information technology systems, it could result in the loss of sales and customers and significant incremental costs, which could materially adversely affect our business. In addition, as a provider of products and services to government and commercial customers, and particularly as a government contractor, we are subject to a heightened risk of cybersecurity incidents caused by computer viruses, illegal break-ins or hacking, sabotage, or acts of vandalism, including by foreign governments, hackers and cyber terrorists. Furthermore, information technology security threats are increasing in sophistication, intensity and frequency. A cybersecurity incident may occur, including breaches that we may be unable to detect in a timely manner. The unavailability of our information technology 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 costs.

On May 31, 2023, Progress Software Corporation, the developer of MOVEit Transfer (“MOVEit”), a managed file transfer solution used by organizations (including us) to transfer data, announced a critical vulnerability in MOVEit that allowed unauthorized third parties to access MOVEit customers’ user environments. We subsequently learned that we had been affected by the MOVEit data incident and that an unauthorized third party was able to gain access to certain data that we maintain. Once we discovered that our IT systems had been affected, we promptly undertook responsive measures, including patching the software according to MOVEit's published protocols and launching an internal investigation in partnership with outside independent cybersecurity forensic experts. Our investigation did not identify any threat actor activity on other IT systems outside of our MOVEit environment. Our investigation has found certain data, including potential personally identifiable information, has been obtained by the unauthorized third party. Based on the investigation and information currently known at this time, we do not expect that this incident will have a material impact on our operations or financial results. However, we have incurred, and may continue to incur, expenses related to this incident, and we remain subject to risks and uncertainties as a result of the incident.

We continue to monitor data security regulations in the jurisdictions in which we operate. The processing and storage of certain information is increasingly subject to privacy and data security regulations, and many such regulations are country-specific. The interpretation and application of data protection laws in the U.S., Europe, and elsewhere are uncertain, evolving and may be inconsistent across jurisdictions. Compliance with these various laws may be onerous and require us to incur substantial costs or to change our business practices in a manner that adversely affects our business, while failure to comply with such laws may subject us to substantial penalties.

If we are unable to protect sensitive information, our customers or governmental authorities could question the adequacy of our security processes and procedures and our compliance with evolving privacy and data security regulations and government cybersecurity requirements for government contractors, potentially causing us to lose business. A breach could also result in the loss of our intellectual property, potentially impacting our long-term capability to compete for sales of affected products. In addition, a breach of security of our information technology systems could result in litigation, regulatory action and potential liability, as well as increased costs to implement further information security measures. If we are unable to prevent, detect or adequately respond to cybersecurity incidents, our operations could be disrupted, our reputation could be harmed and our business could be materially and adversely affected.