ITT Corporation Form 10-Q Summary
Business Context and Reporting Period
ITT Corporation reported results for the three and nine months ended September 30, 2011. The company operated through Defense & Information Solutions, Fluid Technology, and Motion & Flow Control. The filing was issued October 28, 2011.
The principal strategic event was the planned tax-free separation of ITT into three publicly traded companies: ITT, Exelis, and Xylem. The distribution was scheduled for October 31, 2011, subject to customary conditions. ITT shareholders were expected to receive one share of Exelis and one share of Xylem for each ITT share held.
Financial Performance and Key Metrics
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Total revenue | $2,981 million | $2,643 million | $8,765 million | $7,960 million |
| Gross profit | $854 million | $768 million | $2,479 million | $2,267 million |
| Gross margin | 28.6% | 29.1% | 28.3% | 28.5% |
| Operating income | $152 million | $(32) million | $600 million | $537 million |
| Operating margin | 5.1% | (1.2)% | 6.8% | 6.7% |
| Income from continuing operations | $71 million | $12 million | $365 million | $382 million |
| Diluted EPS from continuing operations | $0.38 | $0.07 | $1.96 | $2.06 |
| Net income | $78 million | $145 million | $370 million | $529 million |
- Revenue increased 12.8% in the quarter and 10.1% year to date. Consolidated growth comprised organic growth, acquisitions, and favorable foreign currency translation.
- Service revenue increased substantially, to $822 million in the quarter from $591 million in the prior-year quarter, primarily reflecting Defense operational-services growth.
- Adjusted income from continuing operations, a non-GAAP measure, was $218 million, or $1.17 per diluted share, in Q3 2011 versus $200 million, or $1.08 per diluted share, in Q3 2010. Year-to-date adjusted income was $620 million, or $3.32 per diluted share.
- Segment operating income increased 9.4% in the quarter and 6.3% year to date. Q3 segment results were Defense $178 million, Fluid $144 million, and Motion & Flow $49 million.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Nine-month cash flow from operating activities was $452 million, down from $654 million in 2010. Working-capital investment, $137 million of Transformation cash payments, and higher postretirement contributions were significant uses of cash.
- Capital expenditures were $186 million, and acquisition spending was $309 million, primarily for the September 2011 acquisition of YSI Incorporated. Management-defined free cash flow was $426 million versus $480 million in 2010.
- Cash and cash equivalents were $2.686 billion at September 30, 2011, compared with $1.032 billion at December 31, 2010. The increase primarily reflected $1.850 billion of senior notes issued by Exelis and Xylem.
- Total reported debt was $3.173 billion at September 30, 2011, compared with $1.365 billion at year-end 2010. The September debt included $1.850 billion of Exelis and Xylem notes, initially guaranteed by ITT.
- In October 2011, ITT repaid or defeased substantially all of the debt due for early retirement, including $1.251 billion of debt outstanding at September 30. The filing states that post-repayment long-term debt was approximately $1.855 billion, substantially issued by Exelis and Xylem.
- Effective with the distribution, ITT replaced its $1.5 billion revolving facility with a four-year $500 million facility, expandable to $700 million. Exelis and Xylem each entered into facilities of up to $600 million, with potential increases to $800 million.
- Postretirement liabilities were $2.671 billion at September 30. A plan remeasurement increased the net pension liability materially; substantially all of the related deterioration was recorded in accumulated other comprehensive income rather than current earnings.
Material Changes Versus the Prior Comparable Period
- Fluid Technology was the strongest operating contributor: revenue rose 16.6% in Q3 and 22.2% year to date, while operating income rose 25.2% and 28.0%, respectively. Organic Fluid revenue growth was 7.6% in Q3 and 8.3% year to date.
- Defense revenue rose 11.9% in Q3 but only 2.6% year to date. The mix shifted from higher-margin equipment to lower-margin operational services, reducing the Defense operating margin to 11.6% from 13.0% in Q3 and to 10.4% from 12.0% year to date.
- Motion & Flow revenue increased 6.3% in Q3 and 10.5% year to date, with mixed end-market performance and weakness in communications and certain European industrial markets.
- Q3 operating income benefited from a $282 million year-over-year decline in asbestos-related costs. This benefit was partly offset by $132 million of Transformation costs.
- Q3 and nine-month Transformation costs were $132 million and $279 million pretax, or $93 million and $202 million after tax. These included advisory, information technology, employee, real estate, debt-extinguishment, and impairment costs.
- Net income declined despite improved continuing operations because 2010 included a $130 million after-tax gain from the sale of CAS, reported in discontinued operations.
- Other comprehensive loss was $766 million in Q3 and $562 million year to date, driven primarily by postretirement remeasurement losses and foreign currency translation losses.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- The filing does not provide a clear consolidated earnings or revenue guidance range. Management described positive demand in Fluid, strong Defense service-contract activity, and continued growth in Motion & Flow, but cautioned about U.S. defense-budget reductions, economic conditions, market mix, and European weakness.
- Orders were approximately $3.239 billion in Q3, up 14.5% year over year. Defense backlog was $12.3 billion at September 30, 2011, versus $11.5 billion at December 31, 2010; conversion depends on government funding and contract execution.
- Management estimated approximately $275 million of remaining after-tax Transformation expense, including approximately $210 million expected before completion, primarily related to debt extinguishment. Additional net after-tax cash outflows of approximately $130 million were expected after the separation.
- Debt extinguishments completed in October 2011 were expected to produce a fourth-quarter loss on extinguishment of approximately $325 million, partly offset by realization of a deferred gain on interest-rate swaps.
- The annual asbestos review reduced the estimated undiscounted asbestos liability to $1.660 billion and related recovery assets to $950 million, leaving net exposure of $710 million. Management cannot reasonably estimate claims beyond the next ten years and warns that future costs and recoveries could materially differ.
- Pending asbestos claims totaled 104,715 at September 30, 2011. Projected net annual asbestos cash outflows were approximately $20 million on average over the next five years and approximately $50 million to $60 million on average over the remainder of the projection period.
- At September 30, the U.S. Salaried Retirement Plan was 66% funded on the remeasurement basis. Future returns and discount rates could require material additional contributions, although the 2011 statutory funding ratio was reported at 80%.
- The separation involved broad indemnifications and cross-indemnifications among ITT, Exelis, and Xylem. ITT agreed to retain responsibility for certain pre-separation asbestos liabilities, while tax-free treatment and post-separation operating and financing profiles remained subject to execution risk.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting during the quarter.
Most Important Facts for Investors to Verify
- Completion and final terms of the October 31, 2011 Exelis and Xylem distributions, including the post-separation capitalization and allocation of pension, asbestos, tax, and other liabilities.
- Actual fourth-quarter Transformation and debt-extinguishment charges compared with the estimated $325 million debt-extinguishment loss and remaining after-tax Transformation costs.
- Post-separation liquidity, credit ratings, revolving-credit availability, commercial-paper access, and compliance with the 3.00-to-1.00 leverage and interest-coverage covenants.
- Performance of Fluid organic growth and Defense service contracts, including the effect of lower-margin service revenue and potential U.S. defense-budget reductions.
- Updated asbestos claims activity, insurer recoveries, coverage litigation, and cash outflows relative to the recorded $710 million net exposure.
- Postretirement plan funding status and any additional contribution requirements resulting from the January 1, 2012 measurement.
- The effect of the October 2011 one-for-two reverse stock split and subsequent dividend policy on per-share comparisons and investor returns.