ITT Corporation 10-Q Summary: Quarter Ended June 30, 2012
Business Context and Reporting Period
ITT is a global industrial manufacturer serving industrial, transportation, energy and aerospace markets through Industrial Process, Motion Technologies, Interconnect Solutions and Control Technologies. The filing covers the three and six months ended June 30, 2012. Exelis and Xylem were spun off on October 31, 2011; their prior-period results are presented as discontinued operations.
Financial Performance and Position
| Metric | Three Months 2012 | Three Months 2011 | Six Months 2012 | Six Months 2011 |
|---|---|---|---|---|
| Revenue | $567.5 million | $552.4 million | $1,144.4 million | $1,085.5 million |
| Gross profit / margin | $173.7 million / 30.6% | $176.0 million / 31.9% | $346.6 million / 30.3% | $344.1 million / 31.7% |
| Operating income / margin | $57.7 million / 10.2% | $46.6 million / 8.4% | $94.2 million / 8.2% | $36.9 million / 3.4% |
| Income from continuing operations | $16.7 million | $18.7 million | $26.9 million | $(2.8) million |
| Diluted EPS from continuing operations | $0.18 | $0.20 | $0.28 | $(0.03) |
| Net income | $16.8 million | $169.7 million | $20.0 million | $291.0 million |
- Six-month operating cash flow was $103.1 million versus $(169.2) million in the prior-year period. Capital expenditures were $29.7 million, producing reported free cash flow of approximately $73.4 million before management’s adjustments.
- Adjusted free cash flow was $142.3 million, compared with $(136.9) million in the prior-year period, primarily reflecting tax refunds and lower transformation-related payments.
- Cash and cash equivalents were $739.1 million at June 30, 2012, compared with $689.9 million at December 31, 2011.
- Total current assets were $1.83 billion and total current liabilities were $921.9 million. Receivables increased to $464.5 million from $396.1 million, while inventories increased to $259.7 million from $253.9 million.
- Short-term borrowings were $40.3 million. No amounts were outstanding under the $500 million revolving credit agreement, and covenant ratios were reported to be well within required thresholds. The filing does not provide a consolidated total-debt balance in the supplied text.
- Six-month financing cash flow was $(15.4) million, including $76.8 million of share repurchases, $17.2 million of dividends paid and $37.8 million of net short-term debt borrowings.
Material Changes Versus Prior Comparable Period
- Second-quarter revenue increased 2.7%; organic revenue increased 6.2%, but unfavorable foreign-currency translation reduced reported revenue by $25.9 million. Six-month revenue increased 5.4% and organic revenue increased 7.4%.
- Operating income increased 23.8% in the quarter and 155.3% year to date, largely because of sharply lower transformation, asbestos and corporate costs and substantially lower interest expense following the 2011 extinguishment of $1.25 billion of long-term debt.
- Gross margin declined 130 basis points in the quarter and 140 basis points year to date because of unfavorable mix, pricing, foreign currency and weaker Interconnect Solutions volume.
- Interest and non-operating expense declined to $3.4 million from $18.2 million in the quarter and to $5.0 million from $43.6 million year to date.
- The effective tax rate rose to 69.2% in the quarter and 69.8% year to date, primarily because of a valuation allowance against U.S. deferred tax assets. This offset much of the operating improvement.
- Interconnect Solutions was the principal operating weakness: revenue declined 8.0% in the quarter and 11.1% year to date, while operating income declined 64.1% and 72.2%, respectively. Industrial Process delivered strong revenue growth but lower margins; Motion Technologies experienced currency and European-market pressure; Control Technologies was comparatively stable.
- Discontinued operations contributed $151.0 million in the second quarter of 2011 and $293.8 million in the first six months of 2011, compared with $0.1 million and $(6.9) million in the 2012 periods. Consequently, reported net income is not comparable without separating discontinued operations.
Guidance, Outlook, Risks and Unusual Items
- Management expected approximately $4.0 million of additional transformation costs, net of tax, during the remainder of 2012, with approximately $10.0 million of related after-tax cash outflows in the remainder of 2012 and $3.0 million in 2013.
- Management expected approximately $15.0 million of repositioning costs, net of tax, during the remainder of 2012 and approximately $15.0 million in total during 2013 and 2014. Expected repositioning cash outflows were approximately $10.0 million in the remainder of 2012 and $25.0 million thereafter.
- Restructuring actions were planned across the businesses in the second half of 2012; approximately $4.0 million to $5.0 million of costs were expected during the remainder of the year.
- Management expected federal tax refunds of approximately $109.2 million during the remainder of 2012 and $24.9 million in early 2013; $85.3 million of the reported $134.1 million tax receivable was attributable to amounts owed to Exelis under the Tax Matters Agreement.
- Asbestos liabilities were $1.662 billion gross, with related assets of $941.8 million and net exposure of $720.4 million at June 30, 2012. There were 96,023 open claims. Management projected net annual asbestos cash outflows of approximately $10 million to $20 million over the next five years, increasing to approximately $35 million to $45 million over the remaining projection period, but stated that ultimate costs cannot be reliably estimated beyond the next ten years.
- Environmental liabilities had a reasonably possible range of $77.5 million to $167.3 million across 66 active sites. The company recorded an $8.2 million insurance-related environmental asset in the second quarter.
- A July 2012 agreement-in-principle could terminate an asbestos cost-sharing agreement for a previously disposed business. Completion was contingent on a parallel insurer agreement, and ITT was evaluating the financial statement impact.
- The company cited risks from European economic weakness, foreign currency movements, customer concentration and communications-market declines, pricing and mix pressure, commodity and supply availability, litigation and environmental recoveries, pension funding, tax valuation allowances, insurer solvency, liquidity access and goodwill recoverability.
- A preliminary IRS audit settlement was expected to require approximately $9.9 million of payment. The filing stated that the financial statement impact was still being evaluated.
Important Facts for Investors to Verify
- Reconcile reported and adjusted earnings, particularly the $23.2 million quarterly and $38.2 million year-to-date tax-related special items and other excluded asbestos, transformation, repositioning and environmental items.
- Assess the sustainability of operating cash flow after removing tax refunds and other working-capital benefits, and verify the timing and allocation of expected tax refunds to Exelis.
- Review total debt, short-term borrowings, commercial paper balances and the terms and covenant headroom of the revolving credit facility.
- Monitor Interconnect Solutions’ customer concentration, communications exposure, backlog and margin recovery, as well as European demand and currency effects on Motion Technologies.
- Update asbestos claim activity, insurer recoveries, coverage exhaustion and projected net cash outflows; the filing warns that ultimate exposure may materially exceed recorded estimates.
- Track the pending asbestos cost-sharing termination, environmental insurance recoveries, IRS settlement and any effects of MAP-21 on tax receivables and pension funding.