ITT Corporation 2011 Form 10-K Summary
Business context and reporting period
ITT reported for the fiscal year ended December 31, 2011. The company is a diversified industrial manufacturer with four continuing segments: Industrial Process, Motion Technologies, Interconnect Solutions, and Control Technologies. Its products serve energy, mining, transportation, aerospace, electronics, and other industrial markets. ITT had approximately 8,500 employees in 31 countries, generated 63% of sales outside the United States, and derived approximately 30% of revenue from aftermarket products and services.
On October 31, 2011, ITT completed the tax-free spin-offs of its Defense and Information Solutions business into Exelis Inc. and its water-related businesses into Xylem Inc. Historical results were recast so these businesses are presented as discontinued operations. ITT also completed a one-for-two reverse stock split.
Revenue, profit, cash flow, margins, debt and liquidity
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Revenue | $2,119 million | $1,908 million | 11.1% increase |
| Gross profit | $655 million | $607 million | 7.9% increase |
| Gross margin | 30.9% | 31.8% | Down 90 basis points |
| Operating income (loss) | $(247) million | $(184) million | Higher loss |
| Operating margin | (11.7%) | (9.6%) | Down 210 basis points |
| Loss from continuing operations | $(578) million | $(132) million | Higher loss |
| Net income (loss) | $(130) million | $804 million | Decline primarily from discontinued operations and special items |
| Continuing operations diluted EPS | $(6.23) | $(1.44) | Lower |
| Adjusted continuing operations EPS | $1.24 | $0.80 | 55.0% increase |
| Cash from continuing operations | $(323) million | $(77) million | Higher use of cash |
| Capital expenditures | $103 million | $127 million | Lower |
| Free cash flow | $(53) million | $(204) million | Improved, but negative |
| Cash and equivalents | $690 million | $206 million | 235.0% increase |
| Total debt | $6 million | $1,360 million | Reduced by $1,354 million |
Segment revenue was $767 million for Industrial Process, $634 million for Motion Technologies, $418 million for Interconnect Solutions, and $318 million for Control Technologies. Segment operating income increased 17.0% to $269 million, and segment operating margin expanded to 12.7% from 12.1%.
Revenue growth was led by Motion Technologies, up 15.7%, and Control Technologies, up 15.6%. Industrial Process increased 10.5%, while Interconnect Solutions increased only 1.2% because growth in aerospace, transportation, oil and gas, and defense was largely offset by an approximately 20% communications-market decline.
ITT received net cash contributions of approximately $1.6 billion from Exelis and Xylem in connection with the separation. The proceeds were used primarily to repay substantially all outstanding debt and fund transformation costs. ITT ended the year with no commercial paper outstanding and had access to a $500 million revolving credit facility, subject to customary covenants.
Material changes versus the prior comparable period
- Revenue increased $211 million, supported by 19.1% growth in emerging markets and stronger oil and gas, mining, transportation, aerospace, and automotive demand.
- Gross margin declined because of material-cost pressure and unfavorable mix, particularly in Motion Technologies and Interconnect Solutions.
- Segment operating income improved by $39 million, but consolidated operating loss worsened because of $396 million of transformation costs, including $297 million of debt-extinguishment costs.
- Net asbestos-related costs declined to $100 million from $385 million, benefiting reported operating results but remaining a major continuing exposure.
- Income tax expense was $260 million despite a pretax loss, principally because ITT recorded a $340 million valuation allowance against U.S. federal and state deferred tax assets and recognized $69 million of tax expense on certain undistributed foreign earnings.
- The balance sheet contracted substantially after the spin-offs: total assets declined to $3.7 billion from $12.6 billion, primarily because approximately $9.3 billion of assets were distributed to Exelis and Xylem.
- Backlog increased to $850 million from $682 million, with nearly all year-end 2011 backlog expected to be fulfilled during 2012.
Guidance, outlook, management commentary, risks and unusual items
Management’s long-term objectives were approximately 5% to 7% average annual organic revenue growth, 50 to 70 basis points of annual operating-margin expansion, free-cash-flow conversion above 105%, and adjusted EPS growth of 10% to 15% annually. The filing does not provide formal 2012 revenue or EPS guidance.
Management expected additional 2012 transformation costs of approximately $15 million to $20 million after tax and net after-tax transformation cash outflows of approximately $30 million to $40 million. Planned 2012 global pension contributions were approximately $20 million to $25 million.
Asbestos is the most significant contingency. At December 31, 2011, ITT recorded an undiscounted asbestos liability of $1.668 billion and related recovery assets of $954 million, for net exposure of $714 million. The estimate covers pending claims and claims projected through 2021, but excludes claims beyond that period because they cannot be reasonably estimated. ITT had 105,486 open asbestos claims. Net annual asbestos cash outflows were projected at $10 million to $20 million over the next five years and $35 million to $45 million over the remainder of the projection period, with payments potentially extending through approximately 2026.
Other risks include international and emerging-market exposure, foreign currency movements, economic cyclicality, commodity and labor-cost inflation, reliance on distributors and key customers, supply-chain disruptions, tax examinations and deferred-tax realizability, underfunded postretirement plans, environmental obligations, cybersecurity, product liability, and the risks and indemnification arrangements associated with the spin-offs.
An Ad Hoc Committee of ITT bondholders filed a lawsuit alleging improper calculation of the October 2011 bond redemption price. Potential additional redemption fees and interest were estimated at up to $15 million, with costs subject to sharing among ITT, Exelis, and Xylem. Management did not expect a material adverse effect. Environmental liabilities were accrued at $102 million, with a reasonably possible range of $81 million to $175 million.
Deloitte & Touche issued an unqualified opinion on the consolidated financial statements and on internal control over financial reporting. Management reported effective disclosure controls and internal control over financial reporting.
Most important facts an investor should verify
- Whether the post-spin ITT businesses can sustain the 2011 growth rate and achieve the stated long-term margin and adjusted EPS objectives.
- The reconciliation between GAAP losses and adjusted results, particularly the treatment of transformation costs, asbestos charges, tax valuation allowances, and other special items.
- The timing and magnitude of asbestos payments, insurer recoveries, policy expirations, and potential liabilities beyond 2021.
- The sustainability of negative operating cash flow and free cash flow after the one-time separation-related cash transfers and debt repayment.
- The effect of lower purchasing scale, transition-service arrangements, and indemnification obligations following the Exelis and Xylem spin-offs.
- Motion Technologies’ customer and distributor concentration, including the distributor representing approximately 31% of segment revenue and 9% of consolidated revenue.
- Interconnect Solutions’ exposure to communications-market weakness and customer production or share losses.
- The potential realization of deferred tax assets following the $340 million valuation allowance and the outcome of ongoing tax examinations.
- Funding requirements for the $330 million underfunded postretirement benefit position and future pension contributions.
- The status and potential cost of the bondholder litigation, environmental proceedings, asbestos coverage litigation, and other indemnified liabilities.