ITT Corporation: 2009 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
ITT is a global engineering and manufacturing company with three reporting segments: Defense Electronics & Services, Fluid Technology, and Motion & Flow Control. This unaudited Form 10-Q covers the three and six months ended June 30, 2009, compared with the corresponding 2008 periods. The filing was signed August 3, 2009.
Key Financial Metrics
| Metric | Three Months 2009 | Three Months 2008 | Six Months 2009 | Six Months 2008 |
|---|---|---|---|---|
| Sales and revenues | $2,780.0 million | $3,064.1 million | $5,337.1 million | $5,870.5 million |
| Gross profit | $778.8 million | $867.1 million | $1,447.9 million | $1,628.0 million |
| Gross margin | 28.0% | 28.3% | 27.1% | 27.7% |
| Operating income | $307.2 million | $354.8 million | $528.7 million | $638.9 million |
| Operating margin | 11.1% | 11.6% | 9.9% | 10.9% |
| Income from continuing operations | $202.6 million | $224.3 million | $389.1 million | $395.2 million |
| Diluted EPS from continuing operations | $1.10 | $1.21 | $2.12 | $2.14 |
| Net income | $201.4 million | $221.0 million | $385.5 million | $392.9 million |
| Cash flow from operations | Not separately provided | Not separately provided | $548.8 million | $490.2 million |
| Free cash flow | $296.2 million | $225.4 million | $461.6 million | $410.8 million |
Quarterly sales declined 9.3%, operating income declined 13.4%, and income from continuing operations declined 9.7%. The six-month declines were 9.1%, 17.2%, and 1.5%, respectively. The year-to-date effective tax rate was 19.3%, versus 31.4% in 2008, primarily due to a $57.7 million tax benefit from restructuring certain international legal entities and permanently reinvesting certain foreign earnings.
Liquidity, Debt, and Balance Sheet
- Cash and cash equivalents were $1,019.0 million at June 30, 2009, compared with $964.9 million at December 31, 2008.
- Total debt was $1,811.7 million, down from $2,146.9 million at year-end 2008. Short-term debt declined to $355.3 million from $1,679.0 million, while long-term debt increased to $1,456.4 million from $467.9 million.
- ITT issued $1.0 billion of senior unsecured notes in May 2009: $500.0 million at 4.9% due 2014 and $500.0 million at 6.125% due 2019. Net proceeds were $992.1 million and were used with operating cash flow to repay commercial paper and other short-term debt.
- Net debt declined to $792.7 million from $1,182.0 million. Net debt to net capitalization improved to 18.6% from 27.9%.
- ITT had a $1.75 billion revolving credit facility, with $338.6 million of commercial paper outstanding and $1,411.4 million of facility capacity in excess of commercial paper. The company stated that it was in compliance with applicable financial covenants.
- Shareholders’ equity increased to $3,459.0 million from $3,059.9 million. Cash dividends declared were $0.2125 per share in the quarter and $0.4250 per share for the first half.
Material Changes Versus the Prior Comparable Period
- Revenue mix and segment performance: Defense Electronics & Services revenue was approximately flat, while Fluid Technology revenue fell 15.3% and Motion & Flow Control revenue fell 30.4% in the second quarter.
- Defense strength: Second-quarter Defense Electronics & Services operating income reached a record $201.3 million, up 1.2%, with a 12.5% margin. Orders increased 28.4% to $1,567.7 million, and backlog remained above $5.2 billion.
- Industrial weakness: Fluid Technology operating income declined 19.6% to $111.6 million, and Motion & Flow Control operating income declined 53.4% to $33.2 million. Weakness reflected lower demand in residential, commercial, industrial, automotive, aerospace, connector, marine, and transportation markets, as well as unfavorable foreign currency effects.
- Cost controls: SG&A declined 11.6% in the quarter and 10.2% year to date. Productivity and sourcing initiatives partially offset lower volumes, foreign currency headwinds, higher employee benefit costs, and restructuring charges.
- Restructuring: Second-quarter restructuring charges rose to $20.4 million from $7.3 million. First-half charges were $31.1 million versus $10.9 million, primarily for headcount reductions and related costs.
- Cash generation: First-half operating cash flow increased $58.6 million, supported by improved receivables collections and working-capital changes. Capital expenditures were $87.2 million, and acquisition spending was $34.6 million.
- Acquisition: ITT completed the acquisition of Laing GmbH in June 2009, expanding its energy-efficient plumbing and HVAC pump portfolio within Fluid Technology.
Guidance, Outlook, Risks, and Unusual Items
- Management expected to incur approximately $35.0 million to $40.0 million of additional restructuring costs during the remainder of 2009, after $31.1 million in the first half.
- Management cited continued uncertainty regarding the global economic downturn, customer demand, municipal funding, real estate, oil and gas, mining, aerospace, automotive, marine, connector, and industrial markets.
- Management expected approximately $40.6 million of net periodic pension cost for 2009 and additional pension and benefit-plan contributions of approximately $38.0 million to $43.0 million during the remainder of the year.
- Restructuring actions announced in the first half of 2009 involved 526 planned position eliminations and were expected to generate approximately $16.8 million of savings in 2009 and $160.7 million from 2010 through 2014.
- Environmental liabilities were accrued at $137.0 million at June 30, 2009. Estimated environmental liability exposure ranged from $109.5 million to $246.7 million across 98 active sites.
- ITT had 102,227 open asbestos-related claims and accrued $29.4 million, net of expected insurance recoveries. Management did not expect currently known claims to have a material consolidated impact, but future claims and associated costs were not reasonably estimable and could be material when recorded.
- The company recorded a $5.1 million loss contingency in the first quarter related to a $50.2 million maximum residual-value guarantee on a corporate aircraft sale-leaseback.
- ITT paid $1.7 million in February 2009 to settle an SEC matter concerning alleged improper commissions involving its Nanjing Goulds Pumps operation.
- Financial-market stress could impair customer demand, receivables collections, insurer and counterparty performance, or access to credit. Other principal risks included defense-budget changes, foreign exchange and interest-rate movements, raw-material availability, litigation, environmental matters, government investigations, pension funding, and the ability to realize restructuring savings.
- No material change was reported in market-risk disclosures, and management concluded that disclosure controls and procedures were effective.
Investor Verification Checklist
- Verify whether Defense Electronics & Services orders and backlog convert into revenue and margins as expected, including the timing of major government awards.
- Monitor order trends and end-market recovery in Fluid Technology and Motion & Flow Control, particularly residential, commercial, industrial, aerospace, automotive, and connector markets.
- Reconcile reported free cash flow to operating cash flow less capital expenditures and assess whether working-capital benefits are sustainable.
- Track additional restructuring charges, headcount reductions, cash payments, and realization of projected savings.
- Review debt maturities, commercial-paper access, credit-facility availability, and the effect of the 2009 senior-note issuance on interest expense.
- Assess pension-plan asset performance, required contributions, and the recoverability of pension costs under government contracts.
- Evaluate environmental, asbestos, silica, product-liability, government-contract, and other legal contingencies, including insurance recoveries and potential unrecorded future claims.
- Separate the recurring tax rate from the $57.7 million discrete tax benefit when assessing earnings quality and future profitability.