ITT Corporation 2011 Q2 Form 10-Q Summary
Business context and reporting period
ITT Corporation is a global engineering and manufacturing company operating through Defense & Information Solutions, Fluid Technology, and Motion & Flow Control. This unaudited Form 10-Q covers the three and six months ended June 30, 2011, compared with the corresponding 2010 periods.
ITT was implementing a plan to separate its businesses into three independent publicly traded companies through tax-free spinoffs of the water-related businesses and Defense segment. Completion was anticipated by the end of 2011, with initial registration statements filed July 11, 2011.
Financial performance and liquidity
| Metric | Three months ended June 30, 2011 | Three months ended June 30, 2010 | Six months ended June 30, 2011 | Six months ended June 30, 2010 |
|---|---|---|---|---|
| Revenue | $3,024 million | $2,739 million | $5,784 million | $5,317 million |
| Gross profit | $840 million | $781 million | $1,625 million | $1,499 million |
| Gross margin | 27.8% | 28.5% | 28.1% | 28.2% |
| Operating income | $260 million | $324 million | $448 million | $569 million |
| Operating margin | 8.6% | 11.8% | 7.7% | 10.7% |
| Income from continuing operations | $168 million | $226 million | $294 million | $370 million |
| Diluted EPS from continuing operations | $0.90 | $1.22 | $1.58 | $2.00 |
| Net income | $168 million | $238 million | $292 million | $384 million |
- Second-quarter revenue increased 10.4%; first-half revenue increased 8.8%. Organic growth contributed $101 million in the quarter and $154 million year to date, while acquisitions and foreign currency also contributed.
- Adjusted income from continuing operations was $220 million, or $1.18 diluted EPS, in the second quarter, compared with $211 million, or $1.14, in 2010. First-half adjusted income was $402 million, or $2.15 diluted EPS, compared with $365 million, or $1.97.
- Transformation costs reduced second-quarter operating income by $62 million and first-half operating income by $147 million. Net of tax, transformation costs were $46 million and $109 million, respectively.
- Net cash provided by operating activities was $204 million in the first half, down from $356 million. Free cash flow, as defined by management, was $153 million versus $250 million.
- Investing cash use was $99 million, including $123 million of capital expenditures and only $1 million of acquisition spending, compared with $504 million of investing cash use in 2010, which included $401 million for acquisitions.
- Cash and cash equivalents were $1,160 million at June 30, 2011, compared with $1,032 million at December 31, 2010.
- Total debt was $1,428 million, including $131 million of short-term borrowings and current maturities and $1,297 million of long-term debt. Commercial paper outstanding was $51 million.
- Liquidity included access to the commercial paper market, a committed credit facility, and public debt markets. Credit ratings were S&P A-2/BBB+, Moody’s P-2/Baa1, and Fitch F2/A-. Rating agencies had placed ratings on watch or under review following the announced separation.
Material changes versus the prior comparable period
- Fluid revenue rose 26.3% in the quarter and 25.3% year to date, supported by organic growth, foreign currency, and the 2010 Godwin and Nova acquisitions. Fluid operating income increased 23.8% in the quarter and 29.4% year to date.
- Motion & Flow revenue increased 14.4% in the quarter and 12.4% year to date. Operating income increased 35.7% and 25.8%, respectively.
- Defense revenue was flat in the quarter and declined 1.8% year to date. Defense operating income declined 26.8% in the quarter and 17.0% year to date, primarily because lower-margin operational services replaced higher-margin surge-related equipment sales.
- Consolidated operating expenses increased 26.9% in the quarter and 26.6% year to date, driven principally by transformation costs, acquisition-related expenses, foreign currency, and higher selling and marketing costs.
- The effective tax rate increased to 32.3% in the quarter from 25.9%, mainly because of transformation costs and a prior-year transaction adjustment. The first-half rate was 29.8% versus 29.4%.
- 2010 discontinued-operation income reflected the sold CAS business; there was no comparable second-quarter 2011 income and a $2 million loss from discontinued operations for the first half of 2011.
Guidance, outlook, risks, contingencies, and unusual items
- Management projected 2011 revenue of approximately $11.5 billion and adjusted EPS of $4.70 to $4.82. The outlook included Defense revenue of approximately $5.6 billion to $5.7 billion, Fluid growth of approximately 17%, and Motion & Flow growth of approximately 10%.
- The outlook reflected recent Defense operational-service contract wins and strength in Fluid, but also anticipated lower Defense equipment demand related to Iraq and Afghanistan and an unfavorable shift toward service revenue.
- Management estimated the after-tax cash impact of pre-spin transformation activities at approximately $500 million, including costs incurred in the first half. Additional pre- and post-separation costs were possible and some were not yet estimable.
- ITT recorded a $55 million non-cash impairment charge for discontinuing an information-technology consolidation initiative. It also recorded $9 million of second-quarter and $14 million of first-half restructuring and asset-impairment charges.
- Asbestos liabilities were $1,692 million, offset by estimated recoveries of $1,028 million, resulting in net exposure of $664 million at June 30, 2011. The company had approximately 104,316 pending asbestos claims and stated that ultimate costs could materially exceed current estimates, particularly for claims beyond the next 10 years.
- Postretirement benefit liabilities were $1,740 million. ITT contributed $28 million to plans during the first half and expected additional contributions of $65 million to $85 million during the remainder of 2011.
- On July 5, 2011, ITT agreed to acquire YSI Incorporated for $310 million, expected to close in the third quarter and funded with cash and debt.
- At or before the planned spinoffs, the two new companies were expected to issue approximately $2.1 billion of debt and pay dividends to ITT, with proceeds intended to repay ITT’s long-term debt and commercial paper.
- Key risks included Defense budget reductions, government funding and contract timing, revenue and product mix, foreign currency and interest rates, transformation execution and financing, asbestos and environmental liabilities, postretirement funding, goodwill impairment, and access to liquidity.
Investor verification points
- Verify the timing, tax treatment, capitalization, debt allocation, and final terms of the three-company separation.
- Assess whether the approximately $500 million pre-spin cash-cost estimate and anticipated post-spin spending remain accurate.
- Monitor Defense backlog, contract awards, government budget actions, and the margin impact of the shift from equipment to services.
- Reconcile adjusted earnings and free cash flow to GAAP results and evaluate the sustainability of adjustments for transformation and tax items.
- Track asbestos claims, insurer recoveries, coverage litigation, and changes in the estimated $664 million net exposure.
- Evaluate the financing and integration implications of the proposed $310 million YSI acquisition and planned debt refinancing.