ITT Corporation 2011 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
ITT Corporation reported results for the quarter ended March 31, 2011. The company operated through Defense & Information Solutions, Fluid Technology, and Motion & Flow Control. ITT announced a planned separation into three independent publicly traded companies, including tax-free spinoffs of its water-related businesses and Defense segment, targeted for completion by the end of 2011.
Key Financial Metrics
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Total revenue | $2,760 million | $2,578 million | 7.1% increase |
| Gross profit | $785 million | $718 million | 9.3% increase |
| Gross margin | 28.4% | 27.9% | 50 basis-point increase |
| Operating income | $188 million | $245 million | 23.3% decrease |
| Operating margin | 6.8% | 9.5% | 270 basis-point decrease |
| Income from continuing operations | $126 million | $144 million | 12.5% decrease |
| Diluted EPS from continuing operations | $0.67 | $0.78 | Decrease |
| Net income | $124 million | $146 million | Decrease |
| Effective tax rate | 26.3% | 34.2% | Lower |
| Operating cash flow | $20 million | $67 million | Decrease |
| Free cash flow | $(12) million | $15 million | Decrease |
Adjusted income from continuing operations increased 18.2% to $182 million, or $0.98 per diluted share, from $154 million, or $0.83 per diluted share. The adjustment primarily excluded $62 million of after-tax Transformation costs and tax-related special items.
- Defense revenue was $1,341 million, down 3.7%; operating income was $137 million, down 2.8%, with a 10.2% margin.
- Fluid revenue was $992 million, up 24.2%; operating income was $124 million, up 36.3%, with a 12.5% margin.
- Motion & Flow revenue was $430 million, up 10.8%; operating income was $65 million, up 18.2%, with a 15.1% margin.
Cash, Debt, Liquidity, and Balance Sheet
- Cash and cash equivalents were $1,074 million at March 31, 2011, compared with $1,032 million at December 31, 2010.
- Total debt increased to $1,439 million from $1,365 million, including $70 million of commercial paper and $1,354 million of long-term debt.
- Net cash used in investing activities was $32 million, compared with $441 million in the prior-year quarter, which included the $391 million acquisition of Nova Analytics.
- Net cash from financing activities was $8 million; dividends paid were $92 million and employee stock-option exercises provided $33 million.
- Management stated that operating cash flow, commercial paper access, committed credit facilities, and public debt-market access were expected to satisfy short-term funding needs.
- Credit ratings at quarter-end were S&P A-2/BBB+, Moody’s P-2/Baa1, and Fitch F2/A-. Following the separation announcement, S&P placed ratings on CreditWatch Negative, Moody’s placed them under review for possible downgrade, and Fitch placed them on Ratings Watch Evolving.
Material Changes Versus the Prior Comparable Period
- Revenue growth reflected $115 million from acquisitions, $52 million of organic growth, and $15 million of foreign-currency translation benefit.
- Gross margin improved despite unfavorable Defense mix and higher commodity costs.
- Operating income declined because of $85 million of Transformation costs, including a $55 million non-cash impairment, $22 million of advisory fees, and $8 million of other costs.
- Corporate and Other expense increased to $138 million from $42 million, primarily because of Transformation-related spending.
- The tax rate benefited from a $23 million tax benefit related to separation costs; the prior-year rate included a $12 million Healthcare Reform Act charge.
- Working-capital investment reduced operating cash flow: receivables increased by $102 million and inventories increased by $76 million during the quarter.
- Orders exceeded $3 billion, up 25.6% year over year, with double-digit growth reported in all three segments. Defense funded backlog was $4.1 billion at March 31, 2011.
Guidance, Outlook, Risks, and Unusual Items
- Full-year 2011 revenue guidance was approximately $11.3 billion, reduced from the prior outlook because of uncertainty in the U.S. defense market.
- Management projected Defense revenue of approximately $5.4 billion to $5.6 billion and a margin of approximately 12%; Fluid revenue growth of approximately 15% and a margin of approximately 14%; and Motion & Flow revenue growth of approximately 10% and a margin of approximately 16%.
- Adjusted 2011 EPS guidance was $4.70 to $4.82. Guidance was based on the pre-separation company structure and did not reflect the planned spinoffs.
- Pre-spin Transformation cash costs were estimated at approximately $500 million after tax. Additional separation-related spending after completion, and potentially additional pre-completion costs, were expected but not fully estimable.
- Defense performance was exposed to U.S. government budget constraints, program delays, the Continuing Resolution, and declining or maturing programs including CREW 2.1 and SINCGARS. The replacement potential of CREW 3.3 remained uncertain.
- Asbestos-related liabilities were $1,689 million and related recovery assets were $1,036 million, producing estimated net exposure of $653 million for claims through the next ten years. ITT had 103,678 open asbestos claims; liabilities beyond ten years were not reasonably estimable.
- Additional risks included refinancing and liquidity, credit-rating changes, postretirement contributions, commodity and labor costs, foreign exchange, environmental and legal contingencies, government contracting, and the timing, tax treatment, and operating consequences of the Transformation.
- The Department of Justice dismissed the deferred third count of a prior ITAR Deferred Prosecution Agreement on April 12, 2011. The company stated that its remaining $50 million payment obligation was not expected to have a material adverse effect.
Investor Verification Checklist
- Verify the final structure, timing, tax treatment, capitalization, and costs of the three-way separation.
- Reconcile reported GAAP results with management’s adjusted income and EPS measures, particularly the $85 million of Transformation costs.
- Monitor Defense orders, funded backlog, government authorizations, program transitions, and the effect of the Continuing Resolution.
- Assess whether Fluid and Motion & Flow growth and margins offset Defense weakness and rising commodity and labor costs.
- Track operating cash conversion, inventory and receivables growth, commercial-paper borrowings, debt refinancing, and credit-rating actions.
- Review asbestos claims, insurance recoveries, environmental matters, and the sensitivity of the estimated $653 million net asbestos exposure.
- Consider the effect of expected postretirement contributions of $80 million to $100 million during the remainder of 2011.