ITT Inc. (ITT) Q3 2008 Earnings Report, Transcript and Summary

Good morning. My name is Julianne, and I will be your conference operator today. At this time, I would like to welcome everyone to the ITT Corporation Third Quarter 2008 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. I would now like to turn the conference over to Mr. Toms Scalera, Director of Investor Relations. Please go ahead.

Thank you, Julianne. Good morning and thank you for joining us for this morning's discussion on ITT's third quarter 2008 results. With me this morning are Chairman and CEO, Steve Loranger; and Chief Financial Officer, Denise Ramos. Steve will start today's call with some highlights from the third quarter. Denise will then provide a detailed business review of the third quarter performance, and will also provide an update for the 2008 earnings outlook. Steve will finish up with an overview of some recent Defense wins. And then, we will move on to a Q&A session. I'd like to highlight that this morning's presentation, press release and all non-GAAP financial measures provided during the call can be found on our website at itt.com/ir. In addition, let me remind you that any remarks that we may make about future expectations, plans and prospects constitute forward-looking statement for preference of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in ITT's annual report on Form 10-K as well as our other public SEC filings. This conference call is being webcast and the replay will be available later today on our website. And now let me turn things over to Steve.

Thank you, Tom and good morning. Today, we are very pleased to deliver a nicely balanced third quarter earnings report that reflects the underlying resiliency in ITT's portfolio. Our dedicated teams continue to drive solid business results, accounting for another strong quarter by all financial measures. We believe our attractive portfolio addressing enduring global needs, strong leadership team and a disciplined management process has put ITT in a good position to deal with the challenging environment in the extreme market volatility that we're all seeing. Today's ITT generates 53% of its revenue from the Defense segment, where our unique range of capabilities are well aligned with current and future customer priorities. Those priorities are in communications, sensing and surveillance, space and advanced engineering integrated services. Both Presidential candidates in the upcoming elections support force expansion and equipment modernization as their top priorities and it has been our ongoing strategy to position the Defense portfolio to address these types of needs. And, in addition, our Defense business is not highly exposed to large development of weapon, ship or aircraft program that made these intensifying budgetary pressures due to constraints caused by our recent financial rescue programs. So, in this environment our Defense business did a very nice hedge with respect to global economics. We also believe that our commercial businesses are more resilient in difficult market conditions. This is due to our highly diversified positions, the critical nature of our products and our high aftermarket content. The strong geographic diversity in our commercial businesses is reflected in our balanced North American and European mix, each representing around 40% of the total. And our significant in-market diversification and 40% aftermarket content provides demand stability for our critical products. During prior economic downturns, we saw increased aftermarket activity as customers try to extend the life of certain equipments. With a larger installed base and expanded direct distribution networks, ITT is well equipped to address these needs in this economic cycle. Our strategies remained focused on long-term growth and continued operational improvements. However, we are prepared for projected softening of the global economy. Our better than expected third quarter results and our anticipated strong full year performance, nicely enable us to take action now to accelerate restructuring activities and advance our operational efficiencies to better weather the potential of 2009 conditions. Denise will discuss the impact of these actions shortly. And so reviewing the third quarter performance, we're extremely pleased with the balanced results that we've delivered across the portfolio. Total revenue grew 32% on a solid 8% organic growth. Segment operating income grew 29%. Earnings per share grew 26% and exceeded the midpoint of our previous guidance by $0.07 per share. And we're very pleased with our free cash flow performance. We grew free cash flow 76% to $759 million, driven substantially by working capital management in EDO performance. This represent a 127% conversion of income from continuing operations. And so with this solid Q3 report, we'll now turn over to Denise for a more detailed review.

Thanks Steve. Starting on slide two; we demonstrated strong financial results in Q3. Consolidated revenues were 32% with acquisitions contributing 23 percentage points. We delivered solid organic revenue growth at 8%, Defense grew 9%, Fluid grew 8%, and Motion grew 6%. Total organic orders improved 13% and that was led by a 21% increase at the span [ph]. Segment operating income increased 29% to $376 million. This was due to solid organic growth and incremental contribution from the EDO and IMC acquisitions. Segment operating margins declined 30 basis points. Favorable productivity, tension in foreign exchange was more than offset by negative impact from acquisitions and escalating material costs. So third quarter EPS of a $1.12 improved 26% compared to the prior year, and was $0.07 higher than the midpoint of our previous guidance range. This improvement was primarily due to higher operating performances at Fluid and Defense and lower interest in taxes. Turning to slide three; in today's challenging credit environment, we thought it would be appropriate to highlight our strong free cash flows generation in current financial position. Year-to-date free cash flow of $759 million represents 127% conversions of net income. For a third straight quarter on year-to-date free cash flow of conversion exceeded 100%; this strong performance was due to higher earnings, lower pension contributions, improved working capital and significant contributions from the acquired EDO businesses. The consistent cash performance reflects the nature of our customer base and the strong efforts of our shared service organization. Keep in mind that the federal government currently represents nearly 50% of our revenue base. The strong 2008 cash flows generations and our disciplined capital deployment strategies together lowered our net debt to net capital ratio to 21.2% at the end of September. Compared to the first quarter of 2008 after all of the financings related to the EDO acquisition that we put in place, net debt declined $389 million to $1.2 billion. During this time, outstanding commercial paper was reduced by $326 million. Keep in mind that at the end of September, cash and cash equivalents were $957 million, of which $197 million is in U.S. investments. Let me comment for a minute on how we see the current situations impacting ITT. For the current volatility of rates for short-term borrowing is expecting us like everyone else, we do continue to get good reception in the market for our commercial paper because of our strong cash generation and balance sheet. Our commercial paper program is backed up by variable revolving credit agreements, totaling $2.75 billion. And as of the end of September, only 60% of funds available to us under our credit facilities supported outstanding commercial paper. So said another way, our commercial paper was 160% backed up by available revolving credit agreement. In this environment, our short-term financing objectives are clearly focused on preservation of liquidity. And to that end, we will intensely focus on our free cash flow performance. We will slowdown our share repurchase activity, discretionary capital expenditures in domestic acquisitions. We will continue to closely monitor customer receivables, and we will continue explore tax efficient strategies to repatriate our foreign cash holdings. Turning to Fluid Technology on slide four; Fluid 8% organic revenue growth reflected balanced global performance. In North American businesses, which represent 44% of Fluid Q3 revenues, grew 7% in the quarter. International businesses grew 8%, led by emerging market expansion of 14%. Total Fluid organic orders grew 6%. Fluid's operating margins improved 100 basis points to 13.9%. Pricing, lower restructuring, foreign exchange, and pension benefit more than offset higher material cost and investment. At the Fluid value center level, our industrial process team grew organic revenue by 14% and this is the sixth straight quarter from double-digit growth. Demand in the oil and gas and power and chemical markets remains strong. And industrial process organic orders improved 26% in the quarter. Water and waste water grew 8% organically due to global, municipal and de-watering product growth. The de-watering businesses were strong due to increased global mining. Water and waste water experienced mid-single digit growth in both the North American and international municipal market. In the treatment businesses benefited from de-salination projects in the Middle-East region, but despite the strong third quarter performance flat orders suggested further slowing in municipal demand. We have been anticipating such softening and we will continue to monitor any developments in this market. Presidential and commercial water grew 4% organically as global, commercials and agriculture strength more than offset soft North American residential market. Global commercial markets grew in the 6% range, with North America up 5% and international up 7%. Growth in these markets is expected to slow in the fourth quarter. So in summary, Fluid balanced third quarter performance exceeded our expectations. However, we are reducing four year Fluid revenues by approximately $40 million due to preliminary indications of additional softening in certain markets. The recent significant change in foreign exchange rate causes an additional $120 million reduction to our 2008 revenue forecast. But overall, organic revenue growth for the year is projected at 5%. Moving on to Motion & Flow control on slide five; total revenues, including the acquired IMC businesses grew 25%. Organic revenues increased 6% on strength at aerospace, friction, and Interconnect Solutions and that more than offset the continued weakness we're seeing at Flow Control. Segment organic orders grew 4%. Motion & Flow Control's margins improved by 10 basis points to 14.2%. Productivity, foreign exchange, and pension favorability were partially offset by acquisitions, investments and footprint actions. At the Motion & Flow Control value center level, the Aerospace Controls unit was strong again with organic revenue growth of 11%. And this performance was fueled by strong aftermarket activity. Friction Technologies had another solid quarter, growing 9% on an organic basis. This was driven by balance OEM and aftermarket strength. During the quarter, our Friction team won another five new platforms, adding to an already impressive 2008 total. In addition to new wins, friction's aftermarket represented 47% of year-to-date sales. Interconnect Solutions grew 8% on an organic basis. This was driven by strength in the North American military, aerospace and oil exploration market. We remained challenged though by our Flow Control business, which declined $6 million or 9% organically, due to continued deterioration in the Marine and Spa & Whirlpool markets in North America. And we are now seeing slowing activity in European markets. The acquired IMC businesses delivered another strong quarter of revenue growth compared to the prior year, led by improvements in the oil and gas, derails and the aerospace market. The IMC businesses grew more than 9% on a pro forma basis. So in summary, the Motion & Flow Control group delivered a solid third quarter that reflected the segment's geographic and end market diversity. Recalibrating our fourth quarter foreign exchange assumptions, results in an approximate $50 million reduction to the midpoint of our previous 2008 revenue guidance. Overall, organic revenue growth for the year is projected at 4%. Turning to slide six, Defense Electronics and Services grew 52%. This was due to organic revenue growth of 9% and strong Fluid 2.1 performance from the acquired EDO operations. Organic orders were 21% with significant contributions from the core product businesses of communication systems, electronic systems, Night Vision and space. The strong orders flow growth drove backlog up to $5.1 billion, and that's an increase of $438 million from the second quarter. Defense margins at 12.2%, declined 140 basis points and this is due to favorable pensions and net cost productivity, offset by the EDO acquisition and mixed impact. Our Advanced Engineering and Sciences business grew organic revenue by 40%. Increased activity on the data analysis contract and FAA air traffic modernization program drove the quarter's growth. Our Systems business grew 12%. And this was due to increased activity on sensor programs involving missile defense and state control programs. Communication systems improved 6%. And this was due to increase in international sales for the Iraqi and Saudi military, an increased JTRS development activity. Electronic systems declined 12% organically and that was due primarily to program timing. Organic orders though increased 218% in the quarter on strong demand for airborne counter measures. We remained confident in our ability to deliver continued revenue strength at Defense. And we are once again raising the mid point of our 2008 Defense revenue guidance by $50 million. This improvement is largely attributable to increased customer demand for CREW 2.1 ID/IQ agreement. Now, let's move on to the well forward of our EPS guidance, which is on slide seven. We are increasing our 2008 guidance before incremental effect to restructurings by $0.07 per share. This increase represents the amount that our third quarter performance exceeded the midpoint of our previous guidance. We then adjusted this amount to reflect the unprecedented recent movements in foreign exchange rates, compared to our prior guidance. The adjustment negatively impacts full year earnings per share by $0.04 per share. Lastly, in response to anticipated global market conditions in 2009, we are accelerating restructuring activities across our businesses during the fourth quarter of 2008. And these incremental actions of approximately $48 million or $0.17 per share primarily relates to reductions in headcount in both U.S. and European operations. In total, our revised full year 2008 earnings per share from continuing operations excluding special item, is now in $3.97 to $4.03 per share range. Keep in mind that our earnings per share guidance fully reflects all restructurings and foreign exchange impact. Turn to slide eight and you'll see our detailed 2008 guidance. In total, we now forecast full year revenue at $11.45 billion to $11.55 billion. And that's approximately 28% higher than reported 2007 full year revenue. Total 2008 organic revenues are projected well in a 6% to7% range. We are increasing the midpoint of our defense revenue guidance by $50 million. And this increase was primarily due to higher CREW 2.1 deliveries requested by the customers. Resetting our revenues forecast to reflect current foreign exchange rates, resulted in approximately $170 million reductions at our commercial unit. Assuming an average euro rate of $1.29 compared to the $1.58 rate using our previous guidance resulted in $120 million revenue reduction of Fluid and a $50 million reduction at Motion & Flow Control. We are also reducing Fluid revenue by an additional $40 million due to anticipated softening in certain municipal and commercial markets. We'll provide any updates to our guidance and an overview of 2009 results during our December 12, 2009 guidance call. So, please hold your 2009 questions until that time. Now, I'll turn back to Steve for some thoughts on recent Defense development and then wrap up.

Thank you, Denise. If you move on to slide nine, please. You know that our Defense team just keeps on winning and we'd like to highlight some of those accomplishments. On the right side of the slide, you'll see an updated summary, of just some of the most recent and significant strategic development and contract wins since July 1st. Defense in strong third quarter financial performance was accompanied by some very significant wins. These wins include a $177 million of Night Vision orders, including $24 million for Enhanced Night Visions guidance, another sole source position for ITT under the $560 million ID/IQ contract. We signed the JTRS or Jitters teaming agreement with General Dynamics, enabling an opportunity for us to correlate the installed base of SINCGAR's in with advanced JTRS technology. And that led to a $117 million win of the JTRS Solider Radio Waveform Development program. We received $490 million award for Foreign Military sales in our Communication Systems business. The CREW program continues on track with a $1 billion CREW 2.1 ID/IQ award electronic systems; $433 million of which is already been included in new orders. What's particularly significant about these CREW orders is that $206 million of this 2.1 award was for non-MRAP vehicles, which plays into our strategy to deploy the 2.1 technology to a much larger install based of vehicles beyond the MRAP. So, we're quite thrilled with the continued direction with the CREW program as it's been earning its right by performing exceptionally well in the field. And finally, we got a $1.3 billion NASA contracts to perform telemetry tracking and command services for near earth missions, which coupled with our already cemented position with the Jet Propulsion Laboratory, Deep Space Network, now enabled ITT to manage all of spacecraft activity that we hear outside of the earth. Highlighted in light green on this slide are the non-DoD and international awards which reflect three key strategic growth priorities: international expansion, cross value centre proceeds and customer diversification. In total, we see future non-DoD and international opportunities from this list, totaling over $4 billion. And the significance is that this is validating that our strategy of customer diversification and adjacency diversification within Defense is working quite well. It should also be noted that the recent $1.3 billion NASA win reflects not only our customer diversification efforts, but also cross values center strategies. For the second time in less than a year, our advanced engineering and systems value centers teamed up to win a significant new incremental multiyear contract. The last such win you recall was the $1.9 billion FAA air traffic control modernization program, where we continued to reach new milestones on schedule and under budget, which has recently enabled the FAA to move more decisively on certifying our installations or application in the air traffic arena. Many of these third quarter wins have been added towards this backlog, which increased 13% from the second quarter to $5.1 billion. It should be noted that we would include funded orders in our backlog calculations. Product backlog has increased during 2008 due to strong funded order activity. Our increasing product backlog provides good visibility to future requirements and is currently funded at a 100% of our projected 2008 product revenue. Service awards typically fund over a shorter time period usually less than nine months. So, as a result, the unfunded portions of many of our new long-term service opportunities listed will not be fully reflecting in the current backlog. And as we continued to execute these programs, additional follow on funding will be provided in short increments. Our current service backlog stands at about 50% of our projected 2008 revenues as this does not calculate... as this calculation does not fully reflect the follow on opportunities. But all in all this feels about right from a traditional book-to-shift point of view and we feel good about our position going into 2009. So, moving out of Defense and just to wrap-up some comments on Q3; during the last several years of relative stability, our dedicated leadership teams have taken their necessary steps to position us for this down cycle, well before its arrival. We aggressively divested shorter cycle businesses, primarily in North American auto and global consumer driven electronic markets. We then redeployed this capital in the long cycle businesses such as EDO, increasing our Defense leading to over 50% in the process. And it should be noted that EDO's year-to-date operating and cash flow performance has far exceeded our higher expectations. And as I mentioned earlier, we're thrilled with the recent successes of our CREW 2.1 product. We've also invested in new strategic growth opportunities that penetrated new geographies and markets with our essential products. These efforts will reflect it in the nearly double-digit organic revenue growth rate we have delivered consistently since 2004. This growth is greatly expanded our installed base, which continues to fuel our exceptionally high levels of aftermarket demand. Our growth initiatives in investments have expanded the scope and reach of our portfolio of critical products that support during global needs. We've also, over the years, invested heavily in our internal operating excellent conditions in the combined power of the ITT world. We've assembled a world class leadership team and devoted necessary resources to critical areas such as global sourcing, value-based moves Six Sigma and value-based product development. Today, our balance sheet is strong. And we've generated record free cash flow every quarter in 2008. These strengths provide us with the financial flexibility required to respond a challenging current conditions as well as position for future strategic opportunities. We will continue to utilize a very disciplined capital allocution strategies that got us to where we are today. We will not rest on the collective laurels of our past successes. As always, we are going to move aggressively to accelerate restructuring activities and remained focused on strategic long-term growth initiatives and the deployment of the operating processes contributing to our continuous improvement. We're going to focus on the preservation of our liquidity, while we prioritizing our internal investment activities based on new hurdle rates. We're going to again remain conservative in our future outlook and very disciplined in our discretionary spending. These actions are not new to our cultural in ITT, but during these volatile and uncertain times they dare repeat it. We think that ITT's best days are ahead and we're going to continue the drive our operations towards that future growth. And the final point I'd like to make is that times like this, really call upon our leadership to be focused and I want to tell you how proud I am of our collective leadership teams throughout ITT. Our managers are stepping up to face a new reality by constraining costs, being decisive on the appropriate decisions to ensure that ITT's long-term business success continues. And so with that, let's turn things over to Tom and we'll take questions.

Julianne, I think we're now ready to start the Q&A session. Question And Answer

Thank you. [Operator Instructions]. Your first question is from the line of Shannon O'Callaghan with Barclays.

Hey, on the 4Q guidance, I mean you guys have a long history obviously of guiding conservatively in typically exceeding those expectations. I mean that will be tougher to do now than probably you can ever remember. When you're looking at this fourth quarter guidance, can you give us some color on the recent activity you are seeing and how do you feel you've calibrated that fourth quarter expectation?

Yes, thank you Shannon. We certainly would agree that it's tougher to do in light of a lot of the changes that we're seeing. So, you can imagine that we've been leading literally around the clock in the last several weeks, trying to home in on what we think is the appropriate solution. There are a lot of factors here that we're considering. First of all, beginning, you've got to begin with the strength of the Q3 beat and the strength of the full year. But then when you factor in this global economic uncertainty, we went to every market, we went to every product and we took a really careful look at our orders. None of these is there since this financial crisis unfolded. We only had a three week look at these orders. But we did see a reduction. But, I'll point out that Gretchen McClain, Colin Sabol and I and the rest of our leadership team just intended to left check of our water conference and we talked to a hundreds of customers. And the fact is that the answer is not clear that some people are seeing some slowdowns in their business, other people are seeing a steady business. But there is a lot of uncertainties and disturbance in terms of the customer network of what's happening. So, we don't know whether we're seeing immediate reaction or how long this may be and I think that's central to your question. But our philosophy is this. Leaders plan to be very conservative on the top-line, which is what we've done. And we planned to be very aggressive on costs, which is exactly our plan. And so remember that, excluding this proactive restructuring decision to reposition for 2009, we're actually raising our full-year operational guidance.

So Shannon, just to give you a little bit of perspective, then Steve articulated very well here. That whether talent here and looking at what's going to happen in the fourth quarter. So, we've paid a lot of attention to what we were seeing in the month of October. But there are a lot of uncertainty as to what's going to happen there from a revenue standpoint. We also know that we've taken some actions internally around discretionary spending. And so, we think that's going to help us and benefit us in Q4. So, we have factored that in also. The other thing is remember 53% of our portfolio is the trends. So, you have... that obviously follow a very different cycle than the commercial businesses. So, Steve's comments really centered a lot around the commercial side of the business.

Okay. That's helpful, thanks. And then also Denise maybe in terms of the cash uses and the balance sheet, how possible is it for you to do some repatriation? I mean between that and your free cash flow, you could just take out the CP, I guess if you wanted to. Is that a goal or are you're looking at do things or anything else to achieve that? And then I guess the other question is, all companies that I think are duly saying that the focus right now is on liquidity, which certainly seems appropriate. But at what point here given sharper actions we've seen which you actually start to think about returning to the share repurchase?

So, on the cash side Shannon, we do have cash at the end of Q3 on the balance sheet of about $950 million. $200 million of that, as I said in the U.S. roughly $750 million international. We are always looking for tax resistant ways, so repatriate that cash home. In fact, we actually executed some of that when we did that when we were purchasing EDO into the... for the funding of EDO. So, we continue to look at ways to do that and we'll continue to do that as we generate a lot of cash flow in Europe for that. So, that's what I would say on the cash repatriation side.

And then just, where do you feel like you would need to get from a balance sheet standpoint, where you would say, hey this markets melted down here and Steve saying best days are ahead of us. When would you consider stepping back in on the share repurchase?

Yes, that's going to be really hard to say, especially where the credit markets are right now. And I think it's a very wise thing to do right now to just slowdown that program. See what... see how things settle out, and then we'll exit it from there as we get into 2009. But at this point in time we've not made any change to that share repurchase program.

Okay, thanks.

Your next question is from the line of Jeff Sprague with Citi Investment Research.

Thank you. Good morning.

Hi, Jeff.

Good morning, Jeff.

Great applause for taking the restructuring and like you everybody else is doing the big kind to one off non-recurring. But can you give us a little bit more color on actually what you are going after on restructuring. Steve, I think Denise said it's mostly headcount but at what point do you look at plans and things kind of deeper than that because most of this is more white color stuff to begin with?

Jeff, thank you. First of all I will be certainly expecting my remarks, because I don't want to get any indications out in front of our internal communication activities which are in process. But of the total quality of restructuring, certainly a great deal of that a substantial quantity of that is associated with positions. And remember that there is a significant diversity among elimination of temporary open suggestions, natural attritions retirements, some voluntary activities as well as headcount reductions. But I can't assure you that a substantial portion of that is associated with that component. There are some ongoing plant activities that have not been fully announced. But, there is certainly one reasonably good size activity in process. And there are a number of smaller, but I would say not material but are smaller closures contemplated in this. We are in a process, where as a result of this economic... this short cycle economics situation, we've made very fast decisions which I'm very confident in. But as you know the execution needs to dealt [ph] appropriately throughout the company because this is manifest in so many different pieces in the company that I'll just reserve in further comment until we finished our internal communications.

So, definitely you look at for the full year, we've always planned about $40 million to $45 million in restructuring. And within that we had a number of actions associated with facilities. So this incremental piece, which is about $50 million over and above that is skewed more towards headcount. But if you look at the restructuring in total for the year, you got about $90 million. And it does include not only headcount but a number actions around facilities.

And how should we think of kind of the payback on that? Do you get one to one kind of back in '09 more or less? Do these actions begun by the end of Q4?

So, how we're looking at it is the actions will be completed by the end of the first quarter of next year, but the payback with that is the little more than one year.

Great. And, Steve or Denise, can you get result little more color on what you see in the price cost dynamic, obviously we're hearing about a lot of cost pressures in this quarter, but we're also watching why will commodity cost drop pretty quickly. So interested in really both sides of the equation, when do you start to see some cost relief and as to enhance the discussion with your customers about price, kind of started to go the other way with customers pushing back on price?

Yes, Jeff. That is an evolving situation right now. We are, as you know, seeing in a couple of areas, some commodity decreases not all. But the better economic forecast would be that we're going to start seeing some commodities come down, which would fundamentally and is included in our planning be a benefit to our business. We have had conversations from customers, who have initiated the same questions to us. And our... for planning purposes we're expecting that it would be more difficult to attain price in the marketplace in that environment. But we fundamentally think that we'll be able to hold our position. Our focus is to respond the customers by providing lower lifecycle cost solutions and ensure that our product is represented in a good, long-term value. So, we'll be working on that side, it's like, like all good companies will.

And for Q4, we don't expect to see much of an impact on the raw material cost. And the reason for that as we remember half of our business represent has typically under long-term supply agreements, the other half on the commercial side utilizing in fact two to three months contract in place. So, again we won't see much of a slowing through within fourth quarter of '08. But we'll be assessing that for '09.

And then just finally on pension. I know Don Foley and every Treasurer in the world is going to be standing over the machine on 1231 to see where all those kind of settles out. So, I won't ask you that project pension for next year. But just in helping us get our arms around higher sensitivity, can you give us a way to think about the impact of, call it the gap between expected return and actual return. For example, could help us... however, you could frame it, 100 basis points gap between expected returns and actual return equals wealth in dollars. Any framework you can give us there?

Yes. There is... and first off let me just say thank you for not asking it me to comment on 2009, because you are right. At the end of December is when we'll be looking great closely at what's happening and make those decisions. So, in terms of pensions, at the end of last year when you look at our U.S salary plan which is by far the largest component of our pensions, we were very happy because we're 114% funded at that point in time. So, we've made some contributions into the plan and then we've had great return on that plan for the last couple of years and I do give a lot of credit to downfall of industries for that. So, we started the year in a very nice position, being a 114% funded. When we look at where we are year-to-date in terms of the return on those assets and by the way we tend to target a 9% effective return. But when you look at where we are to-date, we're in about 15% to 18% down on a year-to-date basis. But actually beating the benchmark, that are out for us. Now, we know that those returns in this year will be smooth over roughly a five year period. So, you won't see the full impact of that in '09. But that would tell you that funding, if everything remains the same for the rest of the year till where we are today, funding would fall somewhere 95% to 98%. You can call it from there, I don't know. So if you assume that and the discount rates, where we would be today, we would basically say that our... the pensions impact to our P&L would be basically neutral to where we are in a way. Now, saying that, we have the Defense portion of our pension plan. And there is a headwind associated from the government pension results that we would have for '09 impacting us. And we think that would be anywhere from $15 million to $20 million. So, that gives you a perspective on it, at least to where we would be today. But again, a lot can change between now and the end of the year. And we'll give you more flavor on that in December when we talk about '09.

Great. Thanks a lot.

Your next question is from the line of Deane Dray with Goldman Sachs.

Thank you. Good morning.

Hi Deane.

I was hoping you could clarify what portion of municipal spending in water and waste water right now for you is new project?

Let me just give a quick one on Deane. For municipal event, when you look at we got about $1 billion of municipal spend globally. How we split that out, it's about 45% tends to be aftermarket, there is about 25% that tends to smaller projects in nature and then about 30% of that is more larger projects.

Great. And I guess for what we've heard from the folks at West Oak [ph], because on the municipal side, there is an expectation that the funds for these projects are typically water tariff related. But there is a potential that State Municipal Government could pass those funds for emergency purposes teachers, roads, police and so forth. Is that part of the risk factor in the spending?

Deane, absolutely. We are hearing some of the same things that we were not using mix by municipality depending on their economic scenario. But, we would agree with the premise of your question. Fundamentally, the tariff revenue stream does support most of our municipal business. And it is the funding of last resort for these municipalities. But to the extent that the municipal bond market had some constraints as you all know; the alternative funding pressure or things that we are considering as we are looking at our Q4 forecast, as well as planning for the '09 period.

Great, that's helpful. And just a quick question to clarify on the cash preservation plans, which all make sense in a number of the multi-user companies are taking similar steps. Steve, you referenced the M&A plants having new hurdle rates. How are you looking that, as you are not shutting M&A down, but you're raising the hurdle rates. Can you clarify that please?

Sure. Obviously in this environment, we believe it's appropriate and prudent to be very conservative and not put any more balance sheet risk then we have to. So, we are not setting down M&A, but I think it will be safe to characterize where we are by saying we are taking a pause on certain, any large M&A activity of which we had some certainty in the pipeline. We may still proceed with some small and we would characterize those by less material M&A acquisitions returns in tens and fiftiesh kind of millions of dollars we can certainly continue to proceed with some very nice acquisitions there and we plan to do that. But if you just flow through the current cost of that, the interest rates and so forth, we think that our hurdle rates will probably be going up 3% to 5%. But keep in mind that our first priority in looking at acquisitions is going to be strategic. But we're also much more constraint today in terms of the hurdle rates in today's environment. And as this credit situation flows through the economy over the next couple of quarters, we'll adjust appropriately.

Great, thank you.

Your next question is from the line of Mike Schneider with Robert W. Baird. Michael Schneider - Robert W. Baird & Co. Inc: Thank you and Good morning.

Good morning, Mike. Michael Schneider - Robert W. Baird & Co. Inc: Wondering if you could just comment on Fluid Tech for a minute. If I look at the high end of the guidance, it looks like your assumption is that Fluid Tech will be down at least 6% organically in Q4. I'm just curious if you could detail where you've made the most significant reduction in your assumptions. I presume that's municipal. But even then it look like you must be assuming strong double-digit declines in that business on the flat orders this quarter. Could you just give us some more detail as to where you put the cushion in the Q4 number within Fluid Tech?

We can throw up the number when... for organic revenue growth for Q4 for Fluid we're looking at about a negative 2% to 3%.

And that's excludes the impact.

Yeah, that's organic revenue growth, 2% to 3%. And so where we're seeing the softness there is we talked about commercials that there was going to be softness on the commercial side, we've seen that primarily in the Americas. And then also what we mentioned earlier and that's on the municipal side. So we're seeing municipal being impacted in a lot of different regions, but most of it being on the... in North America. Now saying all of that, IT that business continues to perform extremely well for us. So, that tends to be somewhat of a compensating factor for this, so we have slowed that through in the Q4 numbers. And the other thing is that we've put in to the Q4 number has to do with that cost controls discretionary spending and those activities that the Fluid team is aligned to run that's going to improve this communalized standpoint. Michael Schneider - Robert W. Baird & Co. Inc: Okay. And when you look to '09, have you actually seen projects that were in backlog within municipal, get cancelled or downsized or anything of the sort?

So, when we look at the order activities to-date, we've had on the commercial side, we've had no significant cancellations. We've had some few modest extensions that we've seen in along the... in the industrial side, municipal, little bit in friction nothing significant at this point, and bidding activity continues. So, from that standpoint we've really haven't seen change yet. Michael Schneider - Robert W. Baird & Co. Inc: Okay. And then within IMC, you mentioned the business grew over 9%. What was the organic number that's currency? And then can you also describe just the pace of orders there because that business seems to be running to longer cycle markets like aerospace as you mentioned, just curious as to what the order patterns are there?

The number that we gave the 9% that is organic for IMC. And then in terms of orders, little bit hard to tell. That's why I don't have that in front of me only because we have tried to integrate that as much as possible into the Motion Flow businesses. So, I don't have much of that right now even though we do know that they do play in some pretty strong markets into some pretty strong market. So, we can get back to little bit on that.

We've seen... I'll point out that we've seen some really nice growth on the rail side. And even in the machine tool business where we've been pioneering some innovative, both motion and energy absorption technology. Michael Schneider - Robert W. Baird & Co. Inc: Okay. And then just quick question on friction, given the automotive market is a mess right now, would you expect to grow that business in '09 based on the new platforms alone?

I can't Michael comment right now 2009, but I will point out that we have had an exceptionally good win rate in friction. And when you walk through the actual platforms, it's safe to say we've won a lot more small automobiles than we have SUVs. And so, on a mix adjusted basis in terms of the downturn and the financial constraints that's driving automotive, our win rate has played quite frankly well into that scenario. And other than I won't comment on 2009. Michael Schneider - Robert W. Baird & Co. Inc: Okay. Thank you.

The other thing to mention is that the aftermarket content in friction is high between 45% and 50%. Michael Schneider - Robert W. Baird & Co. Inc: Thank you.

Your next question is from the line of John Inch with Merrill Lynch.

Thank you. Good morning.

Hi John.

Hi. So, and I apologize if you've mentioned this. But the $40 million sequential take up from Fluid; you said that's a combination of municipal and commercial. I think you've also talked about the fact that your European municipal business has still been pretty good, which I think is half of the total billion if I'm not mistaken. Can you Denise perhaps just give us a sense of the $40 million, how does that split between municipal and commercial and if I'm not mistaken, you had also said historically, but you guys have kind of have deflected the prospects of the softening U.S. municipal. So, sort of multiple parts to it, so maybe just a little bit more color the 40 and how I should think about the impacts of the business?

Of course. So the $40 million is off of the prior forecast that we had and as you said John we had already forecasted that we will see some slowing in municipal and commercial. So, this is you've even a little bit more swelling than what we had anticipated maybe three months ago. It is a lot of the focus on the $40 million is North American municipal that we think could be down in the double-digit for us. We are seeing a decline in Europe but not to the extent that we're seeing in North America. And then on the commercial side of the business, we're forecasting that to be slow than what we've seen before. So, if you had to split it on the $40 million, it's tough to say, but you could maybe say 60% of that is on the municipal side and about 40% on the commercial side.

Yes, John. The other thing I would like to put in perspective on the Fluid Technology numbers, which I think would reflect a little stronger than the numbers. As remember that this reduction is off a forecast that we put together that was showing very nice fourth quarter growth. When you look at it on a year-over-year basis including the fact that last year it was a 14% growth rate in Fluid, we're really down only like 1.5% on a real basis year-over-year. And so that suggest that we just didn't see the anticipating growth that we thought earlier in the year. So, now again it's a reduction of a forecast as opposed to a real reduction year-over-year by the same magnitude.

Well, I guess another way to look at is if you annualize the 40 to 160 that's about 4% of the total revenues of Fluid in '07. So, I mean guess Fluids been running kind of higher then that on a trend line basis organically. It sounds to me like there is probably the risk of some more municipal softening in Europe coming. But, is there any reason why this business kind of as guys work it all in, including some of sort of actions you are taking or have seen in the fourth quarter. But that business couldn't at least hold flat in the current environment sort of beyond on the fourth quarter?

Yes, John. I think in this environment it's tough to run rate anything. We have the same debates among our self. So, we wouldn't recognize that now that you suggested simply because we know we have a lot of cyclicality in this business and a lot of lumpiness with respect to project timing. Cyclicality as is associated with temperature and the winter time with respect to buildings and so forth. So, our business does have quarter-to-quarter variation. So, we're looking at all that and we will be back with you in December in terms of the 2009 forecast.

Okay, that's fair. Now the margin reductions for the year, Denise 12.5 to 12.2 that looks like it was totally eaten up by the additional restructuring, was there an FX impact associated with the especially that true in with your FX impact associated with the $0.04 of take down that you have called out?

Yes. So, for the LIC service most of it, it is restructuring a large component of that restructuring and actually for foreign exchange, there is actually a slight positive associated with it. But the message is its restructuring.

And then lastly our you expecting a fourth quarter R&D tax credit as part of the guidance or any kind of --

We are going to annex and build into our Q4 number. So, about we think it's going to be about $3 million.

Great. Thanks very much.

Your next question is from the line of John Baliotti with FTN Midwest Securities.

Hi, Good morning.

Good morning, John.

Hi John.

Steve,if you look at portfolio today saying that you may have seen some softening in kind of... is there a chance sort of big picture to way that percent wise. Things like flow, things like some of the water businesses versus the longer cycle the things like Defense. Just kind of proportionate revenue, you had a sort of rough line of that?

It's an interesting question we are looking at it. And I will tell you John, the short cycle volatility, what we are seeing right now, really kind of precludes what I think is purely valid analysis of that. So, the way I think about it is just taking the best portfolio that does respond to non-economic cycle budgets. It's around U.S. foreign policy and so forth and all of things that you know about. So, quite frankly in this environment when you see a rush to 1% key bills, we take a business that's producing 6% on the top line and 15% on the bottom line in the quarter, is a pretty dug on good hedge. So, that side of the portfolio while it certainly has its unique pressures and challenges. We think is a good hedge and good sustaining a good component to sustain solid consistent economics underneath this portfolio. On the balance of the commercial side, we try to address these areas that are more essential in nature, which we'll discussed a lot in terms of bringing thirsty people fresh water and so forth. And this sort of essential focus or its attractive focus that we talk about in Fluid technology and Mo Flow, coupled with some good processes has enabled us to actually outperform the GDP market. So, right now while we have the short cycle economics that is really confusing situation, we need long-term on the commercial side, we're pretty well positioned to certainly meet and hopefully as we have in the last five years, handling the global GDP with the essential major. So, in sort of a bigger picture view, we liked the balance of our portfolio. And I would just leave it like that.

Yes, I mean I think if you're do impact to last recession, you guys performed pretty well and defense I think at a time was only about a third of the portfolio. Now, it's more than half. And back then you all said business is like switches. Some of the things that are not point of portfolio anymore. So, and I think in the last... since last quarter, I think you'd won reported levels about $2.5 billion of more Defense wins. So, it seems like I mean so you don't need my encouragement to be conservative, but it seems like you've got versus some other companies you've got a pretty good base to start with.

Well, we do and the other thing to keep in mind in this downturn to some degree it is true in the last downturn, is when we talk about essential and attractive nature is we target from a strategic portfolio. That implies a high after market content. There is... I think there is well in excess of 10 million water well pumps in the United States alone. And we knew water well pump fails to work. You get another one right away. It's not an economic decision. And that's an example of playing in areas where the aftermarket is really, really critical. So, I think we agree with you. We did try to move out of the electronic switches business and some other shorter cycle businesses such as the new automotive. And right now this portfolio is not being hurt by those short cycles. So, we think we've got a stronger overall longer cycle position right now. And also keep in mind our global nature. Our global markets, I don't have the number right now, but in the prior quarter we were up in the 25% range on our emerging market. And we think long-term there is still going to be quite a bit in that arena. And I just see that our emerging market growth in Q3 was up 15%. So, all in all, we feel pretty good about where we are. But we're just as vigilant and concerned about this economic situation as anyone else. We all apologize to those who're in the line, we got time for one more question and then we will have to button it up.

Your final question is from the line of Scott Davis with Morgan Stanley.

Yeah, hello.

Hi, good morning guys.

Good morning.

Good morning.

I don't want to ask about '09, but a little bit big picture and again since I am not a Defense expert I want to excuse the basic needs for this question. But, when you think about some of the key businesses here like Night Vision Goggles, do you have a feel for... I know there has been huge pent-up demand in the last two years. Where are we as far as kind of the level of troops equipped versus maybe the military goal?

That's hard to say for a very good reason. In Night Vision Goggles alone, we're seeing about 5% growth rate this year. And, we've easily got that two year backlog. But, remember as an example, we continued to innovate with our new technologies. And while we are installing our PVS14 to the U.S. army, marine and aviation communities now, we're also rapidly increasing our enhanced Night Vision Goggle which overlays thermal visibility on top of the image and justification, which has an innovative capability of allowing our soldiers to be able to see through smoke and fire. And so, which they cannot do with the existing goggle, so that innovation is creating demand. We are doing the same things Scott, with respect to SINCGAR's radios. We continue to build up the installed based with innovations such as the Soldier radio Waveform besides that various, we functionality and we're up and cost strategies and that stimulates demand. Our total SINCGAR's demand where we've seen some maturing with U.S army, as we discussed has been more than offset by very, very high international growth leveraging of that installed based. Moving over the CREW as an example, the performance of our CREW 2. Jammer is nearly proving itself in conflict right now. And the U.S. government and our customers have told us that this is central technology. Now, why are they saying that? IED is the number one cause of debt in our conflict and we are more than proud to be able to say that not a single U.S. solider have lost their life pro in IED explosion when their vehicle was equipped with one of our latest bomb Jammers. And now on top of that we are now in discussions with U.S. Government to increase and address new electronics threats with the 2. Series and as you well know we are in the Advance Technology development of the CREW 3.1 and CREW 3.2 series. So, the big picture answer to your question is that technical innovation is continuing to stimulate demand over the installed base. And I think I would just close by saying that when you realize what we're really doing over there, I can only quote my nephew who is an in for treatment in a lock right now. When he returned from his first tour of DD, wrote a letter to Mike Hayman saying the one thing that if he only had one piece of gear over there in a lock, it would be his Night Vision Goggles. Because that was the one peace of gear that enabled him to only night and to protect him safely and as I mentioned he was in harms way [ph]. And so, we're continuing to innovate in those areas. So I thank you for the question Scott and let me now just take a moment to wrap up for all of you. Thanks for joining us. Clearly, trying economic times and we appreciate everybody's of ITT during this recession of volatility. When you reflect on how ITT has performed in the past and how we're positioned to continue to perform, just keep the following in mind: we do manage our portfolio to attract these businesses. We are providing essential products and technology, we have an excellent focus on customers, we've solid delivery and quality execution. And as Denise mentioned, we've got a strong balance sheet, we're really disciplined conservative and we're super focused on strong cash flow generation. We've got great leadership teams and a great culture. These teams know their customers, know their businesses and we got some excellent management processes. And all this together has enabled us to execute our plans very well. In this environment, we're taking a proactive and anticipatory business management approach. We're continuously adapting the changing environment. We decides here, we are focused on customers as well as opportunities. We're driving high levels of cost controls as well as intensive focus on lean Six Sigma efficiencies. And in the entire time, as Denise mentioned, we are continuing with our long-term value creation strategy. We're keeping these on track because as I mentioned, we clearly believe that our best days are ahead of us. So, with that, we'll, thank you for your attention and look forward to communicating in much more detail with all of you in December.

Thank you for participating in today's ITT Corporation third quarter 2008 earnings conference call. You may now disconnect. .