ITT Inc. (ITT) Q3 2009 Earnings Report, Transcript and Summary

Welcome to the ITT Corporation's third quarter 2009 earnings conference call. Hosting the call today from ITT headquarters is Steven Loranger, President and Chief Executive Officer. He is joined by Denise Ramos, Senior Vice President and Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 1 p.m. Eastern Standard Time. The dialing number for the replay is 1-800-642-1687 and enter pin number, 33971518. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Tom Scalera, Director of Investor Relations. Tom, you may begin.

Thank you, Christy. Good morning and welcome to ITT's third quarter 2009 investor review. Presenting this morning are Chairman and CEO, Steve Loranger and Chief Financial Officer, Denise Ramos. Today, Steve will highlight third quarter 2009 results and Denise will provide a detailed review of the quarter's performance and the 2009 earnings outlook. I'd like to highlight that this morning's presentation, press release, and reconciliations of GAAP and non-GAAP financial measures provided during the call and during this presentation can be found on our website at itt.com/IR. Lastly, please note that any remarks we may make about future expectations, plans and prospects as well as other circumstances set out in our Safe Harbor Statement constitute forward-looking statements for purposes of the Safe Harbor Provision. 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 third quarter 2009 earnings press release and Form 10-K as well as our other public SEC filings. Now, let me turn things over to Steve

Thank you, Tom. Good morning and thanks to all of you for joining us to review our strong third quarter operating results. When this economic crisis began, I encouraged our management teams to focus on controlling what we could control and to make sure that their actions preserved and protected the strategic future of this portfolio. Now, through three quarters of 2009, I'm extremely proud and confident to say that our teams have been successful on both fronts. The proof is in our consistently solid 2009 results. Our teams had outperformed their markets and achieved ambitious business targets through an excellent customer focus, strong productivity initiatives, and very disciplined cash management. Most importantly, we have continued to invest strategically in our premier portfolio. Notwithstanding a tough economic environment, this year we've continued to invest in new product developments key programs such as the ADS-B and expanded R&D activity and new market reaching opportunities that better leverage the power of the ITT brand. These investments continue to pay off. Let me highlight some strategic wins that demonstrate the unique scope and reach of ITT. We won a system implementation award for a plant to treat wastewater for agricultural irrigation in Peru. We won an important development award for the next-generation counter-IED jammer system CREW 3.3. We won our largest ever international customer award in space and we had another nice North American rail win. I could name a number of more of these kinds of examples, but the point is that our portfolio and investment focus continued to produce results. Let's turn to the third quarter on slide three. From an operating perspective in the third quarter, we delivered earnings per share that was $0.18 better than our previous guidance midpoint primarily due to strong productivity. We're raising our adjusted full year EPS guidance once again representing only an 8% decline versus the prior year, which as you recognize is among the best in our peer group. We delivered solid organic revenue that declined only 4% versus the prior year. We're increasing our full year organic revenue forecast for both Fluid and Motion and Flow Control. Finally, in the quarter, we delivered $916 million of free cash flow that represents 174% conversion of continued net income. I think this cash performance is a strong testimony to the underlying quality of our 2009 operating results. From a non-operating perspective, we recorded a third quarter net liability for future asbestos-related claims. As we've indicated in our recent SEC filings, we did complete our estimation process related to future asbestos claims in the second half of 2009. The resulting charge to continuing earnings of $0.71 per share is classified as a special item. Denise is going to provide a lot more details shortly. In my mind, it's very important to note two things. This charge does not represent any change or increase to our exposure. It's simply an accounting charge to recognize a liability for future claims. Most importantly, the forecasted net annual cash outflows over the 10-year period are not projected to be material to our financial position. So with that overview, let me now turn it to Denise to go through the quarter's exceptional performance.

Thanks, Steve. Our third quarter results on slide four were stronger than our internal expectations due accelerated productivity benefits mix and timing of investments. We delivered organic revenue that only declined 4% compared to the prior year, a relatively strong outcome in current market conditions. That performance included a 2% improvement at defense a 10% decline at fluid and a 16% decline at motion. On a sequential basis, organic revenue also declined 4% primarily due to defense timing and some seasonality in the commercial businesses. Total third quarter organic orders declined 26% on weakness at defense and that reflected the lumpiness of current year orders and the difficult comparison to a record quarter that we had in 2008. Fluid declined 15% compared to the prior year but they did improve 1% sequentially. In the third quarter, organic book-to-bill ratios for both Fluid and Motion and Control has exceeded 1.0 for the first time since the economic crisis began. Segment operating income decreased 6% to $352 million and segment margins declined only 10 basis points to 13%. When you exclude the non-operating impact of pension, foreign exchange and higher restructuring expense, segment margins actually improved 80 basis points operationally. This reflects our continued commitment to accelerated investments and footprint realignment and integrated supply chain initiatives that have generated nice productivity gains during all of 2009. At quarter's end, we once again raised our productivity expectations setting us up nicely for the fourth quarter and into 2010. Excluding special items for tax and future asbestos claims, earnings per share of $1.03 declined only 7% versus the prior year. This performance was $0.18 better than the midpoint of our previous guidance primarily due to strong underlying productivity and some timing benefits. Now, let's turn to our financial position overview which is on slide five. During the third quarter, our strong financial positions grew even stronger due to record year-to-date free cash flow of $916 million. This result was 21% better than the prior year's third quarter and is further evidence of our overall earnings quality in 2009. Excluding non-cash special items, our free cash flow conversion of income from continuing operations expanded to 174%. Our working capital performance did provide the foundation for this strong free cash flow performance. As a percent of sales, working capital includes 40 basis points to 12.9% primarily due to strong receivable collections. During 2009, we have purposefully improved our overall liquidity by generating strong free cash flow paying down and terming out commercial paper and strategically deploying capital. So as a result of these concentrated efforts, our net debt-to-net capital ratio has been reduced by over 1,900 basis points from 27.9% to 8.5%. We've paid down $464 million in debt reducing outstanding commercial paper to $225 million at quarter's end. We expect to pay down the commercial paper balance fully by year end. In addition, third quarter cash and cash equivalents now total $1.35 billion with over 75% of this cash currently invested outside of the U.S. primarily in Europe. Another positive liquidity development relates to our updated pension funding projections. We do not currently expect any mandatory contribution to our U.S. salary pension plans prior to 2011. So our strong free cash flow generation and responsible capital deployment activities are building a stronger balance sheet. Turn to Fluid Technology on slide six. Fluid's third quarter revenue declined 10% on an organic basis and this was generally in line with expectations. This performance reflected stronger than anticipated results at industrial process but offset further challenges in commercial markets. Stabilizing conditions became more evident in the municipal and residential markets. On a sequential basis, organic revenue declined 7% reflecting some seasonality. Organic fluid orders declined 16%, but on a sequential basis organic orders increased 1%. The quarter's organic book-to-bill ratio stabilized at 1.0. Fluid's operating margin performance in the quarter was strong once again. Aggressive cost initiatives helped offset volume declines and generated a 90 basis point net operational improvement. However, the total margin declined 80 basis points to 13.1%. This is due to negative impact from higher restructuring foreign exchange and pension costs. Fluid productivity actions remain ahead of schedule exiting 2009 and leading into 2010. At the fluid value center level, water and wastewater revenue declined 5% organically due to weakness in dewatering and slight declines in municipal markets. Organic orders declined 4% due to weakness in EMEA municipals, but they did improve in North American municipal markets primarily due to large pump projects. During the third quarter, we received our first U.S. stimulus-funded orders involving a number of different treatment and transport projects across our entire water and wastewater portfolio. These wins reflect the strength of our portfolio of products that are 100% buy-American compliant and they support our forecast for stable to improving U.S. municipal markets. In total, the water and wastewater book-to-bill ratio was 1.07 for the quarter. Industrial process declined 11% due to continued weakness in North American general industrial markets. However, the revenue performance did exceed our internal expectations due to stronger oil and gas and power results. Organic orders declined 30% compared to a strong prior year. This was due to lower customer investments in large projects across most key end markets served. However, on a sequential basis, organic orders improved 8%. Residential and commercial water, revenue declined 16% and orders declined 20% organically due to global commercial market weakness. Our residential business further stabilized with the second quarter of sequential growth after a difficult first quarter of 2009. For the year, we are continuing to project residential declines in the low-teens. Despite difficult market conditions, we did not adjust our previous commercial forecast. Also, at residential and commercial water, the integration of our recent land acquisition is progressing nicely and is ahead of schedule. We are excited about the future opportunities that this strategic acquisition brings to our fluid portfolio. Now on slide seven you will see the detailed full year key end market forecast supporting the increase in our fluid organic revenue guidance to down 10% from down 12%. The primary driver of this improvement is a more positive forecast in our industrial markets combined with some stability in residential and municipal markets. Total fluid revenue including acquisitions and FX is now forecasted to decline 14%. On slide eight, our Motion and Flow Control segment continued to show strong productivity gains in the face of topline pressures. Third quarter organic revenues declined 16%. This performance was well in excess of our internal expectations, due to stronger results in the automotive market. On a sequential basis, organic revenue was only down 3% primarily due to seasonality. Segment organic orders declined 15% on weakness at Control Technologies and Interconnect Solutions, but that more than offset improvements at Motion Technology. The segment's third quarter book-to-bill ratio was positive at $1.03. Motion Technology's organic revenues and orders declined 3% in the third quarter. Both results reflected increased activity in the European auto market related to various countries automotive stimulus programs. However, weakness in the truck and trailer markets offset these automotive gains. During a difficult 2009 automotive market, our team has continued to gain market share due to our advanced technology, our operational excellence and customer focus. We had new platform wins in the quarter from Ford and Audi, and for the quarter Motion Technology's book-to-bill ratio was strong at $1.11. Control Technologies revenue declined 20% and orders declined 29% on an organic basis due to slowing demand primarily in global industrial and aerospace markets. Interconnect Solutions revenue declined 30% organically reflecting weakness in industrial markets. Orders declined 23% compared to the prior year, but actually increased 14% sequentially. Segment operating margins at Motion and Flow Control declined to 13.2% due to lower volumes, higher pension and foreign exchange. However, accelerated productivity actions and prior investments mitigated the impact of lower volume resulting in detrimental margins in the quarter under 20%. Slide nine includes the latest full year key end market overview for Motion and Flow Control. In total, we raised the full year organic revenue forecast for Motion and Flow at 300 basis points to down in the 16% range compared to the prior year. Total motion revenue including foreign exchange is now projected to be in the down 23% range. The forecast improvements primarily reflect our strong Q3 automotive performances to some stabilizing conditions in the general industrial markets. On slide 10, we have our third quarter defense results. Third quarter revenues of $1.57 billion improved 2% compared to the prior year and were generally in line with our internal expectations. This performance was anchored by the success of Avionics programs in our Electronic Systems business coupled with strong results from our service businesses. In the quarter, our systems business improved 8% with strong performance on Middle East contracts and recent program wins including Maxwell Air Force Base, the Tethered Aerostat Radar Counter-Drug Program and LOGCAP. Advanced Engineering and Sciences improved 5% due to increased activity on various data analysis contracts and the FAA Air Traffic Control Modernization Contract. In the quarter, Communications systems declined 13% as expected due to lower domestic SINCGARS shipments partially offset by stronger international SINCGARS. In addition, shipments of networking and antenna equipment declined compared to the prior year. Total defense organic orders declined 34% due to timing and difficult comparisons to a record prior year. As a result, backlog declined to $4.9 billion. As you know, timing of defense orders can be very unpredictable. For example, just after the quarter closed, we received our largest ever international satellite order at Space. This win provides further validation of the commitment that we have to grow our defense business internationally and that brought our backlog quickly back up over $5 billion and we do expect to maintain that level at year end. Defense's third quarter operating margins was very strong at 13%. This result was 80 basis points better than the prior year due to net cost productivity and favorable product mix primarily involving CREW shipments that more than offset higher pension. Defense operating income grew 8% compared to the prior year and exceeded $200 million for a second straight quarter. So now that we've completed our third quarter operating review, I'd like to discuss the net liability we recorded in Q3 for future asbestos-related claims. The projected net liability primarily relates to products sold prior to 1985 that contained a third-party manufactured part alleged to contain asbestos. It does not relate to a new class of claims or a change in our methodology to process or defend these claims. It is simply a quantification of our estimate of claims to be filed in the next 10 years based on our current experiences and history. Prior to this quarter, we had not recorded a reserve for asbestos claims to be filed in the future. While the likelihood of future claims was probable, until now we did not have sufficient reliable data to estimate future costs. As you know, the accounting rule states that liabilities should only be recorded when they are both probable and reasonably estimatable. So as we indicated in our 2008 10-K and 2009 10-Q, we engaged outside consultants earlier this year to construct a comprehensive database of our existing claims, settlement values and legal costs to begin the cost estimation process. We also utilized a leading provider of liability estimation services to assist in the projection of future incidences of asbestos-related disease in the various industries in which we operated. These estimates were integrated with ITT's historical experiences around key variables, such as claims filed, percentage of claims settled, settlement values, and legal costs. After the completion of a qualitative assessment of the input from various internal and external experts, the data elements were combined into a 10-year forecast of the gross liability from future asbestos-related claims. Our forecast timeframe is 10 years because we believe that it is long enough to fairly represent current trends. Next, we examined the recoverability of various related insurance policies on a year-by-year basis. It should be noted that 63% of the insurance receivable is covered under court-enforceable agreements that we've already negotiated with certain primary insurance carriers. These policies are called coverage-in-place agreements and they typically carry less collection risk than other policies. For the receivable portion related to non-coverage in place policies, we discounted the expected future recoveries based on the expert opinion of legal counsel on a policy-by-policy and year-by-year basis. So the net liability for future asbestos claims recognized in the third quarter is the combination of the10-year future claims liability net of the projected insurance and other recoveries. As is typical of all reserves, we're going to review and assess the adequacy of the existing liability and receivable balances on a quarterly basis. New trends and assumptions will need to be analyzed Also, because the net liability is a 10-year estimate as one-year drops-off, we will add another year of projection over the course of the year. When this amount is revalued each year, there will be a corresponding adjustment to earnings. Lastly, the most important point on this slide is that we do not project a material impact to our future net annual cash flows. This point bears repeating. We've done the work required to project our asbestos-related net annual cash flows 10 years forward and we do not see a material change from our current net cash run rate. Now let me give you some numbers. Over the last three years, our cash outflows for asbestos claims have been in the $10 million to $15 million range. For the forecasted 10-year period, our average net annual cash outflows are projected to be in the $15tmillion to $20 million range. That represents less than 2% of our forecasted net cash from operations. Now, let's turn to slide 12 and look at the balance sheet and income statement adjustments recorded in the third quarter to reflect this net liability from future asbestos claims. On the balance sheet, we increased our existing liability by $662 million representing undiscounted future claims and legal costs. This was partially offset by the $439 million increase in our asbestos-related receivables. So the resulting net liability adjustment in the quarter was $223 million. The $223 million net liability adjustment resulted in a $139 million after tax or $0.75 per share charge. $131million or $0.71 per share of this charge was for continuing operations and was classified as a special item and excluded from our adjusted EPS from continuing operations. Now, there are a lot of numbers here to process from an accounting perspective and we understand that. So we've added a detailed schedule to the appendix of our presentation to hopefully help clarify. Additional details will be available in the third quarter 10-Q that we expect to file soon. So with that, I'd like to now turn to our 2009 guidance going forward on slide 13. As Steve indicated, we've once again increased the midpoint of our adjusted EPS guidance this time by $0.12 to $3.72 exceeding the high-end of our previous guidance range. We also tightened the range due to solid year-to-date performances. The revised 2009 adjusted full year EPS guidance range, excluding special items, is now $3.70 to $3.74 per share. This represents only an 8% decline to the prior year. So here is how you should think about the guidance. We exceeded the midpoint of third quarter guidance by $0.18; $0.08 was driven by exceptional productivity across all segments and $0.02 related to lower interest. We pulled all of this into our new full year guidance. The remaining $0.08 of the Q3 performance primarily related to the timing of restructuring and defense product mix which is a neutral on a full year basis. In addition, our guidance includes $0.06 primarily related to fourth quarter productivity at fluid. These improvements are expected to be partially offset by $0.04 of incremental corporate expenses, new investments and share count. So to summarize, the $0.12 raise included $0.10 of the Q3 performance plus $0.06 of incremental Q4 productivity and interest net of the $0.04 of incremental expenses and investments. On a full year basis, the organic revenue forecast of down 4% remains unchanged. However, we did increase the organic revenue forecast at fluid by 200 basis points and at motion by 300 basis points due to some stabilizing market conditions and strong year-to-date performances. Defense revenue growth is now projected in the 3% range primarily due to timing on key new service contracts and international shipments. For example, expected revenues for both LOGCAP and the NASA Extends Contract, which is currently under protest have largely pushed into 2010. So with that review, I'd like to turn things back to Steve before we begin the Q&A session.

Thank you, Denise. Let me wrap up with a few thoughts. This time of year, there is always a lot of interest in what's going to happen in the future. So I thought it would be useful to just outline at a high level how we see the 2010 environment. At this point, we see the same global GDP forecast out there that I think you all see. We are thinking about the range of a 2% U.S. GDP in 2010, 2% to 3% in Europe and 4% to 6% in the rest of the world, obviously, driven by the emerging markets. So, clearly, we do agree with the general economic consensus that the overall negative momentum in this economy is abating and we do see signs of recovery, albeit at a very measured pace. As you know, different markets in different geographic regions respond differently. So in terms of the markets that we compete in, here is what we're seeing. For next year in the industrial commercial and aerospace segments, we see those markets still under topline pressure. In the automotive residential and marine markets, they are stabilizing nicely. In two of the largest segments in our portfolio, municipal and defense, coupled with emerging markets, those are all looking very solid. So when you add all this up going through the mix of our markets and in businesses, all-in, ITT is leaning towards a modest topline growth again in 2010. This coupled with our accelerated productivity initiatives in 2008 and 2009 are helping us feel a lot better about 2010 earnings at this point. It should be noted that additional productivity and lower restructuring are expected to more than offset some of the non-operating 2010 headwinds we're expecting to see. So when you combine the topline growth, again, with the fact that we've got some substantial productivity and lower restructuring, again ITT will be on a growth trajectory for EPS growth in 2010. So that's a positive statement that I wanted to conclude with, with respect to how we're looking at the future and now we will turn things back to Tom for our Q&A.

Thanks, Steve. Christy, we are ready to start the Q&A session

[Operator Instructions]. Our first question is coming from John Inch with Merrill Lynch.

I want to go back to asbestos. I mean from where I'm sitting, it's a little hard to believe that in September you sort of went radio silent because of the way an asbestos charge. It just seems like a little bit of a red herring. Were you working on a deal that didn't go through or is there still some other backdrop as to why events in the quarter kind of played out the way they did with respect to investor communications?

It shouldn't be hard to believe at all. Obviously, once we understand that an accounting charge could be material, as you well know from FD, we were prohibited from any selective disclosures of that information to investors. I think you need to respect that. But you have to also understand that if we did talk to investors and didn't mention these processes, we could later be accused of having some misleading communications. So, obviously, the most prudent course was to enter a quiet period while this asbestos liability was being finalized. Let me make a broader comment with respect to the intimation underlying your question, John.

Sure.

Notwithstanding this quiet period, you know as a matter of policy, we don't comment on rumors or speculation. Even though, we were aware that there was some misguided speculation out there during the past few weeks of the quiet period, we did not feel inclined at all to comment. Now I can say that today, we're not in a quiet period and I want to say, today, that the only reason we extended our blackout period beyond that normal timing was because we were in the process of completing our work on the projected asbestos liabilities that we just announced.

Can we switch then to defense? Book-to –bills, $0.81, it's really sort of a two part question in defense. So with the trend of book-to-bill, Steve and Denise, and I guess SINCGARS is down 13%, why do you feel still good about the trajectory of the business? Is it because of the $ billion or just maybe a little bit of color, because obviously the book-to-bill peaked right a year ago. Do you still expect it to kind of move in this trajectory or how would you like us to think about it?

So, John, let me just answer specifically about Q3. Defense orders, as I said, they can be very, very lumpy. In fact, Q2 was up significantly, Q3 down significantly, if you look at our defense orders on a year-to-date basis, we're down about 2%. But we expect for the year that we're going to grow orders on a full year basis and we expect our backlog to end above $5 billion at the end of the year. So I just wanted to give you that perspective from an orders and a backlog standpoint. Steve, you may want to comment going further.

Yeah, John, I think that is an excellent question and it's obviously central in terms of how we're thinking about our defense portfolio. So allow me a moment to just put the whole topline situation in perspective with defense. I think there is a general feeling that we obviously are going to be coming underneath some topline pressure in defense as we go through these budget cycles. As we have communicated with Secretary Gates in President Obama's last budget, remember that we're interpreting that in our business because of where we play as a slight positive for ITT on a relative basis. So all in, we feel like we're in a relatively good position. But we have also planned for and completely understand that there are some components of our Defense portfolio that will be going down at least in a short cycle period. Among them are our domestic SINCGARS for the U.S. military. We are planning for that to be down next year. Also, the CREW 2.1, primarily because of the extraordinary pull in this year that we did to accelerate getting that vital product out to troops, we're also expecting the CREW 2.1 to be down a bit next year. To the other side of your equation I want to highlight that our space business around GPS 3 satellites and environmental satellites is going to be up. Our air traffic management business at Advanced Engineering is going to be up. Our system business is enjoying some strong wins with expectations on LOGCAP base operations and that's going to be up. We have some other jammer programs around some very special operations that is providing a huge increase in our IIW business and that's going to be up. The night vision business which is fully in backlog for the next two years around enhanced night vision goggles is going to be up. Our precision approach radar business in Electronic Systems is going to be up. Our international SINCGARS in the Communication business next year is going to be up. So when you add all that up, we absolutely feel very strong about seeing a small but yet nonetheless continued growth trajectory. The defense orders, as Denise mentioned, are only down 2% year-to-date and we expect orders to finish in the middle single digits for the full year ending a backlog slightly greater than $5 billion. So we've mentioned to you on many, not to you John but to the whole team here, that where we play and the kinds of things we've done with our investments to migrate some of our businesses into adjacencies, the value of our technology investments coupled with a great team, you know we really feel like our defense business is continue to be solid.

Just lastly what kind of restructuring, Denise, do you expect for the fourth quarter? I think you did seven or nine this quarter. That was a little lower than we thought. What do you expect for the fourth quarter?

For the full year, John, we're looking at about $80 million, so that would imply that we're looking at about $35 million for the fourth quarter.

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

Just wondering if you could elaborate or perhaps, Denise, elaborate on just some of those non-operational headwinds you mentioned. I guess specifically I would love a little insight on 2010 restructuring spend 29 expected benefits from '09 spend and anything you can give us on pension as it relates to the P&L. I understand your comment on cash already. Thanks

Let me give you a perspective on that. So, when we look at 2010 and we look at those non-operational items you think about restructuring. We've got about $80 million in this year. Normal run rate for us is about $40 million to $50 million. So you can assume a number like that for 2010. When you then add to that benefits we may see from our foreign exchange standpoint, you then think about our pension and the fact that we do expect to have incremental pension expense on a year-over-year basis. We think in terms of asbestos, we're going to have some more expense next year than this year, and you net all that out, you'll get basically flat on these non-operational items on a year-over-year basis. You also asked about the particular benefits that we're getting from the restructuring actions that we took in '09 and what that incremental benefit would be in 2010. So those actions that we took in 2009 we'll get some savings this year and then we'll get some savings next year. The incremental benefit of that we estimate to be around $35 million or so.

On pension can you just give us some, I mean understanding they all offset maybe in a big bucket, but really rough order magnitude, what kind of pension headwind are you looking for?

It's early right now. If you assume the discount rates, the same discount rates that we had at the end of last year and that was at about six in the quarter, it's roughly about $0.15 for us.

Steve, notwithstanding your very clear comments about what's been going on, you do kind of look loaded for bear from a capital availability and liquidity standpoint. What is your current view on that M&A environment and M&A opportunities? How we should think about cash redeployment here as we maybe move into a more stable looking world in 2010?

As part of our strategy for winning in the new economies, we obviously, went into this economy with the idea of continuing to build and preserve a very strong balance sheet. So I appreciate you recognizing that. We do have good cash. $1 35 billion on hand right now We paid down in the $400 million range of commercial paper and termed our debt. So, when you look at our ratios we do agree that we're in pretty good shape. We're optimistic about acquisitions. Our acquisition strategy has not changed. We do have a strong and active pipeline. We are looking in core areas obviously. Then in the other adjacencies we've got a lot of activity that we're looking at areas, such as building on our fluid business in dewatering building on our fluid business in analytics and monitoring control technologies. We are looking at some rail and aero opportunities. On the defense side, obviously we're building significantly some cyber technology today and that's of interest in the future. Air Traffic Management is also a solid platform for us, as we build on our ADS-B next-gen program and in other areas in communications. So, right now the acquisition environment is starting to turn a little more favorable. We're hopeful that we'll be deploying some of this capital we've reserved over the next year.

If I could just to understand the asbestos, because Denise you were kind of alluding to asbestos going through the P&L going forward. So I just want to understand that? So your future asbestos spending is not offset by a reserve uses today, but there are some going forward P&L impacts?

Let me explain how this will work. So, there are two components to think about. As we go out into next year what we need to do since we have a 10-year estimate on these future claims, as we drop off a year, we will need to add a year. So, we will see that impacting us on a year-over-year basis. The other thing is we will look at the assumptions that we have embedded within the estimates that we have, and we will determine if there needs to be any true-up associated with that. So that could be something else. It could be positive or negative for us. But, when you look at that first piece of it and adding that other year we estimate that, that will be relatively small on an annual basis for us.

Your next question comes from the line of Shannon O'Callaghan with Barclays Capital.

Steve, you talked about and Denise both of you I think when you talked about radios, you had said as expected domestic radios down. Communication systems was down about 13% in the quarter I mean is that the right order of magnitude when you're talking about declines in the next year, I mean is that how that piece of your business I know it's in the all radios, but is that a proper assumption for communication systems?

No, not quite I mean we're going to be off next year in the domestic SINCGARS. We are expecting some increase in our international sales. We've also had another large order internationally that has been somewhat enigmatic with respect to timing. So all in, we do not expect the communication business to be off quite that much, but it will be off a bit. Now the one thing I did want to point out got back to this question about the backlog as our domestic SINCGARS backlog is filled in our plan well beyond 2010, in fact almost through 2011 now. So we've got a really nice position in terms of what we expect from the domestic SINCGARS.

I'm just trying to think through defense a little bit, I mean you put these different buckets with things under pressure things that are solid and defense was solid. So I mean if all the topline is going to be up slightly next year, it sounds like this defense would be a little better. When you think about some of those pieces it doesn't necessarily sound that way. I'm interpreting defense as being better than the average growth of the company next year or inline?

No, we're still detailing that, but I'm intentionally not giving you the revenue numbers because, we really haven't finalized them. If you'll listen to what I said the ups outweigh the downs, that's why in terms of what we are looking at. So we are getting a mix shift in defense and we're also driving for some additional productivity in defense, we're still detailing it. The message I wanted to leave you all was with respect to your concerns on the defense budgets and how it impacts ITT is that, we see defense as having another solid year next year.

On the industrial process business can you give us a little more color on what you saw get better there and why you're encouraged?

Yes, the main driver on the industrial process side is really what we are seeing on the oil and gas side of the business, a little bit on the power side. But it's really driven by the oil and gas and the activity levels that we're seeing there. We're seeing good activity levels in terms of bids and quotes and proposals coming through. So, that's actually much better than what we thought, a lot of that around the Middle East area, but that's what's really driving them.

Let me just ask one question on the communications during the quarter as well. I mean can you just flush out a little bit more for us your understanding of your materiality and what that does to you in sort of constraining your communications? I mean it was not material you're saying on a 10-year cash basis to your cash flows, but clearly a material item in the quarter. Can you just give us a little understanding of why you took the approach you did around that?

I'll just repeat that, materiality is defined in GAAP in terms of what constitutes materiality, but I think the more prudent advice that I want to offer is that when you sit on our side of the table we're playing a high stakes game here with respect to the credibility and consistency of our external communications. As you know, it is extraordinarily important to us to maintain the proper level of visibility and transparency. But when we have activity inside the company, which all companies have that could be material we have to err on the side of caution with respect to external communications, which is the guidelines we get from the SEC and from GAAP. So, I understand the nature of your comments. But upon knowledge when a management team has some knowledge that there may be some material impact, the US law tells us to stop talking to people, and that's exactly what we do.

Was the estimate finalized very recently such that you couldn't sort of pre-announce an item like that and then move forward?

It was just finalized this week actually. This is a very extensive process that you have to go through when you try to assess what this future of claims to be, you've got not only the liability side of it, you have the insurance side of it. So, we've been working this number and this estimate for a period of time right now and at the point that we thought that it could potentially be material was when we went into the blackout period. But it took us this period of time in order for us to actually finalize that number.

Your next question comes from the line of Deane Dray with FBR Capital Markets.

Can we stay on this asbestos topic if we could, Denise I'm still not clear on what triggered the calculation that you could now estimate your 10-year liability. Was this an increase in new claims a resolution of claims, it didn't look like through mid-year your new claims activity had spiked. So what was the triggering event?

Yes. So as we indicated in our 10-K and in our 10-Q while we knew that it was probable that we would have some of these future claims, we could not estimate what the cost would be associated with that. The reason we could not estimate it is because we were not actually administering these claims up until the past a year to two years. So, we had to develop a database, so that we could look at that and then project what we thought what this estimate would be. So it was really that work that was taking place and we had indicated in our 10-K that this work was underway and that we were hoping to complete it in the second half of 2009 which is exactly what we did.

Denise, I don't understand when you say you were not administering your claims. Was this done through a third-party service?

It was done through our insurance carrier. We then entered into these agreements with these insurance carriers and at that point in time we took over the management of these claims and the legal administration of these claims.

Yes, Deane, I want to add a couple of points to that, that there was no change in terms of company's exposure to liability. It is just one of these accounting principles that you get to a point of having a database at which you actually can make a reasonable estimate. So we're not forecasting any new claim types or any new exposures, but just the process of us taking over some of the claims administration and getting the coverage, in place agreements with the insurance companies was really the point at which and this was a two-year or so process. But the point at which we actually got the visibility where we could make the forward-looking liability projection.

Have you considered putting this liability into a 524(g) trust? Is that still a possibility?

Yes, we know that that's been done in the past. We have no plans to do that. We feel very comfortable with the strategy and the legal strategy that we have in place. We address these cases on a very individual-by-individual basis. We've been very successful with that approach. We will continue to do that. So, we have no plans and we don't feel that we need to create this trust.

What were the new claims in the quarter and will you be disclosing that on a go-forward basis?

All that disclosure, you will see a lot of disclosure on this issue in the 10-Q, Deane, so, I would encourage you to read it. Then we'll be happy to answer any questions that you have, but it's very detailed in the 10-Q.

Just to make sure you've cleared that your liability in terms of number of claims hasn't changed but you did comment on your insurance recoveries. Going through that stress test in your primary carriers did you change any of your receivable assumptions?

What we did when we estimated that insurance receivables. We first looked at the coverage-in-place agreement that we have. Those are court-enforceable documents and that insurance receivable about 60% 65% of it is associated with those coverage-in-place agreements. We then went carrier-by-carrier, policy-by-policy, year-by-year, and we looked at each one of our other carriers and we made a determination as to what we thought the coverage would be going forward. So it was through that process and we engaged internal people and external people through that process that we then came up with our estimates.

Did that estimate change versus your previous estimate and brought insurance recoveries?

Well, this estimate is associated with a 10-year timeframe. We did not have a previous estimate on that. So it was through this process that we created that estimate.

Your next question comes from the line of Nigel Coe with Deutsche Bank.

Just wanted to just re-hone it in on that mix because it looks like some of your EBITA margins, talking approximately down next year [compensated] by LOGCAP and ADS-B, which is lower margin. Just wondering how does that mix gel with the productivity you talked about, I mean should we expect margins to be down next year?

Nigel, great question again because you're right some of the businesses I mentioned coming down tend to be higher operating margin not exclusively, some of those that are going up are also nice margin. But I think it's safe to say that any time you're expanding and growing in adjacent markets, you tend to have mix going negative for you. That's just a principle of business management. So offsetting that does to your point have to be increased productivity. Our expectation is that we'll see some earnings growth in defense next year as well, moderate but nonetheless, we expect to see it. So, when we get closer we're going to have a phone call in December with everybody when we will have detailed the plans. We have not actually detailed the plans right now. We're going through that process now. I'm just trying to give you some early visibility. But, to the point of your question we'll understand the negative mix, there's a little bit in there. The defense team is working extremely hard to drive some productivity to see if we can't put out some modest earnings growth next year.

In order to capture that productivity do you need to do some structuring in defense because obviously you haven't done any structuring so far in defense?

I don't have the answer to that. The productivity in defense is a little bit different. We will achieve that a little bit differently than we achieve that on the commercial side. So, right now we're just working our way through what the requirements may be. Remember speed really matters a lot in defense and alignment of your deliverables to your program schedule. So, there's a couple of different ways you can get productivity. We'll fill you in on that in the December timeframe.

Then, Denise, I hate to flog a dead horse, but on the asbestos, I think you said in your prepared comments that 15 to 20 of cash flow surrounding it seems in the calculation, yet the experience has been more like 10 to 15, just wondering why you're seeing the step up in the cash claims?

Again, that was an estimate over our 10-year timeframe, so you will see a little bit of variability on a year-over-year basis, and you will have some inflation that you factor into for that 10-year timeframe. So it's really the inflation piece of it and the fact that you're looking at it over a longer period of time that just gives you that difference, again not significant.

Then once you pay off the CP which I assume is remaining in the US does that mean you have more US free cash flow that maybe you can think about buybacks going forward?

Well, we will have more US cash flow, now. We look very hard as where we're going to deploy our cash. We look at organic investments that we want to make in order to grow the business as Steve talked about from an acquisition standpoint, we look at that. We have dividends. Share repurchase that has been part of our capital deployment process. In the past we've not been actually in the market around that at this point in time. So, those are trade-off and decisions that we just make going forward. But at this point in time from a share repurchase standpoint, we've not been active in the market.

Then just one final one for me on the defense backlog, were there any significant contract close-outs during the quarter?

Contract close outs, any significant contract close outs...

Like a wind down of a contract?

Nigel I'm not aware of them, but I'll tell you we'll have Tom follow up with you on that one. I'm not aware of any big ones.

Your next call comes from the line of Steve Tusa with JPMorgan.

When you look at the defense business the 13% margin you guys did despite the SINCGARS being down, which I think you talked about as being negative mix and you said favorable programs drove that. Could you maybe just describe what else was going on there because it was a pretty good margin?

Steve it was very simple, it was CREW. So we had strong margins on CREW in the third quarter When we talk about mix it was really the fact that we had more CREW in the third quarter and we're going to have as opposed to some services business got pushed in the Q4. So, that's why we had a 13% margin in Q3 for defense.

Earlier in the year the defense ramp looked a little bit unrealistic and you guys talked about international orders being kind of the key to hitting the targets, I guess you're taking it down modestly. Did those orders not come through maybe I didn't catch it in the beginning of the call? What is the reason again for the modest sales reduction this year at defense?

There is international in there, but you have to remember that there are in terms of our NASA contract that, that has gotten pushed out because it's in protest by the incumbents. So those revenues are going to be coming in later then what we had anticipated. Also with our LOGCAP contract it's just been delayed in terms of more revenues coming through on that portion. So, those are two items that will get pushed out into 2010. We are still looking for some international orders.

Then one last question just on the fourth quarter order number I think it's a little bit north of $2 billion is that right that you're looking for in the fourth quarter?

For defense that's correct.

It's pretty strong growth relative to I think a very strong number last year. Are we going to be seeing some big ones come across the tape here over the course of the next couple of months?

One of the things to think about is when you go from Q3 to Q4 our systems business tends to get funded a lot in Q4. So we're going to see that flowing through the Q4 number. So that's probably your biggest variance at least when you think about it on a Q3 to Q4 basis. So we just get a lot of that funding that occurs in Q4.

Your next question is from Gautam Khanna from Cowen and Company.

Yes, you mentioned a lot of potential market areas you'd like to address via M&A. But could you characterize the more promising opportunities in your pipeline with respect to which market areas they might address, potential size and valuations you're seeing?

Gautam, I think I did. I think the areas that I mentioned are indeed the areas that are the most promising from market attractiveness. When we look at M&A activities, first of all we look at where we are, where we play, so it's always safer to build off of capability and the business model similarities that you already have. Then we look at market growth rates. We look at market size. We look at competitive concentration. We look at operating margin capability as a function of technology and so forth and those markets I mentioned, dewatering, analytics, rail aero, cyber, air traffic and communications, are those areas that we do find promising. One of the nice features of a company like ours is that we can play in multiple markets. But it's important that where we play, we play with business models and technologies, certainly related to what we do. In that list I'm proud to say that we already have businesses in those markets already today. So, we're really talking about building out stronger platforms in areas that we already enjoy today.

I guess what I was trying to ask was with respect to your near-term opportunity pipeline things that are relatively close, where do those acquisitions fall by segment and how large might they be?

I think I answered the question. We're working on all of them.

Fair enough. I'll move on.

The size is really proportional to the targets. But quite frankly, the size ranges, there's a wide variety of sizes that we're looking at.

With respect to your CREW deliveries, what is your current unit backlog on 2 1 and how many did you deliver this quarter?

Well I can tell you that the delivery for the year is in the 9,000 range. We would up significantly over the plan period because the US government really needed to accelerate getting that jammer into the theater because you know it's been spectacular in terms of its effectiveness in jamming roadside bombs. We've got about half of the CREW backlog for our planned production in 2010. We'll give you an update on that when we look into the overall defense plan. But what's important is that, there is two subjects here. One is the CREW 2.1 program and the other is what we would say is the Counter-IED business platform. Now, remember the CREW 2.1 is the significant program that we are shipping, but we also have a very strong opportunities in, shall we say, irons in the fire in a band-C upgrade in the CREW 3.2 and 3.3 technology developments. We are selling the CREW 2 1 into international markets. As I mentioned, we have a very substantial jamming position with some special programs. So all in, you have to add up all of that, but we've really got a broader based technology platform in this kind of sensing and transmission technology. So that's why we continue to feel good about this for the future, albeit, CREW is not the whole story.

Your last question comes from John Baliotti with FTN Equity Capital.

Denise, with regard to pension just give us some direction as far as where it's coming from or will that be in the Q as well?

I'm sorry, John, was the question around pension?

I'm sorry, it's asbestos. Where is that residing in terms of the segment? Is that going to come out in the Q or are you able to give any color as far as where that legacy exposure is?

Okay. Sure. So you mean where the charge will be. It will be in corporate, John.

No I mean like which businesses are carrying that? In other words, where's the exposure emanating from?

So the asbestos issue is around our pump business. It will actually be recorded in corporate.

On the defense margin you mentioned that the CREW deliveries had delivered a lot of the boost year-over-year in margins, systems were also up and I'm just wondering, I know you guys have talked about keeping us framed around a run rate a lower margin than what you have today. But is the cycle improvements and productivity improvements there that are just ongoing? Are you seeing that edge the long-term margin up in defense? Because I know that depending on any given quarter, services are stronger than product. That's obviously going to weigh on the margin. But it seems like if you look longer term, the margin continually to steadily progress upward?

John, we're still looking at a long-term margin about 11.5% to 12%. So, yes, we always drive for productivity. We get a nice amount of productivity within our defense business. As you indicated, you also have that shifting mix that occurs within the portfolio between products and services. So you really have to look at that in total and we still think that longer term, that's about 11.5% to 12%. So that's the range you should be thinking about.

It seems like since second quarter, there has been about $400 million or $420 million of contracts that we can track. Does that sound about right? I know that you only track the fully funded portion of the backlog, but that seems like it's still a steady flow that's been coming in since the last quarter. Does that seem about right?

Yes. That's right, John.

Just finally on the cost savings that you're talking about for next year is there a way to kind of divide them between how much you think is structurally out of the system versus what might come back if we get some volume improvement in the portfolio?

Sure. Most of the productivity improvements that we're seeing this year aligned around actual structural changes that have occurred in the business. So we're going to be very prescriptive around not allowing costs to increase as we get volume increases coming through here. Now, there will naturally be some that will come through. We also know that there have been some actions that have taken place around furloughs and travel and those things, some of that will come back. But that is relatively insignificant when you look at the total size of the restructuring benefits that we've actually achieved.

Okay, Christy, I think we're all done with the Q&A session.

I'll turn the floor back over to Mr. Steven Loranger for closing remarks.

Thank you all for your interest in ITT. 2009 has really been another important year of strategic growth and we feel good about the fact that notwithstanding a really tough economy that we certainly had to address in terms of a lot of restructuring and footprint activity, we have continued to make some significant investments in growing our markets and making some nice strategic advances in the architecture of our business around global footprint and consolidating some of our sourcing initiatives. So as we're turning the corner in this economy, we are feeling a lot better about the future. We went into this economy with the idea of building balance sheet resetting the cost position of the company and increasing our strategic investments for growth. We think that we've substantially accomplished that and we think that it is giving us a nice platform for future growth. On the subject of the asbestos charge, I do want to comment that there is a complex accounting activity and we do understand the question. We have done a very substantial job of disclosing the details of that in the 10-Q, so please take an opportunity to read that, but if you have any questions, give Tom Scalera and his team a call and I will work with you through any additional questions that you may have. So with that, I just want to say thank you all for your interest and we'll talk to you in the next couple of months.

This concludes today's teleconference. Please disconnect your lines at this time and have a wonderful day.