ITT Inc. (ITT) Q2 2010 Earnings Report, Transcript and Summary

Good morning. My name is Wes, and I will be your conference operator today. At this time, I would like to welcome everyone to the ITT Corporation Second Quarter 2010 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Mr. Tom Scalera, Director of Investor Relations. Please go ahead, sir.

Thank you, Wes. Good morning, and welcome to ITT's second quarter 2010 investor review. Presenting this morning are Chairman and CEO, Steve Loranger; and Chief Financial Officer, Denise Ramos. I'd like to highlight that this morning's presentation, press release and reconciliations of GAAP and non-GAAP financial measures can be found on our website at itt.com/ir. As always, 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 Form 10-K, as well as our other public SEC filings. And now let me turn the things over to Steve.

Good morning, and thank you, all, for joining us. Let me start by sharing some exciting news that we just received. Our Information Systems business just won two contracts totaling $800 million to provide facilities operations, maintenance and training services in both Northern and Southern Afghanistan. As part of our strategy to expand our Information Solutions business into new areas, we're really pleased that both contracts were awarded by a new customer for this business, the U.S. Army Corps of Engineers. So we're really thrilled to initiate a long-term relationship with the Corps and further, we're going to continue some ongoing work to explore some future opportunities with our Fluid Technology business in the Corps, which is the world's largest provider of environmental engineering solutions. Today, we're also announcing our plan to divest CAS, the $240 million SETA or Systems Engineering and Technical Assistance business in our Defense segment. This divestiture will reduce the potential for future OCI or organizational conflicts of interest. CAS, as some of you know, is an outstanding business. However, as we continue to grow our Defense & Information Solutions business in adjacent growth areas, CAS will be better positioned for growth with another company. As a result, CAS' financial results will be now presented in discontinued operations and will not be reflected in continuing results or our future guidance. Turning to the second quarter. We're once again pleased with ITT's strong productivity and solid operating margins, and we're making substantial progress realigning our portfolio of essential products and services. Our second quarter adjusted continuing EPS of $1.14 exceeded our expectations by $0.10 per share, and it represents a 9% growth compared to the prior year. Our Motion & Flow control business once again delivered exceptional performance with significant increases in orders, revenue and operating income. Our Fluid Technology team delivered solid margin expansion with outstanding productivity. And we're continuing to see stabilizing market conditions across our commercial businesses, which was validated by very strong order growth in our organic segments. Our Defense business delivered improved productivity and lower expenses, which were enabled by the defense transformation our strategic realignment. Organic revenue declined 3% in the quarter, but that also exceeded our expectations. Our strategy and defense to expand in adjacencies continues to work for us as we leverage the diversity of our businesses to offset declines in some of our core products, mainly the U.S. SINCGARS [Single Channel Ground and Airborne Radio System] and the crew. The weaker Q2 orders reflect timing shifts, either into the second half of 2010 or deferrals into 2011. So as you think about the year, we recalibrated our Defense sales down by about $500 million. But keep in mind that half of this adjustment will relates to the discontinued CAS business. The other portion primarily relates to an Iraqi SINCGARS order that was deferred into 2011. By way of background, you may recall that we were awarded this contract in 2008, and we have already outfitted 3 of 11 Iraqi battalions. But despite the vital need for this equipment, future turn ons of this contract are now expected to be delayed. But the important takeaway here as you're reflecting on our Defense business is that nothing has fundamentally changed in the architecture and in fact, our strategy to drive adjacent growth is accelerating. So keep in mind when you're looking at the backlog that our Q2 funded orders and backlog statistics do not reflect $2.2 billion of recently awarded long-term service contracts with the FAA, SE2020 program and the Afghanistan North and South contracts. So in total, we delivered a very strong second quarter and a focused execution of our global teams, combined with the improving conditions in certain end markets, gives us confidence in our ability to deliver a solid second half in 2010. This performance positions us to fully offset the full year $0.11 impact from our recent portfolio positioning activities. So as a result, we're raising our full year operating continued adjusted EPS and we're growing this EPS by 11% now in 2010. And keep in mind that this performance follows a best-in-class EPS result in 2009, which all results in a records earnings performance for 2010, our best year yet. Turning to Slide 4, you can see that 2010 has been an exciting year for ITT as we continue to purposefully execute our strategy to reposition this portfolio. Following the first quarter creation of ITT Analytics after the Nova acquisition, in the second quarter, we announced an agreement to acquire Godwin Pumps and we acquired Canberra Pumps in Brazil. These investments will total $1 billion, and we greatly expanded the scope, reach and technical capabilities of our Fluid Technology segment. The Nova acquisition provides an attractive entry point, indeed an adjacent growth platform that we've been targeting for years. And after a couple of months of working together, we're all thrilled with the growth opportunities that we see with ITT Analytics in the water, wastewater, industrial process and nutrition markets. We're also pleased that Nova is already exceeding our expectations for 2010. Godwin Pumps will further expand our global position in water, wastewater and industrial processes. Godwin's a leading supplier of automatic self-priming portable pumping solutions, servicing attractive segments in industrial, mining, construction, municipal and oil and gas. Godwin Pumps is a great compliment to our existing Fluid Technology portfolio, and with Godwin, we expect to establish ITT among the leaders in a growing $3 billion global dewatering market. We've also been very active increasing our presence in emerging markets and Canberra Pumps expands our footprint in Latin America, enabling us to provide more products to the growing oil and gas and mining markets there. On the Defense side, for the past four years in anticipation of budgetary pressures, we've been very aggressively penetrating new customers and adjacencies. As a result, we have successfully grown over 25% or $1.5 billion of Defense revenue outside the U.S. armed services budget. So as we see budget pressures in our core DoD areas, we're pleased with the offsetting progress we're making with important customers, which include, of course, NASA, FAA, Department of Homeland Security and numerous international customers. So as we rebalance our revenue mix and increase our leadership positions in growing markets, this year's transactions will add nearly $400 million in revenue to one of the largest fluid business platforms in the world. As a result, the commercial rating of our portfolio increases to 46% of our revenue base, up from 42% at the beginning of the year. And if you divide our Defense segment into an armed services and non-U.S. armed services components, you're going to now see that our aggregate commercial and non-U.S. armed services mix is now 60% of our portfolio. And just a final note, since the EPG [Electrical Products Group] Conference, many of you have asked about how we plan to execute the portfolio repositioning strategy, and I think the best answer to these questions are really pictured in this slide here. We're going to continue to make organic investments and acquisition in markets where we already have a solid foundation. And these, as we've mentioned, include analytical instrumentation, air traffic management, dewatering, fluid, and most notably, treatment and global solutions, as well as cyber technology. And as you know, these are all solid businesses that already exist within ITT today and these markets align nicely with enduring and essential global trends. So the result of this strategy will be a rebalancing of our business portfolio and our end markets. And as some of these growth platforms reach a critical mass in the future, we then will move to expand the reporting unit visibility accordingly. So with that summary, I'll turn it over to Denise to discuss the specifics of the quarter.

Thanks, Steve. Slide 5, you'll see that second quarter 2010 revenues improved 1%. When you exclude the positive benefits from acquisitions and the negative impacts from foreign exchange, our organic revenue was flat. In total, this performance was consistent with our expectations. The mix was slightly different. Defense was in line, Fluid was down due to the European Municipal weakness and Motion exceeded our strength across all their end markets. Motion & Flow Control 21% organic growth, reflected recent share gains and improving end market demand. In Fluid, organic revenue was down 4%, mostly due to difficult comparisons in our Late Cycle Industrial Process business, as well as weakness in our European Municipal business. However, this trend is expected to turn positive in the third and fourth quarters of 2010. Total organic orders declined 22%. Defense declined due to difficult prior-year comparisons and delays in deferrals in contract timing, but commercial orders were very strong. Motion & Flow improved 70% and Fluid improved 15%. Segment operating income improved 7%, and margins improved 80 basis points due to operational productivity from global strategic sourcing, restructuring and our Lean Six Sigma activity. Year-to-date free cash flow of $250 million was ahead of expectations, and it is in line with our full year target conversion of 100% of net income. Our balance sheet remains strong. We have $844 million in cash. We have a net debt to net capital ratio of 13.4% and that does include the funding of the Q1 Nova acquisition. It does not yet include funding impacts of Godwin or the future proceeds from the CAS divestiture. And then lastly, our adjusted continuing earnings per share, when you exclude the discontinued CAS business, grew 9% to $1.14 per share. This also excluded an $0.08 net benefit from the completion of a prior-year tax audit. Turn to Slide 6, and we'll talk about Fluid Technology's second quarter results. Total Fluid revenues improved 1%. When you exclude favorable foreign exchange and acquisition benefits, organic revenue was down 4%. But on a sequential basis, organic revenue improved 13%, reflecting some seasonality. Residential and Commercial Water grew 2% organically due to stabilizing global residential condition and minor restocking in the commercial building markets. Water & Wastewater declined 1%, as strong global dewatering and double digit U.S. treatment growth was more than offset by European Municipal softness. Organic revenue in industrial process was down 16% due to lower oil and gas and mining project activity that was compared to a very strong prior year. However, this result did exceed expectations as performance in the high-margin Aftermarket business improved nicely in the quarter. Fluid operating income grew 16%, and operating margins expanded 190 basis points on 100 basis point of operational productivity. You know, these improvements reflect the benefit of very aggressive restructuring actions and expanded global strategic sourcing activities that more than offset cost inflation and mix. Fluid organic orders grew 15% in the quarter, and the book-to-bill ratio was 1.07 due significant improvement in industrial process and Water & Wastewater. Organic orders at Industrial Process grew 20%, and the book-to-bill ratio was 1.07. The strength was due to improving aftermarket demand and strong oil and gas and industrial project activity. IP's orders in Latin America grew 68% in the quarter and showed further benefit from our second quarter acquisition of Canberra Pumps. Canberra will help Fluid drive growth in Brazil's oil, gas and mining industries. And In addition, we plan to introduce Fluid's leading-edge technologies to Canberra's existing product portfolio to better serve our growing Brazilian customer base. Water & Wastewater's organic orders expanded 15% due to Dewatering, U.S. Municipal and some large global treatment projects. It more than offset weakness in European Municipal, and Water & Wastewater's book-to-bill ratio was strong at 1.12. On Slide 7, let's take a look at the Godwin acquisition that we do expect to close during the third quarter. So Godwin Pumps is a great complement to our existing dewatering portfolio. ITT's combined Dewatering worldwide business will enjoy over 15% market share and it will represent nearly $465 million in annual revenue, with very significant future growth prospects. Dewatering, which is the removal of unwanted water and other fluids, is an attractive adjacency for us because dewatering is driven by climate and regulatory drivers. It's highly fragmented and it services attractive end markets that we know very well like mining, oil and gas, construction, industrial and municipal. So why Godwin Pumps and why now? Well, Godwin has a history of strong financial performance and a solid reputation in the industry. They have complementary products to our existing dewatering portfolio, including their automatic self-priming portable pumps, and we do see significant geographic expansion opportunities to bring Godwin's capabilities through our global distribution and customer networks. We expect the Godwin acquisition to close in the third quarter, to be dilutive by $0.04 in 2010 via transaction costs and purchase accounting adjustment, but we do expect this business to be nicely accretive in 2011. Now let's turn to Slide 8, and let's review another extraordinary quarter for Motion & Flow Control. Organic revenue grew 21%, with each business generating double digit growth in the quarter. Flow Control expanded 33% due to a 40% improvement in marine and a 20% improvement in beverage. Interconnect Solutions grew 25% due to improved demand across all end markets. The performance was led by triple-digit growth in the handheld communication market. And Motion tech delivered organic revenue growth of 19% that reflected benefits from recent share wins and the European automotive stimulus. So Motion & Flow Control operating income improved 27% due to benefits from the higher volumes, expanded productivity actions and lower restructuring costs. Their operating margins improved 90 basis points in total, and excluding certain costs associated with product transition, operating margins would have improved over 250 basis points. Motion & Flow Control's organic orders improved 17%. The 62% growth at Interconnect Solutions reflected strong demand across all served markets. The 30% increase at control technology reflected industrial and aerospace demand outside of Europe. Motion Technologies' orders declined 16% due to expiring European stimulus programs. However, Motion Tech continued to win global platform in both auto and global rail. The auto wins included BMW, Renault and Opel. As a result of our strong Q2 performance and the generally positive demand indicators across most end markets served, we are raising the full year Motion & Flow Control segment's organic revenue forecast from 7% to 18%. At year end, our growth in both the automotive and aerospace market is projected to be in the high single digits and in general, industrial, we are forecasting in the high teens. Defense & Information Solutions' second quarter results are on Slide 9. Defense's organic revenue declined 3%, which was right in line with our expectations coming into the quarter. Geospatial revenue grew 14% due to a 26% improvement at night vision that included triple digit international strength. Second quarter international night vision customers included Israel, Canada and Norway. Information systems improved 3% due to expanded activity under the LOGCAP contract and the FAA next generation air traffic control program, ADS-B. Electronic Systems declined 12% due to anticipated reduction in U.S. SINCGARS and CREW 2.1 productions. These were partially offset by increased sales of special-purpose jammers, radar systems and composite structures. operating margins expanded 10 basis points, benefiting from 100 basis points of operational improvements that were partially offset by pensions and $7 million of restructuring expenses. The benefits associated with the Defense transformation are already exceeding our very aggressive plans. Our current annual gross savings target from the Defense restructuring and cost-containment actions is $110 million. So achieving this goal will drive an incremental $60 million of benefit into 2011. Organic orders decline due to the deferral into 2011 of radio and jammer equipment orders and timing delays of service contracts and jammer upgrade that are now expected in the second half of 2010. In addition, the prior year included $500 million of radio and special-purpose jammer orders, which again underscores the lumpy nature of quarterly Defense orders. Based primarily on the international deferrals and the adjustment to eliminate the $100 million of backlog associated with the discontinued CAS business, we now forecast year-end backlog to be in the $4.5 billion to $4.7 billion range. In the Air Traffic Management area, we were awarded a $1.4 billion system engineering 2020 contract in May, that is to conduct development work across all dimensions of air traffic control, including ground systems, aircraft systems and safety security and environmental standards. We also recently announced the commercial availability of real-time U.S. air traffic data to customers such as airlines, airport operators and companies. It's interesting to note that the $2.2 billion of long-term services contracts that we've recently won will have minimal impact on our backlog and order statistics in the future. And that's because we only include fully-funded orders in our backlog and these awards will typically find in six- to 12-month increments. Now let's turn to Slide 10, and let's walk through our revised 2010 EPS guidance. Let's start by reviewing the Q2 performance. So in the second quarter, our adjusted EPS of $1.14 per share exceeded our revised continuing EPS guidance, adjusted for CAS by $0.10. And that was due to $0.06 of operational strength from all segments and higher volume at Motion. Corporate taxes and share count were also favorable to expectations. Now let's talk about the full year. Our new 2010 adjusted EPS guidance range is $4.08 to $4.18. Let's keep in mind that this new guidance reflects $0.11 of dilution associated with the recently announced portfolio actions. So if you exclude the impact of these actions, our guidance would have been $4.19 to $4.29, and at the midpoint, this is $0.11 higher than our previously issued guidance. The new $4.13 midpoint represents 11% growth versus a comparable $3.73 per share in 2009. We've tightened the range to better reflect our expectations for the full year. Again, keep in mind that our new guidance midpoint includes $0.04 of dilution related to the recently announced Godwin and Canberra transactions and it excludes $0.07 of earnings from the discontinued Defense CAS business. However, our strong second quarter performance and our balanced second half outlook positioned us to completely offset the $0.11 of dilution associated with these portfolio actions. Now in order to help model the potential impacts of the Defense discontinued operations, we have included a reconciliation in the appendix. On Slide 11, we've provided additional details around our third quarter and 2010 outlook. For the third quarter, we are projecting a 1% increase in total revenues to $2.7 billion and continuing adjusted EPS in the $0.94 to $0.98 range. This forecast does include $0.03 of net dilution from the Godwin and Canberra acquisition. It also excludes about $0.02 from the discontinued Defense CAS business. It should be noted that this forecast also reflects a reallocation of our second half Defense revenues based on current customer delivery schedules. So this results in a Defense third quarter revenue forecast that is down 5% versus the prior year. The Fluid third quarter organic growth forecast is 5% and Motion is 16%. Q3 segment margin performance also reflects higher FX, material costs and investments when compared to Q2. For the full year, Defense organic revenue growth is expected to be flat compared to the prior year. That's due to revised timing of orders and customer fielding plans. Total Fluid revenue growth was increased to 6%, while full year organic results are expected to be flat due to some additional slowing in Europe and the unfavorable impacts of foreign exchange. Motion & Flow Control's total revenue growth guidance was raised to 14% and organic revenue was increased to 18% from 7% due to improved conditions across all major end markets served. 2010 continuing ITT revenue is now expected to grow 3% in total and 2% organically to $11 billion. This forecast excludes approximately $240 million of discontinued cash revenue. Segment operating margin guidance was increased to 12.5% due to expanded productivity initiatives that are expected to more than offset material cost pressures and some margin dilution from acquisitions. The full year operating margin performance is 60 basis points better than the prior year. So now let's turn things over to Tom, and let's begin the Q&A.

Okay, Wes, we are now ready to start the Q&A session.

[Operator Instructions] Our first question comes from Scott Gaffner of Barclays Capital.

I was hoping maybe you could just maybe give us a sense for how much the reallocation of revenues in the Defense business in the second half. How much on an EPS basis do you think that shifted from 3Q to 4Q?

So when we look at our Q3 to Q4, we look at the numbers that we have out there, basically what we've got is, is we have an increase in Defense revenues of about $250 million or so. So we had -- when you look at that, we've got about -- part of that came from -- went from Q3 into Q4, maybe $100 million or so, couple of hundred million did that. but that is really associated with the radios and the jammers that we moved from Q3 into Q4.

And then what's the risk around those revenues then maybe getting it pushed even further from 4Q into 2011, do you think?

Well, Scott, right now, we think we've made the appropriate adjustment and we feel good about the risk, about this risk question. So right now, we are anticipating these orders to come in the second half.

And then just maybe if you could go back to the two big wins that you had in Defense in the quarter, the real-time air traffic data services or that's the new service that you're going to offer and then the NextGen FAA contract. Could you give us maybe some timing and size on those? And were they already included in your thoughts around the Defense guidance going into 2011 that you gave on the previous calls?

Yes, Scott, they were certainly contemplated. The significant win in the air traffic control system is building on ITT's successful execution of the current prime contract on ADS-B. So ITT was one of three primes that were selected for the SE2020. It was about a $1.8 billion order, expected to be distributed over a five- to seven-year timeframe as the FAA is continuing to do engineering to equip, to modify the air traffic control procedures and to fully implement the data, weather, as well as air navigation components of the next-generation systems. So what you're going to see is incremental. You're going to see incremental releases of that contract in small pieces as they turn on various pieces of it. And I just wanted to correct myself, it's a $1.4 billion contract.

And then just looking at the CAS divestiture, I mean, is that really just all sort of conflict-related and we shouldn't take that as maybe a sign that you're looking to maybe to divest a few more smaller pieces of the Defense business going forward?

Yes, Scott. I can confirm that it is exclusively driven by OCI. You do know that the U.S. government has set forth some procurement regulations that disadvantaged or discouraged companies from doing advanced engineering in the procurement arm of the U.S. government, and at the same time, supplying equipment and services. And so while in this particular case, there's no actual conflict of interest. It is subject to the perception of OCI, which we believe is in -- so therefore, we believe that it's in ITT's best interest to distance ourself from that so that we can have a broader set of opportunities to be bidding on our traditional equipment.

Your next question comes from Jeff Sprague of Vertical Research Partners.

Steve, if you get to that $4.5 billion to $4.7 billion backlog in Defense at year end, what percent of that would be deliverable in 2011?

There's a lot of mix in there, Jeff. But a top-level estimate would be about 75% of that would be deliverable in 2011. So then your next question is going to be, well, what kind of book-to-bill ratio do you have are you expecting in the later part of this year? And we're expecting similar book-to-bills as we had in prior years. So you add all that up, and it does confirm, as Scott just referred to, this sort of long-term Defense forecast that we gave you before. Despite these pressures that we're seeing on the core budgets, we're nicely offsetting those with the adjacency wins in new customers. So that's why we are maintaining our long-term forecast to say, we'll be in the low- to mid-single digits kind of growth, and we expect the 2011 to be another solid year for Defense. The other thing you have to keep in mind there on the question, Jeff, is that a big component of our backlog is services, and the very nature of the services business is that actually is a fairly short-cycle backlog program. So that's why our book-to-bill is probably a little bit higher than that of the industry average.

I was wondering, Steve or Denise, if you can elaborate a little bit on kind of underneath the waves in Motion. You had big productivity in Q1. The margins are actually down quite a bit sequentially. Denise mentioned something about internal transition or something. Could you give us a little more elaboration on what's going on there? How to think about the margins in the back half in Motion?

Yes, sure. So in the second quarter, we were moving some of our products from California into Mexico. And so we just had some additional costs associated with that, which hit the MoFlow margins in the second quarter. It was to the tune of a little over 300 basis points. That's a one-time item that hit. When we look at the margins going into Q3 and Q4, we're going to see some really nice improvement in those Motion & Flow margins. And the reason is, is because we've got some very strong top line performance, which is going to flow very nicely through in the back half of the year. So when we look at Motion & Flow, and we look at them on a full year basis, from an operational perspective, their margins are improving over 200 basis points. So very, very strong productivity that we're seeing out of Motion & Flow. It's just that we had this one-time issue that came up and impacted us in the second quarter.

And just finally for me, you mentioned pension in Defense, obviously, that's kind of an ongoing item that people are aware. But can you just remind us where 2011 is baked on pension based on 12/31/09, and kind of what the early read might be into '11 based on where we stand year-to-date in '10 on asset returns and discount rate?

Sure. As you know, pension is impacted greatly by where you end up the year on your discount rate. That is a key variable that can swing this significantly. Utilizing the discount rate that we had at the end of '09, and keeping that consistent, we would see incremental pension expense of about $35 million to $40 million next year. We've seen the discount rate just moved significantly throughout this year. So really hard to say where it will end up at the end of the year. What you can think about, though, is that the sensitivity around that discount rate is that if it moves 25 basis points, it's about $9 million on a full year basis for us.

Your next question comes from Gautam Khanna of Cowen and Company.

The Defense backlog year-end target is down a little bit organically. How much of that is due to the international, the foreign timing slip [ph] (1:02:30)?

Just about all of it is due to that.

It's almost all the timing on the Iraqi order. Yes, that's almost all of it. The other piece of it is part of the CAS discontinued operation.

I just wonder, are you baking in any sort of sensitivity around if the DoD budget isn't passed by September 30 or by year end relative to the continuing resolutions?

No, we're not right now. We think we've got a pretty solid view of what's going to happen in our budgets in the 2011 time frame. And there's obviously -- there's always opportunity for timing changes inside the budget. But right now, the budget that has been generally forecast and discussed publicly by DoD is the budget that we're planning on. And remember also, as you're thinking about the year-over-year in Defense, Denise mentioned we're well ahead of schedule on the economic benefit from the Defense transformation, and that's going to be a nice boost, about a $60 million incremental operating income boost on a year-over-year basis in 2011.

Your next question comes from Jim Lucas of Janney Montgomery Scott.

First question, housekeeping, I may have missed this, but the book-to-bill in MoFlow in the quarter?

Book-to-bill in MoFlow is 0.99, but you really got to look at the individual components. So if you look at Motion, it's 0.84. But remember, that's because we had very strong performance in Motion Technologies in the first half of the year because of the stimulus funding. So that's what's really impacting that number. When you look at the other segments, ICS is 1.14; Control is 1.09; Flow, a little bit below 1, at about 0.97. But Motion is really the one impacting the 0.99. The other businesses are performing extremely well.

And switching gears to the Fluid business. Could you give a little bit more color of what you're seeing in the European municipal side? You called that out for a couple of quarters now. And from just an overall macro standpoint, are you seeing any pockets of improvement in Europe? Or is that an area you're continuing to look for weakness?

Yes, Jim, the picture has not changed significantly from what we said before. The European municipal business is definitely slow and we are seeing what we would characterize about a minus 5% for the year. So we're expecting that to be slow. And as you know, unfortunately, as you're looking at our Fluid numbers, that's a fairly good-sized piece of our portfolio, about 15% or so of our Fluid Technology portfolio. The good news in this is that these delays will be spent, there are regulatory drivers, as well as just the non-discretionary component of infrastructure upgrade. So we do expect that there will be some rebound on these municipal businesses over time, but it will be proportional to the economic health of Europe. On the other side, on the global, the United States Municipal business is nicely strong for us. We're seeing a good year there. So when you take a look at the Global Municipal business, we're sort of seeing flat. And what that means is emerging in U.S. is up nicely, offset by Europe.

With those delays that you're seeing in Europe, is that funding-related? Or is there something else underlying there?

It's purely economic confidence. With the situation that you know in Greece, in Spain and so forth, the municipalities have just been directed, like everyone else, to be conservative until the Eurozone figures out how they're going to fund these country issues that, as you know, are affecting beyond Spain and Greece, but there's obviously solutions in Italy as well.

There's been no cancellation on projects. What we've seen is, is we've seen delays coming through, but there's been no cancellation. So we do believe that these budgets will be spent.

And then switching gears, following up on the portfolio shifts. You alluded earlier not looking for any additional moves on Defense divestitures here in the intermediate term. You've done a couple of very nice acquisitions in Fluid, yet you still have a lot of financial capacity. I was wondering about the managerial bandwidth to look at additional deals within Fluid going forward here.

Well, Jim, you're exactly right. We have put $1 billion on the table already this year, and we're certainly have the capacity to do a similar amount in the future or in the short-term future. So we do have an active pipeline. It is focused around the attractive areas that I mentioned: In cyber, air traffic, in global water treatment and so forth. Now with respect to the managerial bandwidth, we are very sensitive to that issue. Well, the good news is because of the diversity of our portfolio, many of these acquisitions are occurring in different business segments. But it is something that we are monitoring and making sure that whatever we do acquire is something that we can effectively execute our synergy plans and integration plans. So as we speak now, we feel like we've got the right teams and the right organizational capacity. But we're going to continue to be mindful of that as we go forward.

And finally, could you just remind us how much authorization you have left on your repurchase program and where repurchases fall in the allocation ranking?

So we have, under that program, it's a $1 billion program, we've executed about $430 million. So we have roughly about $570 million, $550 million, $570 million left under that program. How we think about it is that with the acquisition pipeline that we have in place. And the acquisitions that we've done to date I think demonstrate that we've got a really strong pipeline is we like to be able to use our cash and our capacity in order to invest in the business in these very solid acquisitions and utilize that to create value. Now over time, we increased our dividend at the beginning of this year by 18%. We've done share repurchases, we're doing acquisitions. Over time, we have a very balanced capital deployment strategy. But right now, we've got some good acquisitions that we've been looking at, that we think really enhance this business, and we're going to continue to look at those.

Your next question comes from Steve Tusa of JPMorgan. C. Stephen Tusa - JP Morgan Chase & Co: Can you just talk about, I'm not sure if you guys talked about the third quarter margins. Denise, maybe you talked about it a bit in the prepared remarks. But I'm having a little bit of a hard time on $2.7 billion of revenues, getting down to your range. So maybe if you could just walk us through the dynamics. I guess you talked about MoFlow a bit, picking up sequentially. How do we see Defense and Fluid kind of trending in the second half from a margin perspective?

So when I look at the second half versus the first half, from a revenue standpoint, we're going to see Defense revenues up in the second half versus the first half. Some of it is due to seasonality, some of it also is due to radios and jammers that we're going to be delivering. We also see recovery on the IP side of the business, which will be a positive for us. Now offsetting that slightly is we've got some of Motion Technologies and not having the stimulus program in Europe. But we see revenues overall benefiting us by roughly about 10 basis points. We also have very, very strong productivity when we look at second half versus first half. So we're going to be up nicely with productivity. Foreign exchange is impacting us by about 20 basis points. And then when we look at the investments that we outlined at the beginning of the year, we said that we were going to be making incremental investments in our business, primarily on the Fluid side and in Motion & Flow. We're keeping to that, and it's that the fact that the investments are tending to be more heavily weighted in the second half versus the first half of the year. So we're seeing that dynamic taking place also. C. Stephen Tusa - JP Morgan Chase & Co: So the Defense business for the year, what kind of margin are you looking for just for full year for Defense?

Yes, we're looking still around a little over 12%. C. Stephen Tusa - JP Morgan Chase & Co: And you're still sticking to even with divestitures and kind of the more commercial mix here maybe as that they moves in, you're still looking for kind of an 11% to 12% is kind of the longer-term target? Or has that been migrated up now, because these margins are holding up pretty well?

Yes.

Yes. We're looking at about 11.5% to 12%, 12.5%. Now remember, and partly because we've been going through this defense transformation, we have these incremental savings that we're going to be getting going forward. So we think that, that's about the right range.

Your next question comes from Ajay Kejriwal of FBR Capital Markets. Ajay Kejriwal - FBR Capital Markets & Co.: Just wanted to follow up on your comment on services and backlog. It sounds like your year-end expectation on services is a bigger component than it was last year, but maybe I got that wrong, so it would be helpful if you comment on that.

Ajay, the comment was intended to just simply highlight the fact that because we had a higher service mix in comparison to other defense companies and that service backlog tends to be short-cycle 30-, 60-, 90-day kind of lead times that we tended to have a relatively lower book-to-bill. So I was just merely pointing out, when you look at the 4.6 book-to-bill, and I was saying that we're still staying on, on our forecast for another solid year in Defense, that you understood that part of that book-to-bill was going to be filled in as a normal part of our services backlog. Ajay Kejriwal - FBR Capital Markets & Co.: So the mix at the year end this year that you expect would be broadly comparable to what you've had, say, in 2009?

From a sales standpoint? Ajay Kejriwal - FBR Capital Markets & Co.: From a services versus product perspective?

Yes, in backlog, when you look at our backlog, about 30% of it is services, about 70% is product. Because remember, services tends to fund in shorter increments, alright? And so if we look at it on a year-over-year basis, I don't have the exact numbers, but we have been migrating to having more services as part of our business than products. So I would expect to see that being slightly different on a year-over-year basis, but it take some time to really make any truly significant shift. Ajay Kejriwal - FBR Capital Markets & Co.: And then on that long-term margin goal, 11.5% to 12.5%, as you look at your backlog currently, what's kind of the implied margin in there? Is it in that ballpark, or is it higher than that?

I'm sorry, Ajay, can you repeat the margins on which? Ajay Kejriwal - FBR Capital Markets & Co.: So the long-term margin goal, Denise commented 11.5% to 12.5%, that's in Defense. So when you look at your backlog currently, is that the margin implied in that backlog?

Yes, I mean...

It's pretty close to that. Ajay Kejriwal - FBR Capital Markets & Co.: And then shifting on to Fluid. I'm wondering what you're seeing in the U.S. municipal markets? You're seeing some strength there, so if you can provide some color, is that related to stimulus or is it more broad-based?

Yes, what we're seeing there is, the stimulus piece of it was relatively small when you look at exactly how much that was contributing. But we are seeing the Municipal business in the U.S. being strong. There are some regulatory drivers that's helping to drive that. So we're seeing strength on the transport side. We also saw some really nice strength on the Treatment side of the business in the U.S. And so in the second quarter, we actually saw our Treatment business being up about 20% in the U.S. So we're seeing some nice growth there, and we are seeing decent growth in Transport also.

So the way we think about it is that we've seen a lot of short-cycle volatility throughout our segments and throughout our geographies. This global economy is not in a steady state equilibrium now. And in this case, we are seeing, as you recall, we had shortfalls in municipality due to budget concerns and expectation of stimulus benefits. It slowed things down in prior periods. Some of that is slowly restoring in terms of the confidence in municipal spending now.

Your next question comes from Nigel Coe of Deutsche Bank.

So just on the Fluid Tech margins, I mean, the year-over-year bulk of the growth is driven by construction being a bit lower. But is there anything related to 2Q, because 2Q margins in 2009 were significantly higher than the second half of the year, and we've seen a pop up this quarter. Any seasonality or mix issues in 2Q? Or was it just the investment flows?

The way we're looking at it -- we appreciate the question, Nigel, fair question. The three major dynamics that are occurring in this economy is, you're seeing an impact of foreign exchange. We do have changes in incremental investments, which we believe are appropriate for the long term, particularly to position more strongly in emerging markets. And we do have the municipal pressure in Europe, as we mentioned. And in some cases, quarter-over-quarter, we're seeing changes in the IP business. So those factors somewhat cloud the long-term story in Fluid Technology, which is to say that we are exceptionally well positioned with our cost base. We're seeing a very, very nice order growth, which once we get past some of these shorter-cycle phenomenons, we should be able to leverage very, very nicely on the top line. So as we're just now in the process of detailing the 2011 plan, we are expecting strong organic growth out of this platform and strong margin expansion. And I think what we're seeing here this year is a lot of short-cycle volatility, somewhat driven by the economic recovery that we're all well aware of.

Nigel, let me just give you some numbers on this, the Fluid Technology margins on a full year basis, because I think it's very impressive. So full year Fluid margins are going to be up about 90 basis points. Now we've been impacted by 30 basis points with foreign exchange. We've been impacted by 80 basis points with acquisitions. Pension hit us for about 30. Now restructuring is a benefit of 100. But when you net all that out and you look operationally how fluid is performing, they're up 130 basis points on basically flat revenues. And we've said that we're making these incremental investments this year for full fluid that will drive our 2011. And those investments are around the emerging markets, it's around the front-end processes with our commercial excellence program, and it's around new technologies and new products. If you back out those incremental investments, you would actually see fluid margins operationally growing 250 basis points. I think that's a testament to the very strong productivity that's being driven in this business.

Sticking with margins and moving on to Defense, to the $110 million of cost saves from the realignments, what is your ability to capture 100% of those cost savings, because if you can just remind me what percentage of your business is cost plus and how much about gets given back to the government over time?

We mentioned, Nigel, that, that was our gross savings. Our cost plus, fixed price mix is around 60-40 I believe. So some bare portion of those savings ultimately get passed back to the government. But we've included all those factors in all of our forecast that we're giving you the margin expansion. As a good U.S. citizen and a very competitive U.S. government contractor, we're proud to be driving productivity that ultimately lowers the cost to the government and lowers our bid rates. So we're unabashed when it comes to driving productivity throughout the Defense portfolio, even if it does result in some segments of our business as a reduction or give back to the government. This just enables ITT to be ever more competitive in the future. So when we look at -- when we think about our win rates, we like having a very well-positioned cost base.

Then just finally, on the M&A cadence, would you expect it to -- I mean, obviously, you've done silent deals both so far this year, but would you expect it to pick up from here, tail off? And can you just confirm, is commercial aerospace an area that attracts you?

In terms of the cadence, I think we're going to stay on our pace. Cadence is determined not by the magnitude of the pipeline, but a combination of action, ability and timing, and then ultimately, valuation. So as you know, it's always hard to be predictive in that area. But I would say we're going to try to stay on this pace. But it's always hard to predict how it's going to come out. With respect to aerospace, aerospace is an attractive area. And despite the fact that it is a little slow right now, as you all know, we do see it long term. I have not mentioned that recently simply because our pipeline is so strong in the other areas which are equally attractive. But aerospace is an area that I would say falls into attractive, but it's not in the front of our pipeline at this point in time. Well, Nigel, I want to thank you for your questions and thank everyone for your interest. And let me just close very quickly, and first of all, apologize for the timing delay, we'll get that fixed. But the highlights, as we're thinking about it is that we did have a solid second quarter, beating expectations, and we're raising the full year operating outlook. And we're proud of the fact that we've offseted the impacts of this portfolio positioning. We do continue to see strong productivity across every one of our business segments. We're excited, quite frankly, about the strong performance in the short-cycle Motion & Flow Control business. And despite some of these headwinds, which Denise just covered, the longer-cycle commercial businesses continue to deliver very strong order growth, which is setting us up for a strong revenue and earnings year in the Fluid Technology business next year. The diversified Defense business continues to overcome budget pressures in the core product areas because we've been very successfully diversifying this customer base. And the portfolio strategy, the rebalance is working, having just added $1 billion investment to the base. So as I think about where we are, this business model at ITT is designed to perform well over time. And our track record over the past several years validates the merits of this business model design. We work really hard to align to essential and attractive segments of enduring global needs. We execute well with exceptional strategic management processes, and we spend a lot of time to drive a very significant differential reallocation strategies to optimize our opportunity. And this all works because underneath, we have great people and great leadership, with a very strong underlying value system. And this combination is really a magic elixir for employee engagement, innovation and customer loyalty. So in the midst of a lot of concerns in this economic time, let me point out that even in light of a highly unstabilized and volatile global economy and with the pressures we understand the Defense budget, in 2010, ITT will surpass our record 2008 performance by delivering an 11% adjusted growth off the strongest 2009 EPS performance in our peer group. So we're turning in yet another record year of earnings performance while we are rebalancing this portfolio and powering through quite successfully a volatile economic period. So I just wanted to close on a high note, we're proud about what we have accomplished, and we look forward to catching up with you on the next quarter. Thank you very much.

And ladies and gentlemen, that concludes the ITT's Corporation Second Quarter 2010 Conference Call. We appreciate your time. You may now disconnect.