ITT Inc. (ITT) Q4 2010 Earnings Report, Transcript and Summary

Good morning. My name is Jackie, and I will be your conference operator today. At this time, I would like to welcome everyone to the ITT Corporation's Fourth Quarter 2010 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Tom Scalera, Vice President of Finance and Investor Relations. Mr. Scalera, please go ahead.

Thank you, Jackie. Good morning, and welcome to ITT's fourth quarter 2010 investor review. Presenting this morning are ITT's Chairman and CEO, Steve Loranger; and ITT's 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. Please note that any remarks we may make about future expectations, plans, prospects and other circumstances set out in our Safe Harbor statement constitutes 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. Let's now turn to Slide 3 where Steve will provide the 2010 highlights.

Good morning, and thank you all for joining us. We're thrilled today to discuss our record-breaking 2010 performance and to provide an update on ITT's transformation into three attractive stand-alone public companies. 2010 was yet another outstanding year for ITT. Our collective strength was once again driven by our leading market positions, our intense focus on customers, our shared culture of operational excellence and our highly skilled workforce. This is also the same foundation that's going to enable our 2011 results and that which will propel our three new entities into the future. For 2010, our adjusted EPS of $4.41 grew an impressive 18% compared to 2009. This performance included another year of incremental $50 million of organic growth investments in emerging markets, commercial excellence in innovation that's going to better position all of our businesses for the future. Excluding these additional investments, our adjusted EPS would've grown 24%. And in addition, our 2010 adjusted EPS has improved 11% compared to the pre-crisis 2008 levels, which reflects the strong productivity we've generated in the aggregate demand strength in our key markets. In 2010, our dedicated operational workforce and leadership once again delivered over $500 million in gross productivity gains, an amount that greatly exceeded our initial 2010 plan. These gains were primarily the result of our strong processes and our deep culture of operational excellence. As a result, in 2010, we once again delivered a very strong free cash flow of $937 million, representing a very high quality 104% conversion of net income. A particular area of pride in 2010 was our very successful deployment of over $1 billion in capital towards strategic growth acquisitions in Dewatering, Analytics, Oil & Gas, Air Traffic Management and Space-Based Surveillance. These acquisitions added $0.08 of earnings in 2010 and they were accretive to our Q4 margins, and each further expanded our strong positions in growth markets. In 2010, Defense and Information Solutions executed a strategic transformation to drive significant cost savings, greater efficiencies and better technical alignment with our customers' Network Solutions strategy. This transformation provides a solid foundation for our Defense business that will continue to generate important strategic wins despite the intensifying competitive and budgetary pressures. These strategic significant wins included the CREW 3.3, the counter IED jamming system, the Systems Engineering 2020 contract on the FAA's Air Traffic Management System and several important service wins in theater. And lastly, we're proud of the optionality that our strong balance sheet has afforded us over the years to continuously invest in organic and inorganic opportunities. And as of today, we're pleased to report that at the end of 2010, we had over $1 billion in cash and cash equivalents. So to summarize. The successes we achieved in 2010 nicely position all of our businesses to compete aggressively in their respective markets in 2011 and well beyond. Now let me turn the call over to Denise.

Thanks, Steve. Let's turn now to Slide 4. For the full year, we delivered solid revenue growth of 3% as Motion and Flow Control strength and the Fluid acquisitions more than offset the decline at Defense. Motion's 15% improvement reflected balanced, double-digit strength across all four of its businesses. Fluid grew 9%, reflecting the contribution from the acquisitions, coupled with growth at Residential and Commercial Water and Water and Wastewater. In the fourth quarter, we delivered total revenue growth of 8% and organic growth of 5%. The organic improvement included 4% growth across the commercial businesses due to general industrial, mining, chemical and global residential strength. Defense grew 5% in the fourth quarter due to strong global SINCGARS shipments. Operating margins improved 230 basis points in the quarter due to 290 basis points of operating productivity. For the full year, operating margins improved 90 basis points as 180 basis points of operating productivity was partially offset by higher pension and incremental growth investments. Total organic orders were down 12% in the fourth quarter. Motion's organic orders were once again outstanding, this time growing 20% due to strong general industrial and better-than-expected auto demand. Fluid organic orders were flat as solid residential demand was offset by softness in southern Europe. The timing on service orders and difficult prior-year comparisons weighed heavily on defense orders which declined 23% in the quarter, underlying their changing dynamics in our customer order pattern. And lastly, a record 2010 adjusted EPS of $4.41 increased 18% from 2009. In the fourth quarter, adjusted EPS of $1.36 represented a 42% improvement to the prior year, and it was $0.11 higher than our previous guidance. The strong Q4 performance relative to expectations included $0.04 of operating performance and $0.07 of corporate tax and other favorabilities. Now let's turn to our financial position on Slide 5. As Steve mentioned, our legacy of strong cash flow generation and disciplined capital management was once again evident in 2010. Last year, we generated $937 million in free cash flow, representing a solid 104% conversion of continuing net income. And in addition, our net debt to net capital ratio was extremely healthy at only 6.9%. In the pension front, the funding status of our U.S. salary plan improved to 83%. This improvement reflected a 2010 return on assets of 14% and a $50 million fourth quarter voluntary contribution. So as you can clearly see, our strong balance sheet and cash position set us up nicely for 2011 and will provide additional flexibility as we look to allocate financial capacity to each newly-formed entity after the spin. So now let's take a look at Fluid results on Slide 6. Total Fluid revenues of $1.1 billion improved 16% reflecting the exceptional results that our recently acquired Dewatering and Analytics businesses have generated. Organic revenues exceeded our expectation, growing 4% in the quarter. Industrial process led the way with a 9% increase due to strength in chemical and Oil & Gas projects in emerging markets. Residential and Commercial Water delivered a fourth straight quarter of organic growth and was up 6% due to strong demand in global residential building services. Water and Wastewater grew 2% due to solid transport equipment demand in U.S. municipal markets. Fluid operating income grew 36%. This improvement reflects the benefits from the 2010 acquisitions, improved productivity and lower restructuring expenses. In total, operating margins improved 200 basis points, including 90 basis points of growth investments. The margin improvement was driven by 280 basis points of operating productivity. Total orders improved 13% and organic orders were flat. Organically, Residential and Commercial Water improved 6% due to increased demand in the global residential markets, offsetting the 5% decline at Water and Wastewater that reflects softness in southern Europe and the timing of treatment projects. However, total water and wastewater orders improved 22% due to strong contribution from the Dewatering and Analytics acquisitions. Now let's turn to Motion and Flow Control on Slide 7. Motion and Flow Control's organic revenue growth of 4% in the fourth quarter also exceeded our expectations. Control Technologies lead the way, with a 24% increase that was driven by very strong demand in the aerospace aftermarket. Interconnect Solutions also delivered strong double-digit growth of 16% due to solid demand across a number of global industrial markets. These gains were partially offset by the 12% decline at Motion Technologies that was caused by comparison challenges related to the prior-year European automotive stimulus program. Motion and Flow Control's operating income improved 118% and margins expanded 600 basis points. These improvements reflected 90 basis points of operational productivity and lower restructuring expenses, which were partially offset by increased growth investments. Last year's fourth quarter included $26 million of restructuring expenses, primarily at Motion Technologies related to the transfer of automotive equipment production into low-cost regions. Fourth quarter Motion and Flow Control organic orders increased 20%. Control Technologies grew 34% due to strength in the aerospace aftermarket. Orders at Motion Technologies exceeded expectations, in global market. And orders at Interconnect Solutions grew 9% due to strength in general industrial markets. 2010 was a truly spectacular year for the Motion and Flow Control businesses. Recent wins on key automotive, rail and beverage platforms further support the growth potential of these businesses on a greatly improved cost, product and technology foundation. Now let's turn to Defense & Information Solutions on Slide 8. Defense revenue grew 5% in the fourth quarter due to Electronic Systems. Strong sales of special-purpose jammers and U.S. and international SINCGARS drove the 23% increase at ES. Geospatial Systems declined 3% due to lower activity on certain space-based program. Information Systems declined 8% on lower software engineering services. Defense operating income grew 18% to $239 million. Strong operating productivity, high margin product volumes and lower amortization more than offset $13 million of restructuring actions that were related to the anticipated ramp down of the U.S. SINCGARS line. Defense generated organic orders of $1.4 billion in the quarter, which were down 23% compared to a strong prior year. Electronic Systems was down 19% due to anticipated declines in domestic SINCGARS. Information Systems declined 23% due to new customer order patterns on a major communication services contract. Geospatial Systems declined at 31%, reflecting a large prior-year Japanese weather satellite program award. Turning to Slide 9. You'll see that despite the challenges in the funded order metric, Defense's 2010 funded and unfunded backlog has increased $1.5 billion in the quarter to over $11.5 billion. We added this comprehensive backlog metric last quarter because we believe that it helps to better outline the strategic foundation for the Defense business in today's environment. In the fourth quarter of 2010, we continued to see changing customer order pattern and backlog dynamics that were primarily driven by the current U.S. Defense budget environment and the impacts of the U.S. budget continuing resolution. An example of this dynamic was seen in a major communication services contract known as TAC-SWACAA. On year-over-year basis, a change in order patterns drove an unfavorable $230 million variance in 2010 orders and backlog. Cause of the variation is simple. In the fourth quarter of 2009, the customer placed a 12-month order. In the fourth quarter of 2010, only a two-month order was funded for this ongoing requirement. In addition, we expect to continue to aggressively diversify our customer base to include new commercial and international customers in new agencies like NASA and the FAA. Keep in mind that as we progress through 2011, we are forecasting that 30% or $1.8 billion of our Defense revenue will come from customers outside the U.S. Armed Forces budget. I'm thrilled to report that since the third quarter, $2.7 billion of important long-term contracts have cleared protest and have moved into the work transition phase. These cleared protests include the Kuwait facilities contract and the NASA communications contract. Our $11.5 billion funded and unfunded backlog metric does not include potential orders under IDIQ awards, including the $1.4 billion dollars SE2020 air traffic management award from the FAA and $1 billion of the cleared NASA communications award. In addition, there were over $700 million in next-generation technology awards from the U.S. Armed Services for CREW 3.2 jammers and enhanced night vision goggles. Lastly, let me point out that only the first minor development contract under the CREW 3.3 jamming system of systems is included in our backlog metrics. The balance of this potential multibillion-dollar program represents another important long-term opportunity for ITT Defense. Now let's turn to our 2011 guidance on Slide 10. Let me start out by pointing out some highlights on this detailed slide. First and most importantly, we are reaffirming our previous 2011 guidance commitments at both the operating segment and the ITT levels. Secondly, we are providing revenue and operating margin guidance in both the current segment structure and on a pro forma, post-spend basis. And lastly, we're providing ITT revenue and adjusted EPS guidance for the first quarter of 2011. It is important to note here that the adjusted EPS and the current segment and pro forma operating margin guidance exclude all spin-related transaction impacts and other special items. We do anticipate that there will be material transaction-related charges and other impacts during 2011 that will be reflected in our reported GAAP results. However at this time, we are not able to provide a comprehensive forecast of the potential impacts of the transactions on our future results. In 2011, we expect to deliver total revenue growth in the 3% to 5% range. This includes solid organic revenue growth at the Fluid and Motion and Flow Control segments of over 5%. That more than offsets the 2% decline at Defense. Driving productivity and controlling SG&A costs remain our key operational priority in 2011. Our expanded productivity initiatives are expected to more than offset increases in commodity prices and wages once again. In total, our Lean Six Sigma initiatives, our Global Supply Chain and benefits from prior restructuring actions, including the Defense transformation, will reduce our overall gross cost base by about $475 million in 2011. As a result, we expect solid margin expansion across the commercial businesses which will build on the over 200 basis point expansion in operating productivity delivered in 2010. The margin expansion is deeply grounded in our culture of operational excellence and our world-class management system and leaders. As for defense margins, they are expected to decline slightly in 2011, primarily due to a higher mix of service volumes. Since our December guidance calls, we have seen an improvement in our forecasted pension expense due to a lower discount rate that has been largely offset by higher commodity pricing pressures. So as a result, we are maintaining our previous 2011 adjusted EPS guidance range of $4.62 to $4.82 per share. For the first quarter, high margin revenue at Defense is expected to decline compared to the prior year due to anticipated reductions in U.S. SINCGARS and jammers. And we are forecasting adjusted EPS in the range of $0.88 to $0.92, representing 9% growth compared to the prior year on a 3% revenue increase. Now let's turn to Slide 11 where Steve will provide an update on the transaction.

Thank you, Denise. With the 2010 results behind us, let me offer some highlights on our exciting value-creating transformation. First, to review this, this transformation is a logical market-based grouping of our existing businesses into industrial, water and defense markets. By combining our strong industrial process business with our other industrial businesses and by including our water-related flow control into water, we've created both an attractive industrial and an attractive water business. Once complete, we believe the spin-off will enable the three new companies to each realize their full potential, and we expected that this transformation will continue to unlock significant shareholder value. With the three new entities concentrating in their respective markets, this plan will improve management focus. Each new company will also benefit from reduced complexity, and it will be more nimble and better suited to build stronger and more intimate customer relationships. In addition, the market focus of each new company will greatly improve alignment with the credit and equity markets. And of course, this will potentially allow for a more efficient valuation and improved growth opportunities. The three new vital companies created under this plan are: first, the Future ITT, which will be a $2.1 billion diversified global manufacturer of highly engineered industrial products and high-tech solutions with an efficient cost structure in leading market positions in growing industrial markets such as oil and gas, mining, aerospace, automotive and electronic components. In addition, the future ITT will have a very strong presence in emerging markets where over 30% of its revenue is expected to be generated. Second, the Future Water technology business will be a true pure-play in the global water market unlike anything that exists today, deriving over 90% of its revenue from water and wastewater applications. This $3.6 billion business will be a global water leader, with the broadest suite of innovative equipment, systems and applications. It will also include the very successful Dewatering and Analytics acquisitions we made in 2010, both of which provide exciting new long-term growth platforms in water. And third, the future Defense business will represent a standalone version of our existing $5.8 billion Defense & Information Solutions segment, which is already an industry-leading provider of innovative technologies and operational services that meet the global requirements of military, government and commercial customers. The foundation for this transformation is deeply rooted in the existing strength of each one of our businesses. This transaction simply refocuses these strengths into three major business categories: Industrial, Water and Defense. And with the strong 2010 performance at our back and an equally impressive 2011 plan, all of our existing businesses are well-positioned for growth with leading market positions, strong operating cultures and world-class leadership teams. It's important to note that each of the future companies is expected to have a capital structure, balance sheet and financial policies that are consistent with investment-grade credit metrics. And of course the foundation for this targeted outcome is resonant with the existing strength of our 2010 balance sheet and our legacy of strong cash flow generation and disciplined capital deployment. Turning to Slide 12 for a progress update on the transaction. As you know, continuous communication is a critical element to the success of any transformational activity, and our management teams all across ITT have intensely focused on connecting with key customers, suppliers, employees and other stakeholders since we announced this January 12. And we couldn't be more pleased that the responses that we've received from every constituency could not have been more positive. Over the last three weeks, Dave, Gretchen, Denise and I have personally visited dozens of our key operating sites around the globe. And let me share with you the two simple messages that we all delivered during the discussions with our operating leaders and our valued employees. First, focus on your customers and second, deliver your operating plans. It's really that simple for the vast majority of our workforce. And we heard back from our teams time and time again that they are excited about being bigger contributors to their future companies in a more focused way. In addition, we've already implemented detailed action plans, and additional resources have already been engaged where needed to affect a successful transformation. As a result of the progress we've made, we are more confident that we will complete the proposed tax-free spins in 2011. There is much work to do, but we're on schedule to finalize and execute this plan before the end of the year. On the financial front, we're aggressively working through a number of activities that are focused on establishing the most efficient cost structure for each of the three new standalone entities. The final designs will be consistent with the strategic model applied by each leader, and it will benchmark nicely with respected peers. So while some incremental costs may be necessary to establish two new corporate entities with public reporting responsibilities, it is our intention to establish appropriately lean corporate structures for each entity and to aggressively explore alternative areas for cost reductions. And the last point I want to make is in the middle of this transformation, I also want to reaffirm our adjusted 2011 guidance excluding the transaction impacts, primarily because of the confidence we have in our management system, our solid business positions and of course, the successful track record of our operational leaders. So in closing, we are very pleased with the exceptional strategic and operating performance delivered by our teams across the globe in 2010. We realized outstanding productivity across the businesses while driving overall top-line growth, generating very strong free cash flow and incrementally adding investments for our future. These factors provide a nice momentum for continuing strong performance in 2011, and they lay a solid foundation for the transformation of our company into three independent, publicly traded companies later this year. Let's turn it over to Tom now to start the Q&A.

Okay, Jackie, I think we're ready to begin the Q&A session.

[Operator Instructions] Your first question comes from the line of Jim Lucas with Janney Capital Markets.

On the Defense backlog, the $1.7 billion cleared protest, how much of that went into the funded backlog?

This is Denise. In the funded portion, very little at this point went into funded, probably about $300 million or so went into the funded portion of it. The rest of it, as we've indicated on the chart, is within -- there's a portion within unfunded for both of those but there still is a portion on the NASA one that remains in outside of funded or unfunded.

And within Fluid, could you talk a little bit on residential, commercial? That was a little bit stronger than I think some would expect for the macro headlines out there. Is that more of a share gain? Are there any particular markets you called out, commercial buildings in particular? And as well, could you talk about muni quoting activity both here and abroad?

On the residential side, we started seeing some nice improvement on the residential side of the business earlier this year. And we've continued to see some nice strength on residential as we've gone throughout the year. And we do anticipate that, that will continue in Q1 and as we go through the rest of 2011. And we are seeing some nice strength in, not only in the Americas, but also in Asia Pac and some of those other areas. And on the commercial side of the business, later recovery than on the residential. And so we are expecting to see some incremental improvement on the commercial side as we go throughout the year, some nice improvement on the commercial side, roughly about 4% or so we're anticipating for 2011. And then on the municipal side, as I indicated, we are seeing some sluggishness in southern Europe, and that's impacting the municipal business overall for us. We are expecting growth on the municipal side about 1% to 2% for this year. We're seeing though that from a quoting standpoint that it's still solid, but we are seeing some delays in the actual projects being completed.

Steve, it was helpful on the update, could you talk about with the business as usual, given the strength of the balance sheet, how you guys are thinking about the M&A environment these days.

Well, our first priority is to affect a successful separation. So while most of all of our value centers remain essentially unaffected, we have advised our teams to not take on additional task that would complicate the separation. So what that means is we're still advancing quite aggressively on a number of strategic bolt-ons. There are a number of areas in analytics, in space-based surveillance, air traffic management and a couple of fluid opportunities that we're going to continue to advance. But the guidelines we're giving to the team is we want these acquisitions to be relatively small and something that the value center can accommodate on its own. So we're going to continue with the smaller ones, and we're not expecting to do any large acquisitions.

Your next question comes from the line of Deane Dray with Citi Investment.

One of the themes this quarter that we heard from a number of companies is escalating material cost inflation and the need to increase pricing to offset that. It really didn't come through, at least it wasn't in the prepared remarks. So I'd like to know what was that material cost factor for the quarter and what are you baking in for 2011?

Sure. So we are seeing higher commodity prices as everyone is. We had baked in a portion of that into 2011. So when we look at commodity increases, we're focused on copper and nickel and steel and little bit on the gold side in the Connectors business. When we look at what happened in the fourth quarter of 2010, the nice part of it is that the initiatives that we've been driving internally from a productivity standpoint across our supply chain on the commercial side of the business has more than offset those commodity increases. And when we think about 2011 and we look at what we're driving from a productivity standpoint in our supply chain and we look at the commodity prices, we are effectively offsetting that also. We do anticipate, as I indicated in my prepared remarks, that the commodity prices could end up higher than what we have in the numbers here. But the teams again have done a really nice job of being to offset that through our global strategic sourcing initiatives. In terms of pricing, what we've seen on the pricing front is when I look at the IP business and the Residential and Commercial Water business, we did take some price increases in the first part of this year, so in this quarter, average about 5% or so. On the IP side that was in the more the baseline business for them. Projects for IP are generally under some pressure still and there's a very competitive environment out there. In terms of WWW, we saw a price increase in the third quarter of last year, and it was selectively done. So we're seeing a little bit of benefit from that this year. And then remember in general, we put together an initiative last year, driving the front end of the business with our BBCE program. And so we're seeing some nice benefits from that, and we expect that, that will continue to help offset some of these cost increases on the commodity front.

Just in terms of orders, I thought it was interesting about the 22% growth between Dewatering and Analytics and was hoping you could separate the two just to give us a sense of where those orders are coming from, how much of this is Nova too since that's the new entry into water test?

For both of those, I don't have the specific numbers, but both of them were extremely strong in the fourth quarter for us and the analytics is the Nova acquisition. On the Dewatering side it was the Godwin acquisition. We're really happy with those acquisitions when you look at the fact that they've been $0.08 accretive for this year. And as we go into next year, we're expecting again some nice acceleration in both of those businesses. In fact, growth in those businesses for next year on the Dewatering front, we're looking anywhere from 7% to 9%. And then on the Analytics side, we're looking at growth of anywhere from 15% to 20%. So really nice acquisitions that are giving us even far more benefits then we had modeled when we went through the acquisition. On the Dewatering front, what we're finding is that we're having increased demand from flooding that's been occurring. So that has been helping in the numbers that we're seeing flow through in Dewatering.

Denise, you said in the prepared remarks a focus on allocating the financial capacity to the three units after the spin. I wanted to know what thought has been given to potentially doing at least a partial recapitalization before the spin? You're sitting on a under-levered balance sheet and you certainly have the capability to do some buybacks before the spin. I just want to know where that thought on that strategy stands.

We are proud of the fact that we've got a very solid balance sheet that's going to enable nice capitalization of all three companies, which was a real major gating item for us. With respect to recapitalization prior to the spin, we completely understand the premise of your question, although our window is closed. And obviously, for material reasons as we're contemplating the structures of these businesses. So at this point in time, we are not contemplating that. But I would add that each of the three companies, all three of the companies, are going to be starting with an extraordinary nice cash and incremental debt capacity position. And should there be any alternative strategies on the balance sheet as you articulated, that could certainly be done after the spin. But that will be the purview of the new management teams.

Your next question comes from the line of Scott Gaffner with Barclays Capital.

Just to follow up on the price cost issue. It sounds like you said you were going to offset the commodity increases with productivity. So then the beneficial position on pension then should have lead to an increase in guidance. Maybe walk us through that a little bit more?

We had already factored in, in the numbers for 2011, that we were going to offset the material cost increases. So if they come through, then we won't offset as much as we had anticipated, which we always do, continue to drive productivity. But when you think about the guidance from what we articulated in December to where we are today, it's still pension because of the slightly higher discount rate benefited us a little bit, we have a slightly lower tax rate going into it, but we have higher share count. And then we're anticipating higher commodity prices if they stay at the levels that we're seeing today. So in essence, those basically offset. It's too soon in the year for us to make any decisions at this point based on what we've seen to change guidance. We've not seen anything that would be significant enough that we would put through on a full-year basis yet.

And then just on the growth investment side. I think you talked about $50 million of growth investment spend in 2010. Should we expect the growth investments to continue in 2011 or are those sort of put on hold with the separation?

The growth investments are going to continue per the 2011 plans. One of the benefits of having these strong businesses, we are able, at this point in time, in this economic environment, to be able to make some outstanding numbers and continue to invest in the business. So we'll obviously be conservative as we're watching these businesses along the way. But the current plan is assuming that everything holds up on the execution side, we'll make those investments.

When we guided back in December, we indicated that we were planning on making some additional investment of about $40 million or so. Now we also articulated at that point that they would be discretionary, and that's to the extent that we want to see what the environment, how it's unfolding, and then we'll make those decisions. But we continue to invest in our businesses here because we think that's the right decision to make.

On your Asbestos liability. How are the claims coming in right now? I mean is the size coming down? Is the number of claims going up, et cetera? Can you just kind of frame that out for us? I know you took the charge a while back for a ten-year liability, but can you just let us know how the incoming claims are going?

We obviously monitor and manage that on a monthly basis. And in comparison to the third quarter charge, which is fully detailed, all the detailed assumptions are in the 10-K, it's playing out as we had articulated and expected in Q3. So really no change.

Your next question comes from the line of Pete Skibitski with SunTrust.

Within Motion, it looks like Control Technologies is really kind of riding the commercial aerospace recovery. I want to ask if that's going to kind of continue to be a strong double-digit grower for you this year? And if there's any particular platforms driving that or if it’s just kind of worldwide traffic growth?

That business is about 40% after-market. And so it does had a component for worldwide traffic growth. Although in the fuel areas, we are riding on a number of the important Boeing programs. For the full year, we expect 12% to 13% growth in that business, which is a nice recovery to have in the Aerospace segment.

And then on Defense. I just want to get your thoughts on the impact if this continuing resolution goes past say April or so impact your guidance and then the expected impact you see from lower war spend in fiscal '12?

The continuing resolution is putting some variation into the contracting process, primarily in the area where the Program Management Offices, the PMOs, are letting smaller total orders than what they have a requirement for, just because of some of the uncertainty. So it's having the effect of shortening our backlog visibility but not really changing our program opportunity. This has the effect of potentially slowing down some orders. But I want to add that we've actually taken all that into account as we'd guided for the year, which when we go through contract by contract in areas, on the night vision orders, electronic warfare orders, primarily in those areas, when we gave you our sales forecast, we had already essentially hedged in those areas. So that's why we're able to say we're reaffirming our sales forecast for Defense for the year. And likewise, I would add the same dynamic is occurring in terms of the activity in theater in the Middle East. It's playing out about the way we had forecast, and we already cranked that into our numbers. So we're not seeing any dynamic that would change the commitments that we made to you with our revenue and mix.

Within Information Systems, which I guess this is where a lot of the war-spend related stuff is, given the backlog are you expecting pretty strong growth there this year?

On the Information Systems, primarily the mission solutions piece, we are seeing a very significant backlog growth. The areas of the maintenance contract in Kuwait, the base construction and maintenance contacts in Afghanistan is an example. And of course, some of the work that's being done in FAA and NASA. That is where an enormous amount of revenue growth is coming. That segment is going to grow about 10% for the year. So that was one of the things when we mentioned about our positioning in Defense business, why we like our hardware and our services mix because it enables us to play in some budget elements that actually are going to show some pretty good growth even in a tough overall defense climate.

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

This is actually Nicole DeBlase on for Nigel. Looking at the unfunded backlog versus the funded backlog, I mean you guys have only been providing this measure to us for a couple quarters, and we find it pretty helpful. But if you could talk about the gap between those two metrics and how that compares to where it's been historically?

Nicole, it's Tom Scalera. We have fairly specific guidelines that we're using to calculate the funded and unfunded metrics. And primarily, as you can see on our slide, we do exclude the IDIQ contracts and other protested awards. So that has been excluded from our funded, non-funded calculation. The way we calculate funds remains unchanged. That is a firm order for which funding has been authorized. So we have that metric today about $4.1 billion, which is generally in line with where we ended Q3 absent that delayed impact of the particular contract Denise referenced as which was TAC-SWACAA, which is a couple hundred million less than initially expected just due to timing of a service order process. So in general, the unfunded orders include basically firm orders and potential options on multi-year contracts, which I think is fairly standard throughout the industry and it does exclude IDIQs and protested contracts that do have a higher degree of uncertainty as far as future realization and timing.

So Nicole, simply stated, the very reason why we're now showing you both of these metrics is that because of the dynamics in the contracting process, the gap has been growing over time. Whereas in years past, with a much more stable Defense budget, our funded backlog was more representative over a short cycle of our shipping opportunity. And today, because of the partial orders that I mentioned and some of the variations, we need to start looking beyond the actual funded backlog into the unfunded. We actually haven't plotted the gap to the point of your question, but we do ask ourself the question, "Does our current funded backlog and anticipated expectation on un-funding moving to funding during the time period support our sales forecast?" And the answer is yes.

And then if we could talk a little bit about 1Q, you guys gave us overall revenues, and I think you commented a little bit on Defense there. But can you give us an idea of what's baked in organically between the three segments?

Sure. So organically, in Q1, we have Defense down about 7%, and that has to do with some of the CREW and SINCGARS that's not being delivered this year versus last year. We've got both Fluid Technology and Motion and Flow up about approximately 5% or so. So we're seeing some nice growth there.

Your next question comes from the line of Steve Tusa with JPMorgan. C. Stephen Tusa - JP Morgan Chase & Co: The industrial process orders up 1%. What's driving that? I would have expected that to be a little bit stronger.

They've been a little bit lumpier this year than what we've seen in the past. Now when you look in total, for the what's been happening with the organic growth this year, it's been about 10%. Part of what we're seeing though in Q4 that's impacting the year-over-year metric is the fact that last year, we received a large order of about $20 million that gave a higher lap for us when you look at this year versus last year. So that factors into the fact that it's only 1%. I think the most important thing to do is look at how they've been tracking on a full-year basis with their order growth, which is on a year-to-date basis is 10%, and it's been building throughout the year.

Your next question comes from the line of David Rose with Wedbush Securities.

The guidance for 2011, I just want to be clear because there are some variables that seem to have offset each other. The tax rate, is that the same as the guidance that you provided for 2011? Is that still 29%?

No, we actually have it now at 28.5%.

And is that something that we should expect on a quarterly basis or equally on a quarterly basis?

Yes, for now that's exactly how you should think about it.

Given lots of questions about the split-up of the businesses, and the important point you made earlier was that you had critical mass. Is there anything that would preclude you from selling off pieces of those businesses before the transaction, particularly in Defense as that's the largest component?

That we think is highly unlikely to happen simply because of the taxable nature. We have extremely low tax base. And we're certainly not seeking any alternatives in that view. But to answer your question and sort of a transactional matter, any particular divestiture prior to the spin would just simply be a normal taxable divestiture. But again, we're not expecting that to happen because it's really not in company's best interest, and certainly we're marching towards focusing on this spin.

Your final question comes from the line of the John Inch with Bank of America Merrill Lynch.

I just want to understand the context, Denise, again of the cleared protest. Would it have been anticipated kind of if you go back to the beginning of last year that at least some of that was going to enter into the funded backlog? Sort if the context is that if that was never really part of the expectations set for 2011, then the funded backlog goes down to 3.8 which is worse. But I'm just not sure how to sort of think about this in that context. I understand there's a million moving parts maybe you could just help me with that. And then the rest of it, do you expect that to kind of contribute more to the funded backlog to help that throughout the remainder of 2011 given the starting point?

There's really no change to our expectations. At any time we get a contract, we would have expected some portion of the total contract opportunity to go into funding. And in this case, to your point, we had it initially in the 2010 backlog. And as you know, we reported we did not get it. We made that report, I think, at the end of the first quarter in 2010. And so that backlog that we're putting in the funding now is kind of the same backlog we would have anticipated 2010. And then the program just flows from there. So there's really no change to our expectation other than the fact that now we've cleared the protest. So it's very legitimately our contract to perform on. And in this case, we just got a $1.7 billion improvement to our program opportunity because we can now count on executing these things whereas before when they were hung up in protest, we couldn't.

So Steve, then what's the timing of the remaining 1.4 to go back into funded backlog? I guess this is a little academic, but it seems now there's a high probability of that shifting there, right? Is that fair to say? Then sort of what would be the timing of that?

These contracts are generally kind of five-year contracts. So if the world were perfect and you straight-lined it, it's probably going to be about $300 million a year, but that's just a theoretical opportunity. But it's going to be on that order and that will have variation according to the timing of the various PMOs to able to let the contracts. But think about spreading those programs over five years.

And then just back to the transaction itself. Understanding your guidance doesn't include what are still to be scoped-out transaction costs. I am though curious about industrial process. Wondering what sort of incremental cost if you were to just focus on that business, do you envision as part of moving that into kind of the core or ITT stub company? Is there a way to kind of frame that?

Yes, right now, we're not contemplating any change in the cost base with IP. The business is, for the most part, operated as all of our value centers are autonomously. There are some shared sales offices and some product lines that are shared in some of the facilities. But at the end of the day, the separation of those is not going to induce any material change in cost, particularly in the landscape of the whole business. So we're actually not anticipating any change to the operating metrics of that unit.

What about restructuring costs, Steve, to say separate some of those shared production lines with respect to your factories?

We haven't detailed that because we have the opportunity of manufacturing supply agreements. And again in the grand scheme, it's a relatively minor -- if you were to look at the total manufacturing square footage and total labor hours, and then look at where they're shared, it's an immaterial fraction of the total amount. So while it's true there could be some minor restructuring cost to move a line if we choose to, we also have the option of just leaving them where they are and having manufacturing service agreements. So right now, John, we're not anticipating any impact to that business' metrics.

So really the only big piece of the future cost increases are going to be the three individual corporate overheads, right?

Yes, I think that's fair. And one of the points that I made kind of the high level but I want to reiterate is that while we did model a very nominal increase in our model just to understand the increases potentially in corporate cost, this is a fabulous opportunity for us to take a fresh look at the role of corporate. And it's a luxury that we have, because we've just finished integrating over 80 individual units into 12 very strong globally capable value centers that each have a lot higher governance and management capacity than in years past. So as Dave, Gretchen and Denise are now structuring these new corporations, they have a very legitimate opportunity to be thinking about allocating some work that we've done historically at corporate, back down to the value centers because they're now capable. So that's a long way of saying that we're going to be aggressive in looking at discretionary cost offsets. One of the major activities we have in the program plan right now is to establish some cost positions for each one of the corporate overheads. But as you certainly have come to know from my own leadership mindset, we're going to be driving a lean organization in every dimension here. Well, I want to thank all of you for your interest and appreciate your patience as we go through this separation. I want to reaffirm that while the separation is keeping us pretty busy here at the corporate and the group level, the good news is it really does not impact our value centers, which is about 95% or 97% of our headcount. So the value center strategies and operating plans are on track. We're going to make those numbers as we committed and continue to march towards a successful separation. So I thank you all for your interest, and we'll talk with you soon. Thank you.

Thank you. This concludes today's conference call. You may now disconnect.