ITT Corporation FY 2009 Guidance Call Transcript

ITT Corporation (ITT)

FY 2009 Guidance Call

December 16, 2008 9:00 am ET

Executives

Steven R. Loranger – Chairman of the Board, President & Chief Executive Officer

Denise L. Ramos – Chief Financial Officer & Senior Vice President

Thomas Scalera – Director of Investor Relations

Analysts

Shannon O’Callaghan – Barclays Capital

John Inch – Merrill Lynch

Jeffrey Sprague – Citigroup

John Baliotti – FTN Midwest Securities Corp.

Michael Schneider – Robert W. Baird & Co., Inc.

Nigel Coe – Deutsche Bank Securities

Scott Davis – Morgan Stanley

Presentation

Operator

Welcome to the ITT 2009 outlook conference call. Hosting the call from ITT headquarters is Mr. Steve Loranger, Chairman and Chief Executive Officer. He is joined by Denise Ramos, Chief Financial Officer and additional speakers. Today’s call is being recorded. At this time all participants have been placed in a listen only mode and the floor will be opened for your questions following the presentation.

(Operator Instructions) It is now my pleasure to turn the call over to Tom Scalera, Director of Investor Relations.

Thomas Scalera

Good morning and welcome to ITT’s 2009 outlook call. Presenting this morning are Chairman and CEO Steve Loranger and Chief Financial Officer Denise Ramos. The format for our call today is as follows, Steve will provide some 2008 highlights and a strategic overview of ITT. Denise will then provide a detailed review of our 2009 financial outlook and Steve will add some closing comments before we move on to the Q&A session.

Today’s presentation materials, press release and webcast are all available at www.ITT.com/IR. Lastly, please note that any remarks we may make about future expectations, plans and prospects constitute forward-looking statements for the 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 10K as well as our other public SEC filings.

Now, let me turn things over to Steve

Steven R. Loranger

Thank you all for joining us today for ITT’s 2009 outlook. By now the uncertain economic landscape is well appreciated by all of you so let me start by outlining some important 2008 highlights and emphasis the many strengths that are embedded in ITT’s portfolio and people. I think you’re going to agree that we are positioned well in this environment.

First, we believe that ITT’s portfolio is truly strong. Our blend of defense and commercial businesses provide critical products and services in markets that are driven by population growth, the environment, global security and global infrastructure. The long term demand drivers for our business are enduring and we feel that the essential and non-discretionary nature of our products will serve us well throughout this cycle.

Entering in to 2008 our management team anticipated challenges in the back half of the year but certainly we did not anticipate what actually unfolded. Through these difficult times, our dedicated team assessed rapidly deteriorating conditions and we acted swiftly. The incremental restructuring charges that we announced in October and our continued commitment to our 2008 targets provide strong evidence that our skilled leaders at ITT can stand up to the biggest challenges.

In fact, let me remind everyone that by every financial and strategic measure, 2008 is adding up to another great year for ITT. This morning, I’m proud to announce that we are reaffirming our 2008 revenue and EPS guidance notwithstanding the significant headwinds that you all know about, we continue to expect to deliver record results in 2008 with total revenue growth of 28% and earnings per share growth of 22% compared to 2007.

We’re also pleased to announce that we’re recommending a nearly 22% increase to our dividend. This increase is consistent with our commitment to grow the dividend at our earnings growth rate and it further reflects our confidence in our strong free cash flow generation. Continuing on our successful journey to leverage our strength and breadth, we’ve also seized this opportunity to further streamline our overhead processes and better position us for additional functional synergies.

Last week we named Dave Melcher as our President of Defense Electronics and Services and Gretchen McClain as our President of Fluid and Motion Control. Gretchen will oversee the streamlining of our fluid technology and motion and flow control structures creating more efficiency and further driving decision making closer to our customers. Dave and Gretchen together will be providing strategic direction, increasing business collaboration and driving shared operating initiatives such as talent development, global sourcing, [inaudible].

In this environment our strategy is very clear. We’re driving sales force excellence to ensure that we stay close to our customers and obtain more than our fair share of top line opportunities. We continue to plan for the long term and we are supporting our strategic growth investments. We’re being proactively ambitious in reducing our cost everywhere we can and leveraging our business and functional strength to achieve competitive advantages and we’re further protecting our already conservative balance sheet with a laser focus on continued high free cash flow generation and delever.

Finally, we’re all working together as a team to maximize our execution excellence with strong employee involvement. We know that ITT’s best days are ahead of us and we plan to continue our successful performance record while ideally positioning our businesses throughout this cycle. We believe that all of these current and future actions give us the competence to maintain our previously issued 2008 guidance and deliver a solid financial plan for 2009.

With that introduction, let me turn it over to Denise to comment on the 2009 specifics.

Denise L. Ramos

On the 2009 outlook summary you will see that we are expecting consolidated organic revenue performance in a range of down 2% to up 1%. This range reflects the underlying strength of our balanced portfolio. Our defense backlog and winning program track record provide a stable base for our 2009 projections while our revenue forecast for the fluid and motion flow control segment reflect the difficult market conditions we’ve all been seeing recently.

This current timeframe provides the base for our 2009 projections and we have not forecasted a meaningful global recovery from these low levels at any point in 2009. Total reported revenue reflects the drag from the stronger US dollar relative to 2008. Our forecast uses a December 5^th Euro spot rate of $1.27 and that translates the nearly 20% of our revenue that is generated in Euro so in total our 2009 revenue is expected to be in the down 6% to down 2% range.

However, when you look at segment operating margins, they are expected to improve to the 12.3% to 12.7% range and that being driven by focused productivity actions, volume improvements at the fence and lower restructuring actions year-over-year. These are partially offset by softness in our commercial businesses and pension and retirement expenses. So, in total we are expecting flat to down 10% EPS performance.

The next slide will provide a detailed go forward from our 2008 guidance to our 2009 outlook for EPS. As you heard Steve mention earlier, we are have confirmed our full year EPS range for 2008 so this low forward that you see builds off of the $4 midpoint of that range. We expect healthy growth from our defense business due to our strong backlog, strong program win rate and exceptional execution.

In addition, we expect incremental benefit at the corporate level from recent cost containment actions so when you put these two together, these actions are expected to contribute $0.30 of incremental earnings per share. Partially offsetting these gains is a $0.25 impact from organic revenue declines in our fluid technology and motion and flow controls segment.

The restructuring actions that we’ve taken over the past couple of years including the incremental actions recently announced in Q4 2008 have helped to lessen the operating impact from these revenue declines. We will also continue to drive incremental supply chain savings through our integrated global strategic sourcing group. Given the combined power of our global spend, our DSS team plans to increase the levels of our consolidated spend in low cost regions from nearly 20% in 2008 to over 24% in 2009.

So, at the operating level, our portfolio hedge played out nicely. In this difficult environment we are pleased to deliver $0.05 of incremental operating earnings in 2009. As we continue down the EPS roll forward, the net non-operating headwinds total $0.25 per share. $0.15 of these headwinds relate to higher interest rate primarily in our commercial paper program and a higher effective tax rate.

We are assuming an increased tax rate of 33% and that reflects our higher mix of US income compared to 2008. Unfavorable foreign exchange rates contribute a $0.14 drag on 2009 earnings. Higher pension and retirement costs create EPS headwinds of $0.13 due to pension asset returns expected to be down in the 35% range and reduced government reimbursements for our defense employees.

Partially offsetting these headwinds will be lower year-over-year restructuring expenses totaling $0.17 and this is entirely due to the incremental restructuring actions announced in Q4 of this year. In 2009, we are planning to return to our normal restructuring run rate of approximately $50 million. New action will primarily focus on further leveraging the global footprint and infrastructure in our fluid and motion control segments.

So when we add up all the pieces, we are forecasting EPS in the range of $3.60 to $4.00. We’ve widened the range of our EPS estimate from our historical range and that’s due primarily to the higher levels of volatility we are expecting in our key fluids and motion and control end markets. In summary, we believe that in this economy, EPS performance in the flat to down 10% range represents solid cost management and is a testament to our balanced portfolio.

Moving on to fluid technology on Slide Six, we expect our fluid technology business to be down approximately 4% on an organic basis and 11% in total after the seven percentage point negative impact from foreign exchange. Our industrial process business is seeing outstanding growth in 2008 due to strong end markets such as oil and gas, power, chemical and mining. So, we’re going to enter 2009 with a record backlog in this business and that is driving modest top line growth expectations.

However, it is important to note that we are not assuming 100% conversion of this backlog so we have tempered our 2009 expectations to account for expected delays and/or cancellations of some of these orders. The water and waste water value center; we believe that our install base will continue to provide stable aftermarket revenues in 2009. We believe that much of the aftermarket spending by municipalities is funded by water tariff so many of these expenditures should be incorporated in to municipal operating budgets.

On the construction side of municipal spending which is roughly 30% of our municipal exposure, we are expecting headwinds from project delays which we are already seeing and potential future project cancellations. Residential markets have been under pressure for a couple of years now and we expect to be down in the low single digits in that market. Keep in mind that nearly two thirds of our residential business is in the aftermarket.

We’re forecasting our global commercial markets to be down in the mid to high single digits. Roughly 50% of our commercial business is in the aftermarket. However, we are expecting to see more new project delays and cancellations over the coming months. So, in summary our fluid team if planning to face difficult market conditions. We do remain focused on our customer needs recognizing that these important markets will eventually return to long term growth.

In the meantime, we’ve taken appropriate cost in productivity actions to mitigate the operating income impact of a sluggish top line. Turning to motion and flow control, our motion and flow control segment includes our businesses that are most exposed to short cycle economic drivers. As a result, we are expecting motion and flow revenue to be down 15% on an organic basis and down 22% in total. The 2009 performance partially reflects trust impairments that’s drawing organic growth in 2008.

Looking at some of the drivers for each value center, motion technology which now consists of our friction and KONI shock businesses includes most of our automotive exposure. About half of our revenues in this value center are in the aftermarket and we have little US exposure. However, we are anticipating significant declines in European OEM production.

Our controls technologies business, which combines our aerospace and controls value centers is expected to grow in the low single digits next year. Our commercial aerospace backlog is solid and is expected to drive modest growth. Interconnect Solutions, participates in many end markets ranging from general industrial to defense. We expect to see mixed performance across these end markets.

This business does not have a significant aftermarket revenue stream and has more short cycle exposure than the other motion and flow value centers. Flow control also benefits from its diversified end markets. However flow controls does have the most exposure to discretionary spending especially in the marine, RV and pool market so we are expecting this business to be down significantly in 2009.

In our energy absorption business we provide critical components in to end markets such as rails and general industrials. We do expect our global rail market to benefit from continued investments in mass transit in both emerging and developed markets but offsetting this will be expected weakness in the general industrial market.

While motion and flow control will face a significant amount of economic pressure, we do believe that this business is better positioned to navigate these rough waters than it was just a few years ago. That has been due to aggressive costs and portfolio actions. Turning to Slide Eight our defense and electronic services segment. During 2008 we set some lofty strategic goals for our defense business including securing a spot on the JTRS team, increasing focus on international customers, integrating $1.6 billion business in ITO and ramping up production of the critical crew jamming device.

Today we are pleased to report that our defense team succeeded on all fronts. Throughout this past year our defense team had a series of significant wins that are incremental to our base of business and that will help ensure continued growth in to the future. Diversified customers like NASA, the FAA and international customers such as Iraq, Spain and Saudi Arabia have selected ITT to address its critical service and technology needs and our teams stand ready to deliver.

These wins give us confidence that we will grow our defense top line in the mid to high single digits over the planning horizon including growth in the 5% range in 2009 with all of our businesses contributing. Growth in 2009 will be lead by our services businesses which we expect to grow in aggregate in a high single digit range. Our service teams work hard to be a preferred supplier to both DOD and non-DOD customers.

Our capabilities and performance have opened the doors to significant programs including NASA’s deep space communications and the FAA’s air traffic control modernization. Our products businesses will enter 2009 with approximately $3.5 billion in backlog. We expect the product businesses to grow in the low single digit range in 2009 led by airborne countermeasures, international communication devices, GPS 3 and night vision.

In 2009, our defense team will continue to execute against its four long term growth strategies: growing the core; penetrating adjacent markets; expanding internationally; and pursuing cross value center opportunities that leverage the unique strength of our portfolio. Our defense portfolio provides tremendous stability heading in to 2009 and we could not be happier with their recent performance.

We provide critical technologies and services to our customers and we believe that our unique portfolio is nicely aligned with President Elect Obama’s defense priorities. That concludes our segment guidance, now I’ll turn back to Steve for some final thoughts.

Steven R. Loranger

If you turn to Slide Nine I want to close out with a discussion on our 2009 operating priorities. ITT leaders across the world are expecting to face unprecedented challenges in 2009 and across our businesses we’ve taken aggressive pro-active steps to confront these conditions. From a market strategy and productivity perspective, we have been on a multiyear journey to optimize our portfolio.

We divested our North American automotive and consumer electronic businesses and we’ve made several strategic acquisitions. The restructuring actions strategic realignment in the global strategic sourcing expansions that we’ve recently undertaken have put us in a far better position to address today’s economic climate. We’ve been limiting our expenses and we’re going to continue to control these costs throughout 2009.

However, the strongest companies make courageous investments during difficult conditions so while we are going to pay significant attention to cost controls in 2009, one thing we will not due is abandon our strategic investments. Our strong organic track record empirically proves the adjustability of our businesses, the strength of our brands and the criticality of our products and services.

In 2009 we’re going to increase our research and development investments in both fluid and motion and flow control. We plan to make a significant capital investment to support our unique position on the FAA next generation air traffic control program. This program provides a significant long term incremental growth opportunity in our rapidly growing non-DOD business area within the defense segment.

In the cross ITT we plan to invest in new IT systems and emerging market opportunities because we refuse to compromise our long term growth aspirations. Lastly, in 2009 we will continue to focus on strong free cash flow generation and balanced capital deployment. As a result, we will once again recommend a dividend increase to the board that’s consistent with our 2008 earnings growth. And, with respect to the constrained credit condition it is prudent to remove the time restriction around our share repurchase program completion.

Let me now take a moment to thank two individuals that have provided create leadership along ITT’s strategic journey. First I’d like to thank Hank Driesse for his years of leadership at ITT. As you know, we pulled Hank away from an imminent retirement and asked him to fill in as an acting basis as the President of our Defense business. Let me first thank Hank for the tremendous success his defense team delivered in 2008 and then again for Hank’s many significant operational and strategic contributions made during his long career with ITT.

Next I’d like to acknowledge the portfolio realignment action, the solid business management and strategic value center consolidation completed under Nick Hill’s leadership at motion and flow control. As you know, Nick decided to retire from ITT and while we are very, very sad to see Nick go we’re extremely thankful for his relentless pursuit of excellence and unique contribution during his 35 year career at ITT.

In conclusion, our financial discipline and aggressive strategic action through the last several years have positioned us nicely going in to a challenging 2009. We feel that the outlook we’re delivering today adequately reflects the unique strength of our balanced portfolio, our strong free cash flow generation, proactive cost actions and our strong balance sheet. So, as this economy unfolds even more positively or more negatively I expect that ITT will maintain and expand on its many positions of strength.

With that, let me turn it back over to Tom and we’ll be happy to take any questions.

Thomas Scalera

We’re ready to start the Q&A session now.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Shannon O’Callaghan – Barclays Capital.

Shannon O’Callaghan – Barclays Capital

You mentioned no recovery baked in to the plan in the second half but glad to hear that. I’m wondering if you have anything assumed in the plan in terms of some benefits from the stimulus packages or state assistance or if you have any expectations around that?

Denise L. Ramos

Yes, we have not baked anything in to our 2009 numbers for potential impacts that we could have from any of the fiscal stimulus plans that are being announced in the US and elsewhere. We know that there are a lot of details yet to be developed around those plans. If we would see something we expect that we could maybe see something in the back half of ’09 but we play in a lot of the areas where we see that some of these investments and some of this spending could occur so we could see that in water, waste water, some of the rail projects that we get involved in and some of the dewatering.

We feel good about it, we’re going to be ready and positioned to be part of anything that comes through but right now in our plan we don’t have anything factored in.

Shannon O’Callaghan – Barclays Capital

So ’09 is sort of set with a continuation of current conditions?

Denise L. Ramos

That’s correct.

Shannon O’Callaghan – Barclays Capital

Then on defense you mentioned confidence in mid to high single digit growth over the planning horizon. We got 5% this year, I mean does that suggest that there could be upside to ’09 or I guess it would suggest in future years you’re expecting 5% to be the minimum if you’re suggesting you could move to high as well?

Steven R. Loranger

Shannon, the way to think about that is that we’re still good for our mid to high single digit forecast over the planning horizon in defense for a number of reasons. First of all specific to the 5%, as you know we had outstanding performance and very, very high demand for the crew jammers this year which worked exceptionally well. So, right now next year we’re expecting another very, very solid year of crew production.

But, because we’re actually finishing the year stronger than anticipated in ’08 which led to the increase in our defense forecast, you’re seeing that slight adjustment over next year. But, beyond the point I would affirm that the performance of the crew has simply been outstanding and we’re continuing to receive orders. In fact, going in to next year with a very solid backlog. The performance of that is validating the need and we’re going to continue to see not only MRAP but non-MRAP production opportunities for that.

Then beyond that, remember that the defense portfolio is really aligned with the new administration’s priorities in the area of force protection, of recharge and new technology, sensing and surveillance communications so we really play in the sweet spot of the defense priorities. The other piece is that we continue to advance our non-DOD and international wins. So, when you add it all up we still feel good about our long term defense outlook.

Operator

Your next question is from John Inch – Merrill Lynch.

John Inch – Merrill Lynch

Could we get what are your margin targets in 2009 for each of the three segments?

Denise L. Ramos

John, when you look at ITT in total as we’ve laid out there we’re seeing improvement of roughly about 30 basis points. When you break it down by segment, there’s a lot going on in the segments when you look at FX and restructuring and tension and that specifically impacts fluid and motion and flow so let me talk about it from more of an operating perspective.

When you look at fluid from an operating perspective we would say that they’re going to be roughly flat and then on top of that you would add an impact from fx, restructuring and pension so they’ll be flat to maybe slightly up. On the motion and flow control side, because of the deterioration on the top line we’re expecting the margins to be down on a year-over-year basis and then with defense we’re expecting defense margins to be up slightly from where they are this year.

The reason for that is there were some integration costs associated with ITO in ’08 that we will not see in ’09. That’s how we’re thinking about it, it’s hard to give you the exact numbers right now since we’re still trying to factor in where fx is going to end up in restructuring and pension but that’s how you should think about it.

John Inch – Merrill Lynch

And defense margins are up Denise even with some of these pension headwinds in defense? How much of a significance is that, can you remind us?

Denise L. Ramos

For defense it’s probably 10 to 20 basis points negative for defense on a year-over-year basis. So, even with that negative we do expect them to be up.

John Inch – Merrill Lynch

Then Denise in fluid your production base that’s anchored in Europe and Sweden, how much is the dollar strength actually benefitting your cost of goods or the margins in fluid? Is there a way to quantify how much fluid margins are expected to benefit based on your $1.27 Euro conversion expectation?

Denise L. Ramos

When you look at the margin expectation for fluid the benefit that we would be seeing based on the $1.27 exchange rate that we have in here would be roughly 50 basis points of a benefit to them. But, it hit them on the negative side on the revenue side.

John Inch – Merrill Lynch

But even with that you expect fluid to be roughly flattish all in?

Denise L. Ramos

All in we expect them to be roughly flat. Now, remember we do have benefit from restructuring on a year-over-year basis because lower restructuring in ’09 versus ’08 so that’s a benefit but then you’re going to get a little bit for pension.

John Inch – Merrill Lynch

Then just lastly, kind of clarification, on Slide Six you describe your water, waste water and residential and water segments. You use the turn stabilizing aftermarket, do you mean that your aftermarket component has begun to stabilize or that the aftermarket component is a stabilizer?

Steven R. Loranger

It’s the latter John. The aftermarket is driven by wear and tear and natural usage of our parts and it tends to be a very stable component of our revenue base. Think of it almost like an annuity.

John Inch – Merrill Lynch

And you haven’t seen any kind of deterioration in that business? Have you seen thus far either in Europe or North America?

Steven R. Loranger

In the aftermarket, no not at all. That gets back to the point we’re always proud to make is that people do not buy our equipment on a discretionary basis. We refer to it as essential. When their water pump breaks they have to get another one and so that piece of the aftermarket business is a very strong component of our sales.

Operator

Your next question is from Jeffrey Sprague – Citigroup.

Jeffrey Sprague – Citigroup

Just on defense, you guys were targeting kind of the backlog at the end of ’08 at about $5 billion, did you close out at that level?

Denise L. Ramos

We expect it will be around the $5 billion level.

Jeffrey Sprague – Citigroup

Then on tax Denise, I think you said you had a headwind in ’09 because tax will be 33% but it looks like you’re close to 33% this year. So, tax rate is lower in Q4 that pulled ’08 down?

Denise L. Ramos

No, we actually think we’re going to end up in ’08 at about a rate of 32.7%. So, when you look at the 32.7% versus the 33% that’s roughly $0.02.

Jeffrey Sprague – Citigroup

So most of the headwind there is really interest not tax that you made out?

Denise L. Ramos

That’s correct.

Jeffrey Sprague – Citigroup

Then just on this whole restructuring questions, certainly we understand the absence of spending being the tailwind but can you give us some sense of what’s imbedded in the margin from the actual benefit from the actions you took as opposed to the lower kind of contemporaneous level of spending that happens?

Denise L. Ramos

When you look at the productivity initiatives that we have baked in to the plan besides the supply chain savings and some of the [VBSF] activities that we have, we do have baked in here some restructuring savings and that would be relative to the $90 million or so of restructuring that we’re spending in ’08 plus we have some benefit flowing through for the restructuring that we’re planning for ’09. We think that on a margin basis that’s going to be roughly about 40 basis points of a benefit to us.

Jeffrey Sprague – Citigroup

The two of those items put together 40 basis points?

Denise L. Ramos

That’s correct.

Steven R. Loranger

Right.

Jeffrey Sprague – Citigroup

I guess just finally for me, fluid and emerging markets, how large of a piece of fluid is that now?

Denise L. Ramos

It’s about I want to say about 10% to 15% roughly.

Operator

Your next question comes from John Baliotti – FTN Midwest Securities Corp.

John Baliotti – FTN Midwest Securities Corp.

I guess if you think about overall, obviously companies are not going to be rewarded by giving anything but extremely conservative guidance right now. But, if you look at your portfolio over time, especially what you guys have done and what your predecessor has done, it’s seems far less volatile than it has in the past.

I guess there’s always this jockeying that goes on right now between does the company mean $3.60 or does the company mean $4.00. I was just wondering Steve if you can kind of give people the sense of what would happen to get to $3.60 versus the $4.00? I don’t get the sense that you’re really trying to direct people one way or the other, it’s just because it’s beginning of the year and you’re trying to give as realistic an outlook as possible.

Steven R. Loranger

John, that’s exactly right. We take a lot of pride in producing guidance for all of you that represents a balanced approach in terms of our estimates as well as a great deal of confidence. Let me tell you what’s not in the range, when we think about it what’s not in the range of volatility is our entire defense business which is half of our enterprise. We feel like that’s solidly locked in the backlog with a great team who executes well.

In all of the cost reductions, this year we are eliminating several hundred million dollars of costs and those are likewise hardwired in to our plan. So, the range comes from our perspective on the commercial market top line and most notably commercial buildings, municipal and transportation. So, when you stratify the level of volatility, it’s really prominently around those markets.

I think we’ve done our best estimates in appropriate but prudent guidance ranges. If these three markets perform a little better than expectations we’ll be at the top of our range. If they perform less than our expectation we’ll be down below. But, the one thing you can be assured is not only have set these hardwired plans in place but we also have a long list of other actions that could be taken if the economy unfolds much more adversely than what we expected.

All in all John we think this is a balanced plan, we think that we set the midpoint right in a place that we’ve got good confidence for the future.

John Baliotti – FTN Midwest Securities Corp.

I think if you look at the defense I remember a long time ago when [Lou] use to give us guidance for defense, long term growth was 5%. Obviously it was a worst case scenario because it came in better it looks like from the midpoint when you gave third quarter earnings release that you’ve won almost $3 billion in awards and I get the sense you’re maintaining that discipline of only basing your growth on fully funded versus what you see as the bigger opportunity.

Steven R. Loranger

Absolutely. We’re maintaining a solid discipline in defense and when leadership teams put plans together you’re also safer to assume a conservative top line and be very ambitious on your speed and efficiency components which is cash and cost. So I think in this environment we have to be ever more vigilant on the internal operating execution. But, the one thing that you know is that the defense team is going to get what they can get.

We have above average win rates. We’ve got some very, very strong strategic position and, as I mentioned, we’re playing in some vital areas. Keep in mind that the international business is really hard to predict for us because of timing. There is no doubt a need for the crew and electronic work there, night vision and [sing] guards, all of which were active in many, many countries but, they all have their own timing and funding issues so that creates a little bit of a reason or us to be more conservative. But, all in all we feel good about our position in defense.

Operator

Your next question comes from Michael Schneider – Robert W. Baird & Co., Inc.

Michael Schneider – Robert W. Baird & Co., Inc.

Maybe we can focus just on INC for minute. It sounds like that business is going to feel the full burn for the global recession. Have you done a goodwill test on that and what are your expectations I guess as we go through 2009 on impairment?

Denise L. Ramos

Let me say in terms of INC, we have been happy with our INC acquisition. We have successfully integrated it in to the various value centers that we have here so obviously you cannot predict something like this happening in the marketplace but again, from a strategic standpoint we like the INC acquisition.

So, saying that, we are in the process of going through impairment and goodwill testing. We do that on an annual basis at the end of the year and at this point in time we do not expect any issue.

Michael Schneider – Robert W. Baird & Co., Inc.

Then if we could just go back to the aftermarket comments, you mentioned that it’s a stabilizing force. I’m curious what you’ve actually seen though because the AWWA released a report recently saying that repair and replacement spending and it’s not really a believable number but would be forecasted to be up 17% this year in the United States as money from new construction related projects is redeployed even partially back in to the existing infrastructure.

What are you seeing in that repair and replacement market? Is the aftermarket actually benefitting from the collapse in new construction or are cities just not spending the money either way?

Steven R. Loranger

We actually haven’t seen a trend. I think we’d have to recognize the theoretical component that your data suggests but we would not expect that level of an increase. For some municipalities, as an example, it might be possible for them to do more of the maintenance work and upgrade than an all new project. Again, that will be on a one off basis but, all in all we’re seeing a solid aftermarket component but nothing that would validate the kind of level that you’re talking about Mike. We’re planning on it being about flat year-over-year.

Michael Schneider – Robert W. Baird & Co., Inc.

And pricing in that aftermarket, are you beginning to experience pricing pressure from your distribution channel or from the municipalities themselves on aftermarket type parts?

Steven R. Loranger

No, not yet.

Michael Schneider – Robert W. Baird & Co., Inc.

Do you expect it?

Steven R. Loranger

In a declining commodity based market after some years of absolution we’ve got deflation, it’s going to obviously be a concern and so particularly in fluid technology our teams are turning their attention to selling lifecycle costs, selling value and increasing the service dimension of what we’re providing so that we can maintain the prices that we have attained the last couple of years and our plan is set accordingly.

Denise L. Ramos

Just to follow up on that, we’ve not assumed any new price increases in ’09. We have assumed some of the flow through from the actions that we’re taking in ’08 and then how we think about it is we think if we do get pressure on the top line that we’re going to be able to offset that with lower raw material costs.

Operator

Your next question comes from Nigel Coe – Deutsche Bank Securities.

Nigel Coe – Deutsche Bank Securities

In fluid there’s quite a lot of moving parts there. I’m assuming that municipal will be weaker in the first half than second half. I’m assuming that commercial will be weaker in the second half than the first half and industrial decels over the course of 2009. Can you just talk about how the 4% organic decline that you’ve got for fluids phases through 2009?

Denise L. Ramos

Again, how we did that is we looked at the performance that we’ve been experiencing during the fourth quarter of this year and we basically used that for all of ’09. To the extent that you might see something worse in the first half of ’09 and then stronger in the second half of ’09 on average we’re saying that it will be what we’ve seen in the last couple of months.

Nigel Coe – Deutsche Bank Securities

Then the 10% to 15% for mo flow is that basically what you saw in 4Q?

Steven R. Loranger

Yes, it is. We’ll obviously be watching that one carefully as the year unfolds because we’ll always worry about an instantaneous reaction in this market.

Nigel Coe – Deutsche Bank Securities

Secondly, you did mention free cash flow, is there any reason that you can’t convert sort of over 100% again in 2009? I mean you referenced any requirement for pension funding next year?

Denise L. Ramos

With free cash flow, when you look at it from an operating basis, we’re planning on generating still very strong free cash flow next year. So, from a working capital standpoint we’re expecting to see some improvement. We target higher inventory turns and other things. So we’ve planned for that in our number for next year.

Now, saying that we are planning on making some additional investments. One has to do with [ADFC] and Steve mentioned it in his remarks that we’re going to have roughly $70 or $75 million of an investment for [ADFC] and the reason for that is because we think that is good for our long term strategic growth in that area so we’re planning on making that investment next year.

The other thing is with the restructuring that hit our P&L in the fourth quarter of ’08 we will have the cash outflow associated with that in ’09. Those will be two things that will impact the free cash flow conversion taking it from that perspective. We are not planning on any additional pension funding in ’09.

Nigel Coe – Deutsche Bank Securities

Finally, just as a course of guidance policy, will you still provide end quarter guidance in 2009?

Denise L. Ramos

At this point in time we’re not planning on changing anything.

Operator

Our final question is from Scott Davis – Morgan Stanley.

Scott Davis – Morgan Stanley

Can you address inventories a little bit. When I look at my model your top line guidance is a little bit weaker than what we had. I noticed you really hadn’t referenced inventories at all. Is there any major destocking going on in either fluid tech or mo flow? And if so, how long does that historically take?

Steven R. Loranger

Two components Scott, one is I do want to address our internal inventories and working capital. Going in to this uncertain environment both Gretchen and Nick Hill got well ahead of the trend by doing some early plant reschedules. At this point we feel pretty good about our working capital conversion and our internal inventories.

Now, that is on our operating side. I think it’s safe to say that many of our distributors are adjusting their inventories which puts the pressure on us for delivery accuracy at this point in time. We’re watching that trend very, very carefully. Keep in mind, to some degree we’re doing some of that ourselves because in fluid technology we actually own 70% of the distribution. So, being very conservative in not stocking more than you absolutely need to have is something that is happening in the environment and again, we’re factoring that in to our sales forecast.

Scott Davis – Morgan Stanley

My last question just relates to a couple of times you referenced project delays and cancellations. Are you speaking more specifically about the US or is it more a global phenomena? In fact, when you think about the cause of delays are they typical things that we would expect, financing and state and local government shortfalls or are there other things like the sharp decrease in commodity costs causing everybody to kind of go back and rebid projects or any other dynamics that are going on there?

Steven R. Loranger

Scott, I think the best way to characterize it is that it’s spotty and it’s equally spotty around the global. So, let me just hit a couple of highlights on that, if you take a look at the municipal business, some of the new projects are really funded out of tax received from bonds so you’ve got to go to the municipalities and some of them are well funded with their long term bonds and are in good shape and they’re pressing on with those projects.

Some of them are taking a pause and it’s very, very selective and I didn’t see that there was any trend in North America over Europe. Remember that we have well in excess of 100,000 municipal customers so it’s not a homogonous buying group, it really is depending on which municipality.

On the industrial side, there’s no doubt that some of the commodity collapse has caused people to take a pause in some of their mining projects where they don’t have too much invested. But, on the flip side we’re continuing to see some oil and gas bio fuel development and other energy kind of projects stay on track notwithstanding oil prices. That’s why we say we’re seeing a little bit of it but we’re not seeing any wide spread reduction at this point.

Again I’d like to thank all of you for your interest in ITT. We’re thrilled to be finishing our fifth record year in a row and with a portfolio that is strong and well positioned with a good leadership team and great processes. Even though we have some uncertainty in front of us, we think we’ve put together a solid plan and you can rest assured that our team is going to be busy executing and achieving business performance in this market on a relative basis that you and ITT has become accustomed to.

Thank you all. Enjoy your holiday season and we’ll talk with you in January.

Operator

This does conclude today’s teleconference. Please disconnect your lines at this time and have a wonderful day.

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