ITT Corporation Q3 2007 Earnings Call Transcript

ITT Corporation (ITT)

Q3 2007 Earning Call

October 26, 2007 9:00 am ET

Executives

Peter Milligan - Director of Investor Relations.

Steve Loranger - Chairman and CEO

Denise Ramos - Chief Financial Officer

Analysts

Deane Dray - Goldman Sachs

Jeff Sprague - Citigroup

Shannon O'Callaghan - Lehman Brothers

Michael Schneider - Robert W. Baird

John Inch - Merrill Lynch

John Balotti - FTN Midwest

Steve Tussa - JPMorgan

Presentation

Operator

Good morning, ladies and gentlemen. My name is Natasha. I would like to welcome everyone to the ITT Industry Third Quarter 2007 Earnings Conference Call. All lines have been placed on mute to prevent background noise. After the speakers' remarks there will be a question-and-answer period (Operator Instructions).

We do ask that you limit yourselves to one question and one follow-up.

Thank you. It is now my pleasure to turn the floor over to your host, Peter Milligan, Director of Investor Relations.

Peter Milligan

Thanks, Natasha. Good morning everybody and thanks for joining us to discuss our third quarter 2007 results. With me this morning are our Chairman and CEO Steve Loranger, and our CFO Denise Ramos.

Steve will provide some highlights for the quarter, Denise will take us through a detail financial review including a review of each segment. So then talk about our updated guidance and Steve will sum up before we move to the Q&A.

And the highlight of this morning's presentation, press release and all non-GAAP financial measures provided during the call can be found on our website at itt.com/IR. In addition, let remind you that our discussion will contain forward-looking statements, which involve risks and uncertainties and actual results could differ materially from projections.

Please refer to our annual report on Form 10-K for a full discussion of these risks. This conference call is being webcast and a replay will be available later today on our website.

With that, I will turn things over to Steve.

Steve Loranger

Good morning, thanks for joining us. We're pleased to report this morning that we have executed another extraordinarily productive quarter for ITT. On top of continued strong organic growth and operational productivity, we made very important changes to our portfolio, including the closing of the IMC transaction, the definitive agreement to purchase ITO Corporation, and the sale of our switches business.

We also continued to run the existing business with a high level of operating performance, which resulted in 19% earnings growth. Our third quarter EPS of $0.92 was led by a well-balanced revenue growth of 9% and outstanding profitability expansion.

Our geographic and end market diversification both among and within our segments, continues to enhance our ability to deliver consistent financial performance because of the good balance of economic and secular drivers.

This diversification enables solid top-line expansion as strong growth across most of our end markets more than offsets softness in the U.S. residential and marine markets. In Fluid Technology, our business delivered solid top-line growth in strong operating margin expansion despite the drag of foreign exchange.

Revenue increased 6% organically, driven by growth in all Fluid Technology value centers, reflecting solid global end market demand and share gains. Over half of our fluid sales were from outside North America, and notably, in Asia, where organic sales increased 20%.

This was also the first full quarter where our advanced water treatment business was aligned with our flight business. We are quickly implementing a seamless transition to a market facing water/waste water platform.

Our legacy treatment business is still facing difficult operating challenges. However, we are confident that we will be effective in turning around this important piece of our water business.

As you've come to know about the ITT management team, when we have issues in our businesses, you can count on to us step subpoena and drive our IMS and our operating excellence processes to fix them.

Finally, Gretchen McClain and her team made great progress advancing several large and challenging factory challenges. In Poland, Nanjing, and Shenyang, were in the quarter we now have production up and running as well as furthering our global leverage strageties by integrating our China sales team.

Within our defense unit, revenue increased 6%, inline with our forecast versus a strong third quarter of 2006. The defense-operating margin continued to expand and reached another high point this quarter, thanks to our excellent performance in fixed price contracts.

We also had some very significant contract wins, most notably the FAA's ADFB contract. This contract represents the initial phase of the next-generation air-traffic control system. As you know, upgrading the air-traffic control infrastructure in the United States is an enormous and vital job. And it puts us in a nice position for follow-on phases of the program. This is an essential program to upgrade the air-traffic control architecture within the United States and it's going to provide greater air traffic productivity in the future, and for the longer term, it positions us as a prime systems integrator in the marketplace which expands the type of projects we can pursue.

We're extremely proud of the defense team on this win and we want to acknowledge the extraordinary efforts to develop a competitive solution with outstanding global partners. That coupled with the Ito agreement and continued high performance represents a great quarter for Steve Gaffney and the defense team.

Turning to motion and flow, Nick Hill and his team continues to deliver outstanding results. This quarter organic revenue increased 9%, and their operating mar again expanded by 70 basis points, which led to an increase in operating income of 24%. The performance of motion flow control is admirable. We benefit strongly from geographic diversification and this performance has been generated despite weakness in the marine and leash mark.

Our cone knee business has turned around their top line by leveraging their technological positions into adjacent markets. Our friction business continues to win platform after platform in a very competitive automotive mark and our aerospace and connectors business continue to gain market share.

As you know, we made the decision earlier this year to make a substantial investment in our motion flow business when we made the IMC acquisition. This was driven by our objective to build on our attractive motion and flow control technologies in both horizontal and vertical dimensions.

The leadership we're seeing from the motion and flow team gives us hey level of confidence that this will turn out to be a well-placed investment. In September, we were thrilled to transition from the great IMC business that Patrick Lee built to officially welcome the international motion control team into the ITT family, and we're pleased that tippet gracious is off to great start. We have two new value center presidents from IMC. Wayne Foley, who leads our controls business, and Mike leads our energy absorption value center.

And finally, as we move into the last quarter of what has been an excellent year for our company, we remain optimistic about our continued performance is and we are increasing our full-year EPS forecast from $3.44 to $3.50 range, now to a new range of $3.50 to $3.53. The midpoint of this new full-year range yields a very strong earnings growth this year of 23%.

And with that we'll turn it the over to Denise to go through the financial results. Thanks, Steve. Let's turn to the results for the quarter starting on slide two. On a consolidated basis revenues grew 9% in the third quarter, 6% organically, driven by continued strength across all of our segments. Segment operating income increased by 18%, and margins expanded by 100 basis points driven by margin improvements throughout each of the operating segments.

EPS on an adjusted basis grew 19% for the third quarter, to $0.92, which is $0.02 above the high end of our guidance range. Also please note that the IMC transaction closed earlier than anticipated and resulted in a $0.02 drag on the $0.92 number I just mentioned.

I do want to remind everyone that the $0.05 full-year dilative impact has not changed. We are now essential expecting $0.03 of it to hit in the fourth quarter. Through the third quarter, free cash flow was $432 million. We remain confident in our guidance of achieving full-year free cash flow greater than or equal to our net income.

Now let's discuss the results of fluid tech on slide three. Total segment revenue grew 10%, or 6% on an organic basis. Total fluid sales were driven by excellent international growth of 14% organically. Sales in central and South America grew more than 50%, and it's becoming an important part of the revenue base. We also experienced tremendous growth in Asia, where sales were up close to 20%. Organic revenue increased by 2% and our water, wastewater group. And as Steve mentioned this is the first quarter, where AWT has been combined into flight.

The legacy flight business grew in the high single digits on an organic basis driven by continued growth in the dewatering market and by the sale of large submersible pumps used in municipal application.

Unfortunately, the strength was masked by weakness in the legacy AWT business which saw double-digit revenue declined on an organic basis. This piece of the business had positive performance in Europe, but continued to struggle in the U.S.

Our residential and commercial water business experienced very solid 7% organic sales growths overall which was comprised of 4% growth in the U.S., 9% in Western Europe, and double-digit gains in Asia and Eastern Europe.

The commercial side of the business saw double-digit growth driven by strong aftermarket sales, and continued demand in the commercial construction market, partially offset by weakness on the residential side of this business particularly in the U.S.

Our industrial process business continues to deliver outstanding results. This business grew 17% organically, driven by very strong growth in the mining and hydrocarbon processing markets.

Moving to profitability, fluid tech's operating margins increased 40 basis points over the prior year, as we benefited from volume driven operating leverage.

Let me highlight a few additional points with respect to operating margins. First, similar to last quarter, the operating margin was constrained by the FX impact of the dollar that continued to weaken throughout the quarter. This quarter the impact was approximately 20 basis points.

Remember that the nature of our sales and production footprint causes us experience lower operating margins with little impact on total operating income, when the dollar weakens.

Then secondly, as we mentioned last quarter, our newly opened plant in Poland continues to increase output and the level of duplicative cost experience as we ramp down production in a number of our legacy plants is decreasing in line with our forecast. We are also seeing greater raw material price pressure than anticipated, which is masking strong productivity improvements.

And finally, turning to orders, fluid experienced a 9% increase on an organic basis, led by double-digit increases in water, wastewater and industrial process.

Let's turn to slide four and review the results of our defense business. Defense delivered 6% revenue growth, which was in line with our expectations. This growth was led by our systems business, which increased sales by 16%, driven by a number of U.S. military contracts around the globe.

Our advanced engineering and sciences business continued its outstanding performance and third quarter sales increased by 37% on the strength of contracts with the joint spectrum task force.

On the product side, our night vision business grew in the mid-teens, while our electronics systems and ACD businesses were essential flat. You recall that by the middle of last year, we had ramped our production to the current levels at the customers' request and we have maintained that level of production since then.

And lastly, our space business saw sales drop. However, the majority of this related to a tough compare to the third quarter of 2006, which included a large favorable contract settlement.

Looking at profitability, on a year-over-year basis, defense's operating margin of 13.5% was up 160 basis points, driven by the continued productivity performance seen in the product side of the business allowing to us once again raise our full-year margin target.

Turning to third quarter orders and backlog for our defense businesses, orders increased 7%, moving the backlog to $3.5 billion. It is important to note that as we entered the year, our expectation was for our backlog to remain flat versus 2006 levels. And while the exact timing of orders makes the next three months difficult to predict, we do believe that we will enter 2008 with a strong backlog that is somewhere in the $3.8 to $3.9 billion range.

Let's turn now to the next slide and let's look at the results in the motion and flow control segment. As Steve said, this segment had another outstanding quarter, with revenues up 18%, 9% on an organic basis, much of the growth was from overseas, where we posted double-digit revenue increases.

Within aerospace controls, revenue grew 26% organically as we continued to deliver excellent products into a very strong market segment. Our friction business delivered 14% organic revenue growth as it continues to win new platforms, particularly in the European market.

Within marine and lee sure, organic revenue grew 3% led by very strong export sales in our marine business. And strong industrial flow control devices in the construction and medical markets. However, offsetting this strength was continued pressure in the spa and whirlpool business.

This is very consistent with overall market trends experienced in the U.S., where the whirlpool bath and spa market continue to decline. Our KONI business has delivered its second straight quarter, where organic revenue growth approached 11%. This has largely resulted from our successful penetration into the bus, truck, and railway markets.

Lastly, our connectors business had another strong quarter with sales increasing 7% organically. In addition, bookings in Asia and North America added to the strong backlog and drove a book to bill greater than one in the quarter.

Looking at profitability, segment margins of 14.3% represented an increase of 70 basis points on a year-over-year basis as we continue to deliver productivity improvements. In addition, it is important to note that the three weeks of IMC results was comprised of $11 million of revenue and $2 million of net operating loss.

This had the effect of lowering margins by 130 basis points in the quarter. Finally, the motion and flow segment saw its organic orders increase by more than 13% during the quarter, led by growth in KONI and friction, which both saw orders increase by more than 20%.

Now let's turn to slide 6, where I’ll review the company's revised earnings outlook. We expect ITT's fourth quarter revenue to increase 11%, which translates into full year revenue growth of 12%. This does include the full fourth quarter impact of IMC revenue, which was not in the base period.

We anticipate fourth quarter segment operating margins to be between 13.1% and 13.3%, and believe our full year margins will be in the 13.2% to 13.4% range. Our fourth quarter EPS target is $0.90 to $0.93 and the midpoint of our full year target has increased by more than $0.04, bringing the full year to a range of $3.50 to $3.53.

Looking at the changes in the full year outlook for our segments, we are forecasting an increase in revenue of nearly $50 million in fluid, more than half of which relates to the impact of foreign currency.

In the defense business, the midpoint of our revenue forecast has increased by $30 million based on the strength in systems and advanced engineering and sciences. On the margin side in defense, we have increased our forecast by 20 basis points to reflect the better than expected performance we saw this quarter.

In our motion and flow business, we are increasing the midpoint of our revenue forecast by $80 million. This reflects the full impact of IMC revenue, which should be in the range of $60 million, including the $11 million it contributed in the third quarter.

The remaining increase is essentially split between the FX benefit and some incremental demand we are seeing across the base business. The full-year margin is now being adjusted down to a range of 14.4% to 14.6%, and this change is entirely attributable to the impact of the IMC acquisition.

As we have mentioned previously, the up-front integration costs and intangible amortization drive this dilutive effect. Now, I would like to turn things back to Steve for a few additional comments before we move to the Q&A.

Steve Loranger

Thank you, Denise. Let me close by saying that we're pleased with the performance of that our organization has achieved year-to-date. We are delivering on what we've set out to do, which is to generate strong organic revenue growth, increase productivity, and effectively reinvest our capital in a balanced way.

In short, our overall corporate strategy is working. This was an extremely busy and productive quarter, and we're now working hard to detail our 2008 operating plans, which we're going to share with you at our upcoming analyst meeting in a few weeks.

And at that time, we'll have the opportunity for ITT's senior leadership team to share the strategies behind their business success and discuss what they see in terms of future opportunities.

So, let me turn things back over to Peter, and we'll begin the Q&A session.

Denise Ramos

Thanks, Steve. Natasha. IF you could introduce the instructions for placing a question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Deane Dray of Goldman Sachs.

Steve Loranger

Good morning, Dean. Dean, you are maybe on mute?

Deane Dray - Goldman Sachs

Yeah.

Steve Loranger

All right.

Deane Dray - Goldman Sachs

Sorry. Can you hear me now?

Steve Loranger

Yes.

Deane Dray - Goldman Sachs

Sorry.

Steve Loranger

All right.

Deane Dray - Goldman Sachs

Steve, could we go to your prepared remarks we talk about the operating challenges in the legacy water and wastewater businesses? So, it sounds like we're not going to get a chance to talk about the AWT going forward as it's combined with flight, so while it goes into the segment or into the business, on a consolidated basis 2% organic revenue growth is very healthy, but there's still some legacy issues in it.

If you could just step through those, how much of that is a portfolio change that you might do, as a productivity initiative that you might address, and are there any specific end-market topics, you think will be a head wind?

Steve Loranger

Okay, Dean, we're going to still, despite the fact that we are integrating this into three market-facing platforms, we'll still break out treatment as to be able to discuss those technology platforms.

So walking through it, keep in mind that treatment is, for the most part, a series of technologies. In the biological segment, we're operating very well. We're well positioned in continuing to invest there.

We do need to invest more to upgrade our technology in ultraviolet and ozone. And in the fresh water filtration segment, notably Leopold, we're extremely well positioned in North America and we're going to continue to invest in those technologies for global expansion.

And then finally, we participate in the small-scale reverse osmosis filtration and desalination markets, and that's an area also where we will continue to invest in our systems and explore further desalination into commercial and industrial markets.

So underneath this, what I'm saying is we have a number of technology investments to ensure that the technologies in the treatment area can be flowed into the municipal, industrial, and commercial market segment. In addition, we also have some product line activity in place, where we'll be migrating some production from various locations to others to ensure that we're leveraging our scale.

And that's all part of the www or water/wastewater integration plan.

Deane Dray - Goldman Sachs

Great. That’s very helpful. And just a follow-up Denise that I hear correctly when you walked through the integrated water business the residential piece in the U.S. was up 4%?

Steve Loranger

No, did you not hear that Deane. The residential portion in the United States is obviously off. Off in the business, but when you walk through the math, since we all know that U.S. housing is down, that is effectively; that's effectively impacting us in the order of $10, $15 million.

So it's of top line in residential. Because the -- because even though we participate in that business, it's only about 5% of Fluid Technology and two-thirds of that 5% is roughly aftermarket. And so it is down a couple of percent on a year-over-year basis, but we're absorbing it.

On the flip side, our commercial businesses in North America, in terms of buildings, are up about in the 10 to 15% range. Yeah, Deane, just it’s a so you know, it's down 4% in the U.S. and the residential is down 1% globally.

Deane Dray - Goldman Sachs

Got it. Thank you.

Operator

Thank you. Your next question comes from Jeff Sprague of Citigroup.

Jeff Sprague - Citigroup

Thank you. Good morning. I guess, two sets of questions. First, defense margins obviously, very impressive again. Just wonder if you could give us a little more color on kind of the mix underscoring that obviously looking at the very strong systems and services growth that would kind of technically blend you lower.

You talked about good fixed price contract performance, but if could you give us a little more color on that, and if there's some positive contract developments or something else in the quarter that underscored those results?

Denise Ramos

Let me comment on that. There was nothing unusual in the quarter that would have produced a higher number than we would have expected. It really does have to go -- is focused on all of the strong productivity initiatives that we've had on the product side of our business.

So we're very, very happy with what we saw in the third quarter on the margin. As you've indicated, though, as the portfolio begins to shift more to the services side we do expect to see the margins come down from these very high levels and we have articulated a long-term margin rate of about 10.5 to 11.5%.

While we don't see that immediately, we will trend to that, and we do expect that the defense margins in Q4 will come down from the level that we're seeing in Q3.

Jeff Sprague - Citigroup

Should we putting the mix issue aside, if we look at systems and services themselves, is there any change in the underlying margin in those businesses around the type of contracts you're doing or where you're doing it or anything like that?

Denise Ramos

No, nothing of significance. Every now and then we'll see a shift in terms of what makes up that service business, but in general it's about 7 to 8% and we really don't see any change in that.

Jeff Sprague - Citigroup

And just to go back to AWT, I know this is kind of the tail that always seems to wag the dog on the call here, but, Steve, your answer sounded maybe a little bit different than what I heard before, in that I think, previously it seemed like the issue was just the sales force wasn't oriented and maybe you had kind of these group of businesses that weren't acting co-recently in the marketplace.

Now, what kind of sounds like maybe they don't have kind of the products and technologies that you think they need to really succeed. Is it both of those issues now, or is it really just more of a product issue at this point?

Steve Loranger

Jeff, it's safe to say that it is in the aggregate both of those issues, but keep in mind that as we think about how to drive businesses for operating performance, we're always addressing all of those issues.

When you think about the fact that Gretchen and her team have been organizing into three market-facing segments that, in and of itself, is very responsive to the sales force issue that we were facing the sales force as well as customer access issue that we were facing in treatment.

We had 140 sales people in treatment that we integrated with over 1,000 sales people inflect as well as our residential and industrial sales forces, and that's giving us a good participation.

So we're still working that side of it. We're looking at making the business the back-end business processes leveragable with some of the base capabilities inflict and now we are turning our attention to insuring that our engineering investments continue to make the products viable in the marketplace.

And I would say that's a very selective statement, principally around our ultraviolet and ozone technology. In the balance of the technologies we're pretty well positioned, but as we think about the future, we want to make sure that we've got the best products for the marketplace.

Jeff Sprague - Citigroup

Great. And maybe just update on the process with Ito, if there's anything you could add, obviously, the stock is trading above your offer. I don't know if there's anything you clearly say that, but…

Steve Loranger

No, Jeff, we obviously very much like the acquisition. It is very complimentary to our existing defense businesses, and we think the combination with the ITT and Ito properties is going to be excellent.

Things are progressing on schedule. We filed the proxy, as you may know, on Wednesday, and the Hart-Scott-Rodino filings were made by both companies in early October.

What's to happen next is once the proxy is finalized, which should happen in the next week or so, the vote, the shareholder vote, will be scheduled, and we sort of -- we would just maintain what we said before as we can't obviously predict the exact timing, but we're pretty confident the transaction will close in early 2008.

So, all-in-all things are on track, and we feel good about the -- feel good about this acquisition.

Jeff Sprague - Citigroup

Thanks a lot.

Operator

Thank you. Your next question comes from Shannon O'Callaghan of Lehman Brothers.

Shannon O'Callaghan - Lehman Brothers

Good morning, guys.

Steve Loranger

Hello, Shannon.

Shannon O'Callaghan - Lehman Brothers

Can you give a little more detail, in this quarter we had some of the pieces of defense move around with the space down big, you mentioned the comp issue. I mean, just as you think about fourth quarter next year, can you give little over view in terms of the relative pieces -- you're expecting to be down big or up big?

Steve Loranger

No, no…

Denise Ramos

Let me just answer.

Steve Loranger

Go ahead.

Denise Ramos

Let me just answer, something and Steve, you can jump in. We're going to be talking more in a couple of weeks about next year, so a lot of that commentary you will hear at that point in time.

From a sales perspective, we've always talked about an 8% to 10% growth in our sales rate. And we have no reason to change that at this point in time. And what we've also said is that as a product-side of our business ramps down we're ramping up the services side.

And you saw that in Q3 with some of the very strong results that we had in the services side of our business. So, from that perspective there's -- we still expect the 8% to 10% range. Steve, do you want to add anything?

Steve Loranger

No, Shannon. No major shifts. Denise and I just reviewed with Steve Gaffney and the team the 2008 revenue and backlog plans, and as is typical this year we sit in pretty good situation in terms of booked, authorized, and probability to be authorized that gives us confidence in the 8 to 10 zone next year, and no major mix shifts are anticipated.

Shannon O'Callaghan - Lehman Brothers

Okay, great, thanks. And then on -- I guess just on the ACD business, I mean, the production has find matters, is there any pressure, that you're seeing to take that higher and just also maybe a comment on side.

Steve Loranger

No, right now we're lockstep with our customer, and we think we're going to maintain that production rate for a while. And actually, I think with respect to side yet, no orders parse, but we believe that this overall situation is constructively unfolding about the way that we've been communicating for the past several years.

And that is that our customer, the U.S. military is continues to contemplate the best path to achieve the advanced intraoperability and the overall communication integration of the jitters framework.

They continue to explore innovative ideas from a lot of industry participants, obviously, including ITT. And as you know, then, that with respect to our advanced technology, such as the Side Hat and the Soldier Radio Wave Form, we already offer much of the desired interoperability and capability in our segment of the Jitters piece.

So as this evaluation is ultimately unfolded, we're confident that we're going to participate meaningfully in the future designs. And I think that that strategy has been validated by continued high production rates of singers the last several years and the fact that we've got good backlog in place for next year validates that strategy.

Shannon O'Callaghan - Lehman Brothers

Okay. Thanks. Just one more from me. On fluid tech you mentioned material costs there. Can you give us a sense, are you getting price now? Is there more you can get? What kind of contribution are you looking for there in terms of offsets?

Denise Ramos

Let me comment. In terms of material costs we are seeing fluid getting hit harder than our other segments with fluid costs because of the specialty metals that go into this even product. So they've been impacted pretty hard, especially on some of the commodities with nickel and chrome and copper.

We've been able to offset some of that through the global sourcing initiative we've had underway for a couple of years, so that has helped. We have also seen some price increases that we've been able to flow into that marketplace to help offset some of that also.

So on balance we're seeing some hit associated with that, but we've taken advantage of supply chain and some pricing.

Shannon O'Callaghan - Lehman Brothers

Okay. Is there more to come, you think, or is this it for now?

Denise Ramos

In terms of what?

Shannon O'Callaghan - Lehman Brothers

In terms of pricing.

Denise Ramos

In terms of pricing or it's something that we always look at, whether or not we're going to take any, I'm not certain at this point in time.

Shannon O'Callaghan - Lehman Brothers

Okay. Thanks very much.

Steve Loranger

Thanks Shannon.

Operator

Thank you. Your next question comes from Michael Schneider of Robert W. Baird.

Michael Schneider - Robert W. Baird

Good morning.

Denise Ramos

Good morning.

Steve Loranger

Hello, Michael.

Michael Schneider - Robert W. Baird

Wonder if we could start with the orders in fluid tech. I guess the surprising element is that you did 9% organic growth against the comparison of last year, which I think is the toughest. Did you 5% a year ago. Can you walk through what changed?

Because it seems to be substantially stronger than the 6% revenue growth you reported for the quarter. Did something accelerate during the quarter? Were there any enormous project booked at IPG? Just some color.

Denise Ramos

The one thing I would point to is just what you said. A lot of it is on IT side. We've been seeing a lot of strength there in the large project sales, and that really has to do because of the strength that we're seeing on commodity front in mining and the oil and gas market.

So that is really strong with us, and on a year-over-year basis we're seeing very strong order growth for that. On the other thing, just the legacy www, the flight business, that continues to be strong with us for us organically also.

Michael Schneider - Robert W. Baird

Okay. And did AWT make some progress during the quarter just on orders?

Denise Ramos

No, you know, AWT continues to struggle. They're strong in Europe. It's weak in the U.S. And so, you know, we're still having some challenges from an order perspective there.

Michael Schneider - Robert W. Baird

Okay. And then just industrial process and Asia specifically, it seems like that's hit an inflection point and that market has been strong for sometime. Is there some new strategy or some new presence that you've got in Asia to explain the acceleration there?

Steve Loranger

Well, we've been, Michael, we've been doing a lot of work in Asia. We have been hiring a number of new sales people, and we've continued to transition some of our products, so I would say that particularly in the premium segment of the business, we've been succeeding pretty well. In Asia, we are seeing very strong markets in the chemical, oil, and gas components. So we feel good about our industrial position there.

Michael Schneider - Robert W. Baird

Okay. Then final question. When I was in Stockholm meeting with the flight management, it seemed clear that there is, now that they're responsible for this AWT division, a renewed emphasis on R&D spending and maybe closing some of the technology gaps that you've at least alluded to earlier.

Does that spending cycle impact your margin goals in fluid tech to improve the margin? I believe it's 80 to 100 basis points a year?

Steve Loranger

Michael, first of all, we are going to invest to ensure that we sustain high levels of organic growth. But I think you can always expect from me that we hold our businesses accountable for an equal component of productivity.

And so as we've been detailing these operating plans, we have been asking for our Fluid Technology business units to increase engineering investment, as well as increasing some selective selling and marketing investments where we want to put capability in emerging markets.

But at the same time, we hold -- we're doing a lot of repositioning, global sourcing, a lot of lean activity, and all in all we're going to continue an appropriate level of margins and earnings growth in the process.

Denise Ramos

And just to add into that, in terms of a margin impact for additional R&D spending, we're not looking at anything that would be really -- that would be really significant.

Michael Schneider - Robert W. Baird

Okay. Thanks and great quarter.

Denise Ramos

Thank you.

Operator

Thank you. Your next question comes from, John Inch of Merrill Lynch.

John Inch - Merrill Lynch

Thank you good morning.

Denise Ramos

Good morning.

John Inch - Merrill Lynch

Hi Denise why again do defense margins come down in the fourth quarter? Can you just sort of a remind us was there any thing I know you – I know -- I heard your comments, but was there anything that was pulled from fourth into third?

Denise Ramos

No, John, there was nothing that was pulled from fourth into third to produce the high margins into Q3. It really is a mix shift where we're going to see more of the services business as being part of the revenue there than we saw on the -- in Q3.

John Inch - Merrill Lynch

And is that specific to 2007, or do you traditionally see this mix shift occurring in the fourth quarter?

Denise Ramos

No, you know, I would say in general we've been talking about this shift that's going to occur in the defense business as we win more on the services side. So, it's nothing that happens from an -- on an annual basis. It's just a shift that we've been talking about that we're going to be seeing.

John Inch - Merrill Lynch

If I read between the lines, I mean it sounds like the side hat could be in 2008 event. Is that reasonable, and, you know, presumably it's going to be prospectively very accretive to your defense margins is that also the way we should be thinking about this?

I know that's not what your guidance is going to be, but if we're looking for some up side next year from obviously the defense margin that are very high could that be one of those catalogs?

Steve Loranger

John, we are -- I can't speculate on that because I think what I was saying earlier was that the timing of the side hat orders is quite frankly involved with the overall U.S. Government's evaluation of various interoperability options in the overall jitters framework.

Clearly if it happens, the side hat would be an upside, but we can't speculate on the timing because at the evaluation in terms of the best path towards the ultimate goal of jitters is quite frankly fairly complicated, a lot of government constituents and technologies are involved. So we can't really speculate on the timing.

John Inch - Merrill Lynch

But, are there -- Steve are there milestones? It just seems to me that this whole jitters versus side hat debate has actually gone on for quite a long time. Is why just part of the bureaucratic process, or are there things that to have get worked through that, perhaps, as external parties we could benchmark or think about?

Steve Loranger

Well would look at it this way. Not part of bureaucratic process, but obviously in its ultimate and clean sheet of paper form, the jitters as it was envisioned several years ago is a massive expensive undertaking.

And what used evident to the user community is that a number of adaptive hybrid technologies from not only ITT but other industry participants are indeed available that could ultimately be better value, lower cost type options.

And so the U.S. government in my view is being very responsible in terms of trying to evaluate what the best path is through this to see how they can ultimately achieve the goals of a fully networked integrated communication system and use some of the existing technology.

So, I'm just saying it is a big undertaking, and it's complicated, involves a lot of different components besides just the radio. Remember, there's vehicle’s communication center there’s airborne issues there’s data processing issues. A lot more to jitters than just the radio component.

John Inch - Merrill Lynch

Yes hey, last for me, Steve, with Ito, your mix of defense is going to be well over the 50% mark. Or you guys after lot of great market positions and technologies there's still going to be this view I suppose, by several people that, feeder operations in the Middle East are going to be winding down.

I mean does this put strategic pressure on you, perhaps, or ITT to redress that balance and look to some industrial M&A activities to perhaps put ITT back on more of an industrial.

Steve Loranger

Let me answer in this way. We recognized the increase in the defense component, but in that and of itself is going to continue to be a very, very strong value creator, particularly with the combined acquisition, independent of the current activity that we have.

The reason is that the world has changed, and that when we think about how contemporary defense and intelligence networks are being operated, those technologies that are around sensing, surveillance, communications, information technology are going to continue to be more vital. So we feel good about that platform.

On the flip side, we are through this process, intending to maintain, a strong balance sheet and economic currency to be able to continue to grow our industrial and commercial markets, particularly globally. We'll do so on a strategic and value based analysis, but nonetheless, I think would you expect that's where our -- that's where our next activity would be.

John Inch - Merrill Lynch

Understood. Thank you.

Steve Loranger

Thanks, John.

Operator

Thank you. Your next question comes from John Balotti of FTN Midwest.

John Balotti - FTN Midwest

Good morning, Steve.

Steve Loranger

Hello, John.

John Balotti - FTN Midwest

How are you?

Steve Loranger

Great, thank you.

John Balotti - FTN Midwest

I got a couple just a quick questions. Denise, I believe you mentioned when you went over the updated segment revenue and profitability that you mentioned that the increase in fluid was currency related. Is that correct?

Denise Ramos

Yes, that had to do with the guidance that we gave for the full year.

John Balotti - FTN Midwest

Right.

Denise Ramos

We increased our revenue, and most of that was FX related.

John Balotti - FTN Midwest

Right and since, we know there's a natural hedge between revenue and margins at Fluid Technology, the fact that the margins stay the same with higher revenue with FX, and also you mentioned the headwinds with material costs, can you just characterize the underlying profitability in terms of how you see it now versus how you see lets say it in the beginning of the year?

Denise Ramos

You mean in terms of their margin…

John Balotti - FTN Midwest

In terms of, if you have higher revenue with currency and there's an offset on the margin, does it imply that the underlying business you're seeing, because of actions you've taken before, that you're seeing improved margin underlying the currency and underlying the material costs?

Denise Ramos

Well, we are see going productivity improvements there, which is why when you look at the margin improvement that we saw in this quarter what we indicated is that we were hit by about 20 basis points associated with that.

So, everything else being the same, if the foreign exchange was the same as what it was a year ago we would have seen 20 basis points in addition to the 40 basis points that we saw. It is true that when you look at it on a net income basis, it's basically a wash, just because of their footprint and how the sales and production flows from how they're structured.

So, yes we see something on the top line. It does it impact our margins but from a net income perspective it's basically flat.

John Balotti - FTN Midwest

Okay. And then return on invested capital, I assume that it was basically flat because of the timing of the closure of IMC.

Denise Ramos

We were about 17% ROIC on how we look at it. IMC does impact ROIC to some degree, roughly 40 to 50 basis points.

John Balotti - FTN Midwest

Okay. And then, finally, on the share repurchase, I think, if my numbers are right that there's about roughly $700 million or so left tin authorization, and I would imagine the third quarter was quiet because of Ito and IMC. Is that fair?

Denise Ramos

Yeah, that's fair. In fact we -- we have the billion dollar program. Under that billion-dollar program, we've repurchased about $350 million to-date.

John Balotti - FTN Midwest

Okay.

Denise Ramos

All right. So, we have about 650 left to go. And, yes, Q3 was -- we only repurchased $5 million in Q3, and that was because of the ITO acquisition and the transaction we were working on.

John Balotti - FTN Midwest

Okay. Great. Thanks, very much.

Steve Loranger

Thanks. Natasha, we have time for one more question.

Operator

Thank you. Your final question comes from Steve Tussa of JPMorgan.

Steve Tussa - JPMorgan

Hi, good morning. Just two quick questions. The first one, I'm still not quite clear, been a lot of good questions asked on defense but the margin there longer-term, it's continued to surprise to the upside is and you guys have a good backlog there and you talk about how visible it is.

What are you missing might be at the beginning of the year when you forecast this thing, and then obviously coming out on the good side of it, so we're not going to ding you for that. Then what is really the risk here as you go forward, you're flattish now object the Syncar stuff and there are some very interesting and attractive opportunities coming up.

Is there any potential for your customer to come back and say, you guys are making great money on this stuff, give us a little back on that, so we'll be a little more favorable to you going forward on some of these contracts?

I'm not sure how that stuff works, but I'm just curious as to, I guess, just to longer-term sustainability of this defense margin. I'm not quite clear why it continues to surprise to the upside.

Steve Loranger

Steve, I think the answer is really simple. We have an excellent operating team in defense, and we push the defense team for productivity like we do in every one of our segments. And this year, particularly in our product segment businesses, we did have above plan productivity.

As an example, Mike and the team down in Night-vision had some breakthroughs in lean manufacturing with respect to tube yields, which is a fundamental issue in terms of cost on our fixed price Night-vision contract.

And we had many successes. So, quite frankly, we're proud of it. That said, you did mention the fact that the government contracting, it is true that as you renegotiate contracts, whether it's fixed price or cost plus, there always is a great daily of cost negotiation, cost visibility, and overtime, you do tend to give that back in either your rates or your cost assumptions in the contract.

That's why defense margins in our business don't continue to expand and why we always come back and say, on a periodic basis, you know, we're pleased with the results, but think about 11%, 11.5% as sort of a long-term sustainable, given margin, given the mix of our service, our product, our cost-plus and fixed price mix.

Steve Tussa - JPMorgan

So you're sticking to that target net, and I'm not at the moment with you, so I'm not sure if you're saying it with a straight face or not but you've really blown that target away for the last couple of year. You're sticking with the 11 to 11.5 for the longer term?

Steve Loranger

Yes, we are. And that does recognize, Steve, the fact that, we do see a slight increase with respect to the service component as well as the cost plus component. And both of those are negative to margin expansion.

Steve Tussa - JPMorgan

Okay. One last quick one detailed one. I'm just not quite getting to your guidance for the fourth quarter. If I take the high end of your sales range and the high end of your margin range, maybe this is just rounding, I’m getting to something like a 13.5% operating margin, if I back into what the OP number is for fourth quarter.

Is there something below the line, its going to be maybe a little bit more of a drag that gets you to the $0.93? I'm having a hard time getting down to that 39 using your annual assumptions and back end of the fourth quarter?

Denise Ramos

Yeah. You'll probably find there's a little bit more on the interest side associated with IMC.

Steve Tussa - JPMorgan

Okay.

Denise Ramos

So, we can work through that in detail with you after the call.

Steve Tussa - JPMorgan

Okay. Appreciated. Good quarter. Thanks.

Denise Ramos

Thanks.

Steve Loranger

That's it. And so we'll wrap up now. Paul and I will be here all day to answer any follow-on questions and we'll look forward to seeing everybody up a couple weeks in New York City.

Operator

Thanks a lot. Thank you. This concludes today's ITT industries third quarter 2007 earnings conference call. You may now disconnect.

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