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ITT (NYSE:ITT)

Q1 2012 Earnings Call

May 04, 2012 9:00 am ET

Executives

Melissa Trombetta -

Denise L. Ramos - Chief Executive Officer and President

Thomas Scalera - Chief Financial Officer

Analysts

James C. Lucas - Janney Montgomery Scott LLC, Research Division

Michael Halloran - Robert W. Baird & Co. Incorporated, Research Division

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

James Krapfel - Morningstar Inc., Research Division

Operator

Welcome to ITT's First Quarter 2012 Earnings Conference Call. Starting the call today from ITT is Melissa Trombetta, Director of Investor Relations. She is joined by Denise Ramos, Chief Executive Officer and President; and Tom Scalera, Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 12:00 p.m. Eastern Daylight Time. [Operator Instructions] It is now my pleasure to turn the floor over to Melissa Trombetta. You may begin.

Melissa Trombetta

Thank you, Jackie. Good morning, and welcome to ITT's first quarter 2012 investor review. Presenting this morning are ITT's Chief Executive Officer and President, Denise Ramos; and ITT's Chief Financial Officer, Tom Scalera.

I'd like to highlight that this morning's presentation, press release and reconciliations of GAAP and non-GAAP financial measures, as well as selected historical financial data can be found on our website at itt.com/ir.

Please note that any remarks we make about future expectations constitute forward-looking statements under 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 10-K and other public SEC filings.

So now let's turn to Slide #3 where Denise will discuss our results.

Denise L. Ramos

Good morning, everyone. I appreciate you joining us as we announce our financial results for the first quarter of 2012. I'd like to take this opportunity to share with you my perspective on our business performance.

In the first quarter, the results demonstrate our continued record of growth, which exceeded our expectations. Organic revenue was up 9% to $577 million. This strength reflected our global balance as both emerging markets and North America markets generated significant growth. Emerging markets expanded 22%. And North America grew an impressive 11%.

We also set a record at Industrial Process with $226 million in shipments, reflecting growth in all regions and all end markets. Every one of our businesses had book-to-bill ratios in excess of 1.0 with the total of the businesses at 1.06. This demonstrates the upward trajectory that we are on, and why we believe the second half will outperform the first half in 2012.

Our EPS of $0.39 per share nicely exceeded our expectations due to very focused execution at each business.

I'm very pleased with our ability to deliver solid results and improve customer focus while continuing to invest for future growth. These results, which were achieved even as we manage through the continuing demand from the spin-off, reflect the collective effort of our businesses to execute our strategy to grow this company.

In our Industrial Process business, we continued to grow in all the right places and significantly populated our installed base around the world.

As we discussed with you previously, this initially generates lower margin, but it positions us nicely for high-margin aftermarket business over the long term. We're ahead of our plan for growth, and combined with our efforts to improve our operating efficiency, we are well positioned for the future.

In our second largest business, Motion Technologies, we gained share against competitors in a difficult European market, and we continued to make progress on our global growth strategy. We are already seeing strong gains in our focus markets of China and North America from our previous investments. And with our focus on improved operating performance, we expect to continue this progress in the second half of 2012 and beyond.

Our Interconnect Solutions business is being challenged by weakness in the global connectors markets that we serve, but is gaining momentum in those areas that support our strategic focus on harsh environment applications. We have positioned ourselves in attractive end markets, including general industrial and aerospace where we're better able to differentiate with customers because of our expertise in highly engineered customized technology.

In Control Technologies, we began initiatives last year to focus on improving operating efficiency and pricing, and we're now seeing the results as we continue to strengthen our unique positions in key aerospace and industrial end markets.

We are delivering on our strategy to grow this company. At the same time, our employees around the world are continuing to drive their productivity improvement that will help us deliver profitable growth over the long term.

Our business has also delivered a number of key strategic wins in the first quarter. As you can see on Slide 4, these achievements include industrial pump wins in the Middle East, automotive and rail gains in emerging markets, large-scale successes in energy absorption, and all are aligned with our 6 profitable growth drivers that the ITT leadership team focus on every day.

While all these wins are important, let me just highlight a few: first, we're extremely pleased with our continuing success in the emerging markets. And once again, we delivered a number of key wins in the quarter that really demonstrate our global range of capabilities. Our petrochemical industrial pump win was based on our footprint and customer relationship in both Saudi Arabia and China that provided our customer with the comfort that we are the right provider to address their needs. Our brake pad win in China validates our continuing investment in the world's largest and fastest-growing automotive market. And our connectors business also supports the Chinese automotive market through electric vehicle chargers. These 2 businesses together generated a lot of interest during their joint participation in the recent Beijing Auto Show. These highlights are true evidence of the benefit of our focused emerging market expansion.

We are also very pleased with the growth we achieved through our aftermarket capture strategy. Not only are we continuing to grow the profitable aftermarket in our core markets, but we are now gaining aftermarket business in oil and gas and mining as we see the benefit of our rapidly increasing global installed base. One such example is our notable win in Chile with a multi-year mining service contract.

We had many wins aligned with our growth driver of investment in technology and innovation. When you look at the hydraulic shock absorber order for the Vincent Thomas Bridge, this truly is a reflection of the value ITT creates for its customers. This project, it goes back about 15 years, when we were first awarded a contract to install hydraulic shock absorbers to protect the bridge in case of earthquakes. Now when it was discovered that the shocks were also absorbing increasingly heavy load from truck traffic, we developed a more robust design that would handle the truck traffic while still protecting the bridge from earthquakes. It's a great example of how we develop unique, go-to positions with customers and continually drive value creation through innovative engineering.

I'd also like to highlight another technology win in our Industrial Process business. In this business, we have a long history of providing highly engineered, customized solutions for our customers. A recent product we introduced, the Goulds HXD (sic) [XHD] slurry pump, is just one of the most recent examples of how we listen and respond to customers. So we were thrilled to see that this pump was recently named Technical Innovation of the Year at the 2012 British Pumps Industry Awards.

Finally, we also made advancements in enhancing our premier customer experience with all 4 businesses demonstrating improvement in on-time delivery and quality. These are sustainable improvements and they will help us differentiate from the competitors in the attractive end markets that we serve.

Going forward, we will continue to build on our track record and customer successes, and we have a sturdy foundation and strategy for how we plan to continue to grow this company.

We have a very strong balance sheet. At the end of March, we had approximately $728 million in cash. We have no long-term debt. And we have investment-grade credit ratings from all 3 agencies. This is a significant advantage for our long-term growth plan. So we're making investments that support our key growth drivers.

The $10 million expansion of our Wuxi, China facility is underway with an opening planned by the fourth quarter, and we are already seeing the impact of that investment in terms of our relationship with our global and local automotive customers.

We are also putting our resources behind investments that support our other growth drivers, including premier customer experience, aftermarket expansion and technological and operational excellence.

With our strong cash position, we will continue to grow both organically and through M&A. We are continuing to build our pipeline with a focus on targets that complement our existing businesses, our core strategies and our technology platform.

When I look at the strength of our business model and our growth capabilities, I feel very confident about our ability to deliver premier performance in 2012 and beyond. These business advantages are complemented by the growing sense of excitement among everyone at ITT about our future, and we are energized by our strong customer focus and performance-based culture.

There is a true passion for providing leading technology, differentiating ourselves with customers and continually becoming more efficient and effective in everything we do. The days ahead will maintain that momentum driving profitable growth. We look forward to continuing to create value for customers, employees and share owners in 2012 and beyond.

So thank you again for joining us today, and now, let me turn it over to Tom.

Thomas Scalera

Thank you, Denise. Now let's turn to Slide 5 for a review of the first quarter in greater detail.

In the first quarter, we exceeded expectations by delivering organic revenue growth of 9%. That was driven by global mining, oil and gas and chemical expansion primarily in Industrial Process. This business is our largest segment by revenue, and in the quarter it delivered both record revenue and record backlog. The strong first quarter top line growth reflected both our geographic and our end market diversity. The 11% growth in North America and 22% expansion in emerging markets more than offset Western European softness. Continued strength in oil and gas, mining and chemical more than offset anticipated global declines in early-cycle global connectors markets.

In the quarter, organic orders increased 2%, and as mentioned, the book-to-bill ratio was strong at 1.06. These gains were driven by oil and gas, chemical, auto and rail strength. We also delivered order strength in Latin American mining and global valves. These gains offset global connector weakness and a $13 million prior year rail seat order. We did see an increase sequentially in Q1 global connector orders, which has continued in April, and we believe this supports our view of a stronger second half for this market.

Q1 adjusted segment operating income of $65 million declined 12% due to reduced connector volumes, increased post-spin stand-alone costs, unfavorable foreign exchange and the ongoing mix shift to large projects in Industrial Process. We did deliver 9% growth in the profitable aftermarket in the quarter. However, our significant project expansion outpaced that aftermarket performance. The strong project growth reflects our recent investments to expand our global installed base, which will continue to deliver high-margin aftermarket opportunities in the future.

For the quarter, our adjusted EPS of $0.39 exceeded our expectations due to stronger top line and margin performances at all 4 businesses. Compared to the pro forma prior year, adjusted EPS decreased 13%, reflecting low segment operating income, a higher share count and a higher tax rate of 31%, partially offset by lower interest expense. Excluding the impact of recurring spin -- synergy costs and foreign exchange, adjusted EPS was in line with the prior year. As a reminder, adjusted and pro forma EPS are defined in the Appendix, but generally exclude special tax items, asbestos and transformation costs.

Overall, the quarter exceeded our expectations entering the year, reflecting additional strength in North America and emerging markets and solid results in a difficult European automotive market. After delivering this solid first quarter, we feel that we are well positioned to achieve our commitments for 2012.

Turning to Slide 6. Growth in the first quarter was strong across many of the attractive end markets we serve. Energy and mining was up over 48%, while industrial processing grew 22%. The growth in these markets was primarily delivered by global strength from our Industrial Process segment.

In oil and gas markets, Industrial Process grew 21%. In mining, they grew 157%. And in chemical, Industrial Process grew 18%. Most of this growth was driven by large projects that add to our backlog and global installed base in these critical growth markets.

The general industrial market continued on a strong pace with 9% growth that was driven by both Interconnect Solutions and global technologies gains in North America.

Aerospace and defense and transportation markets were only slightly positive for the quarter. Defense weakness offset aerospace strength in the quarter while transportation was negatively impacted by slower rail investments in China, weak connectors demand and the relatively weak European automotive market.

So now let's turn to the revenue by geography on Slide 7. Here, the strengths of our balance and diversity are once again evident. In the quarter, we delivered revenue growth of 11% in North America due to solid pump and valve demand at our Industrial Process business in general industrial, chemical, mining and oil and gas markets. Our chemical and oil and gas businesses in North America are benefiting from increased U.S. chemical activity that is being fueled by lower natural gas prices tied to the growth of U.S. natural gas production.

We also saw the continued benefit from Motion Technologies' penetration of the North American automotive market through continued share gains at Ford.

Revenue in Europe was up 1%, excluding foreign exchange, due to gains in automotive and Industrial Processing that more than offset connector weakness. Western Europe's decline of 3% was offset by 36% growth in Eastern Europe. Our total European automotive results were actually up 3% despite the lower European market production rates in the quarter. And this strength reflects our continued market share gains in Europe.

Emerging markets grew 22% due to gains in Latin America, the Middle East and Eastern Europe. These improvements were driven by our 52% growth at Industrial Process and 32% growth at Motion Technologies that more than offset connector weakness primarily in China. Industrial Process benefited from mining activity in Latin America and Asia, oil and gas activity in Eastern Europe and Asia and general industrial and chemical gains in the Middle East while Motion Technologies delivered automotive growth in China, Eastern Europe and Latin America.

Turning to Slide 8. Here you can see that segment operating margins contracted 270 basis points. However, these margins exceeded our internal expectations due to stronger productivity actions, which contributed 140 basis points. From an operational perspective, margins declined 120 basis points, primarily due to a mix of large projects in Industrial Process and lower volumes and mix at Interconnect Solutions.

Second quarter 2012 consolidated segment operating margins are expected to be in line with the first quarter as many of the same factors impacting the first quarter are expected to repeat in the second. 2012 margins are expected to improve in the second half compared to the first half due to anticipated interconnect solutions volume improvements, favorable product mix, higher aftermarket content and operational improvements at Motion Technologies.

So now let's turn to Slide 9 for a capital overview. As you can see, we have a very strong financial foundation to drive long-term growth. Our capital deployment priorities remain focused on organic growth through strategic investments, a solid dividend and targeted share repurchases that offset option dilution.

In addition, we continue to build our M&A pipeline. In the first quarter, we deployed over 10% of our cash through dividend payments, share repurchases, pension contributions and strategic investments. In addition, in the quarter, we funded $30 million of transformation cash costs associated with the spin-offs.

Our dividend payment totaled $9 million in Q1, and we spent $36 million on share repurchases under our authorized program to offset the impact of recent option exercises on our diluted shares outstanding. Since the quarter's end, we've continued to repurchase shares, and on a year-to-date basis, we've deployed $74 million to repurchase a total of 3.2 million shares. As a result, we are on track to reach our 2012 full year guidance of $94.5 million diluted shares outstanding.

In the first quarter, we also contributed $32 million to our U.S. pension plans, $15 million of this was discretionary and the other $17 million was made in advance of the required communications for 2012. As a result, we increased our U.S. pension funded status from 66% at year end to approximately 85% at the end of Q1.

Finally, we've invested $9 million in strategic investments in the quarter that include the Wuxi, China automotive facility; a new Korean facility that primarily serves oil and gas markets; expanded aftermarket capabilities, especially in regions where we have recently expanded our installed base; and investments in advanced order configuration to enhance the premier customer experience.

We also generated strong free cash flow in the quarter with 166% adjusted free cash flow conversion, and we ended the quarter with $728 million in cash and $23 million in short-term debt. As you can see, over 95% of our cash is currently held offshore. This cash is the foundation of our strong balance sheet, and it will support our long-term growth plan.

Finally, turning to Slide 10. We are pleased with our strong first quarter results, and we are maintaining our prior guidance measures due to the overall economic uncertainty in Europe and the sluggish market conditions impacting our Interconnect Solutions end markets. We are beginning to see some positive indications from the monthly flows here; however, it is too early to forecast the 2012 trend line for this business.

Compared to organic revenue growth guidance of 5% to 7%, we are off to a strong start with 9% organic growth in the first quarter. We continue to target 10% emerging market growth as we gain share in many attractive end markets such as oil and gas in the Middle East, mining in Latin America and automotive and rail in China and Eastern Europe.

Organic revenue growth in the second quarter will be up slightly compared to the prior year, due to lower Interconnect Solutions volumes, which compared to a strong first half of 2011. However, revenue will be down sequentially due primarily to Motion Technologies seasonality. As mentioned, second quarter margins are expected to be in line with first quarter levels.

For the full year, we continue to anticipate adjusted pro forma EPS to be in the range of $1.62 to $1.72 per share. This represents 4% growth at the midpoint. And keep in mind that when you adjust for the $20 million of incremental stand-alone costs or dis-synergies as we call them, our adjusted earnings per share is growing 13% at the midpoint.

So now, let me turn it back to Jackie to start the Q&A session.

Question-and-Answer Session

Operator

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

James C. Lucas - Janney Montgomery Scott LLC, Research Division

A couple of questions here, first one to start on Industrial Process. Could you bring us up-to-date, housekeeping question, what percent of the segment is aftermarket today? And could you expand little bit more about the growing aftermarket capabilities and investments you're making there? Is that specifically for your installed base or are you finding opportunities to take advantage of other product out there?

Denise L. Ramos

Let me talk about our aftermarket opportunities and then I'll turn it over to Tom to talk about the numbers there. In terms of the aftermarket, we're so encouraged with the aftermarket in our IP business and you know that's critical when you think about value creation for that business because you seed the projects so that you then get the strong aftermarket content associated with that. So a couple of things that we're doing in that arena is -- one thing, remember, we bought Blakers, which was that company that we bought in Australia at the end of last year. They're in distribution and they also do servicing for the mining industry. So that was one of our opportunities to get more into the aftermarket. We're also building aftermarket facilities globally. And so, we know that when we bid on some of these projects, particularly in oil and gas and mining, that our customers look to make sure that we've got sufficient capabilities so that we can service these highly complex products that we sell them out into the future. So we're making sure that we're coupling that with these sales that we're getting into these markets. In fact, some of the strategic agreements that we've put into place we've incorporated aftermarket as part of the agreement that we have there. In terms of others and going after servicing others, obviously we'll take that opportunity when it comes and we'd be happy to do that. But our focus right now is really on our products and making sure that we deliver the service that's needed for our customers.

Thomas Scalera

Just to follow up on some of the numbers, Jim, the aftermarket content at Industrial Process ranges between 30% and 40% of our revenue. What we're seeing certainly in Q1 is significant growth in our project business, which actually grew 76% year-over-year in Q1. So as we really grow globally with these larger projects, it's changing in our weighting fairly rapidly. But as Denise articulated, we have a number of strategies over time to capture that aftermarket when it arrives. The impact of that growth actually tilts our weighting about 7 points towards the project content compared to what we've historically seen. And again, this is where we've chosen to make our investments for long-term growth, but those are some of the numbers and some of the impacts that they're having. As the year progresses through, what we're going to see in the second half is some favorable project margin performance, but the waiting is going to generally stay fairly consistent throughout the year given this project expansion.

James C. Lucas - Janney Montgomery Scott LLC, Research Division

Okay, that's helpful. And with regards to some of these projects, the larger projects that you're bidding on today, what is the overall pricing environment that you're seeing out there?

Denise L. Ramos

Unfortunately, the pricing environment is not like what it was back in 2007 and 2008. There have -- we've seen prices that have come down. But I would say that it's pretty much stabilized at this point. We haven't seen pricing up, we haven't seen pricing down. I'd say it's pretty stable. In terms of how we're approaching it, now that we are a global player and we've established ourselves as such and the validation of that is through the strategic agreements that we have in place, we're becoming much more selective in the projects in which we're going after. And we can do that when you think about the kind of growth that we're having in these projects. So we've seeded the business, we've seeded our capabilities. People understand us better now. We're more mature and we're looking at these projects and making sure that we're just being more selective as we go forward to make sure that we're going to have the most profitable projects for us.

James C. Lucas - Janney Montgomery Scott LLC, Research Division

Okay, that's helpful. And then just one final question here. The Motion side, obviously, the Auto business thing seemed to be going very well. Could you talk a little bit about the shock absorber business in terms of that being the volume down short term and what -- any particular markets that are weaker and what the outlook for the rest of the year looks like?

Denise L. Ramos

Sure. First, just let me say that we are extremely pleased with the automotive market and the performance of our friction business in Motion Technologies. The fact that they're able to grow slightly in Europe when we've seen Europe in decline, this again indicates and supports the fact that we have this very strong position in that business. In terms of the shock absorber business, we've had some lower orders there on the rail side of the business. It's been particularly impacted by China and the delays that we've seen in China. We've also seen some slowdowns in Europe. And that's because of the economic conditions in Europe. So those are things that are impacting that business, but we're seeing strong orders that came through in Q1, which is an indication that the business is there, the demand is there and now we just have to deliver against it.

Thomas Scalera

And Jim, in that space, we also serve bus, truck and trailer markets and we're seeing some global pressures in that part of the shock absorber product line.

Operator

Your next question comes from the line of Mike Halloran with Baird.

Michael Halloran - Robert W. Baird & Co. Incorporated, Research Division

So staying on the Motion Tech side there. The really strong orders in the first quarter, could you just talk a little bit about timing of when those orders start pushing through and then what that means, where you're seeing the strength, specifically if there's been any sort of sequential or changes as you work through the first quarter?

Denise L. Ramos

Well, the orders that we've got for Motion Technologies, the strategy we've had in that business, it's been primarily a European business. And so we recognized that we wanted to become more global and take the strong capabilities that we have with material science and with our production efficiency. We wanted to take it into China where we see that many of our customers have gone. And so we've been servicing our customers in China through our Barge facility in Italy. And the volume is so strong in China now with it being the #1 automotive market that we're now investing in building this brake pad facility in Wuxi, China along with an R&D center to service our customers better in that market. So China's been a strong growth area for us. We've also been penetrating into North America. So Ford has been someone that we've partnered with. We're on some of their global platforms. So we've been happy with the business that we've built over there, and we're planning on expanding our relationships with some of the North American suppliers with GM and with Chrysler where we're going to leverage some of the strong customers that we have in Europe with Fiat and Peugeot into those relationships.

Michael Halloran - Robert W. Baird & Co. Incorporated, Research Division

Okay, but from a timing perspective, I mean, what are the lead times on those? I mean, is it pretty much book and ship at this point or...

Thomas Scalera

Yes, Mike, the lead times are, typically on the automotive side, it's usually about a 2-month kind of book-to-ship cycle on average. We get longer-term visibility through the auto production rates and close relationships with our customers, so we have visibility into their production rate. But the orders typically ship pretty quickly in the following quarter typically. Q1 for us is a strong revenue quarter and you saw that coming through in Q1. And that's usually when we see the most aftermarket activity on the automotive side. It kind of front loads through the channel, which is the way the European markets are typically populated. So you see the book-to-bill strong at 1.03, which we're very encouraged by when you consider that Q1 revenue is at the highest point for the year. So we're seeing some good indications. We're performing extremely well in Europe. The order visibility again is about a month or 2 and the longer-term visibility comes from the strength of our relationships and really getting to know our customers' production schedules.

Michael Halloran - Robert W. Baird & Co. Incorporated, Research Division

And then on the guidance side, maintain full year guidance. You guys are talking about seeing upside of your expectations in the first quarter here. You talked a little bit about some sequential improvement, really early signs in some of your weaker markets. Could just talk a little bit about why the guidance was maintained? If there's any areas of weakness or if it's just really there's enough uncertainty that you don't feel like -- you feel like it's a little early in the year to be moving things around aggressively one way or another.

Denise L. Ramos

Yes, it's a good question. We left a range out there. And so we have the range of $1.62 to $1.72 and the reason we did that is because it is early in the year. And there is uncertainty in Europe. There is uncertainty in the connectors business. And so the range is designed to accommodate those uncertainties that we have. As we get into the year, we're going to get more certainty and more clarity around where we see those trends, but some of those trends are in our shorter lead-time businesses. So it makes it difficult to really project out into the future. We're seeing good signs right now, we're seeing good order trends, so we're encouraged by that. But we just want to see a little bit more data to be able to be more certain.

Michael Halloran - Robert W. Baird & Co. Incorporated, Research Division

And then on capital deployment side, specifically with your acquisitions, could you talk a little bit about what you're seeing in the environment from a valuation perspective? What the activity looks like for you guys, what the pipeline looks like and how aggressively you're pursuing and what types of things you're pursuing at this point?

Denise L. Ramos

Yes, sure. Acquisitions are an important part of our growth out into the future. We are looking at a very balanced capital deployment strategy. We've indicated in the first quarter what we've done associated with that with share repurchases and dividends and pension funding. And we've also indicated the large investments that we're making organically, a couple of those large ones being the Wuxi investment in China and then we're building a new facility in Korea for our IP business. We're also spending some dollars associated with the front end of these businesses in making sure that we deliver the right customer experiences with that. So we're investing organically. But acquisitions is important to us. And so we're 6 months as a company, we have been hard at work in building the pipeline and looking at the various opportunities that we have in the spaces within which we play. We have 4 businesses. We see -- we're building pipelines across all 4 of these businesses, some further along than others. But internally, we do have some nice momentum in looking at these acquisitions, recognizing that a way to create value for this company is not only organically, but through acquisitions. So we're actively looking at things. We will always stay very balanced and very disciplined in this process.

Thomas Scalera

Yes, and I think our focus will be close to core. So what we like about these markets is we have a very strong strategic roadmap that we've been pursuing. And I think we have really good visibility into where we can add some technologies, some geographic expansion and which end markets we really focus in on. So we're going to remain disciplined and close to the core. We've articulated a couple areas that we would focus from a size perspective, which we think are in the right valuation sweet spot when we stay close to the core. I think that gives us the best chance to realize some good valuations. So we're going to be disciplined, but we like the roadmap that we're pursuing and we're continuing to build out the pipeline.

Denise L. Ramos

The nice thing is having the 4 businesses. Gives us a lot of opportunity. And so we got a lot of different spaces that we can evaluate and that we can look at to make sure that we're making the right investment. So we like the fact that we've got a pretty big football field ahead of us here.

Operator

[Operator Instructions] Your next question comes from the line of Matt Summerville with KeyBanc.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

Just a couple questions. First, with regards to the project business versus aftermarket in IP, if the mix is pretty consistent in Q2, does the mix start to tilt in your favor in the back half of the year? And I guess, bigger picture, what I'm trying to understand is what is the average kind of duration between when you install a new pump versus starting to get that aftermarket stream?

Thomas Scalera

Yes, great questions, Matt. So we're going to see the shift really starting to pick up gradually as we've been putting these large projects online globally. We're not going to see a significant shift in the second half. There will be gradual increases as we go. What's really going to help the margin profile in the back half of the year for the Industrial Process business is the mix within our large project base and backlog. So we see a number of kind of midsized projects where we do have very good profitability on those. And that waiting is much higher as we go through the year versus the larger projects where there's the most competitive pricing environment and where the install cycle is the longest. So it would take 12 to 18 months or longer, in some cases, for the large projects to go through the order design and installation phase. Typically, with some of those large projects, it may take another year or 2 for the facility to get fully up and running and kind of burn through their initial run of parts. So we're closely monitoring and working with our teams to help really calendarize this activity. But it really does vary by project. How big, where it is, when the facility starts running, the utilization rates in those facilities and then the burn rates on the parts pick up from there. What we particularly like about these new areas of growth, oil and gas and mining, is once they do get up and running and they get the momentum going from utilization perspective, the part rate burn is much faster than what we've seen in some of our legacy core markets so that provides a lot of additional long-term value creation for us once the cycle really kicks in.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

And then, Tom, as we think about -- you mentioned these large projects versus midsized projects. Is there a difference in end markets in geographies that also contributes to the more favorable margin profile?

Thomas Scalera

In some cases -- in the Middle East, in particular, we see -- we've been seeing some larger projects in oil and gas where there's been very competitive pricing in those spaces. We've had a large project actually last year in Q2. We had a very large project in oil and gas in Brazil. And so I think there have been some larger emerging market projects that we've seen over the last 12 to 24 months. I would say in a lot of our core markets, we are seeing more the midsized projects playing through.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

And then just lastly, you guys are in the midst of doing quite a bit of organic expansion. Embedded in your $1.62 to $1.72 do you have start-up costs or learning curves, if you will, associated with bringing these plants online whether it be China, Europe, Korea over the next couple of quarters? Is that sort of fully loaded in your thought process with numbers?

Denise L. Ramos

Matt, it is. We've already put that into the numbers that we have here.

Operator

Your next question comes from the line of Ajay Kejriwal with FBR.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

So Denise, my first question, on the leverage, so first quarter revenues up $44 million, operating income down $9 million. And I know there are mix issues and you've talked about spin dis-synergies and investments, et cetera. But if you step back and peel those and maybe look out, what do you think is the underlying leverage potential in the business? Where do you think the business should be in terms of incrementals?

Denise L. Ramos

Some of -- with the margins that you're seeing in the first quarter, what's impacting them are really a couple of things: One is you're seeing a decline in the connectors business and that's -- you're seeing some under absorption of the fixed cost that we have in that business. As we -- as those volumes begin to get stronger -- we're projecting that in the back half of the year -- you're going to see much better margins coming out of that business. The other thing that we've been spending a lot of time here talking about is in IP with the seeding of these project businesses. And the fact that when you -- in seeding them, you're not going to have the aftermarket, then when the aftermarket kicks in, you're going to see more of that, more of a normal margin that'll come back. So you're going to start seeing some of that in the IP business. The other thing, I think, that's important is we've been driving some very strong operational improvements in this company. So on the IP side with this tremendous growth that we've seen, we've been spending a lot of time looking at our front-end systems and our capabilities and driving much more efficiency through our facilities in order to accommodate this new level of revenue that we've had in that business. The other strong growth business that we've had, Motion Technologies, because of the growth that they've had, we've been increasing the capacity in the Barge facility so that we can accommodate that and then building out the Wuxi facility to help for all the other incremental volumes that we're going to be getting. So we think that as the top line grows, we'll be getting more leverage of our fixed costs. We also think that these operational improvements will absolutely help from a bottom line margin perspective. And we continually, in this company, drive productivity. We have a very strong process around that and continue to look at these opportunities that we have. In fact, if you look at our margins and -- you'll now have an opportunity to look at our historical financial statements, you look at our margins last year, we actually grew our margins. Our segment margin is 160 basis points and 100 basis points in total. So it is something that we're focused on and we're going to continue to drive.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Okay. And then on that margin comment, second half expectation of improvement, and if my math's correct, looks like your guidance implies 15.5% to 16% in the second half. And you talked about mix. What's the visibility in the second half margin? Is it what you're seeing in your backlog or is it just mix returning to more normal? Can you talk a little bit about that, please?

Denise L. Ramos

I'd say on the IP side, we've got record backlog. And so we do have much more visibility in that business than we might in some of the shorter-cycle businesses that we have. We also know that within that backlog, that we're going to be -- more selective pricing with these projects that we have in that backlog will begin playing through in the back half of the year. In terms of ICS, we are projecting higher volumes that is based on just a general market recovery, but we are seeing sequentially good order trends when we look at the first 4 months of this year and we ended up with a book-to-bill of 1.05. So we're feeling pretty good about where we are for the year.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Good, and then maybe one last one for me. On the spin dis-synergies, could you give some color on what that is? It looks like Process got the bulk of that $2.3 million. There's nothing in Interconnect. Can you help throw some light on that, what those dis-synergy costs are?

Thomas Scalera

Sure. Really when you think about the legacy of the Industrial Process business, it used to be in our Fluid Technology segment, and over the years, we had leveraged sales offices and other support functions with a number of the businesses that are now with Xylem. So we're seeing incremental costs in 2012 to put leases and support functions in place, primarily at the Industrial Process business that we didn't see in 2011 pre-spin. So this is a comparative event for 2012, but it is part of our ongoing cost structure going forward.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Okay, so this will be recurring costs?

Thomas Scalera

Correct, these are -- really think of them as leases, sales office and support for the global Industrial Process business. They will be part of the recurring run rate. We just called them out this year, it's 10 at the segment levels for the full year and $10 million of incremental costs at corporate that will be in our base for 2012 going forward. But when you compare us to 2011, those items were not in our 2011 baseline. So when we talk about the growth that we're driving operationally for the year, we think about 13% on an apples-to-apples basis, when you think about a new cost structure being consistent in both '11 and '12.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Got it, and that's different from the growth investments, which is mostly in SG&A? Is that correct?

Thomas Scalera

Absolutely, yes. The growth investments are very targeted at expansion in the Wuxi, China automotive facility, premier customer experience initiatives where we're driving the front end in the Industrial Process business as we're building out these more complex projects. And as we really start to evolve the entire portfolio, quite frankly, we're seeing a lot of value out of improved front-end order configuration capabilities. It allows us to take much more sophisticated orders, process them more efficiently and then move them into production so that's an area that we've been focusing on from a strategic investment perspective. And the last major category is what we're doing in the aftermarket to help really start to install some new capabilities to be more aggressive in the aftermarket capture strategy.

Operator

Your next question comes from the line of Jim Krapfel with Morgan Stanley.

James Krapfel - Morningstar Inc., Research Division

It's actually Morningstar. Most of my questions have been answered, but back to your earnings guidance, does the weaker euro also factor into your keeping guidance unchanged? I believe your prior guidance is simply at EUR 1.35 whereas now it's near EUR 1.31?

Thomas Scalera

Yes, sure, Jim, we're seeing about EUR 0.03 incremental headwind relative to our initial guidance from the current FX levels. And our tax rate has come down a little bit from the 32% we started the year with. We're closer to 31% right now. Those 2 net off quite frankly. So at the end of the day, the guidance is maintained.

Operator

Your final question comes from the line of Matt Summerville with KeyBanc.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

I was just wondering, you gave kind of the book-to-bill color by business, but can you just give us the year-over-year organic change in orders by the 4 businesses? And then, Denise, in your opening remarks, you talked about making progress with certain operational metrics including on-time delivery and quality. Can you provide a little more color around that in terms of where those things have been, where they are now and where they can get to?

Thomas Scalera

Sure, Matt. So I'll start off with the organic order overview for the quarter. So we grew organic orders in total 2%. We called out a prior year order that was $13 million and that related to rail seat actuation applications that we had in 2011 Q1. The order came for $13 million, and that's not an ongoing program, certainly not one we're seeing a lot of activity around in 2012 given the delays in the China rail investments right now. So we grew 2% in total, but that order actually reduced our growth, which would have been 4% had it not been for that prior year order. And that's at the total ITT level. As we go down through the individual segments, the Industrial Process business is growing 8% organically, which again adds to a very strong backlog we had going into the year. And we're seeing some pretty good growth across a number of different end markets and geographies as well. On the Motion Technologies side, we're seeing pretty good order strength really in our rail business and continued strength in our automotive business. So the 10% organic order growth is a solid result for us across Motion Technologies and a good indication that we're performing well, especially in difficult European automotive markets, and continuing to gain traction in China and North America. Going through the rest, in the Interconnect Solutions business, we're down 15% organically and what we're seeing there is kind of the end markets we're serving in the global connector space are down and we're seeing fairly consistent level of declines with the broader global markets, particularly where we serve. One area we're not very big in the connector space is automotive, and that is one of the areas that the broader connector markets are seeing some strength in. But our connectors business does not have significant content on the automotive side. So we're down 15% in the quarter, but we have seen some good sequential movement in the order book at connectors, including a solid April. And then lastly, at our Control Technologies business, we're down 13%, but again that China rail seat program from the prior year, which was $13 million, was the biggest driver. If we adjust for that, we're actually flat year-over-year and where we're seeing a little bit of the order pressure is really on timing around the aerospace orders. So we don't see anything too significant in the order book, and our Control Technologies industrial orders are actually very strong in the first quarter.

Denise L. Ramos

In terms of the operational metrics, we have a very strong process internally where on a monthly basis we track and monitor what's happening with past dues and delinquencies and on-time delivery, and it has been a key initiative of mine to improve those metrics. When I look at the individual businesses -- let me just talk about a couple of them. In our friction business, we actually do a very good job at that. We have very strong production efficiency within Motion Technologies where some of the challenges has been in Motion Technologies is when we did a restructuring in our rail business and moved it from the Netherlands into the Czech Republic. We saw that -- through that, we created some challenges for ourselves in on-time delivery and past dues. So we've been -- we have a detailed action plan around that and we've been seeing improvements there. IP recently has been challenged just because of the tremendous growth that they've had. And so we have detailed action plans for them to be able to get these highly complex projects that they have out the door sooner than they've been able to do up to this point and we've got all these detailed actions associated with that around the front end, around better engineering talent, and that's being worked. On the CT side, we identified operational challenges last year with CT, primarily on the industrial side of the business. And a new leader was put into place and the new leader has been driving the operations there, and you would be very impressed if you saw what he's been able to deliver in terms of these on-time delivery metrics and significantly reducing these past dues and delinquencies. So that just gives you a flavor for how we look at it and how we monitor it. But it is one of the key initiatives that we are driving as a company. I believe there's a lot of value to be created by being able to run your factories and your operations much more efficiently and effectively.

Operator

Thank you. That was our final question. I'd now like to turn the floor back over to Denise Ramos for any closing remarks.

Denise L. Ramos

Well, thank you. I'd like to thank each of you for joining us today and for your continued interest in ITT. I couldn't be more proud to be leading this team. You saw the results, and in the days ahead, we're going to have many more accomplishments to share with you and you're going to be hearing from us more about how we are performing and where we are taking this company. So thank you again for joining us, and I look forward to our next call.

Operator

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day.

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