UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

Commission file number 1-5672

 

ITT CORPORATION

 

 

4 West Red Oak Lane, White Plains, NY 10604
(Principal Executive Office)

 

Telephone Number: (914) 641-2000

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of April 18, 2008, there were outstanding 181,684,401 shares of common stock ($1 par value per share) of the registrant.

 

 

ITT CORPORATION

 

TABLE OF CONTENTS

 

 

FINANCIAL INFORMATION

 

Item 1.

FINANCIAL STATEMENTS

 

ITT CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED INCOME STATEMENTS
(In millions, except per share amounts)
(Unaudited)

 

 

 

 

The accompanying Notes to Consolidated Condensed Financial Statements are an integral part of the above income statements.

 

ITT CORPORATION AND SUBSIDIARIES

 

 

 

 

The accompanying Notes to Consolidated Condensed Financial Statements are an integral part of the above balance sheets.

ITT CORPORATION AND SUBSIDIARIES

 

 

 

 

The accompanying Notes to Consolidated Condensed Financial Statements are an integral part of the above cash flow statements.

(In millions, except per share amounts, unless otherwise stated)

 

 

The unaudited consolidated condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of management, reflect all adjustments (which include normal recurring adjustments) necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such SEC rules. Unless the context otherwise indicates, references herein to “ITT,” “the Company,” and such words as “we,” “us,” and “our” include ITT Corporation and its subsidiaries. ITT believes that the disclosures made are adequate to make the information presented not misleading. ITT consistently applied the accounting policies described in ITT’s 2007 Annual Report on Form 10-K in preparing these unaudited financial statements. These financial statements should be read in conjunction with the financial statements and notes thereto included in ITT’s 2007 Annual Report on Form 10-K.

 

ITT’s 2008 and 2007 quarterly financial periods end on the Saturday closest to the last day of the quarter, except for the last quarterly period of the fiscal year, which ends on December 31st. For simplicity of presentation, the quarterly financial statements included herein are presented as ending on the last day of the quarter.

 

 

Sales and revenues and costs of sales and revenues consist of the following:

 

 

The Defense Electronics & Services business segment comprises $545.5 and $416.1 of total service revenues for the three months ended March 31, 2008 and 2007, respectively, and $478.9 and $376.4 of total costs of service revenues, respectively, during the same periods. The Fluid Technology business segment comprises the majority of the remaining balances of service revenues and costs of service revenues.

 

 

ITT recognizes stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123R, “Share-Based Payment,” (“SFAS 123R”). See Note 1, “Summary of Significant Accounting Policies,” and Note 19 “Stock-Based and Long-Term Incentive Employee Compensation,” within the Notes to Consolidated Financial Statements of the 2007 Annual Report on Form 10-K for complete details regarding ITT’s accounting for compensation plans and application of SFAS 123R.

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

Stock-based and long-term incentive employee compensation cost reduced consolidated results of operations as follows:

 

 

Total compensation costs capitalized were immaterial for the periods presented.

 

Stock Option and Restricted Stock Compensation Plans

 

The ITT 2003 Equity Incentive Plan (“2003 Equity Incentive Plan”) was approved by shareholders and established in May of 2003. This plan provides for the grant of stock options, stock appreciation rights and restricted stock awards (in the form of restricted stock shares or restricted stock units). The number of shares initially available for awards under this plan was 12.2. As of March 31, 2008, 1.7 shares were available for future grants.

 

A summary of the status of our stock options as of March 31, 2008 and changes during the three months then ended is presented below:

 

 

The intrinsic value of stock options exercised (which is the amount by which the stock price exceeded the exercise price of the options on the date of exercise) during the three months ended March 31, 2008 and 2007 was $2.9 and $33.8, respectively.

 

For the three months ended March 31, 2008, the amount of cash received from the exercise of stock options was $4.3 with an associated tax benefit realized of $0.8. SFAS 123R requires that we classify as a financing activity the cash flows attributable to excess tax benefits from stock option exercises. For the three months ended March 31, 2008 and 2007, cash provided by financing activities, related to these excess tax benefits, was $0.6 and $7.3, respectively.

 

The aggregate intrinsic value of stock options outstanding and stock options exercisable as of March, 31, 2008 was $121.6 and $118.7, respectively. This represents the total pre-tax intrinsic value, based on ITT’s closing stock price per share of $51.81 on March 31, 2008, which would have been received by the option holders had all options holders exercised their options as of that date. On March 31, 2008, 7.2 exercisable options were considered to be in-the-money because the exercise price of those options was less than the stock price on that date.

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

As of March 31, 2008, the total number of outstanding stock options expected to vest, reflecting estimated forfeitures and options that have already vested, was 9.1. These stock options have a weighted-average exercise price per share of $39.13, an aggregate intrinsic value of $120.5, and a weighted-average remaining contractual life of 4.5 years.

 

The fair value of each option grant was determined on the date of grant using the binomial lattice pricing model. The following weighted-average assumptions were used for stock option grants during the three months ended March 31, 2008 and 2007, respectively:

 

 

A summary of the status of our restricted stock awards as of March 31, 2008 and changes during the three months then ended is presented below:

 

 

During the three months ended March 31, 2008, ITT awarded 0.4 of restricted stock awards with restriction periods of three years. The fair market value of these awards was based on ITT’s stock price on the date of grant.

 

At March 31, 2008, there was $65.9 of total unrecognized compensation cost related to non-vested awards granted under the stock option and restricted stock compensation plans. This cost is expected to be recognized ratably over a weighted-average period of 2.3 years.

 

Long-Term Incentive Plan

 

The ITT 1997 Long-Term Incentive Plan (the “LTIP”), approved by shareholders in 1997, authorizes performance awards to be made to key employees of ITT. The LTIP is considered a liability plan, under the provisions of SFAS 123R. Accordingly, ITT is required to reassess the fair value of its LTIP awards at the end of each reporting period.

 

Payment, if any, of target cash awards generally will be made at the end of the applicable three-year performance period and will be based on ITT Corporation’s performance measured against the total shareholder return performance of other stocks comprising the S&P Industrials Index.

 

The fair value of each award is calculated on a quarterly basis using Monte Carlo simulations. The three-year volatility of the outstanding awards as of March 31, 2008 was approximately 18%. The number of companies included in the applicable benchmark group ranges from 316 to 362 for the awards outstanding as of March 31, 2008.

 

At March 31, 2008, there was $19.8 of total unrecognized compensation cost related to non-vested awards granted under the long-term incentive plan. This cost is expected to be recognized ratably over a weighted-average

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

period of 1.5 years. The total cash paid to settle the LTIP liability for the annual 2005 and the annual 2004 grants during the first quarter of 2008 and 2007 was $19.3 and $17.6, respectively.

 

 

2008 Restructuring Activities

 

Three Months Ended March 31

 

During the first quarter of 2008, ITT recorded a net restructuring charge of $3.6, reflecting costs of $1.2 related to new actions and $2.6 related to prior year plans, as well as the reversal of $0.2 of restructuring accruals that management determined would not be required.

 

Components of First Quarter 2008 Charge

 

 

The charges associated with actions announced during the first quarter of 2008 represent a reduction of structural costs, primarily in the Fluid Technology business segment. Planned position eliminations total 22, including 17 office workers and five management employees. The costs associated with prior years’ plans primarily reflect severance costs.

 

2007 Restructuring Activities

 

Three Months Ended March 31

 

During the first quarter of 2007, ITT recorded a net restructuring charge of $6.4, reflecting costs of $4.5 related to new actions and $2.2 related to prior year plans, as well as the reversal of $0.3 of restructuring accruals that management determined would not be required.

 

Components of First Quarter 2007 Charge

 

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

The charges associated with actions announced during the first quarter of 2007 represent a reduction of structural costs in all segments and the closure of one facility in the Defense Electronics & Services business segment. Planned position eliminations total 41, including 18 factory workers, 22 office workers and one management employee. The costs associated with prior years’ plans primarily reflect an asset impairment cost for a closed facility, as well as additional severance and other costs.

 

The following table displays a rollforward of the restructuring accruals:

 

 

The accrual balance at March 31, 2008 of $28.4 includes $21.0 for severance and $7.4 for facility carrying costs and other.

 

The following is a rollforward of employee positions eliminated associated with restructuring activities through March 31, 2008:

 

 

As of March 31, 2008, of the planned facility closures, one facility in the Motion & Flow Control business segment and one facility in the Defense Electronics & Services business segment remain to be closed. These closures are expected within the next three months.

 

 

2007 Dispositions

 

Switches

 

On July 26, 2007, ITT completed the sale of substantially all of its Switches businesses to a private equity firm for net proceeds of $223.2, and an after-tax gain of $84.4. The Switches businesses have been reported as discontinued operations since the third quarter of 2006.

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

Revenues and operating income for Switches reported in discontinued operations were as follows:

 

 

 

Components of net periodic pension cost were as follows:

 

 

Net periodic pension cost decreased in the first quarter of 2008, as a result of the higher discount rate adopted at year end 2007 leading to a lower amortization of actuarial losses, higher expected returns on plan assets due to increased asset levels, and lower amortization of deferred losses, partially offset by an increase in interest costs and higher average foreign exchange rates. Based on the facts and circumstances described below the decrease in net periodic pension cost will be partially offset by reduced recoveries of costs under our U.S. Government contracts.

 

The Defense Electronics & Services business segment represents approximately 67% of the active U.S. Salaried Plan participants. As a result, we have sought and will seek reimbursement from the Department of Defense for a portion of our pension costs, in accordance with government regulations. U.S. Government Cost Accounting Standards (“CAS”) govern the extent to which pension costs are allocable to and recoverable under contracts with the U.S. Government.

 

ITT contributed approximately $7.7 to its various plans during the first quarter of 2008. Additional contributions totaling between $17.0 and $22.3 are expected over the balance of 2008.

 

Components of net periodic postretirement cost were as follows:

 

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

Net periodic postretirement cost decreased in the first quarter of 2008 primarily as a result of the higher expected returns on plan assets due to increased asset levels, partially offset by higher past service costs.

 

See Note 18, “Employee Benefit Plans,” in the Notes to Consolidated Financial Statements of the 2007 Annual Report on Form 10-K for additional details of pension and postretirement benefits.

 

 

 

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

 

A reconciliation of the data used in the calculation of basic and diluted earnings per share computations for income from continuing operations is as follows:

 

 

Shares underlying stock options and restricted stock awards excluded from the computation of diluted earnings per share because they were anti-dilutive were as follows:

 

 

 

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

 

 

 

 

 

ITT follows the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” (“SFAS 142”) which requires that goodwill and indefinite-lived intangible assets be tested for impairment on an annual basis, or more frequently if circumstances warrant.

 

The application of purchase accounting under SFAS No. 141, “Business Combinations” (“SFAS 141”), requires that the total purchase price be allocated to the fair value of assets acquired and liabilities assumed based on their fair value at the acquisition date, with amounts exceeding the net fair value being recorded as goodwill. The allocation process requires an analysis of items such as acquired contracts, customer relationships, fixed assets, contractual commitments, legal contingencies, and brand value to identify and record the fair value of all assets and liabilities assumed. In valuing acquired assets and liabilities, fair values were based on, but not limited to, future expected discounted cash flows, comparable market rates, replacement costs, expected settlement amounts, and discount and growth rates.

 

In December 2007, ITT acquired all of the outstanding shares of EDO Corporation (“EDO”), a global aerospace and defense company. As a result, we assigned preliminary fair value amounts to the tangible and intangible assets acquired and liabilities assumed. As additional information was obtained, adjustments were made to the purchase price allocation during the first quarter of 2008; however, the allocation is subject to further refinement. These adjustments are reflected in the tables below within the Defense Electronics & Services business segment.

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

Changes in the carrying amount of goodwill for the quarter ended March 31, 2008 by business segment are as follows:

 

 

Information regarding other intangible assets is as follows:

 

 

Amortization expense related to intangible assets for the three month periods ending March 31, 2008 and 2007 were $21.0 and $7.6, respectively.

 

Estimated amortization expense for intangible assets for each of the five succeeding years is as follows:

 

 

Customer relationships, proprietary technology, trademarks and patents, and other are amortized over weighted average lives of approximately 11 years, 12 years, 18 years, and 18 years, respectively.

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

 

 

 

 

 

In accordance with the Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109,” (“FIN 48”) we recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. We adopted the provisions set forth by FIN 48 effective January 1, 2007.

 

As of March 31, 2008 and December 31, 2007, we have $101.2 and $103.3, respectively of total unrecognized tax benefits. The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is $40.7 and $42.8, as of March 31, 2008 and December 31, 2007, respectively.

 

We do not believe that the total amount of unrecognized tax benefits will significantly change within 12 months of the reporting date.

 

We classify interest relating to tax matters as a component of interest expense and tax penalties as a component of income tax expense in our income statement. We have accrued $37.6 and $36.2 for payment of interest and penalties as of March 31, 2008 and December 31, 2007, respectively.

 

 

The Company is from time to time involved in legal proceedings that are incidental to the operation of its businesses. Some of these proceedings allege damages against the Company relating to environmental liabilities, product liabilities (including asbestos), employment and pension matters, government contract issues and

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

commercial or contractual disputes, sometimes related to acquisitions or divestitures. The Company will continue to defend itself vigorously against all claims. Although the ultimate outcome of any legal matter cannot be predicted with certainty, based on present information, including the Company’s assessment of the merits of the particular claim, as well as its current reserves and insurance coverage, the Company does not expect that such legal proceedings will have a material adverse impact on the financial position, results of operations, or cash flows of the Company on a consolidated basis.

 

Environmental:

 

Accruals for environmental matters are recorded on a site by site basis when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies. The Company’s environmental liability includes matters associated with properties containing disposed or recycled wastes generated by current or former properties of ITT, and nearby properties impacted by contamination originating at those properties. It is difficult to estimate the total costs of investigation and remediation due to various factors, including incomplete information regarding particular sites and other potentially responsible parties, uncertainty regarding the extent of contamination and the Company’s share, if any, of liability for such conditions, the selection of alternative remedies, and changes in clean-up standards. In management’s opinion, the total amount accrued and related receivables are appropriate based on existing facts and circumstances. Management does not anticipate that these liabilities will have a material adverse effect on the consolidated financial position, results of operations or cash flows.

 

In the ordinary course of business, and similar to other industrial companies, the Company is subject to extensive and changing federal, state, local, and foreign environmental laws and regulations. The Company has received notice that it is considered a potentially responsible party (“PRP”) at a limited number of sites by the United States Environmental Protection Agency (“EPA”) and/or a similar state agency under the Comprehensive Environmental Response, Compensation and Liability Act or its state equivalent. As of March 31, 2008, the Company is responsible, or is alleged to be responsible, for approximately 92 ongoing environmental investigation and remediation sites in various countries. These sites are in various stages of investigation and/or remediation and in many of these proceedings the Company’s liability is considered de minimis. At March 31, 2008, the Company’s best estimate for environmental liabilities is $130.1, which approximates the accrual related to the investigation and remediation of ground water, soil, and soil vapor, as well as related legal fees. This includes the Company’s estimated accrual for environmental liabilities associated with its former automotive business. The low range estimate for its environmental liabilities is $95.7 and the high range estimate for those liabilities is $216.1. On an annual basis, the Company spends between $8.0 and $12.0 on its environmental remediation liabilities. These estimates, and related accruals, are reviewed periodically and updated for progress of investigation and remediation efforts and changes in facts and legal circumstances. Liabilities for environmental expenditures are recorded on an undiscounted basis.

 

The Company is involved in an environmental proceeding in Glendale, California relating to the San Fernando Valley. The Company is one of numerous PRPs who are alleged by the EPA to have contributed to the contamination of the aquifers. In January 1999, the EPA filed a complaint in the United States District Court for the Central District of California against the Company and Lockheed Martin Corporation, United States v. ITT Industries, Inc. and Lockheed Martin Corp. CV99-00552 SVW AIJX, to recover costs it incurred in connection with the foregoing. In May 1999, the EPA and the PRPs, including the Company and Lockheed Martin, reached a settlement, embodied in a consent decree, requiring the PRPs to perform additional remedial activities. Pursuant to the settlement, the PRPs, including the Company, have constructed and are funding operation of a water treatment plant. The operation of the water treatment plant is expected to continue until 2013, at which time a separate allocation for continued operation of the plant is expected. ITT and the other PRPs continue to pay their respective allocated costs of the operation of the water treatment plant. In 2007, one PRP defaulted on its percentage share of costs, and the PRP Group is

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

pursuing a remedy of the default; however, this default will increase ITT’s allocated share of the liability. Additionally, modification to the allowable hexavalent chromium National Pollution Discharge Elimination System discharge standard occurred in 2007, and the impact of this change has resulted in additional costs for potential modifications to the water treatment plant. As of March 31, 2008, the Company’s accrual for operation of the water treatment plant through 2013 was $8.8 representing its best estimate; its low estimate for the liability is $4.8 and its high estimate is $14.0.

 

Prior to the 1995 Distribution Agreement (See “Company History and Certain Relationships” within Part I, Item 1 of the 2007 Annual Report on Form 10-K for a description of the Distribution Agreement), the predecessor ITT Corporation operated a facility in Madison County, Florida from 1968 until 1991. In 1995, elevated levels of contaminants were detected at the former manufacturing site. Since then, ITT has completed the investigation of the site in coordination with state and federal environmental authorities and is in the process of evaluating various remedies. A final remedy for the site has not yet been selected. Currently, the estimated range for the remediation is between $4.0 and $17.0. The Company has accrued $6.6 for this matter, which approximates its best estimate.

 

The Company is involved with a number of PRPs regarding property in the City of Bronson, Michigan, operated by a former subsidiary of the predecessor ITT Corporation, Higbie Manufacturing, prior to the time ITT acquired Higbie. The Company and other PRPs are investigating and remediating discharges of industrial waste, which occurred as early as the 1930s. The Company’s current estimates for its exposure are between $6.9 and $15.6, and it has an accrual for this matter of $11.0, which represents its best estimate. The Company does not anticipate a default on the part of the other PRPs. ITT is pursuing legal claims against some other potentially responsible parties for past and future costs while ITT has received notice of potential claims from third parties.

 

The Company operated a facility in Rochester, New York, called Rochester Form Machine from 1979 until 2003. Rochester Form Machine was a former subsidiary of the predecessor ITT Corporation known as ITT Higbie after ITT acquired Higbie in 1972. In August 2003, the Company, through its subsidiary ITT Fluid Handling Systems, entered into an Order on Consent with the New York State Department of Environmental Conservation to investigate and remediate facility-related impacts to soil, soil vapor, indoor air and ground water. As of March 31, 2008, the Company’s current estimate for this exposure is between $4.1 and $16.2 and it has an accrual for this matter of $6.5, which represents the best estimate. The Company is pursuing a legal claim against certain other PRPs who may share responsibility.

 

In a suit filed in 1991 by the Company, in the California Superior Court, Los Angeles County, ITT Corporation, et al. v. Pacific Indemnity Corporation et al., against its insurers, the Company is seeking recovery of costs it incurred in connection with its environmental liabilities including the matters listed above. Discovery, procedural matters, changes in California law, and various appeals have prolonged this case. For several years, the case had been on appeal before the California Court of Appeals from a decision by the California Superior Court dismissing certain claims of the Company. The dismissed claims were claims where the costs incurred were solely due to administrative (versus judicial) actions. However, in April 2007, the Superior Court vacated its earlier ruling, dismissing the claims based on the California Supreme Court’s decision in Powerine Oil Co. v. Superior Court. As a result, the Court of Appeals dismissed the appeal as moot. The case is now back before the Superior Court and the parties are engaged in further discovery. During the course of the litigation, the Company has negotiated settlements with certain defendant insurance companies and is prepared to pursue its legal remedies where reasonable negotiations are not productive.

 

Product Liability and Other Matters:

 

The Company, including its subsidiary Goulds Pumps, Inc. (“Goulds”), has been joined as a defendant with numerous other industrial companies in product liability lawsuits alleging injury due to asbestos. These claims stem primarily from products sold prior to 1985 that contained a part manufactured by a third party, e.g., a gasket, which allegedly contained asbestos. The asbestos was encapsulated in the gasket (or other) material and was non-friable.

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

In certain other cases, it is alleged that former ITT companies were distributors for other manufacturers’ products that may have contained asbestos.

 

As of March 31, 2008, there were approximately 103,000 open claims against the Company, essentially unchanged from December 31, 2007. Frequently, the plaintiffs are unable to demonstrate any injury or do not identify any ITT or Goulds product as a source of asbestos exposure. During the first quarter of 2008, the Company resolved approximately 1,400 claims. Nearly all of these claims were dismissed, with settlement on a small percentage of claims. The average amount of settlement per claim has been nominal and substantially all defense and settlement costs have been covered by insurance.

 

The Company’s estimated accrued costs, net of expected insurance recoveries, for the resolution of all of these pending claims were $25.7 and $24.8 as of March 31, 2008 and December 31, 2007, respectively. While it is probable that the Company will incur additional costs for claims to be filed in the future, these additional costs are not reasonably estimable at this time.

 

Although it is impossible to predict the ultimate outcome of these product liability suits, based on current information, the Company’s experience in handling these matters, and its substantial insurance program, management does not believe that these claims will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

The Company is involved in two actions, Cannon Electric, Inc. et al. v. Ace Property & Casualty Company (“ACE”) et al. Superior Court, County of Los Angeles, CA, Case No. BC 290354, and Pacific Employers Insurance Company et al., v. ITT Industries, Inc., et al., Supreme Court, County of New York, N.Y., Case No. 03600463. The parties in both cases are seeking an appropriate allocation of responsibility for the Company’s historic asbestos liability exposure among its insurers. The California action is filed in the same venue where the Company’s environmental insurance recovery litigation had been pending since 1991. The New York action has been stayed in favor of the California suit. ITT and ACE and Nationwide Indemnity have successfully resolved the matter and the Company is working with other parties in the suit to resolve the matter as to those insurers.

 

In addition, Utica National (“Utica”) and Goulds have negotiated a coverage-in-place agreement to allocate the Goulds’ asbestos liabilities between insurance policies issued by Utica and those issued by others. The terms of the settlement provide Goulds with substantial coverage from Utica for asbestos liabilities. Goulds will continue to seek coverage from its other insurers for these liabilities.

 

The Company provides an indemnity to U.S. Silica Company for silica personal injury suits against its former subsidiary Pennsylvania Glass Sand filed prior to September 12, 2005. ITT sold the stock of Pennsylvania Glass Sand to U.S. Silica Company in 1985. The Company’s indemnity had been paid in part by its historic product liability carrier, however, in September 2005, the carrier communicated to ITT that it would no longer provide insurance for these claims. On October 4, 2005, ITT filed a suit against the insurer, ITT v. Pacific Employers Insurance Co., CA No. 05CV 5223, seeking its defense costs and indemnity from the insurance carrier for Pennsylvania Glass Sand product liabilities. In April 2007, the Court granted the Company’s motion for summary judgment on the carrier’s duty to defend the silica cases; however, that decision was overturned on appeal. The matter was returned to the Superior Court in part for determination of several factual issues. The Company will continue to seek its past and future defense costs for these cases from this carrier. Management believes that these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows. All silica related costs, net of insurance recoveries, are shared pursuant to the Distribution Agreement. See “BUSINESS — Company History and Certain Relationships” of the Company’s 2007 Annual Report on Form 10-K for a description of the Distribution Agreement.

 

On October 25, 2006, The Hartford and Fencourt Reinsurance Company (“Fencourt”), a subsidiary of The Hartford, filed a contribution claim against ITT for losses incurred by Fencourt as a result of a reinsurance contract obligation it owes to Century Indemnity Company (a subsidiary of Ace Insurance). Century Indemnity Company

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

was an insurer of ITT’s Domestic Casualty Program from 1978 through 1992. Fencourt, formed in 1978, was a captive insurer of ITT and provided reinsurance to Century for certain ITT self-insured losses. Fencourt was transferred to The Hartford in the demerger of ITT in 1995. This matter is covered by the 1995 Distribution Agreement (See “BUSINESS — Company History and Certain Relationships” of the Company’s 2007 Annual Report on Form 10-K for a description of the Distribution Agreement) and that agreement contains clear language that The Hartford agreed to assume the liabilities of Fencourt and indemnify ITT against all claims against Fencourt. The case is stayed pending the resolution of an arbitration proceeding currently pending in New Jersey. The Company believes that this matter will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

In December 2005, the Company received an anonymous complaint regarding the possible payment of commissions to foreign government officials by employees of its Nanjing Goulds Pumps company, in Nanjing, China. Such commission payments may violate the Foreign Corrupt Practices Act. The Company is conducting an investigation utilizing internal and external resources and voluntarily disclosed the preliminary results of the investigation to the United States Department of Justice and the Securities and Exchange Commission. At the conclusion of the investigation, the U.S. government could impose a civil penalty or a criminal fine and/or order that the Company disgorge any profits derived from contracts where inappropriate commissions were paid. The Company does not expect that this matter will have any material adverse impact on the financial position, results of operations or cash flows of the Company on a consolidated basis.

 

On March 27, 2007, the Company reached a settlement relating to an investigation of its ITT Night Vision Division’s compliance with the International Traffic in Arms Regulations (“ITAR”). As part of the settlement, the Company pleaded guilty in the United States District Court for the Western District of Virginia to one ITAR violation relating to the improper handling of sensitive documents and one ITAR violation involving making misleading statements. The Company was assessed a total of $50 in fines, forfeitures and penalties, which was accrued for fully as of December 31, 2006. Of the total, $30 was paid in 2007 and the remaining balance is to be paid over five years, including $4 during the first quarter of 2008. The U.S. government has agreed to defer action regarding a third count of ITAR violations pending the Company’s implementation of a remedial action plan. The Company has also agreed to invest $50 over the next five years in research and development and capital improvements for its Night Vision products. As a result of the guilty plea, the Company became subject to automatic statutory “debarment” from future export licenses. However, because the debarment is applicable to only a portion of the Company’s Night Vision business, it is expected that the net effect of the debarment will restrict less than 5% of total Night Vision sales for a period of not less than one year. The Company can seek reinstatement of export privileges after one year. On October 11, 2007, the Company and the Department of Defense finalized an Administrative Compliance Agreement wherein the Company agreed to take certain remedial actions including implementing compliance programs and appointing an independent monitor for the oversight of the Company’s compliance programs. On December 28, 2007, the Company finalized an administrative agreement with the Department of State. Management believes that these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

On April 17, 2007, the Company’s Board of Directors received a letter on behalf of a shareholder requesting that the Board take appropriate action against the employees responsible for the actions described in the Company’s agreements with the United States Attorney’s Office for the Western District of Virginia, which were disclosed on Form 8-K filed on March 30, 2007. The Board of Directors has appointed a Special Litigation Committee to evaluate the request.

 

On April 20, 2007, the Company received notice of a shareholder derivative action, Sylvia Piven trustee under trust agreement dated April 3, 1973 f/b/o Sylvia B. Piven, derivatively on behalf of ITT Corporation v. Steve Loranger et al. and ITT Corporation, U.S. District Court for the Southern District of New York, CA No. 07-CV-2878 (the “Piven” action), alleging that the Company’s Board of Directors breached their fiduciary duties in connection with the

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

Company’s compliance programs at its Night Vision business. The Piven Complaint seeks compensatory and punitive damages for the Company from its Directors, the removal of the Directors, and the election of new directors. On July 12, 2007, the Company received notice of a second shareholder derivative action, Norman Levy, derivatively on behalf of ITT Industries, Inc. v. Steven R. Loranger et al. and ITT Industries, Inc., U.S. District Court for the Southern District of New York, CA No. 07-CV-6339 (the “Levy” action). The Levy Complaint asserts similar claims as the Piven Complaint and seeks compensatory damages for the Company from its Directors. On August 20, 2007, the Company received notice of the third derivative action, Anthony Reale v. Steven R. Loranger et al. and ITT Company [sic], U.S. District Court for the Southern District of New York, CA No. 07-CV-6339 (the “Reale” action). The Reale action also names as John Doe defendants the individual managers allegedly responsible for the actions that gave rise to the Night Vision guilty plea, as well as the law firm that advised the Company in connection with a voluntary disclosure of violations. All three actions are consolidated before the U.S. District Court for the Southern District of New York, In Re ITT Corporation Derivative Litigation, CA No. 07-CV-2878 (CLB). On April 10, 2008, the Court denied the Company’s motion to dismiss the consolidated Complaint and the Company has filed a Motion for Reconsideration. Management believes that this suit will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

 

Guarantees & Indemnities

 

Since ITT’s incorporation in 1920, we have acquired and disposed of numerous entities. The related acquisition and disposition agreements contain various representation and warranty clauses and may provide indemnities for a misrepresentation or breach of the representations and warranties by either party. The indemnities address a variety of subjects; the term and monetary amounts of each such indemnity are defined in the specific agreements and may be affected by various conditions and external factors. Many of the indemnities have expired either by operation of law or as a result of the terms of the agreement. We do not have a liability recorded for the historic indemnifications and are not aware of any claims or other information that would give rise to material payments under such indemnities. Existing material indemnities are discussed in detail below.

 

In December of 2007, we entered into a sales-type lease agreement for our corporate aircraft and then leased the aircraft back under a five-year operating lease. We have provided, under the lease, a residual value guarantee to the counterparty in the amount of $50.2, which is the maximum amount of undiscounted future payments. We would have to make payments under the residual value guarantee only if the fair value of the aircraft was less than the residual value guarantee upon termination of the agreement. At March 31, 2008, we do not believe that a loss contingency is probable and therefore do not have an accrual recorded in our financial statements.

 

ITT has a number of individually immaterial guarantees outstanding at March 31, 2008, that may be affected by various conditions and external forces, some of which could require that payments be made under such guarantees. We do not believe these payments will have any material adverse impact on the financial position, results of operations or cash flow on a consolidated basis in the foreseeable future.

 

ITT CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

(In millions, except per share amounts, unless otherwise stated)

 

Product Warranties:

 

ITT warrants numerous products, the terms of which vary widely. In general, ITT warrants its products against defect and specific non-performance. In the automotive businesses, liability for product defects could extend beyond the selling price of the product and could be significant if the defect shuts down production or results in a recall. Changes in product warranty accruals for March 31, 2008 and 2007 were as follows:

 

 

 

 

 

 

 

Business Overview

 

ITT Corporation and its subsidiaries (“ITT”, “we”, “us”, “our” and “the Company”) is a global multi-industry company engaged directly and through its subsidiaries in the design and manufacture of a wide range of engineered products and the provision of related services. We generate revenue and cash through the design, manufacture, and sale of a wide range of engineered products and the provision of related services. Our three principal business segments are Fluid Technology, Defense Electronics & Services, and Motion & Flow Control.

 

ITT is a global corporation with worldwide operations. We have a diverse business portfolio, which we believe is designed to respond to the following macro-economic growth drivers: global security and infrastructure demands, population growth, environment trends and emerging markets. Although our business is affected by global, regional and industry-specific economic factors. Our geographic and industry diversity, as well as the diversity of our product sales and services, has helped limit the impact of any one industry, or the economy of any single country, on the consolidated operating results. While we do have some businesses that are linked to long- and short-cycle economies such as construction, defense, mining and minerals, transportation, automotive, and aerospace as industries, a disproportionate amount of our portfolio is responsive to large-scale drivers that are less sensitive to economic cycles. Furthermore, we drive our business to have the right mix of products and services by seeking a good combination of original equipment manufacturer (“OEM”) and after-market participation, a balance between products and services, and a proper global distribution.

 

Our growth strategy is centered on both organic and acquisition growth. Our ability to grow organically stems from our value-based product development process, new and existing technologies, distribution capabilities, customer relationships and strong market positions. In addition to our growth initiatives, we have a number of strategic initiatives within the framework of the ITT Management System aimed at enhancing our operational performance. These include global sourcing, footprint rationalization and realignment, Six Sigma and lean fulfillment.

 

2008 Outlook

 

Overall, we expect revenues to increase to between $11.4 billion and $11.5 billion. Revenues in the Defense Electronics & Services business segment are expected to grow to between $6.0 billion and $6.1 billion led by continued growth in the Advanced Engineering & Sciences and Systems divisions and the integration of the newly acquired EDO Corporation (“EDO”). The Fluid Technology business segment expects to grow revenues to between $3.8 billion and $3.9 billion due to continued growth in the Water & Wastewater and Industrial Process businesses. In the Motion & Flow Control business segment, revenues of $1.6 billion and $1.7 billion are expected, with growth largely attributable to the integration of International Motion Control, Inc. (“IMC”) into the segment.

 

Summarized below is information on each of the three business segments, including markets served, goods and services provided, relevant factors that could impact results, business challenges, areas of focus and selected financial data.

 

Fluid Technology

 

Fluid Technology is a leading global provider of fluid systems and solutions, including the design, development, production, sale and after-sale support of a broad range of pumps, mixers, controls and treatment systems for

residential, municipal, commercial, industrial, and agricultural and turf applications. The following provides a summary of the Fluid Technology businesses and the goods and services each provides to its respective end-markets:

 

 

Competitive advantages of the Fluid Technology business segment include selling premier brands, enjoying strong distribution capabilities, and benefiting from an installed base of over 14 million pumps worldwide, which provides a strong foundation for repair, replacement and retrofit aftermarket sales. The demand drivers of the business include population growth, urbanization, migration to coastal areas, social awareness, increased regulation, aging infrastructure, and demand from developing markets.

 

Factors that could impact Fluid Technology’s financial results include: broad economic conditions in markets served, weather conditions, the ability of municipalities to fund projects, raw material prices and continued demand for replacement parts and servicing. Primary areas of business focus include: new product development, geographic expansion into new markets, facility rationalization and global sourcing of direct material purchases.

 

Defense Electronics & Services

 

Defense Electronics & Services develops, manufactures, and supports high-technology electronic systems and components for worldwide defense and commercial markets, as well as provides communications systems, engineering and applied research. Defense Electronics & Services consists of two major areas: Systems and Services and Defense Electronics. With the acquisition of EDO completed at the end of 2007, components of EDO have been integrated into various businesses of the Defense Electronics & Services business segment. In addition, we have identified two new businesses, “Integrated Structures” and “Intelligence & Information Warfare,” as a result of the acquisition.

 

The following provides a summary of the Defense Electronics & Services businesses and the goods and services each provides to its respective end-markets:

 

 

Management believes that the Defense Electronics & Services business segment is well positioned with products and services that support our customers’ needs. In addition, we expect new product development to continue to contribute to future growth.

Factors that could impact Defense Electronics & Services’ financial results include: the level of defense funding by domestic and foreign governments, our ability to receive contract awards, the ability to develop and market products and services for customers outside of traditional markets and our ability to obtain appropriate export licenses for international sales and business. Primary areas of business focus include: new or improved product offerings, new contract wins, integration of acquisitions and successful program execution.

 

Motion & Flow Control

 

The businesses of the Motion & Flow Control business segment primarily serve the high end of their markets, with highly engineered products, high brand recognition, and a focus on new product development and operational excellence. Revenue opportunities are balanced between OEM and aftermarket customers. In addition to its traditional markets of the U.S. and Western Europe, opportunities in emerging markets such as Asia are increasing.

 

The following list provides a summary of the Motion & Flow Control businesses and the goods and services each provides to its respective end-markets.

 

 

The Motion & Flow Control businesses’ financial results are driven by economic conditions in its major markets, the cyclical nature of the transportation industry, production levels of major auto producers, demand for marine and leisure products, weather conditions, raw material prices, the success of new product development, platform life and changes in technology. Primary areas of business focus include: expansion into adjacent markets, new product development, integration of acquisitions, manufacturing footprint optimization, global sourcing of direct material purchases and lean fulfillment.

 

Results of Operations

 

For the quarter ended March 31, 2008, ITT reported sales and revenues of $2,806.4 and net income of $171.9, or $0.94 per diluted share, compared with sales and revenues of $2,070.3 and net income of $140.0 or $0.76 per diluted share for the quarter ended March 31, 2007. Net income for the quarter ended March 31, 2008 includes income from discontinued operations of $1.0 or $0.01 per diluted share, respectively, compared to $3.2 or $0.02 per diluted share for the same comparable prior year period.

 

Further details related to these results are contained in the following Consolidated Financial Results and Segment Review sections.