News Column

ITT CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

July 31, 2014

(In millions, except per share amounts, unless otherwise stated) OVERVIEW ITT Corporation is a diversified manufacturer of highly engineered critical components and customized technology solutions for growing industrial markets. Building on its heritage of innovation, ITT partners with its customers to deliver enduring solutions to the key industries that underpin our modern way of life. We manufacture key components that are integral to the operation of systems and manufacturing processes in the energy, transportation and industrial markets. Our products provide enabling functionality for applications where reliability and performance are critically important to our customers and the users of their products. Our businesses share a common, repeatable operating model. Each business applies technology and engineering expertise to solve our customer's most pressing challenges. Our applied engineering aptitude provides a superior business fit with our customers given the critical nature of their applications. This in turn provides us with a unique insight to our customer's requirements and enables us to develop solutions to assist our customers achieve their business goals. Our technology and customer intimacy in tandem produce opportunities to capture recurring revenue streams, aftermarket opportunities, and long lived original equipment manufacturer (OEM) platforms. Our product and service offerings are organized into four segments: Industrial Process, Motion Technologies, Interconnect Solutions, and Control Technologies. These businesses generally operate within niche positions in large, attractive markets where specialized engineered solutions are required to support the needs of large industrial, transportation, and energy customers. Industrial Process manufactures engineered fluid process equipment serving a diversified mix of customers in global infrastructure industries such as oil & gas, mining, power generation, chemical and other process markets and is a provider of plant optimization and efficiency solutions and aftermarket services and parts. Motion Technologies manufactures brake pads, shock absorbers and damping technologies for the global automotive, truck, trailer and public bus and rail transportation markets. Interconnect Solutions manufactures a wide range of highly specialized connector products that make it possible to transfer signal and power in various electronic devices that are utilized in the aerospace and defense, industrial and transportation, oil & gas, and medical markets. Control Technologies manufactures specialized equipment, including actuation, valves, switches, vibration isolation, custom-energy absorption, and regulators for the aerospace and defense, and industrial markets. Executive Summary During the second quarter of 2014, we delivered revenue growth of 8.8% primarily driven by global energy and mining project growth in industrial pumps, auto brake pad market share gains and aftermarket expansion, and global KONI rail shock absorber growth. This strength reflected growth of 9.4% in emerging markets and 8.6% in developed markets. Organic revenue, a non-GAAP measure, increased 7.5% over the prior year. Total ITT orders expanded 8.8% due to strong global auto brake pads, KONI shock absorbers, and energy and chemical pump orders, that were partially offset by a decline in defense and communication connector orders. Consolidated operating income was $54.5 for the quarter, representing a $13.1, or 31.6%, increase from the prior year, due to segment operating income which grew $15.1 to $88.6. Adjusted segment operating income, a non-GAAP measure, increased $13.6, or 17.1%, over the prior year and reflects a 100 basis point improvement in adjusted segment operating margin driven by higher revenue, strong net operational productivity and restructuring savings, and the benefits from initiatives at our Interconnect Solutions segment and KONI division. See the "Key Performance Indicators and Non-GAAP Measures" section included within Management's Discussion and Analysis for a reconciliation of the adjusted non-GAAP measures. Income from continuing operations attributable to ITT Corporation during the second quarter of 2014 was $41.2, or $0.44 per diluted share, reflecting an increase of $0.17 per diluted share from the prior year. Adjusted income from continuing operations, a non-GAAP measure, was $55.4, or $0.60 per diluted share, for the second quarter 20 -------------------------------------------------------------------------------- of 2014, reflecting an increase of $8.4, or 17.9%, driven by higher segment operating income and a lower effective tax rate. During the quarter we made organic investments that were focused on re-balancing and expanding our global auto brake pad production capacity, expanding our Oil & Gas Western Hemisphere Center of Excellence facility in Seneca Falls, New York, and building-out our aftermarket reach and capabilities. These targeted investments continue to help us build on our already strong foundation and will drive our long-term organic growth. During the second quarter of 2014, our focus on the premier customer experience drove wins on key strategic contracts including: n $42 in large, long-term oil & gas and petrochemical project wins



n $17 in rail awards, primarily in China and Europe

n $7 multi-year aerospace component wins

Further details related to these results are contained in the Discussion of Financial Results section.

21 -------------------------------------------------------------------------------- DISCUSSION OF FINANCIAL RESULTS Three and Six Months Ended June 30 Three Months Six Months For the Periods Ended June 30 2014 2013 Change 2014 2013 Change Revenue $ 663.0$ 609.2 8.8 % $ 1,337.5$ 1,217.4 9.9 % Gross profit 214.8 197.8 8.6 % 429.6 388.3 10.6 % Gross margin 32.4 % 32.5 % (10 )bp 32.1 % 31.9 % 20 bp Operating expenses 160.3 156.4 2.5 % 326.8 309.7 5.5 % Expense to revenue ratio 24.2 % 25.7 % (150 )bp 24.4 % 25.4 % (100 )bp Operating income 54.5 41.4 31.6 % 102.8 78.6 30.8 % Operating margin 8.2 % 6.8 % 140 bp 7.7 % 6.5 % 120 bp Income tax expense 12.4 14.4 (13.9 %) 25.4 29.4 (13.6 %) Effective tax rate 23.0 % 36.7 % (1,370 )bp 25.1 % 39.9 % (1,480 )bp Net income attributable to ITT Corporation 38.3 25.8 48.4 % 70.5 46.6 51.3 % REVENUE Revenue for the three months ended June 30, 2014 increased $53.8 or 8.8%, over the prior year, resulting from strength at each of our business segments and reflecting growth in emerging markets of 9.4% and developed markets 8.6%. The Motion Technologies segment experienced growth of $26.6, or 15.5%, driven by strength in the brake pad and shock absorber product categories, led by an increase in friction aftermarket and KONI rail equipment. The Industrial Process segment saw revenue gains of $20.7, or 7.7%, primarily from projects in global oil & gas and mining markets in Latin America. Our Interconnect Solutions segment generated sales growth of $3.4, or 3.4%, with increased revenues in global aerospace, oil & gas and industrial connector markets, partially offset by a decline in defense and communication connector markets. Our Control Technologies segment grew $3.5, or 5.0%, reflecting strength in commercial aerospace original equipment (OE) and aftermarket spares and in the industrial markets related to energy absorption equipment. The following table illustrates revenue generated from each of our business segments and within a specific country or region, the corresponding percentage change, and the organic growth. See the section titled "Key Performance Indicators and Non-GAAP Measures" for a definition and reconciliation of organic revenue growth. For the Three Months Ended June 30 2014 2013 Change Organic Growth By segment: Industrial Process $ 289.4$ 268.7 7.7 % 7.9 % Motion Technologies 198.0 171.4 15.5 % 11.3 % Interconnect Solutions 103.7 100.3 3.4 % 2.2 % Control Technologies 73.7 70.2 5.0 % 5.0 % Eliminations (1.8 ) (1.4 ) 28.6 % - Revenue $ 663.0$ 609.2 8.8 % 7.5 % By region: United States $ 243.1$ 222.9 9.1 % 9.0 % Germany 71.3 56.3 26.6 % 20.5 % France 33.0 36.9 (10.6 )% (14.7 )% Other developed markets 113.5 108.3 4.8 % 2.3 % Total developed markets 460.9 424.4 8.6 % 6.8 % South and Central America 58.0 52.6 10.3 % 15.9 % Eastern Europe and Russia 31.6 34.5 (8.4 )% (12.7 )% Middle East and Africa 37.9 29.8 27.2 % 23.5 % China and Hong Kong 46.2 32.1 43.9 % 44.1 % Other emerging markets 28.4 35.8 (20.7 )% (22.5 )% Total emerging markets 202.1 184.8 9.4 % 9.0 % Revenue $ 663.0$ 609.2 8.8 % 7.5 % 22

-------------------------------------------------------------------------------- Revenue for the six months ended June 30, 2014 increased $120.1, or 9.9%, over the prior year, with growth at each of our segments resulting from emerging market growth of 12.2% and developed market growth of 8.9%. The Industrial Process segment saw revenue gains of $49.4, or 9.4%, primarily from the chemical, oil & gas, and mining markets in North America and Latin America. The Motion Technologies segment experienced growth of $51.2, or 14.0%, driven by strength in the brake pad and shock absorber product categories, led by an aftermarket increase in Europe and OEM growth in China. Our Interconnect Solutions segment generated sales growth of $12.6, or 6.6%, with growth stemming from the oil & gas, aerospace, and medical markets. Our Control Technologies segment grew $7.8, or 5.6%, reflecting strength in commercial aerospace and aftermarket spares, as well as energy absorption and natural gas valves. The following table illustrates revenue generated from each of our business segments and within a specific country or region, the corresponding percentage change, and the organic growth. See the section titled "Key Performance Indicators and Non-GAAP Measures" for a definition and reconciliation of organic revenue growth. For the Six Months Ended June 30 2014 2013 Change Organic Growth By segment: Industrial Process $ 574.9$ 525.5 9.4 % 10.3 % Motion Technologies 415.8 364.6 14.0 % 10.2 % Interconnect Solutions 203.7 191.1 6.6 % 5.7 % Control Technologies 146.6 138.8 5.6 % 5.7 % Eliminations (3.5 ) (2.6 ) 34.6 % - Revenue $ 1,337.5$ 1,217.4 9.9 % 9.0 % By region: United States $ 465.4$ 433.7 7.3 % 7.3 % Germany 165.0 131.7 25.3 % 20.1 % France 70.6 73.6 (4.1 )% (8.0 )% Other developed markets 239.8 224.8 6.7 % 5.4 % Total developed markets 940.8 863.8 8.9 % 7.4 % South and Central America 114.5 97.4 17.6 % 24.7 % Eastern Europe and Russia 62.5 64.3 (2.8 )% (6.6 )% Middle East and Africa 69.3 63.2 9.7 % 7.9 % China and Hong Kong 90.8 60.1 51.1 % 50.2 % Other emerging markets 59.6 68.6 (13.1 )% (14.4 )% Total emerging markets 396.7 353.6 12.2 % 12.6 % Revenue $ 1,337.5$ 1,217.4 9.9 % 9.0 % Industrial Process Industrial Process revenue for the three months ended June 30, 2014 increased $20.7, or 7.7%, primarily due to global growth in the oil & gas market of approximately 20%. Our growth in oil & gas was mainly driven by increased demand and share gains in our highly engineered pump project business. We also experienced revenue growth during the quarter in the mining market of approximately 25% related to several large projects in Latin America. Our revenue results in the chemical market were down slightly from the prior year despite growth in the U.S., primarily related to market conditions in China. The overall growth during the quarter stemming from large engineered projects and base pumps was partially offset by softness in parts and service. Industrial Process revenue for the six months ended June 30, 2014 increased $49.4, or 9.4%, primarily due to growth in the oil & gas market of 19%, chemical market of 17%, and mining market of 25% mainly related to the project pump business in North America and Latin America. This growth was partially offset by softness in base pumps, parts and service, and power process pumps. Our six month 2014 results reflect $25.8 of incremental revenue related to timing of certain large, long-term industrial pump projects. Orders for the three months ended June 30, 2014 increased $17.4, or 6.3%, to $291.5 reflecting a book to bill ratio of 1.01x. The order growth during the second quarter of 2014 primarily reflected higher oil & gas and chemical business activity in the North America, Europe, and Middle East regions. Also during the second quarter of 2014, we experienced slight growth in our parts business over the prior year which is expected to improve modestly through the remainder of 2014. Orders for the six months ended June 30, 2014 improved $0.8, or 0.1%, to $588.4 reflecting a book to bill ratio of 1.02x as growth in large engineered projects was offset by a decline in our base pump business. In addition, the timing on a number of project orders expected to be received during the first half 23 -------------------------------------------------------------------------------- of 2014 have been delayed by customers. We continue to expect that the majority of these delayed project orders will be received during the second half of the year. Backlog as of June 30, 2014 was $698.8 reflecting an increase of $17.1, or 2.5%, over December 31, 2013. Growth in emerging markets, including Russia and Venezuela, is an important component of the growth strategy for Industrial Process and ITT. To date, we have not experienced any significant disruptions, although we continue to closely monitor developments given the instability in the current political environments. The continuation or escalation of the current geopolitical instability in these regions could negatively impact our revenue and future growth prospects. Motion Technologies Motion Technologies revenue for the three months ended June 30, 2014 increased $26.6, or 15.5%, over the prior year reflecting growth in Friction Technologies and KONI of approximately 15% and 18%, respectively, and includes a $7.3 benefit from foreign currency effects. Organic revenue growth for the second quarter of 2014 was $19.3, or 11.3%, over the prior year, and includes year-over-year favorability of $4.7 from the timing of automotive brake pad shipments. Friction Technologies' revenue growth came from increased pad volume to all channels, especially aftermarket, which reflects increasing demand for replacement parts due to our growing base of automotive platforms, as well as improving European economic conditions. Volume driven revenue growth was partially offset by unfavorable year-over-year OE pricing. KONI's revenue growth was the result of improved performance and increased demand for our shock absorber products in the global rail market and North American and European automotive markets. Motion Technologies revenue for the six months ended June 30, 2014 increased $51.2, or 14.0%, reflecting approximately 13% growth in Friction Technologies and 19% growth in KONI, and includes a $13.9 benefit from foreign currency effects, partially offset by unfavorable year-over-year OE pricing. Growth in Friction Technologies came from both the aftermarket and OE channels. Aftermarket benefited from the addition of a new production line, as well as improved production press efficiency rates coming from specific Lean initiatives to meet increased demand. The year-over-year increase in OE was driven by growth in China which corresponds with our investments and strategic focus to gain market share in the Asia Pacific region. Growth in KONI came from strength in each of the product groups, however, railway provided the largest sales growth mainly stemming from Western Europe and North America. Orders for the three months ended June 30, 2014 increased $39.6, or 23.4%, over the prior year, driven by continued strong order intake within the rail market globally and new automotive platform wins in both Europe and China. Orders for the six months ended June 30, 2014 increased $67.7, or 18.5%, primarily driven by OE strength in China, as well as European aftermarket. We also won placement on a number of significant automotive and rail platforms, including new business in North America. In addition, KONI had a book-to-bill ratio of 1.15x during the six months ended June 30, 2014 stemming from strength in each of its business groups. Interconnect Solutions Interconnect Solutions revenue for the three months ended June 30, 2014 increased by $3.4, or 3.4%, as compared to the prior year. Organic revenue growth of 2.2% for the second quarter of 2014 primarily resulted from strength in the medical, oil & gas, and aerospace markets, partially offset by declines in the defense and communications markets. Emerging market growth for the second quarter of 2014 was 5.9%. Interconnect Solutions revenue for the six months ended June 30, 2014 increased by $12.6, or 6.6%, resulting from growth in each core market. Growth in the aerospace and defense market of 7% was driven by an increase in build rates from commercial airline manufacturers and a strong backlog coming into 2014. Sales to the industrial and transportation market provided an increase of 11% primarily due to growth in electric vehicle connectors in Europe and Asia, and in heavy equipment stemming from agriculture and construction applications. We experienced revenue growth of 10% in the oil & gas market primarily reflecting increased demand in Canada and the U.S. In addition, we experienced growth of 16% in the medical device market. Growth during the six month period was partially offset by a decline in the communications market. Control Technologies Control Technologies revenue for the three months ended June 30, 2014 increased by $3.5, or 5.0%, as compared to the prior year driven by growth of 9% and 3% in our CT Industrial and CT Aerospace divisions, respectively. The industrial growth was due to gains in energy absorption products across all regions due to our intensified focus on direct opportunities in the infrastructure and heavy vehicles markets. The aerospace growth was due to higher commercial OE of approximately 13% due to increased production rates and growth in aftermarket spares of 24 -------------------------------------------------------------------------------- approximately 44%. These gains were partially offset by an aerospace aftermarket program that is nearing its end of life in 2014, and lower year-over-year sales from our Enivate product line. Control Technologies revenue for the six months ended June 30, 2014 increased by $7.8, or 5.6%, as compared to the prior year driven by growth of 5% in both our CT Aerospace and CT Industrial divisions, respectively. The aerospace growth was due to higher commercial OE of approximately 22% due to increased production rates and growth in aftermarket of approximately 21%. These gains were partially offset by a 5% decline in revenue from defense applications, an aerospace aftermarket program that is nearing its end of life in 2014, and lower year-over-year sales from our Enivate product line. The industrial growth was due to gains in energy absorption products driven by strong demand from our European distribution network and from higher sales of natural gas valves due to the continued conversion of commercial vehicles to a natural gas fuel source. GROSS PROFIT Gross profit for the three and six months ended June 30, 2014 was $214.8 and $429.6, respectively, reflecting increases of $17.0 and $41.3 over the same prior year periods. The table below provides gross profit and gross margin by segment for the three and six months ended June 30, 2014 and 2013. Three Months Six Months For the Periods Ended June 30 2014 2013 Change 2014 2013 Change Gross profit: Industrial Process $ 89.7$ 90.5 (0.9 )% $ 177.2$ 172.3 2.8 % Motion Technologies 54.1 44.5 21.6 % 116.1 97.1 19.6 % Interconnect Solutions 38.6 33.2 16.3 % 74.1 61.2 21.1 % Control Technologies 31.9 29.2 9.2 % 61.4 57.0 7.7 % Corporate and Other 0.5 0.4 25.0 % 0.8 0.7 14.3 % Total gross profit $ 214.8$ 197.8 8.6 % $ 429.6$ 388.3 10.6 % Gross margin: Industrial Process 31.0 % 33.7 % (270 )bp 30.8 % 32.8 % (200 )bp Motion Technologies 27.3 % 26.0 % 130 bp 27.9 % 26.6 % 130 bp Interconnect Solutions 37.2 % 33.1 % 410 bp 36.4 % 32.0 % 440 bp Control Technologies 43.3 % 41.6 % 170 bp 41.9 % 41.1 % 80 bp Consolidated gross margin 32.4 % 32.5 % (10 )bp 32.1 % 31.9 % 20 bp OPERATING EXPENSES Operating expenses for the three and six months ended June 30, 2014 increased $3.9 and $17.1, or 2.5% and 5.5%, respectively. Operating expenses as a percentage of revenue for the three and six months ended June 30, 2014 declined 150 basis points and 100 basis points to 24.2% and 24.4%, respectively, from the same prior year periods, primarily due to the cost savings generated by recent restructuring and Lean initiative actions. The following table provides further information by expense type, as well as a breakdown of operating expense by segment. Three Months Six Months For the Periods Ended June 30 2014 2013 Change 2014 2013 Change Sales and marketing expenses $ 56.3$ 57.5 (2.1 )% $ 111.6$ 109.3 2.1 % General and administrative expenses 69.5 66.6 4.4 % 147.2 135.7 8.5 % Research and development expenses 18.6 16.4 13.4 % 36.3 32.8 10.7 % Asbestos-related costs, net 15.9 15.9 - % 31.7 31.9 (0.6 )% Total operating expenses $ 160.3$ 156.4 2.5 % $ 326.8$ 309.7 5.5 % Total Operating Expenses By Segment: Industrial Process $ 64.3$ 62.4 3.0 % $ 127.5$ 121.7 4.8 % Motion Technologies 19.4 21.2 (8.5 )% 41.2 40.8 1.0 % Interconnect Solutions 26.3 26.5 (0.8 )% 64.8 55.8 16.1 % Control Technologies 15.7 13.8 13.8 % 29.7 27.2 9.2 % Corporate & Other 34.6 32.5 6.5 % 63.6 64.2 (0.9 )% 25

-------------------------------------------------------------------------------- Sales and marketing expenses for the three and six months ended June 30, 2014 were reasonably consistent with the prior year, as higher costs associated with the increase in sales volume were offset by a decline in third-party commission expenses. General and administrative (G&A) expenses for the three months ended June 30, 2014 increased $2.9, or 4.4%, as higher costs related to various operational and corporate strategic initiatives and higher compensation and benefit-related costs of $3.5, were offset by lower costs of $6.6 related to activities in 2013 to transform and reposition the Company following the 2011 spin-off transaction (Repositioning costs) and legal settlement favorability. G&A expenses increased $11.5, or 8.5%, during the six month period of 2014 over the prior year due to an increase in restructuring costs of $10.2, primarily related to the Interconnect Solutions turnaround strategy. We estimate that restructuring actions taken during the first half of 2014 will yield approximately $17 in annual net savings (see Note 3, "Restructuring Actions," in our Notes to the Consolidated Condensed Financial Statements for additional information on this restructuring initiative). R&D costs for the three and six months ended June 30, 2014 increased $2.2 and $3.5, or 13.4% and 10.7%, respectively, as we continued to invest in new product developments for use in new automotive platforms and expanding multiphase pump technology, as well in various other targeted growth markets. During the three and six months ended June 30, 2014, we recognized net asbestos related costs of $15.9 and $31.7, respectively, which is consistent with the prior year costs. These costs primarily reflect the recognition of incremental asbestos liabilities and related asbestos assets to maintain our rolling 10-year projection of unasserted claims. See Note 16, "Commitments and Contingencies," in our Notes to the Consolidated Condensed Financial Statements for further information on our asbestos-related liabilities and assets. OPERATING INCOME Operating income for the three and six months ended June 30, 2014 increased $13.1 and $24.2 reflecting an operating margin growth of 140 basis points and 120 basis points, respectively, as compared to the same prior year periods. The following table illustrates the 2014 and 2013 operating income results of our segments, including operating margin results. Three Months Six Months For the Periods Ended June 30 2014 2013 Change 2014 2013 Change Industrial Process $ 25.4$ 28.1 (9.6 )% $ 49.7$ 50.6 (1.8 )% Motion Technologies 34.7 23.3 48.9 % 74.9 56.3 33.0 % Interconnect Solutions 12.3 6.7 83.6 % 9.3 5.4 72.2 % Control Technologies 16.2 15.4 5.2 % 31.7 29.8 6.4 % Segment operating income 88.6 73.5 20.5 % 165.6 142.1 16.5 % Asbestos-related costs, net (15.9 ) (15.9 ) - % (31.7 ) (31.9 ) (0.6 )% Other corporate costs (18.2 ) (16.2 ) 12.3 % (31.1 ) (31.6 ) (1.6 )% Total corporate and other costs (34.1 ) (32.1 ) 6.2 % (62.8 ) (63.5 ) (1.1 )% Total operating income $ 54.5$ 41.4 31.6 % $ 102.8$ 78.6 30.8 % Operating margin: Industrial Process 8.8 % 10.5 % (170 )bp 8.6 % 9.6 % (100 )bp Motion Technologies 17.5 % 13.6 % 390 bp 18.0 % 15.4 % 260 bp Interconnect Solutions 11.9 % 6.7 % 520 bp 4.6 % 2.8 % 180 bp Control Technologies 22.0 % 21.9 % 10 bp 21.6 % 21.5 % 10 bp Segment operating margin 13.4 % 12.1 % 130 bp 12.4 % 11.7 % 70 bp Consolidated 8.2 % 6.8 % 140 bp 7.7 % 6.5 % 120 bp Industrial Process Industrial Process operating income for the three months ended June 30, 2014 decreased $2.7, or 9.6%, with an associated decline in operating margin of 170 basis points, as compared to the three months ended June 30, 2013. The decline in operating income and margin was primarily the result of an unfavorable shift in sales mix of approximately $4.0 primarily from our higher margin North American base pump business to the engineered project pump business which continues to operate in a challenging project pricing environment. In addition, operating income was unfavorably impacted by higher restructuring charges of $1.8 and increased costs of $2.4 associated with strategic growth investments primarily related to emerging market expansion and Lean initiatives. Foreign 26 -------------------------------------------------------------------------------- currency movements resulted in an unfavorable impact of $2.1 to operating income during the second quarter of 2014. These unfavorable items were partially offset by net savings from lean and sourcing initiatives as well as benefits from increased sales volume. Industrial Process operating income for the six months ended June 30, 2014 decreased $0.9, or 1.8%, with an associated decline in operating margin of 100 basis points, as compared to the same prior year period. The decline in operating margin was primarily the result of an unfavorable shift in sales mix of approximately $10.3, an increase in strategic growth investment costs, and unfavorable foreign currency movements. These unfavorable items were partially offset by net savings from lean and sourcing initiatives as well as benefits from increased sales volume. Motion Technologies Motion Technologies operating income for the three months ended June 30, 2014 increased $11.4, or 48.9%, resulting in a 390 basis point improvement in operating margin. Operating income for the six months ended June 30, 2014 increased $18.6, or 33.0%, resulting in a 260 basis point improvement in operating margin. Sales volume growth, coupled with favorable product mix from a heavy weighting of aftermarket sales, legal settlement favorability, and continued improvement in our manufacturing press efficiency rate, were the primary drivers of the operating income and margin growth. In addition, KONI had a year-over-year operating margin improvement of 870 basis points and 820 basis points during the quarter and year-to-date periods, respectively, due to strong volume growth, fixed cost reductions, and manufacturing improvements. The favorability of these items was partially offset by OE pricing negotiations, as well as higher costs related to the capacity expansion and maintenance activities. Interconnect Solutions Interconnect Solutions operating income increased $5.6 for the three months ended June 30, 2014, resulting in operating income of $12.3 and a 520 basis point improvement in operating margin. Operating income increased $3.9 for the six months ended June 30, 2014, resulting in operating income of $9.3 and a 180 basis point improvement in operating margin. The increase in operating income and operating margin was primarily the result of net savings from restructuring, productivity, and sourcing. In addition, higher sales volumes and a favorable change in sales mix provided operating income growth to both the three and six month periods, as well as lower postretirement employee benefit costs due to modifications made to one of the segment's plans during the fourth quarter of 2013. Control Technologies Control Technologies operating income for the three and six months ended June 30, 2014 increased $0.8 and $1.9 over the prior year, respectively, reflecting a 10 basis point improvement in operating margin for both periods. Benefits from increased volume and pricing initiatives of approximately $1.7 and $4.1, for the three and six months periods of 2014, respectively, were partially offset by unfavorable sales mix. In addition, net savings from lean and sourcing initiatives were offset by higher year-over-year strategic investment related costs. Other Corporate Costs Other corporate costs for the three months ended June 30, 2014 increased $2.0 over the prior year, primarily due to higher compensation and benefit-related costs and increased investment expenses in corporate Human Resource and other department initiatives. These additional costs were partially offset by lower transformation and repositioning costs of $6.6. Other corporate costs for the six month period were relatively flat year-over-year as higher costs associated with corporate initiatives and employee compensation were offset by the decline in transformation and repositioning costs of $8.1. INCOME TAX EXPENSE For the three months ended June 30, 2014, the Company recognized an income tax expense of $12.4, representing an effective tax rate of 23% compared to an income tax expense of $14.4, and an effective tax rate of 36.7%, for the three months ended June 30, 2013. For the six months ended June 30, 2014, the Company recognized income tax expense of $25.4 representing an effective tax rate of 25.1% compared to income tax expense of $29.4, and an effective tax rate of 39.9%, for the six months ended June 30, 2013.The tax rate for 2014 is lower than the prior year period due to the absence of a valuation allowance that was recorded in 2013 against U.S. deferred tax assets and an increase in income during 2014 that is eligible for the tax holiday in Korea. The Company operates in various tax jurisdictions and is subject to examination by tax authorities in these jurisdictions. The Company is currently under examination in several jurisdictions including Germany, Italy, Korea, the United Kingdom and the U.S. The calculation of our tax liability for unrecognized tax benefits includes dealing with uncertainties in the application of complex tax laws and regulations in various tax jurisdictions. Due to the 27 -------------------------------------------------------------------------------- complexity of some uncertainties the ultimate resolution may result in a payment that is materially different from our current estimate of the unrecognized tax benefit. The settlement of an examination could result in changes in amounts attributable to us through the Tax Matters Agreement entered into with Exelis, Inc. and Xylem, Inc. Over the next twelve months, the net amount of the tax liability for unrecognized tax benefits in foreign and domestic jurisdictions could change by approximately $85.0 million due to changes in audit status, expiration of statutes of limitations and other events. LIQUIDITY Funding and Liquidity Strategy Our funding needs are monitored and strategies are executed to meet overall liquidity requirements, including the management of our capital structure on both a short- and long-term basis. We expect to fund our ongoing working capital, dividends, capital expenditures and financing requirements through cash flows from operations and cash on hand or by accessing the commercial paper market. If our access to the commercial paper market were adversely affected, we believe that alternative sources of liquidity, including our 2011 Revolving Credit Agreement, described below, would be sufficient to meet our short-term funding requirements. We manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct business and the cost effectiveness with which those funds can be accessed. We have identified and continue to look for opportunities to access cash balances in excess of local operating requirements to meet global liquidity needs in a cost-efficient manner. A majority of our cash and cash equivalents is held by our international subsidiaries. We have and plan to transfer cash between certain international subsidiaries and the U.S. and other international subsidiaries when it is cost effective to do so. Our intent is generally to indefinitely reinvest these funds outside of the U.S. consistent with our overall intention to support growth and expand in markets outside the U.S. through the development of products, increase non-U.S. capital spending, and potentially acquire foreign businesses. However, we have determined that certain undistributed foreign earnings generated in Luxembourg, Japan, Hong Kong, and South Korea should not be considered permanently reinvested outside of the U.S. Net cash distributions from foreign countries totaled $50.0 and $28.2 during the six months ended June 30, 2014 and 2013, respectively. The timing and amount of additional future remittances, if any, remains under evaluation. The amount and timing of dividends payable on our common stock are within the sole discretion of our Board of Directors and will be based on, and affected by, a number of factors, including our financial position and results of operations, available cash, expected capital spending plans, prevailing business conditions, and other factors the Board deems relevant. Therefore, there can be no assurance as to what level of dividends, if any, will be paid in the future. In the second quarter of 2014, we declared a dividend of $0.11 per share for shareholders of record on June 13, 2014 which was paid on July 1, 2014. The second quarter dividend declared of $0.11 is a 10% increase from the prior year. Significant factors that affect our overall management of liquidity include our credit ratings, the adequacy of commercial paper and supporting bank lines of credit, and the ability to attract long-term capital on satisfactory terms. We assess these factors along with current market conditions on a continuous basis, and as a result, may alter the mix of our short- and long-term financing when it is advantageous to do so. We access the commercial paper market to supplement the cash flows generated internally to provide additional short-term funding for strategic investments and other funding requirements. We manage our short-term liquidity through the use of our commercial paper program by adjusting the level of commercial paper borrowings as opportunities to deploy additional capital arise and it is cost effective to do so. As of June 30, 2014, we had an outstanding commercial paper balance of $22.5 and during the first half of 2014 we had an average outstanding balance of $65.4. There have been no material changes that have impacted our funding and liquidity capabilities since December 31, 2013. Credit Facilities On October 25, 2011 we entered into a four-year revolving $500 credit agreement (the 2011 Revolving Credit Agreement). The 2011 Revolving Credit Agreement is intended to provide access to additional liquidity and be a source of funding for the commercial paper program, if needed. Our policy is to maintain unused committed bank lines of credit in an amount greater than outstanding commercial paper balances. The interest rate for borrowings under the 2011 Revolving Credit Agreement is generally based on the London Interbank Offered Rate (LIBOR), 28



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plus a spread, which reflects our debt rating. The provisions of the 2011 Revolving Credit Agreement require that we maintain an interest coverage ratio, as defined, of at least 3.0 times and a leverage ratio, as defined, of not more than 3.0 times. At June 30, 2014, we had no amounts outstanding under the 2011 Revolving Credit Agreement and we were in compliance with the financial and other covenants set forth therein. Sources and Uses of Liquidity Our principal source of liquidity is our cash flow generated from operating activities, which provides us with the ability to meet the majority of our short-term funding requirements. The following table summarizes net cash derived from operating, investing, and financing activities from continuing operations, as well as net cash derived from discontinued operations, for the six months ended June 30, 2014 and 2013.


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Source: Edgar Glimpses


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