Form 10-K
Table of Contents

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

Form 10-K

ANNUAL REPORT

(Mark One)

 

  þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2012

OR

 

  ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition period from              to             

Commission File No. 1-5672

 

 

ITT CORPORATION

 

Incorporated in the State of Indiana   13-5158950
  (I.R.S. Employer Identification No.)

1133 Westchester Avenue, White Plains, NY 10604

(Principal Executive Office)

Telephone Number: (914) 641-2000

 

 

Securities registered pursuant to Section 12(b) of the Act, all of which are registered on The New York Stock Exchange, Inc.:

COMMON STOCK, $1 PAR VALUE

Securities registered pursuant to Section 12(g) of the Act:

None.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes þ    No ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes ¨    No þ

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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes þ    No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.    Yes þ    No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    þ

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):

 

Large accelerated filer    þ   Accelerated filer    ¨   Non-accelerated filer    ¨   Smaller reporting company    ¨

(Do not check if a smaller reporting company)

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

The aggregate market value of the common stock of the registrant held by non-affiliates of the registrant on June 30, 2012 was approximately $1.6 billion. As of February 11, 2013, there were outstanding 92.3 million shares of common stock, $1 par value, of the registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A for its 2013 Annual Meeting of Shareholders are incorporated by reference in Part II and Part III of this Form 10-K.

 

 

 

 


Table of Contents

TABLE OF CONTENTS

 

ITEM         PAGE  
PART I   

1

  Description of Business      1   

1A

  Risk Factors      13   

1B

  Unresolved Staff Comments      20   

2

  Properties      21   

3

  Legal Proceedings      22   

4

  Mine Safety Disclosures      22   

*

  Executive Officers of the Registrant      23   
PART II   

5

  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Performance Graph      24   

6

  Selected Financial Data      26   

7

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      27   

7A

  Quantitative and Qualitative Disclosures About Market Risk      54   

8

  Financial Statements and Supplementary Data      55   

9

  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      55   

9A

  Controls and Procedures      55   

9B

  Other Information      57   
PART III   

10

  Directors, Executive Officers and Corporate Governance      59   

11

  Executive Compensation      59   

12

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      59   

13

  Certain Relationships and Related Transactions, and Director Independence      59   

14

  Principal Accounting Fees and Services      59   
PART IV   

15

  Exhibits and Financial Statement Schedule      60   

Signatures

       II-1   

Exhibit Index

       II-3   

 

 

* Included pursuant to Instruction 3 to Item 401(b) of Regulation S-K.


Table of Contents

Forward-Looking and Cautionary Statements

Some of the information included herein includes forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995 (the Act). These forward-looking statements include statements that describe our business strategy, outlook, objectives, plans, intentions or goals, and any discussion of future operating or financial performance. Whenever used, words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “target” and other terms of similar meaning are intended to identify such forward-looking statements. Forward-looking statements are uncertain and to some extent unpredictable, and involve known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from those expressed in, or implied from, such forward-looking statements. Factors that could cause results to differ materially from those anticipated include:

 

  n  

Uncertainties with respect to our estimate of asbestos exposures, third party recoveries and net cash flows;

 

  n  

Economic, political and social conditions in the countries in which we conduct our businesses;

 

  n  

Changes in U.S. or international sales and operations;

 

  n  

Contingencies related to actual or alleged environmental contamination, claims and concerns and related recoveries from insurers;

 

  n  

Decline in consumer spending;

 

  n  

Revenue mix and pricing levels;

 

  n  

Availability of adequate labor, commodities, supplies and raw materials;

 

  n  

Foreign currency exchange rate fluctuations;

 

  n  

Changes in government regulations and compliance therewith;

 

  n  

Competition, industry capacity and production rates;

 

  n  

Declines in orders or sales as a result of industry or geographic downturns;

 

  n  

Ability of third parties, including our commercial partners, counterparties, financial institutions and insurers, to comply with their commitments to us;

 

  n  

Our ability to borrow and availability of liquidity sufficient to meet our needs;

 

  n  

Changes in the recoverability of goodwill or intangible assets;

 

  n  

Our ability to achieve stated synergies or cost savings from acquisitions or divestitures;

 

  n  

The number of personal injury claims filed against the Company or the degree of liability;

 

  n  

Our ability to effect restructuring and cost reduction programs and realize savings from such actions;

 

  n  

Changes in our effective tax rate as a result in changes in the geographic earnings mix, valuation allowances, tax examinations or disputes, tax authority rulings or changes in applicable tax laws;

 

  n  

Changes in technology;

 

  n  

Intellectual property matters;

 

  n  

Potential future postretirement benefit plan contributions and other employment and pension matters;

 

  n  

Susceptibility to market fluctuations and costs as a result of becoming a smaller, more focused company after the Distribution; and

 

  n  

Changes in generally accepted accounting principles within the U.S.

The forward-looking statements included in this disclosure speak only as of the date of this report. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. See Item 1A. “Risk Factors,” for further discussion pertaining to known and unknown risk affecting the Company.


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PART I

 

ITEM  1.    DESCRIPTION OF BUSINESS

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

COMPANY 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 industries that underpin our modern way of life. Founded in 1920, ITT is headquartered in White Plains, N.Y. with approximately 9,000 employees in more than 30 countries and sales in well over 100 countries. The Company generated 2012 revenues of $2.2 billion.

We manufacture 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. For example, our industrial pumps serve the critical function of transporting inorganic fluids throughout chemical processes at petrochemical plants. The pumps are critical to the production requirements of the customer’s plant and their reliability helps our customers meet the delivery time and quality expectations of the users of the petro-chemical products they produce.

ITT is a global company with a balanced and diversified portfolio, positioned to capitalize on secular macro trends such as large-scale urbanization, energy creation and efficiency, resource scarcity, and the growing middle class in emerging economies. In 2012, 61.0% of our sales were outside the U.S., including 28.7% from emerging growth markets. Further, approximately 30% of our revenue is derived from aftermarket products and services where we capture repeatable revenues from our large installed base of specialized products. Additionally, approximately 45% of our revenue is derived from positions our products hold on long-lived customer platforms. Similar to the aftermarket, these are also long-term recurring revenues.

Our product and service offerings are organized in four segments: Industrial Process, Motion Technologies, Interconnect Solutions (ICS), and Control Technologies. These businesses generally operate with in niche positions in large, attractive markets where specialized engineered solutions are required to support large industrial and transportation customer needs.

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 an aftermarket service provider.

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 aerospace, industrial, defense and oil & gas markets.

Control Technologies manufactures specialized equipment, including actuation, valves, switches, vibration isolation, custom-energy absorption, and regulators for the aerospace, defense and industrial markets.

The table below provides revenue by segment for each of the last three years. See section titled “Segment Information” in Company Overview and Note 21, “Segment Information” to the Consolidated Financial Statements for further information about each of our segments.

 

(In Millions)    2012     2011     2010  

Industrial Process

   $ 955.8      $ 766.7      $ 693.7   

Motion Technologies

     626.2        634.4        547.7   

Interconnect Solutions

     375.7        417.8        412.9   

Control Technologies

     277.1        285.5        259.4   

Eliminations

     (7.0     (18.8     (23.0

Total consolidated revenue

   $ 2,227.8      $ 2,085.6      $ 1,890.7   

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 Corporation was incorporated as ITT Industries, Inc. on September 5, 1995 in the State of Indiana. On July 1, 2006, ITT Industries, Inc. changed its name to ITT Corporation.

Company Transformation

On October 31, 2011 (the Distribution Date), ITT completed the tax-free spin-off (referred to herein as the Distribution) of its Defense and Information Solutions business, Exelis Inc. (Exelis), and its water-related businesses, Xylem Inc. (Xylem) by way of a distribution of all of the issued and outstanding shares of Exelis common stock and Xylem common stock, on a pro rata basis, to ITT shareholders of record on October 17, 2011. Exelis and Xylem are now independent companies trading on the

 

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New York Stock Exchange under the symbols “XLS” and “XYL”, respectively. The Distribution was made pursuant to a Distribution Agreement, dated October 25, 2011, among ITT, Exelis and Xylem (the Distribution Agreement). Following the Distribution, ITT did not own any shares of common stock of Exelis or Xylem. All information herein has been restated to reflect the Distribution, and the results of Exelis and Xylem are presented as discontinued operations in all periods.

Business Strengths and Strategies

Management believes that the Company has several competitive advantages that allow it to sustain and grow its market positions. ITT is a diversified industrial technology company with established businesses that share five unifying characteristics:

 

  1. The design and manufacture of highly engineered products for critical applications

 

  2. Leaders in attractive and defensible niches

 

  3. Global footprint & highly diversified

 

  4. Longstanding brands and operating history

 

  5. Proven management system and leadership

As a result, these businesses share a common, repeatable operating model. Each business is a leader in applying its technology and engineering expertise to solve some of the most pressing challenges of our customers. Our applied engineering aptitude provides a special business fit with our customers given the critical nature of their applications. This in turn provides us with unique insight to our customer’s requirements and enables us to develop solutions to better 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. ITT possesses a core competency operating this unified model across businesses in order to create value. These businesses also tend to operate in varying business cycles, which reduces exposures to any one economic cycle.

The oil & gas business in our Industrial Process segment is representative of the capability that many of ITT’s businesses have to generate profitable growth from our common operating model. In 2007, Industrial Process began to pursue growth in the oil & gas market because of its long-term attractiveness, our existing engineering capabilities, brand strength and the aftermarket potential. We started by investing in our technology through product line extensions and followed with expansion through pursuing adjacent markets. To supplement these organic growth drivers, we expanded our strategic footprint and increased proximity to our customers through new facilities in India in 2008 and Saudi Arabia in 2009. The acquisition of Canberra Pumps during 2010 provided an opportunity to realize additional growth opportunities in global oil & gas markets, while the acquisition of Joh. Heinr. Bornemann GmbH (Bornemann) in 2012 provides us with a leadership position in the upstream oil & gas market worldwide, especially with respect to multi-phase boosting. Additionally, we have been actively upgrading and expanding our global test capabilities to accommodate high horsepower pumps that are used in the oil & gas market. For example, we significantly upgraded and expanded our plant in Brazil and acquired our distributor in Australia in 2011 to serve the growing oil & gas market in those regions. As a result of our operating model, during this time period we have signed global strategic account agreements with five market leading oil & gas customers, complementing our existing forty-plus strategic agreements. Together, these actions have led to a compound annual growth rate for oil & gas revenues in our Industrial Process business of 9.2% from $146.0 in 2007 to $227.0 in 2012.

ITT possesses leading brands, such as Goulds Pumps, Bornemann, Cannon, KONI, Enidine and ITT, in many of its niche markets. These brands are associated with quality, reliability, durability, and engineering excellence. The Company’s brand extends internationally and is very well recognized in emerging growth markets including China, India, Brazil and Saudi Arabia.

In addition to branding efforts, we collectively utilize the well-established ITT Management System (IMS), which is a framework for running our businesses in a data-driven manner and serves as a guide for the behaviors, decisions and actions of our employees. The IMS consists of four core integrated processes:

 

  1. Profitable Growth – Value-Based approach to organic growth through strategic planning, market segmentation, and new product development

 

  2. Operational Excellence – Value-Based Lean Six Sigma (VBLSS) and goal deployment process for continuous, sustained cost reduction

 

  3. Resource Optimization – Alignment of our production, sourcing, and footprint with our growth strategies

 

  4. Leadership & Learning – Continuous training and development of our employees

We deploy the IMS in each of our segments and at each of our major facilities. In addition, we have implemented a system of integrated councils, including the Risk Center of Excellence, which is dedicated to improving ITT’s risk management process through a proactive risk assessment, that are comprised of leaders from each business and that focus on core growth and efficiency improvement areas across ITT. The focus areas are 1) Commercial Excellence; 2) Operational Excellence;

 

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3) Technology; and 4) Global Sourcing. This collaborative cross-functional, cross-business approach provides us with the opportunity to leverage best practices and key resources in customer relationship management, coordinated sourcing initiatives, innovation, and technology sharing.

ITT’s long-term objectives are to increase the Company’s earnings and financial returns through a balanced operating strategy. The elements of this strategy are disciplined organic growth through global market expansion and new product development, combined with operational improvements through the IMS that focus on reducing costs and cycle times and improving productivity on a continuing basis. We believe we can drive growth by helping our existing customers grow while cultivating new customers through geographic and product expansion. While the IMS is principally an internal tool, IMS benefits our customers through our continuous improvement efforts which are centered on exceeding our customer’s requirements.

Our long-term goals are to drive average annual organic revenue growth of approximately 5%-7%, with corresponding operating margin expansion of 50-70 basis points, achieve an adjusted free cash flow conversion rate of greater than 105%, and deliver adjusted earnings per share growth of 10%-15% per year. We intend to reach these goals through a combination of leveraging our niche market positions, continuing to expand globally by following and supporting our customers and their growth, introducing new products, reducing costs and increasing productivity.

ITT’s strategy to achieve these goals consists of the following six key elements, which collectively are expected to grow revenues, expand margins, and drive increased profitability and cash flow:

1. Premier Customer Experience

ITT places significant focus on managing the relationships it has with its customers through a formalized process referred to as Value-Based Commercial Excellence (VBCE). VBCE is a continuous improvement process which our businesses use to strategically price our products and services, develop our value propositions, and assist our customers to solve their toughest business challenges. ITT is able to accomplish this by providing an efficient and productive customer experience through advanced order configuration, on-time delivery, and reliable products and services. In addition, ITT has key strategic account relationships throughout the industries we serve. Strategic accounts are customer partnerships, often global in scale, which promote the shared benefits of improved business processes between ITT and its customers. Our strategic account agreements promote customer intimacy, optimized service and delivery performance, and provide growth and profit improvement opportunities. In some instances we are able to leverage these relationships across segments. For example, both Industrial Process and ICS supply products and services to certain oil & gas customers through Industrial Process’s strategic account relationships. Additionally, ITT’s Global Supply Chain Services (GSCS) capabilities and operational excellence initiatives are key supporting elements to the premier customer experience. The Company views its customer relationships as its primary vehicle for growth and technological advancement. Understanding our customer’s growth plans and challenges allows ITT’s businesses to tailor and deliver reliable and timely products and services. Our customers recognize this and ranked ITT’s Goulds Pumps as the Readers Choice #1 in chemical pumps by Chemical Processing magazine in 2012.

2. Investment in Technology and Research & Development

The Company has a core competency in application engineering because a majority of our products feature leading technologies that operate in harsh environments. Harsh environments reflect challenging surrounding conditions such as the extreme cold and darkness of outer space or the high pressure of the ocean floor. For example, our electrical connectors are built specifically to service satellites in space and our oil & gas drilling products are designed to function under the intense pressure of the ocean floor.

ITT has differentiated itself in the critical arena of technology and research & development (R&D). ITT has a proven track record in new product development and introduction. ITT’s approach to technology is to work with its customers in tailoring the right approach to a particular customer need or problem. In our Industrial Process business, our engineers work with our customers in a number of highly challenging environments to improve the way our pumps are installed and operated. This allows the customer to run their processes more reliably and cost effectively by using less energy, which is the largest operating cost in a pump’s life cycle. In 2012, Motion Technologies developed its first high performance copper-free brake pads and Control Technologies launched the first environmentally friendly hydraulic shock absorbers for industrial applications to meet the requirements of our customers.

3. Focused Expansion in Emerging Growth Markets

ITT is a global company with 61.0% of its 2012 revenue derived from international markets, including 28.7% from emerging growth markets. Accordingly, ITT has located approximately half of its manufacturing facilities outside of the U.S. to lower costs, achieve strategic proximity to its customers and to further increase international sales and market share. For example, ICS has had a long-term presence at its Shenzhen, Guangdong Province, China facility. Shenzhen is a low cost manufacturing site that also possesses component fabrication capabilities such as metal stamping, plating, machining and injection molding. Shenzhen produces products for both domestic consumption in China and for global customers. The plant and its experienced, skilled workforce produce a number of ICS products such as universal contacts, electric vehicle connectors, and medical connectors. In addition, the Shenzhen site is staffed with engineers who design specific products for the Asia Pacific and China region.

 

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ITT’s businesses are in a position to grow with its customers in these rapidly expanding global markets. Many of these markets are bolstered by secular trends driving development throughout the emerging economies such as a growing middle class, urbanization, and resource scarcity. These trends are fueling increased consumer consumption of energy, durable goods, automobiles, rail and air travel. For example, Goulds Pumps are used in processing petrochemicals in Saudi Arabia for use in a host of consumer goods such as plastics, while Motion Technologies’ brake pads are installed on Shanghai General Motors and Mercedes automobiles in China, and KONI rail dampers are making high speed trains more comfortable for passengers in China.

We have and expect to continue to expand our R&D capabilities to make products that are relevant to local markets. Our focus is on products where reliability and engineered solutions are valued. We have established R&D technology centers in key markets such as India and China. Motion Technologies recently opened a R&D center and production facility in Wuxi, China that will be focused on expanding and enhancing braking technologies for the local transportation market. Industrial Process is expanding its Korea process pump technology Center of Excellence in order to continue to capture a larger share of the burgeoning oil & gas market in the Eastern Hemisphere.

Because of the global nature of our businesses, ITT benefits from opportunities in emerging growth markets and in developed markets. For example, Motion Technologies is the leading manufacturer of automotive brake pads in Europe. One of the largest growth opportunities for this European-based business is the developed markets in North America, which present a tremendous opportunity. To connect with the opportunity in North America, Motion Technologies has a research, engineering and sales center in Michigan in order to be located close to, and work directly with, customers on the design and development of brake pads specifically tailored to the North American market.

4. Increased Aftermarket Capture and Platform Expansion

Aftermarket sources accounted for $644.3 and $620.0 of our 2012 and 2011 revenue, respectively. Our Industrial Process, Motion Technologies, and Control Technologies segments benefit from repeat sales of original products, consumable spare parts, and services as a result of our large, global, and growing installed base of products. Aftermarket business generally carries higher margins than original product sales and tends to be a more stable, recurring revenue stream than project-based businesses. The key drivers of aftermarket demand are the wear and tear on critical components in harsh environment applications. We develop our aftermarket business through our end user sales channels and dedicated service personnel. The Company views this as a valuable source of future earnings and is actively marketing its capabilities while investing in technologies that reduce the customer’s total life cycle cost. For example, our Industrial Process business has an established international service center network with eight Pump Repair and Overhaul shops (PRO shops) in the U.S. and facilities in Australia, Brazil, Chile, Saudi Arabia, Thailand, and Venezuela.

Our Motion Technologies segment also has recurring revenue streams from automotive and rail platform content. Its products generally serve on long-term platforms whereby once the original equipment products are sold, aftermarket parts are needed to replace and extend the life of a vehicle. Our up-front investments to gain positions on automotive platforms generate long-term repeatable revenue. Another example of a recurring revenue stream is on various aerospace platforms where ICS has been supplying content for many decades, such as with our rectangular & circular connectors which have been used in commercial and military aerospace applications for over 45 years.

5. Margin Expansion through Operational Excellence

The Company strives to increase its profit margins and improve its competitive position in all of its businesses through its operational excellence strategy. The core elements of this strategy are Value-Based Lean Six Sigma (VBLSS), GSCS, VBCE and shared service utilization. These strategies enable the Company to realize operating efficiencies, increase customer satisfaction, and increase free cash flow while lowering operating costs, streamlining processes, eliminating waste and improving cycle times.

The ITT culture has long embraced VBLSS as its central operating tenet. VBLSS encompasses Lean manufacturing as well as continuous process improvement in other critical areas such as customer service and order entry and fulfillment. Our intent is to drive ever increasing levels of quality, speed, and efficiency throughout the organization. We have recently launched an enterprise-wide Lean transformation initiative with the goal of improving all elements of a Lean enterprise that encompasses not only core lean, problem solving and continuous improvement principles but also leadership, talent and cultural aspects. We are targeting achievement and sustainment of a lean assessment score of 80% within the next 3-5 years at our significant revenue producing facilities representing approximately 80% of ITT’s total revenue.

GSCS, which includes low cost region sourcing and leverage through a shared buying channel, has enabled us to mitigate the effects of inflation and increasing material costs in order to maintain or improve profitability. ITT produces its array of engineered products in low-cost and emerging growth markets such as China, India, Brazil, Saudi Arabia, South Korea, Czech Republic and Mexico. Certain operations, including shared services, are leveraged among the Company’s segments resulting in additional cost savings and synergies through the consolidation of operations and reduced general and administrative expenses.

 

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ITT has driven world-class commercial capabilities through VBCE, a sales and marketing initiative intended to accelerate organic growth and margin expansion through increasing sales efficiency and effectiveness. VBCE initiatives target both pricing and improving the value-creation potential for our customers. This leads to pricing based on the differentiated value we deliver to our customers and is an important part of our pricing model. VBCE also drives our global account management where we continue to grow margins across our markets and verticals by providing our customers a premier customer experience.

6. Effective Capital Deployment to Drive Organic and Inorganic Growth

Effective capital deployment and a disciplined focus on liquidity and cash management is a major part of how we achieve our financial performance goals. ITT’s businesses operate in growing and highly fragmented markets, which allows for increasing market share opportunities. ITT estimates the sum of its served addressable markets to be in excess of $30 billion worldwide. Given these dynamics and ITT’s technology investments, global reach and vibrant brands, the Company believes it has the opportunity to continue to expand geographically, broaden its product lines, improve its market position, and increase earnings through revenue growth and operational efficiencies on an organic basis and through acquisition. ITT continues to prioritize deploying capital for organic growth and then acquisitive growth. ITT’s acquisition strategy generally targets firms in similar businesses and end-markets that produce unique and differentiated products and technologies.

Targeted Leverage of Our Capabilities

In addition to the six key elements of the strategy described above, ITT leverages its diverse set of resources and capabilities across its businesses in order to maximize the Company’s value creation potential. The Company is continually evaluating cross-business revenue synergies and cost saving opportunities and views the following assets and capabilities as core to this objective:

 

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ITT Brand – The ITT brand is well regarded and widely recognized, particularly in emerging growth markets. This provides our segments with brand recognition for new products in key emerging growth markets such as Brazil, China, and India.

 

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IMS – Increased performance and productivity through the common application of the ITT Management System.

 

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Shared Services – North American and other regional shared services initiatives to consolidate business functions, including information technology, and reduce overhead costs.

 

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Councils – Cross business operational councils in areas such as operations, commercial excellence, and technology and new product development. While our technologies may vary significantly between each of our segments, our engineering leaders across the businesses leverage our collective strengths through collaboration and cooperation in areas such as design tooling, specific technologies and best practices including our long-standing, results-driven value-based product development process.

 

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Strategic Accounts – Further development and expansion of our global strategic account program to bring the combined technical capabilities of multiple ITT businesses to address incremental customer opportunities.

 

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Sourcing – Indirect sourcing activities across ITT’s businesses are managed centrally to better leverage our third-party contracts and pricing and to evaluate vendor performance.

Segment Information

Industrial Process

The Industrial Process segment is a global manufacturer of industrial pumps, valves and related equipment, and is a provider of plant optimization and efficiency solutions and aftermarket services and parts. Headquartered in Seneca Falls, New York, its operations include five product categories:

Goulds Pumps, Inc. is the largest product category in the Industrial Process segment and is a market leader with over 160 years of product design history and is focused on customer needs primarily in the oil & gas, chemical, mining, general industrial, pulp & paper, and power markets. The Goulds Pumps brand is among the most widely recognized brands in the global pump industry. Goulds has a broad portfolio of centrifugal pumps including ANSI (American National Standard Institute) and ISO (International Standards Organization) chemical pumps, API (American Petroleum Institute) pumps for the petrochemical and oil & gas industry, slurry and process pumps for the mining industry and paper stock pumps for the pulp & paper industry. Our portfolio also includes vertical, axial flow, multi-stage and other pumps that are used in a multitude of industries.

Industrial Process has transformed its Goulds Pumps business considerably over the past five years. Investments have been made in this segment to automate the product selection and order entry process to drive highly efficient transactions and accuracy. In order to support more complex industrial pump orders, including engineered to order API products for the global oil & gas, petro-chemical and power generation markets, a great deal of investment has been made over the last decade. Industrial Process has been successful in penetrating these markets by upgrading existing products and infrastructure, increasing global engineering resources, enhancing global product and project management and driving

 

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operational excellence. Order fulfillment for the more complex orders often involves customization and multiple customer milestones as orders progress from order entry to manufacturing and testing, to shipment, to installation and start-up.

Bornemann, acquired during the fourth quarter of 2012, is a manufacturer of pumps and systems utilized in the oil & gas, marine, food and pharmaceutical industries. Technologies include twin screw pumps, multiphase boosting system pumps and progressive cavity pumps. Bornemann twin screw pumps are rotating displacement pumps that are ideal for mixtures of crude oil, gas, water and the finest solids. Twin screw pumps can be used onshore, offshore and subsea and the dry running technology also allow the presence of gases. The multiphase boosting system pumps provide a complete system solution for a wide range of performance conditions and harsh environmental conditions. Progressive cavity pumps are used to convey a wide range of media, in particular highly viscous and abrasive materials such as slurry, liquid manure, crude oil and greases. Progressive cavity pumps are an optimum solution to conveying tasks where the conveyed product is too viscous and flows too poorly to be pumped by other types of pumps.

ITT Engineered Valves is a manufacturer of process valves for the biopharmaceutical, mining, power, pulp and paper and general industrial markets. ITT Engineered Valves has 65 years of experience in design, fabrication and engineering of market leading industrial knife-gate (Fabri-Valve) and sanitary diaphragm valves (Pure-Flo). Pure-Flo is a leading provider of sanitary valves to the global biopharmaceutical market.

ITT PRO Services is the aftermarket solutions offering of Industrial Process which strives to extend equipment life in its customers’ facilities. PRO Services provides an array of services focused on reducing equipment total cost of ownership and increasing plant output by minimizing downtime. The typical services provided include parts supply, inventory optimization, field service, energy and reliability assessments, repairs, upgrades and overall equipment maintenance. PRO Services offerings include ProShop Repair and Upgrades, ProCast, ProSmart, Goulds Pumps Parts, PumpSmart, and Plant Performance Services.

ITT C’treat is a leading provider of water treatment systems for offshore oil and gas production platforms and has been in business since 1980. Its skid-mounted, reverse osmosis watermakers convert seawater to drinking water and process water for the world’s largest offshore oil & gas exploration and production corporations.

Industrial Process services an extensive base of customers from large multi-national engineering, procurement and construction firms (EPC) to regional distributors with thousands of customers. We estimate this segment’s served addressable market to be in excess of $14 billion worldwide. In 2012, Industrial Process’ customers operated in the oil & gas (24%), chemical & petrochemical (23%), mining (17%), general industrial (15%), pulp & paper (9%) and power (8%) markets. These customers are geographically distributed with a regional mix of North America (54%), Latin America (17%), Asia Pacific (15%), Middle East & Africa (9%) and Europe (5%).

Industrial Process recognizes that serving the customer before, during and after installation is critical. Our success in the marketplace is largely due to our global and diversified channel structures. End-users are serviced by an extensive network of independent industrial distributors, which account for approximately 40% of orders, and representatives which complement our customer-focused direct sales and service organization. We also have focused channels dedicated to supporting the EPC firms as their needs are often different from those of other customers.

The pump and valve markets Industrial Process serves are highly competitive. For most of our products there are hundreds of regional competitors and a limited number of larger global peers. We consider our larger competitors to include Flowserve Corporation, Sulzer Pumps, ClydeUnion (SPX Corporation), Ebara Corporation, The Weir Group PLC and Pentair, Inc. Primary customer purchase decision drivers include price, delivery times and on-time delivery performance, brand recognition and reputation, perceived quality, breadth of product offerings, commercial terms, technical support and localization. Pricing is typically very competitive for large projects because of the increased potential for aftermarket opportunities for the original equipment provider.

Our ability to compete is based on having a wide range of engineered industrial pumps designed to meet our customers’ most demanding applications and our capacity to provide customers with an array of after sale services and support. For large projects, our breadth of product offering is an important sales factor as it simplifies the customer’s procurement process. Industrial Process’ ability to expand its product portfolio has been, and is expected to continue to be, a competitive strength.

We benefit from our large global installed base of products, which, because of their function in the processes in which they are installed, require frequent maintenance, repair and replacement. The frequency of repair and maintenance services depends on utilization levels and the conditions and environment in which they operate. Our direct and distributor channels provide market leading service to our customers. As we increase the number of our global installations, we continue to add service centers and personnel. By positioning our facilities close to customers, we are able to provide quicker responses to their growing aftermarket needs.

The Industrial Process segment demonstrates ITT’s ability to achieve the Premier Customer Experience because the organization works with its customers over the life cycle of the installation and operation of its products in the customers’ facilities or its customers’ end users in the case of an EPC firm. Industrial Process is able to accomplish this because of its extensive global customer relationships, breadth of product offering, product availability, project management skills, and aftermarket and reliability services.

 

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Motion Technologies

Motion Technologies, headquartered in Lainate, Italy, is a global manufacturer of highly engineered and durable components, consisting of brake pads, shock absorbers and damping technologies for the transportation industry. The transportation industry encompasses both personal and public transport equipment, such as passenger cars, light and heavy-duty commercial and military vehicles, buses and rail transportation. Motion Technologies consists of two product categories, Friction Technologies and KONI. Friction Technologies provides the automotive market with high-performance, high-quality brake pads while KONI provides the transportation industry with shock absorber and damping equipment. Motion Technologies primarily serves the high-end of the transportation industry, with a reputation for quality products and a focus on new product development and operational excellence.

We believe that Motion Technologies is positioned and structured to benefit from the anticipated growth in the transportation industry. We believe this growth will be driven by increasing urban and middle class populations, creating a significant need for additional mass transit infrastructure and individual desire for automobile ownership.

Friction Technologies

Our Friction Technologies business applies innovative research of new friction materials and the identification of highly productive technologies to produce a range of brake pads installed as original equipment (OE pads) on cars and light to heavy duty commercial vehicles. OE pads are sold either directly to original equipment manufacturers (OEM) or to Tier-1 and Tier-2 brake manufacturers. Our OE pads are designed to meet customer specifications and environmental regulations, and to satisfy an array of geographic applications. Most automobile OEM platforms (car model) require specific brake pad formulations and have demanding delivery and volume schedules.

Friction Technologies also manufactures aftermarket brake pads designed for the automotive service and repairs market. This market consists of both OEM dealers, also referred to as original equipment service (OES) networks, and independent aftermarket (AM) networks. Brake pads sold within the OES network generally match the specifications of an original auto platform OE brake pad, while our robust catalogue of AM pads features technology designed to provide up to the highest levels of braking performance. Within the service and repairs market, pads are sold either directly to OEM manufacturers and to the Tier-1 and Tier-2 brake manufacturers or indirectly through European distributors, primarily Continental AG and TRW Automotive. Combined sales to Continental and TRW, Motion Technologies’ largest customers, were approximately 60% of 2012 Motion Technologies revenue and 16% of consolidated ITT revenue.

Our dedication to customers and to the advancement of braking technologies has built a legacy of quality, reliable products that meet the demands of customers across the globe, creating our leadership position in the European brake pad market. Historically, revenue for Friction Technologies has been generally balanced between OE pads and AM pads. However, during 2012, revenue from OE pads was higher than AM pads due to an increasing share of auto platforms wins. We anticipate that OE sales growth will continue outpace AM sales growth over the next 2-3 years as we continue to pursue placement on additional OE platforms.

KONI

The KONI business organizes its various performance shock absorber products into three main product groups: railway rolling stock; car & racing; and bus, truck & trailer. Each product group is managed by a dedicated team for product development and engineering, assembly lines and sales & marketing, thus assuring the best possible concentration of product specialization and know-how.

Railway Rolling Stock provides a wide range of equipment for passenger rail, locomotives, freight cars, high speed trains and light rail. Offerings include hydraulic shock absorbers (primary, lateral and inter-car), yaw dampers as well as visco-elastic and hydraulic buffers. This market group also engages in the revamping of air springs which are primarily used on high speed trains and light rail in the United States. Revenue opportunities for our rail damping systems are balanced between OE and AM customers. Sales are either directly to train manufacturers and train operators carrying out scheduled train maintenance programs or indirectly through distributors.

Car & Racing features performance shock absorbers using our Frequency Selective Damping (FSD) technology. FSD products are popular with car and racing enthusiasts who desire to modify their shock absorbers for increased handling performance. KONI car shock absorbers are sold all over the world, through a distribution network that markets KONI products into specific geographies or customer groups.

Bus, Truck & Trailer manufactures shock absorbers and bus dampers, destined to both OE and AM customers.

The rail damping systems and bus dampers market have attractive growth prospects because mass transit systems are benefiting from ongoing large-scale urbanization trends and infrastructure investments. The long-term, enduring nature of these factors fosters a market environment that tends to demonstrate mitigated levels of cyclicality. In addition, train and bus vehicles are sustainable transportation modes that reduce traffic congestion and smog levels in urban areas.

Motion Technologies has a market reputation derived from many years of mutual collaboration with major OE manufacturers and is focused on customer satisfaction, quality and on-time delivery. Motion Technologies has a global

 

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manufacturing footprint, with production facilities in Western Europe, Eastern Europe and China. Although approximately 60% of Motion Technologies revenue is derived from its top two customers, demand for its products stems from a variety of end customers around the world.

Motion Technologies competes in markets primarily served by large, well-established national and global companies. The brake pads and linings market, which we estimate to be in excess of $6 billion, includes companies such as Nisshinbo Automotive Corporation, Honeywell International, Inc., Akebono Brake Corporation and Federal-Mogul Corporation. Key competitive drivers within the brake pad business include technical expertise, formulation development capabilities, scale production, product performance, high-quality standards, customer intimacy, reputation and the ability to meet demanding delivery and volume schedules in a reduced amount of time. OEM customers usually require long-lasting and well-established relationships, based on mutual trust, local proximity and a wide range of cooperative activities, starting from the design to the sampling, prototyping and testing phases of brake pads. Within the AM pads market, Motion Technologies is a leading European provider in a highly fragmented global market.

Competitive drivers in the rail damping systems business include price, technical expertise and product performance. Rail damping systems are considered critical components because of safety requirements and thus they have to be specifically designed according to many different train applications, and must satisfy strict compliance requirements. We estimate the rail damping systems and bus dampers segments have a combined addressable market of approximately $0.5 billion. Motion Technologies is a global leader in the rail dampers component of the complete rail damper system.

Interconnect Solutions

Headquartered in Santa Ana, California, ICS designs and manufactures a broad range of highly engineered connectors and cable assemblies for critical applications in harsh environments that make it possible to transfer signal and power in an increasingly connected world. ICS also provides custom products for unique applications using its engineering expertise to solve difficult connectivity problems and reliability challenges. Through the Cannon, VEAM and BIW Connector Systems brands, our product portfolio and customized engineered connector solutions serve customers in the defense, aerospace, industrial, communications, oil & gas, medical, transportation, and rail markets. In the oil & gas market, ICS is a major solution provider for down-hole electric submersible pump applications. Within the defense and aerospace markets, ICS has a rich legacy and demonstrated track record of providing a broad portfolio of industry standards-based products as well as customer specific solutions across a broad range of mission critical systems applications. ICS is considered a leading company in the harsh environment niche because of our technological capabilities, customer relationships, cost performance and global footprint.

Our technological capabilities in filtering, sealing, contact geometry, composite materials and plating allow us to deliver innovative connector solutions that address our customers’ unique and challenging requirements. Our product portfolio includes high performance, military-specification, and commercial electrical connectors of the following types: Circular, Rectangular, Radio Frequency, Fiber Optic, D-sub Miniature, Micro-Miniature and cable assemblies. Applications include avionics, commercial and military aircraft, rail, industrial automation and production, medical imaging and diagnostics, construction, agriculture and military equipment. ICS has eight production facilities, including two in the United States, and one in Mexico, Italy, Germany, England, China and Japan, providing geographic proximity and highest level of customer support to over 2,500 global customers. Products are sold either directly to OEM’s, contract manufacturers and cable system operators or indirectly through our partnerships with leading distribution companies, creating an extensive global distribution channel. We have long-lasting relationships with our distributor partners, as many have been selling ICS products for over 70 years. Sales to distributors represented approximately 34% of 2012 ICS revenue.

We estimate the global market for connectors and related products to be in excess of $45 billion in 2012. ICS competes with a large number of competitors in a highly fragmented industry. We estimate our addressable market to be approximately $6 billion in 2012. The major competitors for these products are Amphenol Corporation, Deutsch (TE Connectivity Ltd.), Souriau (Esterline) and Glenair, Inc.

Control Technologies

Control Technologies, headquartered in Valencia, California, specializes in highly engineered aerospace components and industrial products. We offer an extensive portfolio of qualified products such as fuel management, actuation and noise absorption components in the aerospace market and a range of products that manage motion and absorb energy in a variety of industrial markets. Our application expertise allows us to offer customized solutions using modular platforms that effectively deliver our technologies for various customer applications. We have strong aftermarket opportunities, particularly in our aerospace business, and a broad customer base with no single customer accounting for more than 10% of Control Technologies revenue. Control Technologies’ distribution network represents approximately 25% of revenue.

 

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CT Aerospace

CT Aerospace designs and manufactures flow control and actuation components, motion control, energy absorption and vibration isolation products primarily for commercial aerospace, military and other markets. We estimate the served addressable market for CT Aerospace to be in excess of $2 billion worldwide. Our aircraft component products consist of fuel and water pumps, valves, electro-mechanical rotary and linear actuators, and pressure, temperature, limit, and flow switches for various aircraft systems. Our aircraft interior products include stowage bin rate controls, rotary hinge dampers and actuators, seat recline locks and control cables and a variety of engineered elastomer aircraft interior isolators to protect equipment and keep the interior of the aircraft quiet. We also provide electromechanical seat actuation for premium seating products. Defense products generally include energy absorption applications and aerospace components. Most of our products are sold direct to the customer by our in-house sales force. We utilize a small third-party business for government spare parts distribution, thereby eliminating extensive administrative costs. CT Aerospace also has a well-established Federal Aviation Agency (FAA) certified repair station which focuses on the aftermarket. The repair station also carries ISO9001/AS9100 and European Aviation Safety Agency (EASA) accreditations.

Our products are custom designed for specific customer applications. We have a highly skilled engineering group for R&D, application engineering and qualification. We conduct fundamental research internally, with universities, and with our customers. We leverage our technical capability to provide innovative and reliable solutions for our customers. Our flow control and actuation products meet reliability requirements through a unique patented shunt disc technology for pressure and temperature switch applications for hostile environments. In addition, our actuator utilizes a patented optical technology for enhanced reliability. Our pumps have the ability to run dry for extended periods, eliminating potential fire ignition sources in fuel system applications and provide high reliability. Our energy absorption products use patented technology to provide innovative solutions, such as self-compensating load variations. Our noise/vibration isolation products use patented innovations to improve noise control, reduce weight, and reduce installation time.

CT Aerospace sells a wide range of products to the aerospace industry and has many customers globally. Our business is neither dependent on one or a small number of customers. Our customers are predominantly commercial airframe manufacturers, airframe systems manufacturers, interior manufacturers, seat manufacturers, commercial airlines and defense contractors. We have positions with the leading commercial airframe and systems manufacturers such as Boeing, Parker-Hannifin, Eaton, Honeywell and Airbus. We have significant content in a number of large commercial transport platforms. We also have significant content on regional and business aircrafts. These platforms provide a long life cycle of original equipment and aftermarket sales.

In the highly regulated Aerospace Market, we benefit from our large installed base of products. We compete by offering a wide portfolio of reliable products, coupled with advanced application expertise and customer support. We believe application expertise and our reputation for quality significantly enhance our market position. Our ability to collaborate with our customers to deliver a wide range of product offerings has allowed us to compete effectively, to cultivate and maintain customer relationships, and to expand into new markets.

Competitors range from large multi-national corporations to small privately held firms. Our markets are often fragmented and thus there are several types of competitors. CT Aerospace competitors include Circor Aerospace, Inc., Hydra Electric, Lord Corporation and Hutchinson Worldwide. Competition in these markets focuses on application expertise with effective solutions, product delivery and performance, previous installation history, quality, price and customer support. We have been successful in establishing long-term supply agreements with a number of our larger customers, thereby increasing opportunities to win future business.

Given the highly fragmented nature of the Aerospace Repair & Overhaul industry, CT Aerospace competes with a large number of Maintenance Repair and Overhaul (MRO) businesses. Some airlines have established repair and overhaul capabilities which makes them competitors as well. We compete in the repair and overhaul segment of our business by offering a high quality service with increased reliability, coupled with advanced technical expertise.

CT Industrial

CT Industrial designs and manufactures energy absorption, precision motion control, and natural gas regulators primarily for heavy industry, infrastructure, automation, and energy markets. We estimate the served addressable market for CT Industrial is over $3 billion globally. Our energy absorption products consist of customized shocks absorbers, vibration isolators and dampers. CT Industrial possesses a specialized set of skills and capabilities in the energy absorption business. Our precision motion control products consist of servomotors, actuators, and controllers.

During 2012, the Company completed the sale of its shape cutting product lines, including the Kaliburn and Burny brands as well as the web tension control products and custom engineered systems sold under the Cleveland Motion Controls brand (collectively referred to herein as the Shape Cutting Businesses).

 

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CT Industrial has solid positions in China, Europe, and North America. It has a broad customer base including end users, OEM’s, and distributors. Channels to market include direct, commissioned representation and buy-resell distributors. CT Industrial competes by offering a wide portfolio of reliable products that are brought to specific markets as a basket of tools to solve critical application problems for customers. CT Industrial focuses on product delivery, quality, performance and application engineering.

Our ability to collaborate with our customers to deliver comprehensive product offerings has allowed us to compete effectively. Two recent examples of this include collaborating with a customer to design unique deep well applications serving off shore oil platforms in our precision motion control business. Another example includes working with a Brazilian customer to develop a unique solution for life extension and efficiency of hydroelectric plants in our energy absorption business.

Competitors change depending on the product line and range from large multi-national corporations to small privately held firms. CT Industrial has a leading position in our energy absorption business. Our position in the top three manufacturers in energy absorption is significant in the automation, heavy industrial and energy markets.

The precision motion control and natural gas regulators businesses are highly fragmented and we compete with a global group of industry participants. The main competitor in the servo motor product line is Yaskawa Electric Corporation. Parker-Hannifin Corporation is a leading competitor in the pneumatic actuation.

CT Industrial will continue to focus on delivery lead times, quality and performance while enhancing our application engineering offering. The development of new customer service strategies will create a differentiated service offering and improve turnaround time in product, quotations and service communications.

Other Company Information

Materials

All of our businesses require various OEM products, manufactured components and raw materials, the availability and prices of which may fluctuate. The principal OEM products, and manufactured components assembled into our products include motors, mechanical seals, machined castings, metal fabrications and miscellaneous metal, plastic, or electronic components. The primary raw materials used in manufacturing our products include steel, gold, copper, nickel, iron, aluminum, and tin, as well as specialty alloys, including titanium. Materials are purchased in various forms, such as sheet, bar, rod and wire stock, pellets and metal powders.

Our global sourcing initiatives continue to expand and are designed to capitalize on sources in emerging growth markets and other low-cost sources of purchased goods balanced with efficient coordinated global logistics. Raw materials, supplies and product subassemblies are purchased from third-party suppliers, contract manufacturers, and commodity dealers. For most of our products, we have existing alternate sources of supply, or such materials are readily available. In some instances we depend on a single source of supply, manufacturing or assembly or participate in commodity markets that may be subject to a limited number of suppliers.

We continually monitor the business conditions of our supply chain to maintain our market position and to avoid potential supply disruptions. There have been no raw materials shortages that have had a material adverse impact on our business as a whole, and we have been able to develop a robust supply chain such that we do not anticipate shortages of such materials in the future.

Although some cost increases may be recovered through increased prices to customers, our operating results are generally exposed to such fluctuations. We attempt to control such costs through fixed-priced contracts with suppliers and various other cost containment strategies, such as our GSCS initiative. We typically acquire materials and components through a combination of blanket and scheduled purchase orders to support our materials requirements for an average of four to eight weeks, with the exception of some specialty materials. From time to time, we experience price volatility or supply constraints for raw materials based on market supply and demand dynamics. In limited circumstances, we may have to obtain scarce components for higher prices on the spot market, which may have a negative impact on gross margin and can periodically create a disruption to production and delivery. We also acquire certain inventory in anticipation of supply constraints or enter into longer-term pricing commitments with vendors to improve the priority, price and availability of supply. We evaluate hedging opportunities to mitigate or minimize the risk of operating margin erosion resulting from the volatility of commodity prices.

Manufacturing Methods

We utilize two primary methods of fulfilling demand for products: build-to-order and engineer-to-order. Build-to-order consists of assembling a group of products with the same pre-defined specifications, generally for our OEM customers’ inventory. Engineer-to-order consists of assembling a customized system for a customer’s individual order specifications. In both cases, we offer design, integration, test and other production value-added services. We employ build-to-order capabilities to maximize manufacturing and logistics efficiencies by producing high volumes of basic product configurations. Engineering products to order permits the configuration of units to meet the customized requirements of our customers. Our inventory management and distribution practices in both build-to-order and engineer-to-order seek to minimize inventory holding periods.

 

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Backlog

Delivery schedules vary from customer to customer based on their requirements. For example, large complex projects in specialized markets such as oil & gas and mining at Industrial Process require longer lead times and production cycles. Delivery delays could arise from changes in the customer’s requirements or technical difficulties. Total backlog, representing firm orders that have been received, acknowledged and entered into our production systems, was $967.0 and $859.8 at December 31, 2012 and 2011, respectively. The ending 2012 backlog includes $94.4 related to our newly acquired Bornemann business. Total backlog at December 31, 2012 was comprised of 59.9% from Industrial Process, 17.9% from Motion Technologies and 11.7% from ICS and 10.5% from Control Technologies. We expect to satisfy nearly all December 31, 2012 backlog commitments during 2013.

Intellectual Property

We generally seek patent protection for those inventions and improvements that are likely to be incorporated into our products or where proprietary rights are expected to improve our competitive position. The highly customized application engineering embedded within our products, our proprietary rights and our knowledge capabilities all contribute to enhancing our competitive position.

While we own and control a significant number of patents, trade secrets, confidential information, trademarks, trade names, copyrights, and other intellectual property rights which, in the aggregate, are of material importance to our business, management believes that our Company, as a whole, as well as each of our core segments, is not materially dependent on any one intellectual property right or related group of such rights. Patents, patent applications, and license agreements will expire or terminate over time by operation of law, in accordance with their terms or otherwise. As the portfolio of our patents, patent applications, and license agreements has evolved over a long period of time, we do not expect the expiration of any specific patent or other intellectual property right to have a material adverse effect on our financial statements.

Research and Development

R&D is a key element of ITT’s engineering culture and is generally focused on the design and development of products and solutions that anticipate customer needs and emerging trends. ITT’s track record for new product development and introduction is strong given our approach to R&D which is designed to work with our customers to tailor a solution to a particular customer need or problem. As a result, our R&D is based on taking technology quickly to the tangible phase, increasing the competitive offering, and increasing the customer service experience through engineered application solutions.

Product development efforts at Industrial Process focus on technologies that reduce customer’s total cost of ownership. We have significantly expanded our API pump coverage to service the oil & gas market. One of our newest products, the Goulds Pumps XHD Extra Heavy Duty Lined Slurry Pump has been honored with a 2012 Breakthrough Product of the Year Award by Processing magazine. The XHD pump has been designed for even the toughest slurry applications, such as primary metals, mineral processing, non-metallic mining, power utilities, and sand and aggregates. The XHD model features more accessible and adjustable components than other slurry pumps. We also launched an updated Multistage Process barrel pump for high pressure and high temperature applications and expanded the range of single and two-stage pumps for oil & gas market applications.

Motion Technologies R&D activities focus on the design and development of products and solutions that either meet specific customers’ needs or anticipate new market trends and environmental regulations. During 2012, Motion Technologies began construction of a new R&D and production center in Wuxi, China that will perform car testing, dyno testing and mass production. The facility became operational in 2012 and is expected to be fully completed by mid-2013. The focus of the R&D center is to enable ITT to provide the appropriate engineering solutions with flexible and time responsive service to our customers directly participating in the development of new local product launches. In addition, this R&D center will function as a Center of Excellence for friction material by offering training programs to local OEMs. Additionally, during 2012, we developed our first high performance copper-free brake pad which was validated by major OEMs.

ICS’s R&D programs are focused on bringing products to market that satisfy the present and future needs of the connectors industry. Our product designs attempt to deliver solutions to size reduction and bandwidth expansion challenges, while providing reliable power and signal connections that meet and exceed the requirements of our customers. The new 38999 Composite products address emerging requirements in aerospace and defense markets where weight and durability are essential.

Control Technologies R&D efforts are aimed at producing innovative technologies that solve our customer’s critical issues. For example, CT Industrial is currently developing a series of energy absorption devices for hydro-electric turbines. The technology, termed VES (Visco-Elastic Support), decouples the turbine from the civil structure, dampening the system to mitigate vibration induced damage. In addition, CT Aerospace is developing a vibration isolator and a high endurance electromechanical actuator for helicopters to reduce rotor noise and improve fuel efficiency.

 

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We anticipate our investments in future R&D activities will moderately increase from current spending levels to ensure a continuing flow of innovative, high quality products and maintain our competitive position in the markets we serve. Such activities are conducted in laboratory and engineering facilities at several of our major manufacturing locations, as well as in our dedicated R&D facilities strategically positioned close to our customers. During 2012, 2011 and 2010, we recognized R&D expenses of $62.7, $63.5, and $59.3, respectively, which are 2.8%, 3.0%, and 3.1% of revenues, respectively.

Cyclicality and Seasonality

Many of the businesses in which we operate are subject to specific industry and general economic cycles. Our connectors business tends to be impacted more in the early portion of an economic cycle, while the automotive and aerospace components businesses tend to expand in the middle portion of the economic cycle and the industrial pump business typically benefits from late cycle expansion.

Our businesses experience limited seasonal variations, with demand generally at an annual low during summer months (our third quarter) mainly attributable to manufacturing shutdowns and the planned industrial maintenance activities of our customers. Revenue impacts from the limited seasonal variations are typically mitigated by our backlog of orders that allow us to adjust levels of production across the summer months.

Environmental Matters

We are subject to stringent federal, state, local, and foreign environmental laws and regulations concerning air emissions, water discharges and waste disposal. In the U.S., these include but are not limited to the Federal Clean Air Act, the Clean Water Act, the Resource, Conservation and Recovery Act, and the Comprehensive Environmental Response, Compensation and Liability Act. Environmental requirements are significant factors affecting our operations. We have established an internal program to assess compliance with applicable environmental requirements for our facilities. The program, which includes periodic audits of many of our locations, including our major operating facilities, is designed to identify problems in a timely manner, correct deficiencies and prevent future noncompliance.

Management does not believe, based on current circumstances, that we will incur compliance costs pursuant to such regulations that will have a material adverse effect on our financial statements. We closely monitor our environmental responsibilities, together with trends in the environmental laws. In addition, we have purchased insurance protection against certain environmental risks arising from our business activities. Environmental laws and regulations are subject to change, however, the nature and timing of such changes, if any, is difficult to predict.

Accruals for environmental liabilities 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. Our estimated liability is undiscounted and is reduced to reflect the participation of other potentially responsible parties in those instances where it is probable that such parties are legally responsible and financially capable of paying their respective share of the relevant costs. At December 31, 2012, we had accrued $96.1 related to environmental matters. Such estimates are subject to change and may be affected by many factors, such as new information about a site, evolving scientific knowledge about risk associated with any contamination involved, developments affecting remediation technology, and enforcement by regulatory authorities.

Employees

As of December 31, 2012, we had approximately 9,000 employees, of which approximately 3,400 were located in the U.S. Approximately 15% of our U.S. employees are represented by unions. We also have unionized employees in Italy and Brazil. No one unionized facility accounts for more than 20% of ITT total revenues. Although our relations with our employees are strong and we have not experienced any material strikes or work stoppages recently, no assurances can be made that we will not experience these or other types of conflicts with labor unions, works councils, other groups representing employees or our employees generally, or that any future negotiations with our labor unions will not result in significant increases in our cost of labor. On July 28, 2012, our contract with the United Steelworkers at our Seneca Falls, NY location was extended five years, to July 28, 2017.

Available Information, Internet Address and Internet Access to Current and Periodic Reports

ITT’s website address is www.itt.com. ITT makes available free of charge on or through www.itt.com/ir our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the U.S. Securities and Exchange Commission (SEC). Information contained on our website is not incorporated by reference unless specifically stated herein. As noted, we file the above reports electronically with the SEC, and they are available on the SEC’s web site (www.sec.gov). In addition, all reports filed by ITT with the SEC may be read and copied at the SEC’s Public Reference Room located at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.

 

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ITEM  1A.    RISK FACTORS

We are subject to a wide range of factors that could materially affect future developments and performance. Because of these factors, past performance may not be a reliable indicator of future results. Set forth below and elsewhere in this document are descriptions of the risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this document. The most significant factors affecting our business and operations include the following:

Business and Operating Risks

Our exposure to pending and future asbestos claims and related liabilities, assets, and cash flows are subject to significant uncertainties.

ITT, including its subsidiary Goulds Pumps, Inc., has been joined as a defendant in numerous lawsuits and claims in which the plaintiffs claim damages for personal injury arising from exposure to asbestos in connection with certain products sold or distributed that may have contained asbestos. We expect to be named as defendants in similar actions in the future. We record an estimated liability related to pending claims and claims estimated to be filed over the next 10 years based on a number of key assumptions, including the plaintiffs’ propensity to sue, claim acceptance rates, disease type, settlement values and defense costs. These assumptions are derived from ITT’s recent experience and reflect the Company’s expectations about future claim activities. These assumptions about the future may or may not prove accurate, and accordingly, the Company may incur additional liabilities in the future. A change in one or more of the inputs used to estimate our asbestos liability could materially change the estimated liability and associated cash flows for pending claims and those estimated to be filed in the next 10 years. Although it is probable that the Company will incur additional costs for asbestos claims filed beyond the next 10 years, we do not believe there is a reasonable basis for estimating those costs at this time.

We record an asset that represents our best estimate of probable recoveries from insurers for the estimated asbestos liabilities. There are significant assumptions made in developing estimates of asbestos-related recoveries, such as policy triggers, policy or contract interpretation, the methodology for allocating claims to policies, and the continued solvency of the Company’s insurers. Certain of our primary coverage-in-place agreements are expected to exhaust within the next twelve months, which may result in higher net cash outflows until excess carriers begin accepting claims for reimbursement. Performance by our insurers could differ from the assumptions underlying the recognized asset and could result in lower collections of receivables than are currently expected to reduce the Company’s asbestos costs.

Due to these uncertainties, as well as our inability to reasonably estimate any additional asbestos liability for claims that may be filed beyond the next 10 years, it is not possible to predict the ultimate outcome of the cost, nor potential recoveries, of resolving the pending and all unasserted asbestos claims. Additionally, we believe it is possible that the cost of asbestos claims filed beyond the next 10 years, net of expected recoveries, could have a material adverse effect on our financial statements.

Many uncertainties exist surrounding asbestos litigation, and the Company will continue to evaluate its estimated asbestos-related liability and corresponding estimated insurance reimbursement as well as the underlying assumptions and process used to derive these amounts. Changes in estimates related to these uncertainties may result in increases or decreases to the net asbestos liability, particularly if the quality or number of claims or settlement or defense costs change significantly, or if there are significant developments in the trend of case law or court procedures, or if legislation or another alternative solution is implemented; however, the Company is currently unable to estimate such future changes. Although the resolution of asbestos claims takes many years, the effect of changes in our estimates related to our pending or estimated future claims in any given period could be material to our financial statements.

In addition, as part of the Distribution, ITT indemnified Exelis and Xylem with respect to asserted and unasserted asbestos claims that relate to the presence or alleged presence of asbestos in products manufactured, repaired or sold prior to the Distribution Date, subject to limited exceptions.

Our operating results and our ability to maintain liquidity or procure capital may be adversely affected by unfavorable economic and capital market conditions associated with global sales and operations and the uncertain geopolitical environment. Adverse conditions in the markets we serve could adversely affect demand for our products.

We have experienced and expect to continue to experience fluctuations in revenues and operating results due to economic and business cycles. Important factors impacting our businesses include the overall strength of the global economy and our customers’ confidence in local and global macroeconomic conditions, industrial spending, interest rates, availability of commercial financing for our customers and unemployment rates.

We serve a diverse mix of customers in global infrastructure industries which can be volatile. The markets in which our business operates include automotive, aerospace, oil & gas, chemical and defense, each of which is impacted by specific industry and general economic cycles. Our revenues, operating results and profitability have varied in the past and may vary from quarter to quarter in the future and can be negatively impacted by volatility in the end markets we serve. We have

 

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undertaken measures to reduce the impact of this volatility through diversification of markets we serve and expansion of geographic regions in which we operate. We may be adversely affected by disruptions in financial markets or downturns in macroeconomic conditions in specific countries or regions, or in the various industries in which the Company operates or be subject to adverse changes in the availability and cost of capital, interest rates, tax rates, or regulations in the jurisdictions in which the Company operates.

Our international operations, including sales of U.S. exports, comprise a growing portion of our operations and are a strategic focus for continued future growth. Our strategy calls for increasing sales in overseas markets, including emerging growth markets such as Central and South America, China, India and the Middle East. In 2012, approximately 61.0% of our total sales were to customers operating outside of the United States. Both our sales from international operations and export sales are subject in varying degrees to risks inherent to doing business outside the United States. These risks include the following:

 

  ¡  

Possibility of unfavorable circumstances arising from host country laws or regulations;

 

  ¡  

Currency exchange rate fluctuations and restrictions on currency repatriation;

 

  ¡  

Potential negative consequences from changes to taxation policies;

 

  ¡  

The disruption of operations from labor and political disturbances;

 

  ¡  

Our ability to hire and maintain qualified staff in these regions; and

 

  ¡  

Changes in tariff and trade barriers and import and export licensing requirements.

Instability in the global credit markets, including the recent European economic and financial difficulties related to sovereign debt issues in certain countries and the instability in the geopolitical environment in many parts of the world, may continue to put pressure on global economic conditions. The world has recently experienced a global macroeconomic downturn, and if global economic and market conditions, or economic conditions in key markets, remain uncertain or deteriorate further we may experience material impacts on our financial statements.

Adverse changes to financial conditions could jeopardize certain counterparty obligations, including those of our insurers and customers. Restrictive credit markets may also result in customers extending terms for payment and may result in our having higher customer receivables with increased risk of default. We closely monitor the credit worthiness of our insurers and customers and evaluate their ability to service their obligations to us. A tightening of credit markets may reduce funds available to our customers to pay for or buy our products and services for an unknown, but perhaps lengthy, period. As it relates to our customers’ ability to pay for products and services, we have not experienced any significant negative consequences as a result of current economic conditions.

Should market conditions deteriorate, this may adversely affect our ability to manage inventory levels and maintain current levels of profitability. If, for any reason, we lose access to our currently available lines of credit, or if we are required to raise additional capital, we may be unable to do so or we may be able to do so only on unfavorable terms.

We are exposed to fluctuations in foreign currency exchange rates, particularly with respect to the Euro, Chinese Renminbi, South Korean Won, Hong Kong Dollar, Mexican Peso, British Pound, Czech Koruna, Australian Dollar and Canadian Dollar. As we continue to grow our business internationally, our operating results could be affected by the relative strength of the European, Asian and developing economies and the impact of currency exchange rate fluctuations. Any significant change in the value of currencies of the countries in which we do business relative to the value of the U.S. Dollar could affect our ability to sell products competitively and control our cost structure, which could have a material adverse effect on our financial statements. In addition to the general risks that we face outside the U.S., we now conduct more of our operations in emerging growth markets than we have in the past, which could involve additional uncertainties, including risks that governments may impose limitations on our ability to repatriate funds; governments may impose withholding or other taxes on remittances and other payments to us, or the amount of any such taxes may increase; governments may seek to nationalize our assets; or governments may impose or increase investment barriers or other restrictions affecting our business. In addition, emerging growth markets pose other uncertainties, including the protection of our intellectual property, pressure on the pricing of our products, and risks of political instability.

A substantial portion of our earnings is generated by our foreign subsidiaries and repatriation of those earnings to the U.S. may be inefficient from a tax perspective. Any payment of distributions, loans or advances to us by our foreign subsidiaries could be subject to restrictions on, or taxation of, dividends on repatriation of earnings under applicable local law, monetary transfer restrictions and foreign currency exchange regulations in the jurisdictions in which our subsidiaries operate. The cost of compliance with increasingly complex and often conflicting regulations worldwide can also impair our flexibility in modifying product, marketing, pricing, or other strategies for growing our businesses, as well as our ability to improve productivity and maintain acceptable profit margins.

 

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Failure to compete successfully in our markets could adversely affect our business.

We provide products and services into competitive markets. We believe the principal points of competition in our markets are product performance, reliability and innovation, application expertise, brand reputation, energy efficiency, product life cycle cost, timeliness of delivery, proximity of service centers, effectiveness of our distribution channels and price.

Maintaining and improving our competitive position will require continued investment by us in manufacturing, research and development, engineering, marketing, customer service and support, and our distribution networks. We may not be successful in maintaining our competitive position. Our competitors may develop products that are superior to our products, or may develop more efficient or effective methods of providing products and services or may adapt more quickly than we do to new technologies or evolving customer requirements. Pricing pressures also could cause us to adjust the prices of certain products to stay competitive. We may not be able to compete successfully with existing or new competitors.

Our operating costs are subject to fluctuations, particularly due to changes in commodity prices, raw materials, energy and related utilities, freight, and cost of labor. In order to remain competitive, we may not be able to recuperate all or a portion of these higher costs from our customers through product price increases. Further, our ability to realize financial benefits from Six Sigma and Lean projects may not be able to mitigate fully or in part these manufacturing and operating cost increases and, as a result, could negatively impact our profitability.

If we fail to manage the distribution of our products and services effectively, our revenue, gross margin and profitability could suffer.

We use a variety of distribution methods to sell our products and services, including third-party distributors and resellers. Successfully managing the interaction of our distributors and resellers is a complex process as we sell a broad mix of products through a network of over 500 distributors and resellers. Moreover, since each distribution method has distinct risks and profit margins, our failure to implement the most advantageous balance in the delivery model for our products and services could adversely affect our revenue and profit margins. In addition, changes to or from a distribution model could introduce additional complexity to the sales and inventory management processes and could cause disruptions to customer service or create channel conflicts.

Our financial results could be materially adversely affected due to the loss of a distributor, channel conflicts or if the financial conditions of our channel partners were to weaken. Our future operating results may be adversely affected by any conflicts that might arise between our various sales channels, or the loss or deterioration of any distribution or reseller arrangement. In particular, two distributors account for approximately 60% of Motion Technologies revenues and approximately 16% of consolidated ITT revenue. Our contract with this distributor consists of several subcontracts which are scheduled to expire at various times between 2014 and 2018. Moreover, some of our distributors may have insufficient financial resources and may not be able to withstand changes in business conditions, including economic weakness. Considerable trade receivables are outstanding with our distribution partners. Revenue from indirect sales could suffer, and we could experience disruptions in distribution if our distributors’ financial conditions, abilities to borrow funds in the credit markets or operations weaken.

Further, we must manage inventory effectively, particularly with respect to sales to distributors, which involves forecasting demand and potential pricing issues. Distributors may increase orders during periods of product shortages, cancel orders if their inventory is too high or delay orders in anticipation of new products. Distributors also may adjust their orders in response to the supply of our products and the products of our competitors and seasonal fluctuations in end-user demand. Our reliance on indirect distribution methods may reduce visibility to demand and potential pricing issues, and therefore make forecasting more difficult. If we have excess or obsolete inventory, we may have to reduce our prices or write down inventory. Moreover, our use of indirect distribution channels may limit our willingness or ability to adjust prices quickly and otherwise to respond to pricing changes by competitors.

Quality problems with our manufacturing processes or finished goods could harm our reputation for producing high-quality products and erode our competitive advantage, sales, and market share.

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. As such, quality is extremely important to us and our customers due to the serious and costly consequences of product failure. Our quality certifications are critical to the marketing success of our goods and services. If we fail to meet these standards, our reputation could be damaged, we could lose customers, and our revenue and results of operations could be materially adversely affected. Aside from specific customer standards, our success in part depends on our ability to manufacture to exact tolerances precision-engineered components, subassemblies, and finished devices from multiple materials. If our components fail to meet these standards or fail to adapt to evolving standards, our reputation as a manufacturer of high-quality components will be harmed, our competitive advantage could be damaged, and we could lose customers and market share.

 

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Our business exposes us to potential product liability risks that are inherent in the design, manufacture, and marketing of products for the markets we serve. In addition, many of the devices we manufacture and sell are designed to be used in harsh environments for long periods of time where the cost of failure is high. Component failures, manufacturing defects, design flaws, or inadequate disclosure of product-related risks or product-related information could result in an unsafe condition or injury to, or death of, an end user of our products. The occurrence of such a problem could result in product liability claims or a recall of, or safety alert relating to, one or more of our products which could ultimately result, in certain cases, in the removal of such products from the marketplace and claims regarding costs associated therewith. Product liability claims or product recalls in the future, regardless of their ultimate outcome, could have a material adverse effect on our business and reputation and on our ability to attract and retain customers for our products.

Our business could be adversely affected by raw material price volatility and the inability of key suppliers to meet quality and delivery requirements.

Our business relies on third-party suppliers for raw materials, components, and contract manufacturing services to produce our products. The supply of raw materials to the Company and to its component parts suppliers and the supply of castings, motors, and other critical components could be interrupted for a variety of reasons, including availability and pricing. Prices for raw materials necessary for production have fluctuated significantly in the past and significant increases could adversely affect the Company’s results of operations and profit margins. Due to pricing pressure or other factors, the Company may not be able to pass along increased raw material and components parts prices to its customers in the form of price increases or its ability to do so could be delayed. Consequently, our results of operations and financial condition may be adversely affected.

For most of our products, we have existing alternate sources of supply, or such materials are readily available. In some instances we depend on a single source of supply, manufacturing or assembly or participate in commodity markets that may be subject to a limited number of suppliers. Delays in obtaining supplies may result from a number of factors affecting our suppliers, including production interruptions at suppliers, capacity constraints, labor disputes, the impaired financial condition of a particular supplier, the ability of suppliers to meet regulatory requirements, and suppliers’ allocations to other purchasers. Any delay in our suppliers’ abilities to provide us with sufficient quality and flow of materials, price increases, or decreased availability of raw materials or commodities could impair our ability to deliver products to our customers and, accordingly, could have an adverse effect on our business, results of operations and financial position.

Portfolio management strategies for growth, including cost-saving initiatives, may not meet expectations.

We regularly review our portfolio of businesses and pursue growth through the acquisition of other companies, assets and product lines that either complement or expand our existing business. Although we conduct what we believe to be a prudent level of investigation regarding the operating and financial condition of the businesses we purchase, a level of risk remains regarding the actual operating condition of these businesses. Until we actually assume operating control of these business assets and their operations, we may not be able to ascertain the actual value or understand the potential liabilities of the acquired entities and their operations. Acquisitions involve a number of risks and present financial, managerial and operational challenges that could have a material adverse effect on our reputation and business, including that an acquired business could under-perform relative to our expectations, the failure to realize expected synergies, integration of technology, operations, personnel and financial and other systems, the possibility that we have acquired substantial undisclosed liabilities, potentially insufficient internal controls over financial activities or financial reporting at an acquired company that could impact us on a consolidated basis, diversion of management attention from other businesses, loss of key employees of the acquired businesses, and customer dissatisfaction or performance.

Our portfolio reviews also include the potential for cost-saving initiatives through restructuring, realignment and other initiatives. We strive for and expect to achieve cost savings in connection with certain initiatives, including: (i) manufacturing process and supply chain rationalization; (ii) streamlining redundant administrative overhead and support activities; and (iii) restructuring and repositioning organizations. Cost savings expectations are inherently estimates that are difficult to predict and are necessarily speculative in nature, and we cannot provide assurance that we will achieve expected, or any, actual cost savings. Our restructuring activities may place substantial demands on our management, which could lead to the diversion of management’s attention from other business priorities and result in a reduced customer focus.

Changes in our effective tax rates as a result of changes in the realizability of our deferred tax assets, the geographic mix of earnings, tax examinations or disputes, tax authority rulings, or changes in the tax laws applicable to us may adversely affect our financial results.

The Company is subject to income taxes in the U.S. and in various foreign jurisdictions. We exercise significant judgment in calculating our provision for income taxes and other tax liabilities. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Furthermore, changes in domestic or foreign income tax laws and regulations, or their interpretation, could result in higher or lower income tax rates assessed or changes in the taxability of certain sales or the deductibility of certain expenses, thereby affecting our income tax expense and profitability.

 

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Any significant increase in our future effective tax rates could reduce net income for future periods. Given the global nature of our business, a number of factors may increase our future effective tax rates, including:

 

  ¡  

Decisions to repatriate non-U.S. earnings for which we have not previously provided for U.S. income taxes;

 

  ¡  

Changes in the geographic mix of our profits among jurisdictions with differing statutory income tax rates;

 

  ¡  

Sustainability of historical income tax rates in the jurisdictions in which we conduct business;

 

  ¡  

Changes in tax laws applicable to us;

 

  ¡  

The resolution of issues arising from tax audits with various tax authorities; and

 

  ¡  

Changes in the valuation of our deferred tax assets, deferred tax liabilities and deferred tax asset valuation allowances.

The amount of income taxes and other taxes we have paid are subject to ongoing audits by U.S. federal, state and local tax authorities and by non-U.S. authorities. If these audits result in assessments different from amounts paid or reserved, future financial results may include unfavorable tax adjustments. We are currently under examination by the U.S. Internal Revenue Service and other tax authorities, and we may be subject to additional examinations in the future. The tax authorities may disagree with our tax treatment of certain material items and thereby increase our tax liability. Failure to sustain our position in these matters could result in a material adverse effect on our financial statements.

The level of returns on postretirement benefit plan assets, changes in interest rates and other factors could affect our earnings and cash flows in future periods.

A portion of our current and retired employee population is covered by pension and other employee-related defined benefit plans (collectively, postretirement benefit plans). We may experience significant fluctuations in costs related to postretirement benefit plans as a result of macroeconomic factors, such as interest rates, that are beyond our control. The cost of our postretirement plans is incurred over long periods of time and involves various factors and uncertainties during those periods, which can be volatile and unpredictable, including the rates of return on postretirement benefit plan assets and discount rates used to calculate liabilities and expenses. Management develops each assumption using relevant Company experience in conjunction with market-related data. Our liquidity, cash flows and financial statements could be materially affected by significant changes in key economic indicators, volatility in the financial markets, future legislation and other governmental regulatory actions.

We make contributions to fund our postretirement benefit plans when considered necessary or advantageous to do so. The macro-economic factors discussed above, including the return on postretirement benefit plan assets and the minimum funding requirements established by local government funding or taxing authorities, or established by other agreements, may influence future funding requirements. A significant decline in the fair value of our plan assets, or other adverse changes to our overall pension and other employee-related benefit plans could require increased funding contributions and could adversely affect our financial statements. Future minimum funding requirements will depend primarily on the return on plan assets and discount rate. Depending on these factors, and the resulting funded status of our U.S. pension plans, the level of future minimum contributions could be material.

Failure to retain our existing senior management, engineering and other key personnel or the inability to attract and retain new qualified personnel could negatively impact our ability to operate or grow our business.

Our success will continue to depend to a significant extent on our ability to retain or attract a significant number of employees in senior management, engineering and other key personnel. The ability to attract or retain employees will depend on our ability to offer competitive compensation, training and cultural benefits. We will need to continue to develop a roster of qualified talent to support business growth and replace departing employees. A failure to retain or attract highly skilled personnel could adversely affect our operating results or ability to operate or grow our business.

We rely on our information systems in our operations. Security breaches could adversely affect our business and results of operations. Our information system structure could make it more difficult to cost-effectively implement changes.

The efficient operation of our business is dependent on computer hardware and software systems. Even the most well-protected information systems are vulnerable to internal and external security breaches including those by computer hackers and cyber terrorists. The unavailability of our information systems, the failure of these systems to perform as anticipated for any reason or any significant breach of security could disrupt our business and could result in decreased performance and increased overhead costs, causing an adverse effect on our business, reputation and financial statements.

Our information systems infrastructure is centralized, but our information system applications are both centralized and decentralized. The centralized infrastructure presents a risk in that a potential security breach could have a company-wide impact. The decentralized applications could result in significant replacement costs were the Company to decide to replace a number of the independent operating systems or consolidate operating systems. The inter-relationship of information systems also presents an additional risk when upgrading or replacing information systems.

 

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Long-lived assets, including goodwill and other intangible assets, represent a significant portion of our assets and any impairment of these assets could negatively impact our results of operations.

At December 31, 2012, our long-lived assets, representing fixed assets, goodwill and other intangible assets, were approximately $1,147.8, net of accumulated amortization, which represented approximately 33.9% of our total assets. Goodwill and indefinite-lived intangible assets are tested for impairment on an annual basis, or whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We also review the carrying value of finite-lived tangible and intangible assets for impairment when impairment indicators arise. We estimate the fair value of reporting units used in the goodwill impairment test and indefinite-lived intangible assets using an income approach, and as a result the fair value measurements depend on revenue growth rates, future operating margin assumptions, risk-adjusted discount rates, assumed royalty rates, future economic and market conditions, and the identification of appropriate market comparable data. Because of the significance of our long-lived assets, including goodwill and other intangible assets, any future impairment of these assets could have a material adverse effect on our results of operations and financial position.

Other Risks, Including Litigation and Regulatory Risk

We are subject to laws, regulations and potential liability relating to claims, complaints and proceedings, including those related to product and other matters.

We are subject to various laws, ordinances, regulations and other requirements of government authorities in the U.S. and in foreign countries. Any violations or failure to comply with securities laws, trade or tax rules or similar regulations could create a substantial liability for us, and also could cause harm to our reputation. Changes in laws, ordinances, regulations or other government policies, the nature, timing, and effect of which are uncertain, may significantly increase our expenses and liabilities.

From time to time we are involved in legal proceedings that are incidental to the operation of our businesses. Some of these proceedings allege damages relating to product liability, personal injury claims, employment and employee benefit matters and commercial or contractual disputes, sometimes related to acquisitions or divestitures. Additionally, we may become subject to significant claims of which we are currently unaware or the claims of which we are aware may result in our incurring a significantly greater liability than we anticipate or can estimate.

Changes in environmental laws or regulations, the discovery of previously unknown or more extensive contamination, or the failure of a potentially responsible party to perform may adversely affect our financial results.

We could be affected by changes in environmental laws or regulations, including, for example, those imposed in response to vapor intrusion or climate change concerns.

Environmental laws and regulations allow for the assessment of substantial fines and criminal sanctions as well as facility shutdowns to address violations, and may require the installation of costly pollution control equipment or operational changes to limit emissions or discharges.

Accruals for environmental liabilities 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. Our estimated liability is undiscounted and is reduced to reflect the participation of other potentially responsible parties in those instances where it is probable that such parties are legally responsible and financially capable of paying their respective share of the relevant costs. Such estimates are subject to change and may be affected by many factors, such as new information about a site, evolving scientific knowledge about risk associated with any contamination involved, developments affecting remediation technology, and enforcement by regulatory authorities.

We record an asset that represents our best estimate of probable recoveries from insurers for the estimated environmental liabilities. There are significant assumptions made in developing estimates of environmental-related recoveries, such as policy triggers, policy or contract interpretation, and the continued solvency of the Company’s insurers. Performance by our insurers could differ from the assumptions underlying the recognized asset and could result in lower collections of receivables than are currently expected.

Developments such as the adoption of new environmental laws and regulations, violations by us of such laws and regulations, discovery of previously unknown or more extensive contamination, litigation involving environmental impacts, our inability to recover costs associated with any such developments, or financial insolvency of other potentially responsible parties could have a material adverse effect on our financial statements.

 

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Failure to comply with the U.S. Foreign Corrupt Practices Act or other applicable anti-corruption legislation, as well as export controls and trade sanctions, could result in fines or criminal penalties.

We operate in a number of countries throughout the world, including countries known to have a reputation for corruption. We are committed to doing business in accordance with applicable anti-corruption laws. We are subject, however, to the risk that we, our affiliated entities or our or their respective officers, directors, employees and agents may take action determined to be in violation of such anti-corruption laws, including but not limited to, the U.S. Foreign Corrupt Practices Act of 1977 and the U.K. Bribery Act of 2010, as well as trade sanctions administered by the Office of Foreign Assets Control, or OFAC, and the U.S. Department of Commerce. Any such violation could result in substantial fines, sanctions, civil and/or criminal penalties, curtailment of operations in certain jurisdictions, and might adversely affect our business, results of operations or financial position. In addition, actual or alleged violations could damage our reputation and ability to do business. Furthermore, detecting, investigating, and resolving actual or alleged violations is expensive and can consume significant time and attention of our senior management.

The Distribution may expose us to potential liabilities.

In connection with the Distribution we may be exposed to potential liabilities. As part of the Distribution Agreement, ITT, Exelis, and Xylem indemnified each other with respect to such parties’ assumed or retained liabilities pursuant to the Distribution Agreement and breaches of the Distribution Agreement or related spin agreements. There can be no assurance that the indemnity from Exelis and Xylem will be sufficient to protect us against the full amount of these and other liabilities, or that each of Exelis and Xylem will be able to fully satisfy its indemnification obligations. Third-parties could also seek to hold us responsible for any of the liabilities that each of Exelis and Xylem has agreed to assume. Even if we ultimately succeed in recovering from Exelis and Xylem any amounts for which we are held liable, we may be temporarily required to bear these losses ourselves. In addition, performance on indemnities that we provided Exelis and Xylem may be significant. Each of these risks could negatively affect our business, results of operations and financial position.

We may be responsible for U.S. Federal income tax liabilities that relate to the Distribution.

In connection with the Distribution, we received an U.S. Internal Revenue Service (IRS) Ruling stating that ITT and its shareholders will not recognize any taxable income, gain, or loss for U.S. Federal income tax purposes as a result of the Distribution. The IRS Ruling, while generally binding upon the IRS, is based on certain factual statements and representations. If any such factual statements or representations were incomplete or untrue in any material respect, or if the facts on which the IRS Ruling was based are materially different from the facts at the time of the Distribution, the IRS could modify or revoke the IRS Ruling retroactively.

Certain requirements for tax-free treatment that are not covered in the IRS Ruling are addressed in an opinion of counsel delivered in connection with the Distribution. An opinion of counsel is not binding on the IRS. Accordingly, the IRS may reach conclusions with respect to the Distribution that are different from the conclusions reached in the opinion. Like the IRS Ruling, the opinion is based on certain factual statements and representations, which, if incomplete or untrue in any material respect, could alter counsel’s conclusions.

If all or a portion of the Distribution does not qualify as a tax-free transaction because any of the factual statements or representations in the IRS Ruling or the legal opinion are incomplete or untrue, or because the facts upon which the IRS Ruling is based are materially different from the facts at the time of the Distribution, ITT would recognize a substantial gain for U.S. Federal income tax purposes. In such case, under U.S. Treasury regulations, each member of the ITT consolidated group at the time of the Distribution would be severally liable for the resulting entire amount of any U.S. Federal income tax liability.

Even if the Distribution otherwise qualifies as a tax-free transaction for U.S. Federal income tax purposes, the Distribution will be taxable to ITT (but not to ITT shareholders) pursuant to Section 355(e) of the Internal Revenue Code if there are one or more acquisitions (including issuances) of the stock of ITT, Exelis or Xylem, representing 50% or more, measured by vote or value, of the then-outstanding stock of any such corporation, and the acquisition or acquisitions are deemed to be part of a plan or series of related transactions that include the Distribution. Any acquisition of ITT, Exelis or Xylem common stock within two years before or after the Distribution (with exceptions, including public trading by less-than-5% shareholders and certain compensatory stock issuances) generally will be presumed to be part of such a plan unless that presumption is rebutted. The tax liability resulting from the application of Section 355(e) would be substantial. In addition, under U.S. Treasury regulations, each member of the ITT consolidated group at the time of the Distribution would be severally liable for the resulting U.S. Federal income tax liability.

Each of Exelis and Xylem has agreed not to enter into any transaction that could cause any portion of the Distribution to be taxable to ITT, including under Section 355(e). Pursuant to the Tax Matters Agreement entered into in connection with the Distribution, ITT, Exelis and Xylem have agreed to indemnify each other for any tax liabilities resulting from such transactions, and ITT, Exelis and Xylem have agreed to indemnify each other for any tax liabilities resulting from such transactions entered into by them. These obligations may discourage, delay or prevent a change of control of our Company.

 

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Anti-takeover provisions in our organizational documents and Indiana law could delay or prevent a change in control.

Certain provisions of our articles of incorporation and by-laws may delay or prevent a merger or acquisition that a shareholder may consider favorable. For example, the articles of incorporation authorize our Board of Directors to issue one or more series of preferred stock. In addition, the articles of incorporation and by-laws, among other things, do not permit action by written consent of the shareholders. These provisions may also discourage acquisition proposals or delay or prevent a change in control, which could harm our stock price. Indiana law also imposes some restrictions on mergers and other business combinations between any holder of 10% or more of our outstanding common stock and us as well as certain restrictions on the voting rights of “control shares” of an “issuing public corporation.”

 

ITEM  1B.    UNRESOLVED STAFF COMMENTS

None.

 

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ITEM  2.    PROPERTIES

We operate in 31 countries through 146 locations, of which 119 locations are leased. Our properties total 6.9 million square feet, of which 3.1 million square feet are leased. We consider the offices, plants, warehouses, and other properties that we own or lease to be in good condition and generally suitable for their intended purpose. We believe these properties are adequate for the Company’s needs and will generally allow for expansion of capacity if needed. The following table details our quantitatively or qualitatively significant locations by segment.

 

LOCATION    SQ FT
(IN ‘000S)
     OWNED / LEASED

Industrial Process

     

Seneca Falls, New York

     828       Owned

Obernkirchen, Germany

     176       Owned

Cheongwon, South Korea

     124       Leased

Amory, Mississippi

     110       Leased

Lancaster, Pennsylvania

     89       Owned

City of Industry, California

     74       Owned

Southaven, Mississippi

     69       Leased

Salto, Brazil

     68       Owned

Baroda, India

     60       Leased

Tizayuca, Mexico

     46       Owned

Axminster, United Kingdom

     45       Leased

Cheongwon, South Korea

     39       Owned

Shanghai, China

     35       Leased

Wangara, Australia

     28       Leased

Dammam, Saudi Arabia

     27       Leased

Motion Technologies

     

Oud Beijerland, Netherlands

     379       Owned

Barge, Italy

     279       Owned

Ostrava, Czech Republic

     261       Leased

Wuxi, China

     206       Leased

Vauda Canavese, Italy

     97       Owned

Termoli, Italy

     94       Owned

Hebron, Kentucky

     42       Leased

Kelsterbach, Germany

     28       Leased

Interconnect Solutions

     

Santa Ana, California

     364       Owned

Nogales, Mexico

     358       Owned

Shenzhen, China

     294       Leased

Weinstadt, Germany

     231       Owned

Basingstoke, England

     179       Leased

Lainate, Italy

     52       Leased

Santa Rosa, CA

     35       Leased

Control Technologies

     

Valencia, California

     200       Leased

Orchard Park, New York

     92       Owned

Wuxi, China

     39       Leased

Westminster, South Carolina

     66       Owned

Billerica, Massachusetts

     24       Owned

Corporate Headquarters

     

White Plains, New York

     54       Leased

 

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ITEM  3.    LEGAL PROCEEDINGS

From time to time, we are involved in legal proceedings that are incidental to the operation of our businesses. Some of these proceedings allege damages relating to personal injury claims, environmental exposures, intellectual property matters, commercial or contractual disputes, sometimes related to acquisitions or divestitures, and employment and employee benefit matters. We will continue to defend vigorously against all claims. See information provided below and Note 19, Commitments and Contingencies, to the Consolidated Financial Statements for further information.

Asbestos Proceedings

ITT, including its subsidiary Goulds Pumps, Inc., has been joined as a defendant with numerous other companies in product liability lawsuits alleging personal injury due to asbestos exposure. These claims allege that certain of our products sold prior to 1985 contained a part manufactured by a third party (e.g., a gasket) which contained asbestos. To the extent these third-party parts may have contained asbestos, it was encapsulated in the gasket (or other) material and was non-friable. Frequently, the plaintiffs are unable to identify any ITT or Goulds Pump product as a source of asbestos exposure. In addition, a large percentage of claims pending against the Company have been placed on inactive dockets because the plaintiff cannot demonstrate a significant compensable loss. Our experience to date is that a majority of resolved claims have been dismissed without payment by the Company.

We record a liability for pending asbestos claims and asbestos claims estimated to be filed over the next 10 years. While it is probable that we will incur additional costs for future claims to be filed against the Company, a liability for potential future claims beyond the next 10 years is not reasonably estimable due to a number of factors. As of December 31, 2012, we have recorded an undiscounted asbestos-related liability for pending claims and unasserted claims estimated to be filed over the next 10 years of $1,347.4, including expected legal fees, and an associated asset of $607.9 which represents estimated recoveries from insurers, resulting in a net asbestos exposure of $739.5.

 

ITEM  4.    MINE SAFETY DISCLOSURES

Not applicable.

 

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EXECUTIVE OFFICERS OF THE REGISTRANT

The following information is provided regarding the executive officers of ITT. Each of the executive officers was elected to his or her position by the Company’s Board of Directors.

 

NAME    AGE AT
2/1/13
   CURRENT TITLE    OTHER BUSINESS EXPERIENCE DURING
PAST 5 YEARS

Denise L. Ramos

   56    Chief Executive Officer and President (2011)    Senior Vice President and Chief Financial Officer, (2007)

Aris C. Chicles

   51    Executive Vice President (2011)    Senior Vice President, Director of Strategy and Corporate Development (2008);

Burt M. Fealing

   43    Senior Vice President, General Counsel and Secretary (2011)    Vice President and Corporate Secretary (2010); Vice President, Corporate Secretary and Chief Securities Counsel, SUPERVALU INC. (2007)

Janice M. Klettner

   52    Vice President, Chief Accounting Officer and Assistant Secretary (2008)   

Munish Nanda

   48    Senior Vice President and President, Control Technologies (2011)    President, Control Technologies (2011); Vice President and Director, Integrated Supply Chain (2008)

Robert J. Pagano, Jr.

   50    Senior Vice President and President, Industrial Process (2011)    President, Industrial Process (2009); Vice President Finance (2006)

Luca Savi

   46    Senior Vice President and President, Motion Technologies (2011)    Chief Operating Officer, World, Comau Inc. (2009); President and Chief Executive Officer, Comau USA (2007)

Thomas M. Scalera

   41    Senior Vice President and Chief Financial Officer (2011)    Vice President of Corporate Finance (2010); Director, Investor Relations (2008)

Neil W. Yeargin

   47    Senior Vice President and President, Interconnect Solutions (2013)    Senior Vice President, Global Commercial / Invensys Controls (2011); Vice President & General Manager, Americas Commercial & Aftermarket / Invensys Controls (2008)

Note: Date in parentheses indicates the year in which the position was assumed.

 

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PART II

 

ITEM  5.    MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

COMMON STOCK – MARKET PRICES AND DIVIDENDS

The table below reflects the range of market prices of our common stock as reported in the consolidated transaction reporting system of the New York Stock Exchange (NYSE), the principal market in which this security is traded (under the trading symbol “ITT”). On October 31, 2011, ITT completed the Distribution and executed a one-for-two reverse stock split (1:2 Reverse Stock Split) of ITT common stock after the market close. Market prices in the table below have been adjusted for the reverse stock split; however, the historical prices prior to the Distribution have not been adjusted for the impact of the Distribution.

 

     2012      2011  
      High      Low      High      Low  

Three Months Ended:

           

March 31

   $ 25.59       $ 19.52       $ 128.00       $ 103.60   

June 30

     23.33         16.88         122.08         108.80   

September 30

     21.85         17.22         120.26         80.50   

December 31

     23.46         19.79         94.98         16.67 (1) 

 

(1) On October 31, 2011, we completed the Distribution of Exelis and Xylem. On October 31, 2011, the closing price of our common stock on the NYSE was $91.20. On November 1, 2011, the first day of “regular-way” trading following the Distribution, the opening price of our common stock on the NYSE was $17.02 and the opening prices for Exelis common stock and Xylem common stock were $10.33 and $25.60, respectively. The opening prices for Exelis and Xylem do not reflect an adjustment for the ITT common stock one-for-two reverse stock split.

After giving effect to the 1:2 Reverse Stock Split, we declared dividends of $0.50 per share of common stock in each of the first three quarters of 2011. We declared a dividend of $0.091 per share of common stock in the fourth quarter of 2011 and each quarter of 2012. In the first quarter of 2013, we declared a dividend of $0.10 per share for shareholders of record on March 15, 2013. 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.

There were approximately 11,700 holders of record of our common stock on February 11, 2013.

EQUITY COMPENSATION PLAN INFORMATION

The information called for by Item 5(a) is incorporated herein by reference to the portions of the definitive proxy statement referred to in Item 10 of this Annual Report on Form 10-K set forth under the caption “Equity Compensation Plan Information.”

ISSUER PURCHASES OF EQUITY SECURITIES

The following table summarizes our purchases of our common stock for the quarter ended December 31, 2012.

 

Period

(In Millions)

   Total
Number
of Shares
Purchased
     Average
Price Paid
Per Share  (1)
     Total
Number of
Shares
Purchased
As Part of
Publicly
Announced
Plans or
Programs (2)
     Maximum
Dollar Value
of Shares
That May
Yet Be
Purchased
Under the
Plans or
Programs (2)
 

10/1/12 – 10/31/12

                           $ 495.7   

11/1/12 – 11/30/12

     1.8       $ 21.80         1.8       $ 455.8   

12/1/12 – 12/31/12

                           $ 455.8   

 

(1) Average price paid per share is calculated on a settlement basis and includes commissions.
(2) On October 27, 2006, a three-year $1 billion share repurchase program (2006 Share Repurchase Program) was approved by our Board of Directors. On December 16, 2008, the provisions of the 2006 Share Repurchase Program were modified by our Board of Directors to replace the original three-year term with an indefinite term. As of December 31, 2012, we had repurchased 12.2 shares for $544.2, including commissions, under the 2006 Share Repurchase Program. The program is consistent with our capital allocation process, which has centered on those investments necessary to grow our businesses organically and through acquisitions, while also providing cash returns to shareholders. Our strategy for cash flow utilization is to invest in our business, execute strategic acquisitions, pay dividends and repurchase common stock.

 

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PERFORMANCE GRAPH

CUMULATIVE TOTAL RETURN

Based upon an initial investment on December 31, 2007 of $100 with dividends reinvested

 

LOGO

 

     12/31/07   12/31/08   12/31/09   12/31/10   12/31/11   12/31/12

  ITT Corporation(a)

  $100.00   $70.55   $77.81   $83.23   $94.89   $117.16

  S&P 500

  $100.00   $63.00   $79.67   $91.67   $93.60   $108.58

  S&P 500 Industrials

  $100.00   $60.08   $72.65   $92.08   $91.54   $105.65

  S&P 400 MidCap

  $100.00   $63.77   $87.61   $110.95   $109.03   $128.52

  S&P 400 MidCap Industrial Machinery

  $100.00   $63.38   $83.42   $109.30   $108.03   $131.83

 

(a) On November 1, 2011, following the Distribution, ITT was removed from the S&P 500 Index and S&P 500 Industrial Index and was added to the S&P 400 MidCap Index and S&P 400 MidCap Industrial Machinery Index.

This graph is not, and is not intended to be, indicative of future performance of our common stock. This graph is not be deemed “filed” with the SEC or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended (the Exchange Act), and should not be deemed to be incorporated by reference into any of our prior or subsequent filings under the Securities Act of 1933, as amended, or the Exchange Act.

 

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Table of Contents
ITEM  6.    SELECTED FINANCIAL DATA

The following table presents selected historical financial data derived from the Consolidated Financial Statements for each of the five years presented. The selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and the Notes thereto.

 

(In Millions, except per share amounts)    2012     2011     2010     2009     2008  

Results of Operations

          

Revenue

   $ 2,227.8      $ 2,085.6      $ 1,890.7      $ 1,757.3      $ 2,109.2   

Gross profit

     680.2        645.0        603.9        560.0        696.2   

Gross margin

     30.5 %      30.9     31.9     31.9     33.0

Asbestos costs(a)

     50.9        100.4        384.8        237.5        14.3   

Transformation costs(b)

     13.0        396.1                        

Other operating costs

     464.8        393.4        399.7        439.9        473.3   

Operating (loss) income

     151.5        (244.9     (180.6     (117.4     208.6   

Operating margin

     6.8 %      (11.7 )%      (9.6 )%      (6.7 )%      9.9

Income tax expense (benefit) (c)

     39.6        260.6        (142.2     (95.9     37.7   

(Loss) income from continuing operations

     109.5        (576.5     (130.4     (109.1     30.3   

Earnings from discontinued operations, net of tax(d)

     15.9        447.0        934.7        737.9        707.6   

Net (loss) income

   $ 125.4      $ (129.5   $ 804.3      $ 628.8      $ 737.9   

Income (loss) from continuing operations per basic share

   $ 1.18      $ (6.22   $ (1.42   $ (1.20   $ 0.33   

Income from discontinued operations per basic share

   $ 0.17      $ 4.82      $ 10.17      $ 8.09      $ 7.78   

Net income (loss) per basic share

   $ 1.35      $ (1.40   $ 8.75      $ 6.89      $ 8.11   

Income (loss) from continuing operations per diluted share

   $ 1.16      $ (6.22   $ (1.42   $ (1.20   $ 0.33   

Income from discontinued operations per diluted share

   $ 0.17      $ 4.82      $ 10.17      $ 8.09      $ 7.69   

Net income (loss) per diluted share

   $ 1.33      $ (1.40   $ 8.75      $ 6.89      $ 8.02   

Dividends declared

   $ 0.364      $ 1.591      $ 2.00      $ 1.70      $ 1.40   

Financial Position

          

Cash and cash equivalents(e)

   $ 544.5      $ 689.8      $ 206.0      $ 186.6      $ 201.8   

Total assets(f)

     3,386.1        3,671.5        12,616.4        11,195.5        10,613.6   

Total short and long-term debt and capital leases (g)

     26.9        6.5        1,359.6        1,493.8        2,140.8   

 

(a) Prior to 2009, we recorded an asbestos liability and related assets associated with pending claims only. In 2009, we also began recognizing asbestos liabilities for claims estimated to the filed over the next 10 years, net of estimated recoveries. It is probable that we will incur additional liabilities for asbestos claims filed beyond the next 10 years and such liabilities may be material. See Note 19, “Commitments and Contingencies,” to the Consolidated Financial Statements for further information.

 

(b) In 2011, $396.1 of transformation costs were incurred to complete the Distribution of Exelis and Xylem (transformation costs), including debt extinguishment costs of $296.8. See Note 5, “Company Transformation,” to the Consolidated Financial Statements for further information.

 

(c) The 2011 tax expense of $260.6 includes a $340.7 valuation allowance for U.S. federal and state deferred tax assets as it became more likely than not that these deferred tax assets would not be realized, a $69.3 tax expense for undistributed foreign earnings that were no longer considered indefinitely reinvested, and a $30.9 tax benefit from an increase in state deferred tax assets which were re-measured based on enacted tax rates using different state apportionment factors as a result of the Distribution.

 

(d) Discontinued operations include the results of the Shape Cutting Businesses (disposed of in 2012), Exelis (disposed of in 2011), and Xylem (disposed of in 2011).

 

(e) The decline in cash and cash equivalents from 2011 to 2012 was primarily due to the acquisition of Bornemann for $193.2 net of cash acquired. The increase in cash and cash equivalents from 2010 to 2011 was primarily due to receipt of a net cash transfer (the Contribution) of $683.0 and $988.0 from Exelis and Xylem, respectively, in connection with the Distribution, offset in part by the extinguishment of $1,251.0 of long-term debt in October 2011. For all periods, cash and cash equivalents excludes cash and cash equivalents held by discontinued operations at the balance sheet date. See Management’s Discussion & Analysis, Liquidity section for further information.

 

(f) The decline in total assets from 2011 to 2012 is primarily due to a reduction in asbestos-related assets and liabilities resulting from a Settlement Agreement executed during the third quarter of 2012. See Note 19, Commitments and Contingencies, to the Consolidated Financial Statements for further information. The decline in total assets from 2010 to 2011 is primarily attributable to the Distribution of Exelis and Xylem on October 31, 2011, which had total combined assets of $9,322.6 as of December 31, 2010. The assets of Exelis and Xylem, although presented as discontinued operations, are included in total assets for 2007 through 2010.

 

(g) The decline in total debt from 2010 to 2011 is primarily due to the extinguishment of $1,251.0 of long-term debt in October 2011. The year-over-year declines in total debt in 2008 and 2009 were due to repayments of outstanding commercial paper balances.

 

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ITEM  7.    MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

OVERVIEW

During 2012, we substantially completed our transformation efforts following the Distribution and made significant progress toward repositioning the post-transformation organization. The Company 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 (ICS), and Control Technologies. Our segments generally operate within niche positions in large, attractive markets where specialized engineered solutions are required to support large industrial and transportation customer needs.

 

  ¡  

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 an aftermarket service provider.

 

  ¡  

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 aerospace, industrial, defense and oil & gas markets.

 

  ¡  

Control Technologies manufactures specialized equipment, including actuation, valves, switches, vibration isolation, custom-energy absorption, and regulators for the aerospace, defense and industrial markets.

EXECUTIVE SUMMARY

As this was the first full year of the “new” ITT, significant time and attention was devoted to focusing our strategy to enable a successful future. As we focused on our product portfolio and potential acquisition pipeline, we completed the acquisition of Bornemann to expand our technological capabilities and footprint in the oil & gas market and sold our Shape Cutting Businesses. We invested in technology and innovation, recently opening a new Motion Technologies R&D Center of Excellence and production center in Wuxi, China. We have added capacity through an expansion at our Industrial Process facility in Brazil and have begun constructing a new engineered pump facility in South Korea and are expanding our engineered pump facility in Seneca Falls, New York. In addition, we strengthened our balance sheet by executing agreements that reduced the risk associated with our net asbestos liabilities. We returned $147.6 to shareholders in 2012 through a combination of share repurchases and dividends. We invested $14.0 in proactive restructuring initiatives and contributed $58.3 to our U.S. pension plans.

We have worked to further our Premier Customer Experience in a variety of ways, including the implementation of advanced order configuration capabilities across three of our four segments that shorten lead times and enable us to be responsive to customer needs and improve on-time delivery to the customer. During 2012, Goulds Pumps was acknowledged as the #1 Readers Choice in Chemical Centrifugal Pumps by Chemical Processing magazine, a testament to our customer focus.

From a results standpoint, 2012 was a mixed year as we experienced positive results from our two biggest segments, Industrial Process and Motion Technologies (on an organic basis), but confronted challenging conditions and declining market share in the connectors market leading to consolidated revenue and gross profit growth of 6.8% and 5.5%, respectively. Revenue growth stemmed from our expanding presence in emerging growth markets which grew 8.5%, strong U.S. growth and an increasing capture of aftermarket opportunities. Operating income was $151.5 for 2012, with a corresponding margin of 6.8%, reflecting the impact of a $30.9 decline in ICS operating income and stable results at our other segments. Year-over-year operating income increased $396.4, from the 2011 operating loss of $244.9, primarily due

 

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to lower transformation costs of $383.1 and lower asbestos-related costs of $49.5. Net income from continuing operations was $109.5 during 2012, resulting in earnings of $1.16 per diluted share, compared to a prior year net loss of $576.5 ($6.22 loss per diluted share).

Also during 2012, improved segment operating performance and reductions in asbestos, transformation and tax costs combined to provide a return to profitability. In addition, we won numerous positions on key strategic contracts and orders, including:

 

   

A $20.0 multi-year aerospace isolation platform win,

 

   

An $11.0 Chemical API agreement in Saudi Arabia

 

   

Our largest valve order to date, a $9.8 chemical valve contract with a customer in India,

 

   

A $6.0 multi-year mining service contract in Chile,

 

   

Approximately $10.0 in orders from our process barrel pump introduced during 2012.

 

   

Key global contracts with major North American, German, Swedish and Japanese auto manufacturers,

 

   

Two ten-year commercial-aviation agreements totaling $7.5, and

 

   

High-speed rail connectors win of $2.0.

Adjusted income from continuing operations was $158.0 for 2012, reflecting an increase of $40.1, or 34.0%, over the prior year. Our adjusted income from continuing operations translated into $1.68 per diluted share, a $0.48 or 40.0% increase over the prior year. See the “Key Performance Indicators and Non-GAAP Measures,” for reconciliation of non-GAAP measures.

Our strategic focus in 2013 is geared towards margin improvement through various operational initiatives, while leveraging our strengths to further expand our global customer base. We expect to continue to invest in technology and R&D to drive organic growth and continue to advance our acquisition pipeline. We plan to implement a series of strategic objectives to grow the top-line of ICS, while improving the overall cost structure of the segment. We intend to continue on our strategic growth path by following our six key growth elements.

One of our key operational initiatives is a VBLSS initiative to achieve Lean transformations at each of our significant revenue-producing facilities in the next three to five years, with the goal of improving the overall depth and breadth across all elements of process efficiency. VBLSS encompasses Lean Enterprise as well as continuous process improvement in other critical areas such as customer service and order entry and fulfillment. Our intent is to drive ever increasing levels of quality, speed, and efficiency throughout the organization to help drive margin improvement.

Our Industrial Process segment is pursuing opportunities in the growing North American oil & gas markets and is looking for opportunities to expand their aftermarket business, while integrating Bornemann to fully leverage their technology and our distribution network. Our Motion Technologies segment continues to expand our share of the automotive market with our advanced braking technologies by further penetrating the Asia Pacific and North American regions. Control Technologies is focused on expanding their customer base, especially internationally, and to increase our direct customer contact to complement our extensive distributor network.

DISCUSSION OF FINANCIAL RESULTS

2012 VERSUS 2011

 

      2012     2011     Change  

Revenue

   $ 2,227.8      $ 2,085.6        6.8%   

Gross profit

     680.2        645.0        5.5%   

Gross margin

     30.5 %      30.9 %      (40)bp   

Operating expenses

     528.7        889.9        (40.6)%   

Operating expense to revenue ratio

     23.7 %      42.7 %      (1,900)bp   

Operating income (loss)

     151.5        (244.9     161.9%   

Operating margin

     6.8 %      (11.7 )%      1,850bp   

Interest and non-operating expenses, net

     2.4        71.0        (96.6)%   

Income tax expense

     39.6        260.6        (84.8)%   

Effective tax rate

     26.6 %      (82.5 )%      10,910bp   

Income (loss) from continuing operations

     109.5        (576.5     119.0%   

Earnings from discontinued operations, net of tax

     15.9        447.0        (96.4)%   

Net income (loss)

   $ 125.4      $ (129.5     196.8%   

 

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REVENUE

Revenue for the year ended December 31, 2012 increased $142.2 or 6.8%, reflecting growth in the global industrial pump market and share gains in the global automotive market, partially offset by revenue declines at ICS and Control Technologies. This increase was partially offset by unfavorable foreign currency fluctuations of $58.9, which primarily related to a weakening of the Euro relative to the U.S. Dollar that affected Motion Technologies.

The following table illustrates the year-over-year revenue results from each of our segments for the years ended December 31, 2012 and 2011. See below for further discussion of year-over-year revenue activity at the segment level.

 

      2012     2011     Change    

Organic

Growth

 

Industrial Process

   $ 955.8      $ 766.7        24.7     20.2%   

Motion Technologies

     626.2        634.4        (1.3 )%      6.0%   

Interconnect Solutions

     375.7        417.8        (10.1 )%      (7.9)%   

Control Technologies

     277.1        285.5        (2.9 )%      (2.9)%   

Eliminations

     (7.0     (18.8     (62.8 )%        

Total

   $ 2,227.8      $ 2,085.6        6.8     7.9%   

The following table illustrates revenue generated with a specific country or region for the years ended December 31, 2012 and 2011, and the corresponding percentage change and on a constant currency basis.

 

      2012      2011      Change    

Organic

Growth

 

United States

   $ 869.3       $ 779.6         11.5     11.8%   

Germany

     200.5         229.8         (12.8 )%      (5.3)%   

France

     118.2         126.9         (6.9 )%      0.4%   

Other developed markets

     401.1         360.9         11.1     6.8%   

Total developed markets

     1,589.1         1,497.2         6.1     7.1%   

South and Central America(a)

     198.4         178.1         11.4     14.6%   

Eastern Europe and Russia

     103.1         105.5         (2.3 )%      4.4%   

Middle East and Africa

     114.3         98.2         16.4     16.5%   

China and Hong Kong

     113.6         115.0         (1.2 )%      (2.2)%   

Other emerging growth markets

     109.3         91.6         19.3     18.3%   

Total emerging growth markets

     638.7         588.4         8.5     10.3%   

Total Revenue

   $ 2,227.8       $ 2,085.6         6.8     7.9%   
(a) Includes Mexico

Industrial Process

The Industrial Process segment reported record sales during 2012 with revenue reaching $955.8, an increase of $189.1 or 24.7% from 2011. This growth was partially derived from our fourth quarter 2011 acquisition of Blakers and our fourth quarter 2012 acquisition of Bornemann, which combined to provide $39.4 of additional revenue during 2012. Organic revenue growth of $155.1 or 20.2% was fueled by fulfilling a record backlog to begin 2012 in the engineered project business and reflected volume growth across most geographic regions and end-markets. Geographically, North America was our strongest region, providing revenue growth of 25.8% with significant strength coming from North American oil & gas and chemical production, as well as improved plant utilization and new product development, primarily our expanded range of single and two-stage pumps. In addition, our past investments in the oil & gas and mining markets continued to drive positive results during 2012, which supported revenue growth of approximately 28.0% during 2012 and helped to drive our second consecutive year of record shipments. Pricing pressure stemming from the increasingly competitive project business environment resulted in a 0.7% year-over-year decline in revenue, which partially offset the growth from additional sales volume.

Orders increased by 4.2% to $954.9 for 2012, or 1.0% on an organic basis, reflecting strong activity in the first half of the year, which gradually slowed during the second half of the year. The second half slowdown in orders was primarily the result of economic uncertainty, primarily in the U.S., during the latter half of 2012, which led to a declining trend in baseline equipment order activity and slowdowns and delays of project business. These factors impacted our fourth quarter 2012 orders and resulted in a 4.4% decline in organic orders as compared to the fourth quarter of 2011. Industrial Process ended the year with a book-to-bill ratio of 1.0 compared to the prior year measure of 1.2. We forecast that 2013 revenue and orders will be driven by continued strength from North American oil & gas production rates; however, growth may be weighted more towards the second half of the year.

 

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Backlog as of December 31, 2012 was $578.9, representing an 18.3% increase from a record prior year, driven by $94.4 of backlog due to the Bornemann acquisition.

Motion Technologies

The Motion Technologies segment had another strong year of sales growth during 2012. Although revenue declined $8.2 or 1.3% from 2011, this decline was attributable to unfavorable foreign currency impacts of $46.5 or 7.3% primarily related to a weakening of the Euro relative to the U.S. Dollar. On an organic basis, 2012 revenue increased 6.0% despite the extremely difficult European automotive industry conditions due to the Eurozone financial crisis. According to the European Automobile Manufacturers’ Association (ACEA), car sales in Europe were 12.1 units in 2012, the lowest level since 1995, a year-over-year decline of 8.2%, as banks were reluctant to finance new car purchases for customers. The 2012 growth was primarily the result of a growing market share from our expanding presence in emerging growth markets and platform wins in the U.S.; however, we also maintained positive growth within Europe of 0.7%, excluding the impact of foreign currency translation, due to our increasing number of positions on new and existing auto platforms and the consumer demand for these platform models.

A strategic area of focus for Motion Technologies is growth within emerging growth market economies, primarily within the Asia Pacific region with an emphasis on China. Our brake pads are installed on many different Shanghai General Motors and Daimler automobile models and KONI rail dampers are utilized on high speed passenger trains. During 2012, aggregate sales to emerging growth markets on a constant currency basis grew by 36.5%, over the prior year, with 78.3% growth from China. To facilitate further growth within the Asia Pacific region, we completed construction of a R&D Center of Excellence and production center in Wuxi, China at the end of 2012 and production is expected to begin in early 2013.

In 2012, we have continued to grow in North America mainly through share gains at Ford that reflect our robust and innovative technical solutions. In 2013 we intend to continue on that path and are preparing to penetrate other North American automakers.

Orders decreased during 2012 by 2.5% year-over-year to $626.3, including an unfavorable impact from foreign currency of 7.1% or $45.3. On an organic basis, orders increased by 4.6%, reflecting growth of 7.1% during the first half of 2012 which leveled out during the second half of 2012 to 1.8%. We believe that the recent declining order trend may continue into the early portions of 2013, as such we estimate a low-single digit decline in orders during the first quarter. Given the significant European automotive industry struggles, it is unclear how our orders and revenue will be impacted in 2013 will be impacted.

Interconnect Solutions

The Interconnect Solutions segment had a challenging year during 2012 as revenue declined by $42.1 or 10.1% from the prior year. This decline was primarily due to a loss of market share in the communications, aerospace and transportation markets and major inventory re-balancing by our primary U.S. distributor due to the significant decline in connector industry demand entering 2012. In addition, our 2012 revenues were negatively impacted by an overall weakness within the harsh environment connector industry. Within the communications market, 2012 revenue declined 22.3% due to a loss of market share by one of our key Smartphone customers. In the aerospace market, 2012 revenue declined 14.1% primarily due to weaker demand from commercial aerospace subcontractors. Within the transportation market revenue declined 22.9%, primarily due to weak economic conditions, resulting in many rail project delays in Europe and China. However, positive results were experienced in the oil & gas market with project wins in the Middle East and North America resulting in revenue growth of 12.0% over the prior year. We also saw revenue growth in Japan and Korea of 13.0% in the aggregate due, in part, to benefits from Japan’s recovery from the 2011 tsunami and floods and increased sales of medical-related connector applications.

We have implemented various recovery initiatives to improve our operating results in 2013. Our revenue initiatives are centered on enhancing our focus on the needs of customers and by providing superior service, solutions and lead times. We will be pursuing additional content placement for our new products and will focus heavily in the aerospace, rail and oil & gas markets. As a result of the revenue initiatives being implemented in 2013, we are forecasting revenue growth will be weighted more in the second half of the year.

Control Technologies

The Control Technologies segment revenue for the year declined $8.4 or 2.9%, the prior year results included $16.1 of revenue related to a seat program on a Chinese rail infrastructure project that was completed at the end of 2011. Revenue from the remaining Control Technologies businesses grew 2.9% during 2012. Year-over-year growth in our commercial aviation-related product applications of $15.6 or 12.3% was driven by the expansion of our Enivate SkyMotion power seat actuation system onto new aerospace platforms and Boeing 787 production ramp-up, which offset a $2.5 decline in Opto actuator sales due to a retrofit program that is largely completed. Revenue from defense-related products declined $7.3 or 14.5% during 2012 primarily due to the reduction of funding for certain U.S. Department of Defense programs. CT Industrial revenue was relatively flat year-over-year as growth in energy absorption equipment and natural gas valves was offset by declines in Europe.

 

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During 2012, we were successful in obtaining new direct strategic relationships to complement our distributor network relationships, a key component of the Control Technologies growth strategy. We expect 2013 strength in commercial aviation and CT Industrial will be offset by further declines in Opto actuator and defense market revenue.

GROSS PROFIT

Gross profit for 2012 was $680.2, representing a $35.2 increase, or 5.5% from 2011. Benefits from increased sales volume from Industrial Process and Motion Technologies and net savings from productivity, sourcing and VBLSS initiatives were partially offset by lower volume and an unfavorable change in sales mix at Interconnect Solutions. Gross profit was also impacted by unfavorable product pricing attributable to the competitive project business environment and increased levels of project business at Industrial Process during 2012. In addition, foreign currency unfavorably impacted our 2012 gross margin by $15.1, primarily due to the weakening of the Euro relative to the U.S. Dollar. The year-over-year decline in gross margin of 40 basis points primarily reflects the volume decline at Interconnect Solutions and unfavorable changes in sales mix and pricing. The following table illustrates the gross profit and gross margin results of our segments for 2012 and 2011.

 

      2012     2011     Change  

Industrial Process

   $ 294.8      $ 244.3        20.7%   

Motion Technologies

     160.4        156.9        2.2%   

Interconnect Solutions

     111.8        133.6        (16.3)%   

Control Technologies

     111.8        109.5        2.1%   

Corporate and Other

     1.4        0.7        100.0%   

Total gross profit

   $ 680.2      $ 645.0        5.5%   

Gross margin:

      

Industrial Process

     30.8     31.9     (110)bp   

Motion Technologies

     25.6     24.7     90bp   

Interconnect Solutions

     29.8     32.0     (220)bp   

Control Technologies

     40.3     38.4     190bp   

Consolidated

     30.5     30.9     (40)bp   

OPERATING EXPENSES

Operating expenses for 2012 decreased $361.2 or 40.6% from the prior year, which was primarily driven by lower Corporate & Other expenses of $417.9. The decline in Corporate & Other expenses primarily relate to lower year-over-year transformation costs and asbestos-related costs, which were partially offset by additional company-wide general and administrative (G&A) expenses of $55.4 for 2012. Further discussion of the changes in operating expenses is provided below. The following table provides further information by expense type, as well as a breakdown of operating expense by segment.

 

      2012      2011      Change  

Sales and marketing expenses

   $ 180.4       $ 163.6         10.3%   

General and administrative expenses

     221.7         166.3         33.3%   

Research and development expenses

     62.7         63.5         (1.3)%   

Asbestos-related costs, net

     50.9         100.4         (49.3)%   

Transformation costs

     13.0         396.1         (96.7)%   

Total operating expenses

   $ 528.7       $ 889.9         (40.6)%   

By Segment:

        

Industrial Process

   $ 195.5       $ 152.8         27.9%   

Motion Technologies

     77.3         71.6         8.0%   

Interconnect Solutions

     104.9         95.8         9.5%   

Control Technologies

     53.5         54.3         (1.5)%   

Corporate & Other

     97.5         515.4         (81.1)%   

Sales and marketing expenses for 2012 increased $16.8 or 10.3% year-over-year, primarily due to increased compensation and other selling expenses associated with the increase in revenue from Industrial Process, as well as additional costs from our Blakers and Bornemann acquisitions. As a percent of revenue, sales and marketing expenses were 8.1% in 2012 compared to 7.8% in 2011.

G&A expenses for 2012 increased $55.4 or 33.3% year-over-year, due to various factors including increased restructuring expenses, an unfavorable change in foreign currency, costs incurred to reposition the post-transformation organization (repositioning costs), lost leverage resulting from the Distribution related to higher standalone facility and infrastructure costs, additional costs related to our fourth quarter 2011 acquisition of Blakers, an increase in strategic investments and an increase in acquisition-related costs. The increase in G&A expenses was partially offset by the recognition of an asset for potential recoveries from environmental insurance policies.

 

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Over the next twelve months, we expect to implement restructuring actions across our businesses to proactively address on-going macro uncertainties with a focus on reducing European costs and improving global efficiency.

During 2012, repositioning costs of $8.7 were recognized within G&A expenses. The Company expects to incur additional repositioning costs of approximately $20.0 to $30.0, during 2013 and approximately $5.0 to $10.0, thereafter. Cash outflows for these repositioning actions are expected to be approximately $30.0 to $40.0 during 2013 and approximately $5.0 to $10.0 thereafter. The remaining repositioning costs primarily consist of advisory fees and costs to exit transition services agreements, including IT infrastructure modifications, resulting from the Distribution.

R&D costs were relatively flat year over year, as we continued to invest in new product developments in targeted growth markets at each segment. As a percentage of revenue, R&D costs declined to 2.8% in 2012 from 3.0% in 2011, primarily as a function of our year-over-year revenue growth. We anticipate our investments in future R&D activities will moderately increase from current spending levels to ensure a continuing flow of innovative, high quality products and maintain our competitive position in the markets we serve.

Asbestos-Related Costs, Net

ITT, including its subsidiary Goulds Pumps, Inc., has been joined as a defendant with numerous other companies in product liability lawsuits alleging personal injury due to asbestos exposure. As of December 31, 2012 and 2011, there were 67 thousand and 66 thousand pending active claims filed against ITT in various state and federal courts alleging injury as a result of exposure to asbestos. We record an undiscounted asbestos liability, including legal fees, for costs that the Company is estimated to incur to resolve all pending claims, as well as unasserted claims estimated to be filed over the next 10 years. We also record a corresponding asbestos-related asset that represents our best estimate of probable recoveries from insurers and other responsible parties for the estimated asbestos liabilities.

The Company records a net asbestos charge each quarter to maintain a rolling 10 year forecast period (referred to as the Asbestos Provision). In addition, in the third quarter of each year, we conduct a study to review and update the underlying assumptions used in our asbestos liability and related asset estimates (referred to as the Asbestos Remeasurement). During the annual study, the underlying assumptions are updated based on our actual experience since our last annual study, a reassessment of the appropriate reference period of years of experience used in determining each assumption and our expectations regarding future conditions, including inflation. For the years ended December 31, 2012 and 2011, the income statement effects from asbestos charges consisted of the following:

 

      2012     2011  

Asbestos provision

   $ 53.8      $ 59.5   

Asbestos remeasurement, net

     2.9        40.9   

Settlement Agreement

     (5.8       

Net asbestos charge

   $ 50.9      $ 100.4   

For the full year 2012, asbestos-related costs, net decreased to $50.9 from $100.4. This decrease was primarily related to the effect of our Asbestos Remeasurement in the third quarter. In the third quarter of 2012, we recognized net asbestos related costs of $2.9, reflecting a decrease of $38.0 as compared to the prior year to reflect the impact of our annual Asbestos Remeasurement. The decrease in the cost recognized as part of the Annual Remeasurement in 2012 is a result of several developments, including an expectation of lower defense costs as a percentage of indemnities paid over the projection period and a reduction in the assumed rate of increase in future average settlement values. These favorable factors were offset, in part, by an increasing number of cases expected to be adjudicated, increased activity in several higher-cost jurisdictions, an increase in average settlement values and an increase in lung cancer activity. The decrease in costs from the Asbestos Remeasurement also reflects changes in our asbestos-related assets, primarily as a result of the decrease in the estimated liability and, to a lesser extent, reductions in expected recovery rates from certain insurers, offset in part by benefits from the Settlement Agreement (described in the paragraph below).

The Settlement Agreement, executed in September 2012, accelerates the cost sharing provisions of a previous agreement with the entity (the counterparty) that had previously acquired the disposed business. Under the terms of the Settlement Agreement, the counterparty assumed full responsibility for pending and future asbestos-related claims filed against the disposed business. As part of the Settlement Agreement, ITT also agreed to relinquish certain insurance assets of the disposed business. As a result of the Settlement Agreement, ITT’s asbestos-related liabilities were reduced by $245.2 while the asbestos-related assets were reduced by $233.8. In addition, under the Settlement Agreement, ITT received a $10.0 cash payment from the counterparty for past and future costs that would otherwise have been paid by the surrendered insurance. Income from continuing operations reflects a benefit of $5.8 from the Settlement Agreement, while income from discontinued operations reflects a benefit of $5.6 from the Settlement Agreement.

See Note 19, “Commitments and Contingencies” to the Consolidated Condensed Financial Statements for further information on our asbestos-related liability and assets.

 

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Transformation Costs

We recognized transformation costs of $13.0 during 2012, a decline of $383.1 from 2011 in connection with activities taken to create the revised organizational structure and to complete the Distribution. Transformation costs incurred during 2012 primarily relate to advisory services performed during the first half of the year and facility-related costs to separate locations previously shared with Xylem businesses. Transformation costs incurred during 2011 included a $296.8 loss associated with extinguishing substantially all outstanding debt in connection with the Distribution, a $55.0 impairment charge related to a decision to discontinue development of an information technology consolidation initiative and $36.8 of employee retention and other compensation costs. Employee retention and other compensation costs incurred during 2011 include $16.8 of compensation costs recognized in connection with the retirement of Steven R. Loranger, our former Chairman, President and Chief Executive Officer in October 2011.

We do not expect to incur significant costs or have significant cash outflows associated with transformation activities during 2013 or thereafter.

OPERATING INCOME (LOSS)

Operating income for 2012 was $151.5, as compared to an operating loss of $244.9 for 2011. The increase in operating income and operating margin is primarily due to lower asbestos-related costs and transformation costs, offset in part by lower operating income at ICS and higher corporate costs. The following table illustrates the 2012 and 2011 operating income and operating margin by segments and at the consolidated level.

 

      2012     2011     Change  

Industrial Process

   $ 99.3      $ 91.5        8.5%   

Motion Technologies

     83.1        85.3        (2.6)%   

Interconnect Solutions

     6.9        37.8        (81.7)%   

Control Technologies

     58.3        55.2        5.6%   

Segment operating income

     247.6        269.8        (8.2)%   

Asbestos-related costs, net

     (50.9     (100.4     (49.3)%   

Transformation costs

     (8.7     (391.2     (97.8)%   

Other corporate costs

     (36.5     (23.1     58.0%   

Total operating income (loss)

   $ 151.5      $ (244.9     161.9%   

Operating margin:

      

Industrial Process

     10.4     11.9     (150)bp   

Motion Technologies

     13.3     13.4     (10)bp   

Interconnect Solutions

     1.8     9.0     (720)bp   

Control Technologies

     21.0     19.3     170bp   

Segment operating margin

     11.1     12.8     (170)bp   

Consolidated operating margin

     6.8     (11.7 )%      1,850bp   

Industrial Process operating income for 2012 increased $7.8 or 8.5%, compared to the prior year, as the benefit from increased sales volume of $31.8 and net savings from productivity, sourcing and VBLSS initiatives of approximately $20.0 was partially offset by weaker project pricing and negative sales mix of $6.1. In addition, operating income was unfavorably impacted by higher year-over-year corporate expense allocations, lost leverage resulting from the Distribution related to higher standalone facility and infrastructure costs, higher warranty costs, an increase in strategic investment spending, unfavorable foreign currency effects, and acquisition impacts and costs related to Bornemann. Operating margin for 2012 declined 150 basis points to 10.4%, as a result of the drivers mentioned above.

Motion Technologies operating income for 2012 declined $2.2 or 2.6% compared to the prior year, resulting in a 10 basis point decline in operating margin. The decline in operating income was primarily due to foreign currency translation effects which reduced operating income by $8.7, and resulted in a 40 basis point decline in operating margin. Operating income benefited by $13.4 from higher sales volume; however, this benefit was reduced by competitive pricing actions and an unfavorable change in sales mix, resulting in a net improvement of 30 basis points in operating margin. Operating income was also unfavorably impacted by expenses incurred in connection with the development of a new R&D Center of Excellence and production facility in Wuxi, China. These items were partially offset by net savings from productivity, sourcing and VBLSS initiatives of approximately $18.0, which provided an approximate benefit of 290 basis points to operating margin.

Interconnect Solutions operating income for 2012 declined $30.9 or 81.7%, resulting in a 720 basis point decline in operating margin. The decline in operating income was due to lower sales volumes which negatively impacted operating income by $16.5 and operating margin by 360 basis points, an $11.7 unfavorable change in product mix primarily due to lower sales of our Universal Connector product line that impacted operating margin by 290 basis points and a prior year gain of $3.6 on the June 2011 sale of a product line that decreased operating margin by 90 basis points. In light of difficult market conditions, during the third and fourth quarters of 2012 restructuring actions were initiated to reduce European costs and improve global efficiency, resulting in a 2012 charge of $7.3, an increase of $4.4 over the prior year. Further restructuring actions are expected during 2013 to continue improve the cost structure of the ICS segment.

 

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Control Technologies operating income for 2012 increased $3.1 or 5.6%, resulting in a 170 basis point improvement. The increase was primarily due to productivity, sourcing, VBLSS and pricing initiatives that provided a 270 basis point improvement, which were partially offset by the impact of lower volume and unfavorable mix of $4.5 and additional recurring costs following the Distribution of $5.2 resulting in a combined decline in operating margin of 180 basis points. In 2013, operating income and margin are expected to be negatively impacted by anticipated sales volume declines from the Opto actuator retrofit program that is nearing completion.

Other corporate costs increased $13.4 or 58.0% during 2012, primarily due to the cancellation of a $10.0 bond guarantee during 2011 and $7.8 of repositioning costs incurred during 2012, partially offset by the recognition of a $10.8 asset related to environmental insurance policies during 2012.

INTEREST AND NON-OPERATING EXPENSES, NET

 

      2012      2011     Change  

Interest expense

   $ 0.1       $ 76.4        (99.9 )% 

Interest income

     2.8         4.1        (31.7 )% 

Miscellaneous expense (income), net

     5.1         (1.3     (492.3 )% 

Total interest and non-operating expenses, net

   $ 2.4       $ 71.0        (96.6 )% 

Interest expense decreased by $76.3 during 2012, due to the extinguishment of $1,251.0 of long-term debt during the fourth quarter of 2011, and a $3.9 reversal of accrued interest expense associated with unrecognized tax benefits primarily related to the completion of a U.S federal tax examination.

INCOME TAX EXPENSE

For the year ended December 31, 2012, the Company recognized an income tax expense of $39.6 representing an effective tax rate of 26.6%. Our effective tax rate in 2012 differs from the statutory tax rate primarily as a result of $29.3 of tax benefits from tax exempt interest which benefitted the effective tax rate by 19.7%, changes in the recognition of previously unrecognized tax benefits of $19.6 related to the completion of tax examinations which benefitted the effective tax rate by 13.2% and an increase in tax expense of $41.2 related to the recognition of an additional valuation allowance which increased the effective tax rate by 27.7%.

For the year ended December 31, 2011, the Company recorded income tax expense of $260.6, an effective tax rate of (82.5)%, The primary difference between the effective rate in 2012 and 2011 is the recognition of a valuation allowance against certain deferred tax assets in 2011 which decreased the effective tax rate benefit by 108.1%. Of the valuation allowance $340.7 was initially recorded in 2011 as a result of our cumulative three year loss position as of December 31, 2011. This was considered a significant source of negative evidence and limits our ability to consider other subjective evidence such as our projections for future growth. Despite income in 2012, the Company continues to be in a three year cumulative loss position. Since the Company is in a three-year cumulative loss position at the end of 2012, it was determined that the size and frequency of the losses from continuing operations in recent years and the uncertainty associated with projecting future taxable income supported the conclusion that a valuation allowance was required to reduce the deferred tax assets. Accordingly, we continue to record a valuation allowance against our deferred tax assets in the U.S., Luxembourg, Germany and China. As of December 31, 2012, a valuation allowance of $493.9 exists, representing an increase of $58.7 primarily due to an increase of $20.1 attributable to U.S. federal and state net operating losses and net temporary differences and an increase of $35.7 attributable to foreign net operating loss carryforwards primarily in Luxembourg and China and net temporary differences.

Our 2011 effective tax rate also reflected, as a result of the Distribution and its impacts on the Company’s expected liquidity, investment opportunities and other factors, a determination that certain earnings generated in Luxembourg, Japan, and South Korea were no longer considered to be indefinitely reinvested. As a result of the change in intent, the Company recorded $69.3 of deferred tax liability on those undistributed foreign earnings during 2011 which decreased the effective tax rate benefit by 21.8%. As of December 31, 2012, we continue to provide for taxes on these undistributed foreign earnings and have accrued an additional $2.1 deferred tax liability. The Company also recorded a $30.9 tax benefit in 2011 from an increase in state deferred tax assets which resulted in a 9.7% increase in the effective tax rate benefit. As a consequence of the Distribution, certain state deferred tax assets were re-valued based on enacted tax rates using different state apportionment factors, increasing the future state tax benefit. The Company recorded a tax benefit of $23.0 for various tax credits, resulting in a tax rate benefit of 7.2%.

 

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EARNINGS FROM DISCONTINUED OPERATIONS, NET OF TAX

During 2012, the Company completed the sale of its shape cutting product lines, including the Kaliburn and Burny brands as well as the web tension control products and custom engineered systems sold under the Cleveland Motion Controls brand (collectively referred to herein as the Shape Cutting Businesses). The financial position and results of operations of the Shape Cutting Businesses for each period presented are reported as a discontinued operation.

On October 31, 2011, the Company completed the Distribution of Exelis and Xylem. The operating results of Exelis and Xylem through the date of the Distribution have been classified in the consolidated financial statements as discontinued operations for 2011 and 2010.

The tables included below provide the operating results of discontinued operations through the date of disposal or distribution. Amounts presented in the “Other” column within the tables below relate to various divested ITT businesses accounted for as discontinued operations in the year of divestiture for which legacy liabilities remain, as well as certain transformation costs which were directly related to the Distribution and provided no future benefit to the Company. See Note 5, “Company Transformation” for further information.

 

Year Ended 2012    Shape
Cutting
Businesses
     Other     Total  

Revenue

   $ 30.2       $      $ 30.2   

Earnings from discontinued operations, before income taxes

     0.6         0.4        1.0   

Gain on sale, before income taxes

     9.0                9.0   

Income tax benefit

             (5.9     (5.9

Earnings from discontinued operations, net of tax

   $ 9.6       $ 6.3      $ 15.9   

 

Year Ended 2011    Exelis      Xylem      Shape
Cutting
Businesses
    Other     Total  

Revenue

   $ 4,916.1       $ 3,107.5       $ 33.5      $      $ 8,057.1   

Transformation costs

     31.2         74.8                134.1        240.1   

Earnings (loss) from discontinued operations, before income taxes

     473.0         321.5         (2.5     (108.9     683.1   

Income tax expense (benefit)

     193.6         70.3         (1.1     (26.7     236.1   

Earnings (loss) from discontinued operations, net of tax

   $ 279.4       $ 251.2       $ (1.4   $ (82.2   $ 447.0   

DISCUSSION OF FINANCIAL RESULTS

2011 VERSUS 2010

 

      2011     2010     Change  

Revenue

   $ 2,085.6      $ 1,890.7        10.3%   

Gross profit

     645.0        603.9        6.8%   

Gross margin

     30.9     31.9     (100)bp   

Operating expenses

     889.9        784.5        13.4%   

Operating expense to revenue ratio

     42.7     41.5     120bp   

Operating loss

     (244.9     (180.6     (35.6)%   

Operating margin

     (11.7 )%      (9.6 )%      210bp   

Interest and non-operating expenses, net

     71.0        92.0        (22.8)%   

Income tax expense (benefit)

     260.6        (142.2     (283.3)%   

Loss from continuing operations

     (576.5     (130.4     342.1%   

Earnings from discontinued operations, net of tax

     447.0        934.7        (52.2)%   

Net (loss) income

   $ (129.5   $ 804.3        (116.1)%   

 

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REVENUE

Our revenue results for 2011 reflect growth in emerging growth markets of 18.4% and in our core markets, such as oil & gas, mining, transportation and aerospace. Our results also benefited from the continued economic recovery within the North American region, increasing production of commercial aircraft, and transportation share gains combined with a recovery in global automotive demand. During 2011, we secured positions on multiple key platforms and developed strategic account agreements with a number of significant customers, including six significant Industrial Process emerging growth market wins each in excess of $2.0, our first major Korean medical connector order and positions on two Embraer Aerospace programs.

 

      2011     2010     Change    

Organic

Growth

 

Industrial Process

   $ 766.7      $ 693.7        10.5     8.8%   

Motion Technologies

     634.4        547.7        15.8     11.0%   

Interconnect Solutions

     417.8        412.9        1.2     (0.2)%   

Control Technologies

     285.5        259.4        10.1     9.4%   

Eliminations

     (18.8     (23.0     (18.3 )%        

Total

   $ 2,085.6      $ 1,890.7        10.3     7.9%   

The following table illustrates revenue generated with a specific country or region for the years ended December 31, 2011 and 2010, and the corresponding percentage change.

 

      2011      2010      Change    

Organic

Growth

 

United States

   $ 779.6       $ 736.1         5.9     5.5%   

Germany

     229.8         205.1         12.0     7.3%   

France

     126.9         116.5         8.9     4.1%   

Other developed markets

     360.9         336.2         7.3     3.0%   

Total developed markets

     1,497.2         1,393.9         7.4     5.0%   

South and Central America(a)

     178.1         138.5         28.6     24.0%   

Eastern Europe and Russia

     105.5         66.4         58.9     51.6%   

Middle East and Africa

     98.2         100.0         (1.8 )%      (2.8)%   

China and Hong Kong

     115.0         112.4         2.3     0.4%   

Other emerging growth markets

     91.6         79.5         15.2     13.2%   

Total emerging growth markets

     588.4         496.8         18.4     15.4%   

Total

   $ 2,085.6       $ 1,890.7         10.3     7.9%   
(a) Includes Mexico

Industrial Process

The Industrial Process segment generated revenue growth of 10.5% reflecting growth in aftermarket (pump parts and service) of approximately 17.0% and pump units of approximately 8.0%. This includes growth in our North American business of approximately 7.0% reflecting positive results across all industrial markets. The chemical market in the U.S. and Canada was a major contributor to the growth as chemical companies increased output due to lower cost North American natural gas feedstock. Growth in international pump units of 14.0% reflects increased activity in South America and the Middle East, primarily within the oil & gas market, partially offset by a decline in revenue from a large 2010 project in Africa. The Industrial Process revenue results include 20.5% growth in emerging growth markets and also reflect the benefits from product development investments in more complex and specialized equipment.

Orders increased during 2011 by 27.5% to $916.7 in both baseline and project business stemming from expanded capabilities focused on the oil & gas and mining markets as well as expanded presence in growth regions, including acquisitions.

Motion Technologies

The Motion Technologies segment generated revenue growth of 15.8% during 2011, primarily driven by a 12.0% or $54.0 increase in braking equipment volume, primarily to OEM. The increase in OEM pads stems from the significant automotive platform wins over the past several years, which included new positions with European, North American and Chinese producers. Sales of shock absorber equipment increased 6.0%, or $6.0; however results were negatively impacted by the Chinese government’s decision to slow the development of the China rail infrastructure expansion program in the second half of 2011. Motion Technologies’ 2011 revenue results included 32.6% growth in emerging growth markets driven by automotive and rail activity in China and a combined growth of 20.3% within the U.S. and Canada.

 

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Interconnect Solutions

The ICS segment generated revenue growth of 1.2% during 2011, as strength in the aerospace, transportation, oil & gas, and defense markets were offset by an approximate 20% revenue decline in the communications market. The year-over-year decrease within the communications market equipment reflects a decline in sales primarily due to lower production rates at a major smartphone customer and share declines in a specific communications application. Revenue growth within the aerospace market was approximately 7.0%, due to increased commercial aviation market production and regional jet OEM demand. Revenue growth within the transportation market was approximately 10.0%, driven by our recently launched electronic vehicle-related connector products and construction and agriculture equipment platform wins in Europe and China. Revenue growth within the oil & gas market was approximately 9.0%, driven by increased demand in the Middle East and Latin America regions. Revenue growth in the defense market was approximately 5.0%, driven by radar and communication equipment platform wins.

Control Technologies

The Control Technologies segment generated revenue growth of 10.1% during 2011, with growth in the aerospace and industrial markets, partially offset by a 9.8% decline in defense revenues. Revenue within the commercial aviation market grew approximately $23.6, or 22.8% driven by 2011 aircraft production increases. CT Industrial revenue decreased $2.2 or 2.3%, as increased demand for oil & gas and energy products, such as our Enidine energy absorption, Neo-Dyne switches and Conoflow regulators, was offset by the divestiture of our Shape Cutting Businesses in 2012. In addition, Chinese rail infrastructure activities provided revenue growth of $10.2 related to a first-class seats program.

GROSS PROFIT

 

      2011     2010     Change  

Industrial Process

   $ 244.3      $ 216.0        13.1%   

Motion Technologies

     156.9        153.0        2.5%   

Interconnect Solutions

     133.6        142.3        (6.1)%   

Control Technologies

     109.5        91.1        20.2%   

Corporate and Other

     0.7        1.5        (53.3)%   

Total gross profit

   $ 645.0      $ 603.9        6.8%   

Gross margin:

      

Industrial Process

     31.9     31.1     80bp   

Motion Technologies

     24.7     27.9     (320)bp   

Interconnect Solutions

     32.0     34.5     (250)bp   

Control Technologies

     38.4     35.1     330bp   

Consolidated

     30.9     31.9     (100)bp   

Industrial Process gross profit increased $28.3 or 13.1% during 2011 due to increased sales volume and net cost reductions from material sourcing initiatives. These items drove an increase to gross margin of 80 basis points over the prior year to 31.9%.

Motion Technologies gross profit increased $3.9 or 2.5% during 2011 from increased sales volume, however gross margin declined 320 basis points to 24.7%. The decline in gross margin was due to increasing material costs and an unfavorable mix shift attributable to recent OEM share gains between 2010 and 2011.

Interconnect Solutions gross profit decreased $8.7 or 6.1%, representing a 250 basis point decline, during 2011 due to an unfavorable change in product sales mix, partially offset by favorable product pricing.

Control Technologies gross profit increased $18.4 or 20.2% during 2011 due to increased sales volume, improved pricing, favorable mix, and operational performance improvements related to recent footprint consolidations and leadership changes. These favorable items were partially offset by increased labor, material and overhead costs. These items drove an increase to gross margin of 330 basis points over the prior year to 38.4%.

 

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OPERATING EXPENSES

Operating expenses increased 13.4% or $105.4 during 2011 to $889.9, primarily attributable to a $396.1 of costs incurred to complete the Distribution of Exelis and Xylem, including debt extinguishment costs of $296.8, partially offset by a $284.4 reduction in asbestos-related costs. The following table provides further information by expense type, as well as a breakdown of operating expense by segment.

 

      2011      2010      Change  

Sales and marketing expenses

   $ 163.6       $ 164.0         (0.2 )% 

General and administrative expenses

     166.3         176.4         (5.7 )% 

Research and development expenses

     63.5         59.3         7.1

Asbestos-related costs, net

     100.4         384.8         (73.9 )% 

Transformation costs

     396.1                   

Total operating expenses

   $ 889.9       $ 784.5         13.4

By Segment:

        

Industrial Process

   $ 152.8       $ 136.9         11.6

Motion Technologies

     71.6         68.4         4.7

Interconnect Solutions

     95.8         105.0         (8.8 )% 

Control Technologies

     54.3         59.4         (8.6 )% 

Corporate & Other

     515.4         414.8         24.3

Sales and marketing expenses were relatively flat year-over-year; however, due to our VBCE initiative these costs as a percentage of revenue declined 90 basis points at the consolidated level from 8.7% in 2010 to 7.8% in 2011, with similar basis point declines at each segment.

G&A expenses decreased $10.1 or 5.7% during 2011, the $10.0 cancellation of a bond guarantee and a $3.6 gain on the sale of an ICS product line were partially offset by additional postretirement costs of $7.6.

R&D costs increased 7.1% over the prior year due to slightly higher spending on new product developments in targeted growth markets at each segment. As a percentage of revenue, R&D costs declined to 3.0% in 2011 from 3.1% in 2010.

Asbestos-Related Costs, Net

ITT, including its subsidiary Goulds Pumps, Inc., has been joined as a defendant with numerous other companies in product liability lawsuits alleging personal injury due to asbestos exposure. As of December 31, 2011 and 2010, there were 66 thousand and 64 thousand pending active claims filed against ITT in various state and federal courts alleging injury as a result of exposure to asbestos.

For the years ended December 31, 2011 and 2010, the income statement effects from asbestos charges consisted of the following:

 

      2011      2010  

Asbestos provision

   $ 59.5       $ 55.3   

Asbestos remeasurement, net

     40.9         329.5   

Net asbestos charge

   $ 100.4       $ 384.8   

The decrease in our Asbestos Remeasurement expense from 2010 to 2011 reflects the impact of our annual update to the underlying assumptions used to measure our asbestos liabilities and related assets and was a result of several developments including a reduction in the assumed rate of increase in future average settlement costs and an expectation of lower defense costs as a percentage of indemnities paid. These favorable factors were offset in part by increased activity in several higher-cost jurisdictions, increasing the number of cases expected to be adjudicated. The 2010 Asbestos Remeasurement reflects an assumed increase in settlement costs and significantly increased activity in several higher-cost jurisdictions, increasing the number of cases to be adjudicated and the expected legal costs to defend the additional cases.

See Note 19, “Commitments & Contingencies,” to the Consolidated Financial Statements for further information on our asbestos-related liability and assets.

Transformation Costs

During 2011, we recognized transformation costs expenses of $396.1 in connection activities taken to complete the Distribution and create the revised organizational structure. Transformation costs incurred during 2011 included a $296.8 loss associated with extinguishing substantially all outstanding debt in connection with the Distribution, a $55.0 impairment charge related to a decision to discontinue development of an information technology consolidation initiative and $36.8 of employee retention and other compensation costs.

 

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OPERATING LOSS

 

      2011     2010     Change  

Industrial Process

   $ 91.5      $ 79.1        15.7%   

Motion Technologies

     85.3        84.6        0.8%   

Interconnect Solutions

     37.8        37.3        1.3%   

Control Technologies

     55.2        31.7        74.1%   

Segment operating income

     269.8        232.7        15.9%   

Asbestos-related costs, net

     (100.4     (384.8     (73.9)%   

Transformation costs

     (391.2              

Other corporate costs

     (23.1     (28.5     (18.9)%   

Total operating loss

   $ (244.9   $ (180.6     (35.6)%   

Operating margin:

      

Industrial Process

     11.9     11.4     50bp   

Motion Technologies

     13.4     15.4     (200)bp   

Interconnect Solutions

     9.0     9.0       

Control Technologies

     19.3     12.2     710bp   

Segment operating margin

     12.8     12.2     60bp   

Consolidated operating margin

     (11.7 )%      (9.6 )%      (210)bp   

Industrial Process operating income increased $12.4 or 15.7% during 2011 due to increased sales volume and net cost reductions from productivity, sourcing and Value Based Lean Six Sigma initiatives. The favorability of these items was partially offset by competitive project pricing levels, increased bad debt expense of $4.3 and transformation costs of $2.6. These items resulted in a net increase to operating margin of 50 basis points over the prior year.

Motion Technologies operating income increased $0.7 or 0.8% during 2011. Although Motion Technologies generated revenue growth of 15.8% during 2011, this growth was volume driven from the lower margin OEM equipment associated with key wins on numerous automotive platforms in the last two years. This dynamic contributed to an overall 200 basis point decline in operating margin, as did rising material costs and increased year-over-year severance costs. The overall impact of these items was offset partially by strategic sourcing initiatives.

Interconnect Solutions operating income increased $0.5 or 1.3% during 2011, as an unfavorable change in product sales mix and a $2.4 increase in restructuring expenses were offset by declines in warranty and compensation costs and a $3.6 gain from the sale of a product line.

Control Technologies operating income increased $23.5 or 74.1% during 2011 due to increased sales volume, improved pricing and favorable mix combined with operational improvements resulting from recent footprint actions. These results also include a favorable comparison to various 2010 inventory adjustments totaling $4.7. These favorable items were partially offset by increased labor, material and overhead costs. These items drove an increase to operating margin of 710 basis points over the prior year to 19.3%.

Corporate costs, excluding net asbestos-related costs and transformation costs, decreased $5.4 during 2011, as unfavorable fluctuations in the value of corporate owned life insurance policies and foreign currency contracts were offset by a $10.0 gain from the cancellation of a bond guarantee during 2011. Employee retention and other compensation costs incurred during 2011 include $16.8 of compensation costs recognized in connection with the retirement of Steven R. Loranger, our former Chairman, President and Chief Executive Officer in October 2011.

INTEREST AND NON-OPERATING EXPENSES, NET

 

      2011     2010      Change  

Interest expense

   $ 76.4      $ 97.1         (21.3 )% 

Interest income

     4.1        10.8         (62.0 )% 

Miscellaneous (income) expense, net

     (1.3     5.7         (122.8 )% 

Total interest and non-operating expenses, net

   $ 71.0      $ 92.0         (22.8 )% 

Total interest and non-operating expense, net decreased $21.0, or 22.8%, during 2011 due to the extinguishment of $1,251.0 of long-term debt in October 2011.

INCOME TAX EXPENSE (BENEFIT)

During the year ended December 31, 2011, we recognized income tax expense of $260.6 on a loss from continuing operations before income taxes of $315.9, an effective rate of (82.5)%, as compared to an income tax benefit of $142.2 on a loss from continuing operations before income taxes of $272.6, an effective rate of 52.2%, in the prior year.

 

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The effective tax rate recorded in 2011 differs from US federal statutory rate of 35% due to several items. First, in 2011, we recorded a valuation allowance which decreased the effective tax rate benefit by 108.1%. Of the valuation allowance, $340.7 primarily related to US federal and state deferred tax assets as it became more likely than not that these deferred tax assets would not be realized as a result of the Distribution. As of December 31, 2011, the Company was in a cumulative three-year loss position, which was considered a significant source of negative evidence indicating the need for a valuation allowance on our net deferred tax assets. Since the Company was in a three-year cumulative loss position at the end of 2011, it was determined that the size and frequency of the losses from continuing operations in recent years and the uncertainty associated with projecting future taxable income supported the conclusion that a valuation allowance was required to reduce its deferred tax assets.

Second, the Company recorded a $30.9 tax benefit in 2011 from an increase in state deferred tax assets which resulted in a 9.7% increase in the effective tax rate benefit. As a consequence of the Distribution, certain state deferred tax assets were re-valued based on enacted tax rates using different state apportionment factors, increasing the future state tax benefit. Third, in 2011 the Company also recorded $69.3 of tax expense for a portion of undistributed foreign earnings that were previously considered to be indefinitely re-invested which decreased the effective tax rate benefit by 21.8%. As a result of the Distribution and its impacts on the Company’s expected liquidity, investment opportunities and other factors, the Company determined that certain earnings generated in Luxembourg, Japan, and South Korea may be distributed in the future. As a result of the change in intent, the Company recorded an additional tax expense on these unremitted earnings. The Company recorded a tax benefit of $23.0 for various tax credits, resulting in a tax rate benefit of 7.2%.

The effective tax rate in 2010 differs from the U.S. federal statutory tax rate due to the release of valuation allowances which increased the effective tax rate by 14.1%, including the release of a $36.0 valuation allowance on a capital loss carry-forward related to the sale of CAS, and $35.0 of tax credits which increased the effective tax rate by 12.6%. These increases were offset, in part, by U.S. taxes on foreign earnings that benefitted the effective tax rate by 16.0% and the write-off of a deferred tax asset as a result of the Patient Protection Act of 2010 which benefitted the effective tax rate by 4.2%.

EARNINGS FROM DISCONTINUED OPERATIONS, NET OF TAX

During 2012, the Company completed the sale of its Shape Cutting Businesses. The financial position and results of operations of the Shape Cutting Businesses are reported as a discontinued operation.

On October 31, 2011, the Company completed the Distribution of Exelis and Xylem. The operating results of Exelis and Xylem through the date of the Distribution have been classified in the consolidated financial statements as discontinued operations for 2011 and 2010.

The tables included below provide the operating results of discontinued operations through the date of disposal or distribution. Amounts presented in the “Other” column within the tables below relate to various divested ITT businesses accounted for as discontinued operations in the year of divestiture for which legacy liabilities remain, as well as certain transformation costs which were directly related to the Distribution and provided no future benefit to the Company. See Note 5, “Company Transformation” for further information.

 

Year Ended 2011    Exelis      Xylem      Shape
Cutting
Businesses
    Other     Total  

Revenue

   $ 4,916.1       $ 3,107.5       $ 33.5      $      $ 8,057.1   

Transformation costs

     31.2         74.8                134.1        240.1   

Earnings (loss) from discontinued operations before income taxes

     473.0         321.5         (2.5     (108.9     683.1   

Income tax expense (benefit)

     193.6         70.3         (1.1     (26.7     236.1   

Earnings (loss) from discontinued operations, net of tax

   $ 279.4       $ 251.2       $ (1.4   $ (82.2   $ 447.0   

 

Year Ended 2010    Exelis      Xylem      CAS     Shape
Cutting
Businesses
    Other     Total  

Revenue

   $ 5,893.1       $ 3,191.7       $ 159.8      $ 17.6      $      $ 9,262.2   

Earnings (loss) from discontinued operations before income taxes

     718.2         395.5         13.4        (3.2     10.7        1,134.6   

Gain on sale of disposal before tax

                     125.8               (0.2     125.6   

Income tax expense (benefit)

     250.6         51.6         (0.2     (1.1     24.6        325.5   

Earnings (loss) from discontinued operations, net of tax

   $ 467.6       $ 343.9       $ 139.4      $ (2.1   $ (14.1   $ 934.7   

 

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LIQUIDITY AND CAPITAL RESOURCES

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. While our ability to generate future cash flows is more limited subsequent to the Distribution, 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.

Euro-denominated cash and cash equivalents accounted for 21.9% of our cash and cash equivalents at December 31, 2012, compared to 64.8% at December 31, 2011; however, a majority of our cash and cash equivalents at December 31, 2012 continues to be held by our international subsidiaries. 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 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. We have and may continue to transfer cash from certain international subsidiaries to 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; however, in connection with the Distribution we reviewed our domestic and foreign cash profile, expected future cash generation and investment opportunities and determined that $515.0 of previously undistributed foreign earnings would no longer be considered indefinitely reinvested outside the U.S. As of December 31, 2012, $534.9 of previously undistributed foreign earnings are not considered indefinitely reinvested outside the U.S. Such undistributed foreign earnings have not been remitted to the U.S. and the timing of such remittance if any is currently under evaluation.

In future periods, we expect to analyze any undistributed foreign earnings and profits for which an applicable outside basis difference exists to continue to support our assertion that such amounts will be indefinitely reinvested outside the U.S. For the foreseeable future, ITT plans to reinvest the excess undistributed foreign earnings in its international operations, consistent with its overall intentions to support growth and expand in markets outside the U.S. through the development of products, increasing non-US capital spending, and potentially acquiring foreign businesses.

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. Aggregate dividends paid in 2012 were $34.2, compared to $193.0 in 2011 and $176.4 in 2010. After giving effect to the 1:2 Reverse Stock Split, we declared dividends of $0.091 per share in each quarter of 2012 and the fourth quarter of 2011, $0.50 per share in each of the first three quarters of 2011 and each of the four quarters of 2010. In connection with the Distribution, ITT decreased its quarterly dividend from $0.50 per share to $0.091 per share. For holders of ITT shares at the Distribution Date, dividends declared by Exelis and Xylem subsequent to the Distribution kept the aggregate dividend after the Distribution consistent with the ITT dividend prior to the Distribution. In the first quarter of 2013, we declared a dividend of $0.10 per share for shareholders of record on March 15, 2013.

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, it is cost effective to do so, and a sufficient return on investment can be generated.

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), 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 December 31, 2012, we had no amounts outstanding under the 2011 Revolving Credit Agreement and our interest coverage ratio and leverage ratio were within the prescribed thresholds.

 

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Our credit ratings as of December 31, 2012 are as follows:

 

Rating Agency    Short-Term
Ratings
     Long-Term
Ratings
 

Standard & Poor’s

     A-3         BBB-   

Moody’s Investors Service

     P-3         N/A   

Fitch Ratings

     F2         A -   

As we no longer have long-term debt securities outstanding or a current Shelf Registration Statement filed with the SEC, Moody’s Investors Service does not currently provide a long-term rating for ITT. Please refer to the rating agency websites and press releases for more information.

Asbestos

Based on the estimated undiscounted asbestos liability as of December 31, 2012 (for claims filed or estimated to be filed over the next 10 years), we have estimated that we will be able to recover 45% of asbestos indemnity and defense costs from our insurers. However, there is uncertainty in estimating when cash payments related to the recorded asbestos liability will be fully expended and such cash payments will continue for a number of years beyond the next 10 years due to the significant proportion of future claims included in the estimated asbestos liability and the lag time between the date a claim is filed and when it is resolved. Subject to these inherent uncertainties, it is expected that net cash payments related to pending claims and claims estimated to be filed in the next 10 years, will extend through approximately 2028.

Insurance reimbursements may vary from period to period and the anticipated recovery rate is expected to decline over time due to gaps in our insurance coverage, reflecting uninsured periods, the insolvency of certain insurers, prior settlements with our insurers, and our expectation that certain policies from some of our primary insurers will exhaust within the next 10 years. Further, certain of our primary coverage-in-place agreements are expected to exhaust within the next 12 months, which may result in higher net cash outflows until excess carriers begin accepting claims for reimbursement. In the tenth year of our estimate, our insurance recoveries are currently projected to be approximately 24%. Future recovery rates may be impacted by other factors, such as future insurance settlements, unforeseen insolvencies and judicial determinations relevant to our coverage program, which are difficult to predict and subject to a high degree of uncertainty.

Annual net cash outflows, net of tax benefits, are projected to average $10 to $20 over the next five years, as compared to an average of $9 over the past three years, and increase to an average of $35 to $45 over the remainder of the projection period.

In light of the uncertainties and variables inherent in the long-term projection of the Company’s asbestos exposures and potential recoveries, although it is probable that the Company will incur additional costs for asbestos claims filed beyond the next 10 years, we do not believe there is a reasonable basis for estimating the number of future claims, the nature of future claims, or the cost to resolve future claims beyond the next 10 years at this time. Accordingly, no liability or related asset has been recorded for any costs which may be incurred for claims asserted subsequent to 2022.

Due to these uncertainties, as well as our inability to reasonably estimate any additional asbestos liability for claims which may be filed beyond the next 10 years, it is not possible to predict the ultimate outcome of the cost of resolving the pending and all unasserted asbestos claims. We believe it is possible that future events affecting the key factors and other variables within the next 10 years, as well as the cost of asbestos claims filed beyond the next 10 years, net of expected recoveries, could have a material adverse effect on our financial statements.

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 for each of the three years ended December 31, 2012.

 

      2012     2011     2010  

Operating activities

   $ 247.1      $ (322.4   $ (74.2

Investing activities

     (274.7     (106.5     (135.0

Financing activities

     (108.0     922.3        248.1   

Foreign exchange

     (4.0     (9.4     (22.1

Total net cash flow from continuing operations

   $ (139.6   $ 484.0      $ 16.8   

Net cash from discontinued operations

     (5.7     (426.5     (200.1

Less: Cash of discontinued operations

                   (826.3

Less: Cash distributed to Exelis and Xylem

            (400.0       

Net change in cash and cash equivalents

   $ (145.3   $ (342.5   $ (1,009.6

 

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Net cash provided by operating activities was $247.1 for 2012, representing an increase of $569.5 from 2011. The increase in operating cash flow was primarily attributable to net income tax refunds of $100.9 during 2012 as compared to net income tax payments of $140.0 during 2011, resulting in a year-over-year change of $240.9. The refunds received in 2012 were primarily related to tax benefits associated with transformation costs incurred in 2011. Additional year-over-year cash flow sources and uses include a decline in cash paid for transformation costs of $307.7 offset by an increase in cash contributions to global postretirement plans of $40.2 and a lower cash use associated with changes in working capital of $74.0, primarily related to changes in the level of trade receivables and inventory. Net cash payments for asbestos decreased by $1.9 compared to 2011.

Net cash used by operating activities was $322.4 in 2011 representing an increase of $248.2 from 2010. The decrease in operating cash flow was attributable to several factors, the most significant of which are a) $355.0 of cash payments associated with the Distribution, b) higher income from continuing operations of $68.4 after adjusting for non-cash expenses of $514.5 related to transformation costs and a higher income tax expense, partially offset by lower net asbestos-related costs, c) a cash use associated with changes in working capital of $149.9, primarily related to changes in the level of trade receivables and accounts payable, and d) a cash benefit from lower accrued income taxes of $158.3. Net cash payments for asbestos matters in 2011 increased by $22.0 and contributions to our global postretirement benefit plans increased by $17.1, while cash payments for restructuring actions decreased by $19.8.

Net cash used in investing activities increased by $168.2 in the 2012 as compared to 2011 due to the acquisition of Bornemann in the fourth quarter of 2012 and the purchase of investments of $38.2, partially offset by proceeds of $38.4 from the sale of the Shape Cutting Businesses as well as lower capital expenditures of $18.5.

Net cash used in investing activities decreased by $28.5 in 2011 as compared to 2010. Spending on capital expenditures decreased by $24.0 as a result of a decision to terminate the planned implementation of an entity-wide enterprise resource planning (ERP) system in early 2011 for which we had capital expenditures of $35.0 in 2010. The ERP implementation was terminated in 2011 and $55.0 of capitalized costs were written off as part of transformation costs included in continuing operations.

Net cash used in financing activities was $108.0 during 2012, compared to cash provided by financing activities of $922.3 during 2011. The year-over-year change primarily reflects the net effects of the Distribution as discussed below. Other significant financing cash flows in 2012 include repurchases of common stock of $116.8 and net repayments on borrowings of $24.5.

Net cash provided by financing activities increased by $674.2 in 2011 as compared to 2010, primarily related to the $1,671.0 Contribution paid to ITT by Exelis and Xylem in connection with the Distribution, lower cash used by Xylem for acquisitions and the net effect of the global cash pooling in which Exelis and Xylem participated prior to the Distribution. The proceeds received by ITT from the Contribution were used during October 2011 to repay substantially all outstanding ITT long-term debt, commercial paper and capital leases, as well as debt extinguishment costs of $296.8 and other cash transformation costs. Cash provided by financing activities in 2011 also included a cash inflow of $60.0 from the exercise of employee stock options, an increase of $26.5 compared to 2010 and a cash outflow of $193.0 related to dividend payments.

Our average daily outstanding commercial paper balance for the year ended 2012 and 2011 was $10.1 and $127.6, respectively. The maximum outstanding commercial paper during 2012 and 2011 was $55.0 and $408.0, corresponding with Xylem’s acquisition of YSI in 2011. We did not have any commercial paper outstanding as of December 31, 2012.

Funding of Postretirement Plans

At December 31, 2012, our global postretirement benefit plans were underfunded by $343.0, of which $137.9 relates to pension plans, including $81.4 for non-U.S. plans which are typically not funded due to local regulations, and $205.1 relates to other postretirement benefit plans. While we make contributions to our postretirement benefit plans when considered necessary or advantageous to do so, the minimum funding requirements established by local government funding or taxing authorities, or established by other agreements, may influence future contributions. Funding requirements under U.S. Internal Revenue Service (IRS) rules are a major consideration in making contributions to our U.S. postretirement benefit plans. During 2012, we contributed $71.0 to our postretirement benefit plans, $58.3 of which was to U.S. pension plans and $9.7 to our other employee-related benefit plans.

On July 6, 2012, the Surface Transportation Extension Act, which is also referred to as the Moving Ahead for Progress in the 21st Century Act (MAP-21), was signed into law. MAP-21, in part, provides temporary relief for employers who sponsor defined benefit pension plans related to minimum funding contributions by spreading the required funding for U.S. pension plans over a longer period of time. We have estimated the MAP-21 impact to the 2013 plan year and expect to make contributions of $3.8 to our global pension plans during 2013.

While the Company has significant discretion in making voluntary contributions, the Employee Retirement Income Security Act of 1974, as amended by the Pension Protection Act of 2006 and further amended by the Worker, Retiree, and Employer Recovery Act of 2008 and applicable Internal Revenue Code regulations mandate minimum funding thresholds. Failure to satisfy the minimum funding thresholds could result in restrictions on our ability to amend a plan or make benefit

 

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payments. In general, certain benefit restrictions apply when the Adjusted Funding Target Attainment Percentage (AFTAP) of a plan is less than 80%. When the AFTAP is between 80% and 60%, there is a restriction on plan amendments and a partial restriction on accelerated benefit payments (i.e., lump sum payments cannot exceed 50% of the value of the participants total benefit). Full benefit restrictions apply if the plan’s AFTAP falls below 60%.

Future minimum funding requirements will depend primarily on the return on plan assets and discount rate, both determined using AFTAP guidelines. Depending on these factors, and the resulting funded status of our U.S. pension plans, the level of future minimum contributions could be material.

Capital Resources

Long-term debt is raised through the offering of debt securities primarily within the U.S. capital markets. Long-term debt is generally defined as any debt with an original maturity greater than 12 months.

As of December 31, 2012, we have sources of long- and short-term funding including access to the capital markets through an available $500 commercial paper program and unused credit lines, as well as general market access to longer-term markets. Our commercial paper program is supported by the 2011 Revolving Credit Agreement.

The table below provides long-term debt outstanding and capital lease obligations at December 31, including the remaining outstanding debt of Bornemann assumed in 2012.

 

      2012      2011  

Current portion of long-term debt and capital leases

   $ 4.1       $ 0.3   

Non-current portion of long-term debt and capital leases

     10.1         4.1   

Total long-term debt and capital leases

   $ 14.2       $ 4.4   

Contractual Obligations

ITT’s commitment to make future payments under long-term contractual obligations was as follows, as of December 31, 2012:

 

     Payments Due By Period  
Contractual Obligations    Total     

Less Than

1 Year

     1-3 Years      3-5 Years      More Than
5 Years
 

Short and long-term debt, including interest and capital leases

   $ 29.0       $ 15.4       $ 4.9       $ 3.8       $ 4.9   

Operating leases

     135.4         14.8         24.5         18.2         77.9   

Purchase obligations(a)

     96.6         84.8         11.8                   

Other long-term obligations(b)

     124.7         18.3         35.4         34.0         37.0   

Total

   $     385.7       $ 133.3       $ 76.6       $ 56.0       $ 119.8   

In addition to the amounts presented in the table above, we have recorded liabilities for pending asbestos claims and asbestos claims estimated to be filed over the next 10 years and uncertain tax positions of $1,347.4 and $117.5, respectively, in our Consolidated Balance Sheet at December 31, 2012. These amounts have been excluded from the contractual obligations table due to an inability to reasonably estimate the timing of payments in individual years. In addition, while we make contributions to our postretirement benefit plans when considered necessary or advantageous to do so, the minimum funding requirements established by local government funding or taxing authorities, or established by other agreements, may influence future contributions. As such, expected contributions to our postretirement benefit plans have been excluded from the table above.

 

(a) Represents unconditional purchase agreements that are enforceable and legally binding and that specify all significant terms to purchase goods or services, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase agreements that are cancellable without penalty have been excluded.

 

(b) Other long-term obligations include amounts recorded on our December 31, 2012 Consolidated Balance Sheet, including estimated environmental payments and employee compensation agreements. We estimate, based on historical experience that we will spend between $10 and $15 per year on environmental investigation and remediation. We are contractually required to spend a portion of these monies based on existing agreements with various governmental agencies and other entities. At December 31, 2012, our recorded environmental liability was $96.1.

Off-Balance Sheet Arrangements

Off-balance sheet arrangements represent transactions, agreements or other contractual arrangements with unconsolidated entities, where an obligation or contingent interest exists. Our off-balance sheet arrangements, as of December 31, 2012, consist of indemnities related to acquisition and disposition agreements and certain third-party guarantees.

 

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Indemnities

As part of the Distribution, ITT provided certain indemnifications and cross-indemnifications among ITT, Exelis and Xylem, subject to limited exceptions with respect to employee claims. The indemnifications address a variety of subjects, including asserted and unasserted product liability matters (e.g., asbestos claims, product warranties) which relate to products manufactured, repaired and/or sold prior to the Distribution Date. The indemnifications are indefinite. The indemnification associated with pending and future asbestos claims does not expire. In addition, ITT, Exelis and Xylem agreed to certain cross-indemnifications with respect to other liabilities and obligations. ITT expects Exelis and Xylem to fully perform under the terms of the Distribution Agreement and therefore has not recorded a liability for matters for which we have been indemnified. In addition, both Exelis and Xylem have made asbestos indemnity claims that could give rise to material payments under the indemnity provided by ITT; such claims are included in our estimate of asbestos liabilities.

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 these indemnifications and are not aware of any claims or other information that would give rise to material payments under such indemnities.

Guarantees

We have a number of guarantees, letters of credit and similar arrangements outstanding at December 31, 2012 primarily pertaining to commercial or performance guarantees and insurance matters. We have not recorded any material loss contingencies under these guarantees, letters of credit and similar arrangements as of December 31, 2012 as the likelihood of nonperformance by the underlying obligors is considered remote. From time to time, we may provide certain third-party guarantees that may be affected by various conditions and external factors, some of which could require that payments be made under such guarantees. We do not consider the maximum exposure or current recorded liabilities under our third-party guarantees to be material either individually or in the aggregate. We do not believe such payments would have a material adverse impact on our consolidated financial statements.

KEY PERFORMANCE INDICATORS AND NON-GAAP MEASURES

Management reviews key performance indicators including revenue, segment operating income and margins, earnings per share, orders growth, and backlog, among others. In addition, we consider certain measures to be useful to management and investors when evaluating our operating performance for the periods presented. These measures provide a tool for evaluating our ongoing operations and management of assets from period to period. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment among competing strategic alternatives and initiatives, including, but not limited to, dividends, acquisitions and share repurchases. These metrics, however, are not measures of financial performance under accounting principles generally accepted in the United States of America (GAAP) and should not be considered a substitute for measures determined in accordance with GAAP. We consider the following non-GAAP measures, which may not be comparable to similarly titled measures reported by other companies, to be key performance indicators:

 

¡  

“organic revenue” and “organic orders” are defined as revenue and orders, excluding the impact of foreign currency fluctuations and contributions from acquisitions and divestitures made during the current year. Divestitures include sales of insignificant portions of our business that did not meet the criteria for presentation as a discontinued operation. The period-over-period change resulting from foreign currency fluctuations assumes no change in exchange rates from the prior period.

A reconciliation of organic revenue from revenue for the years ended December 31, 2012 and 2011 is provided below.

 

     

Industrial

Process

    Motion
Technologies
    Interconnect
Solutions
    Control
Technologies
    Eliminations    

Total

ITT

    %
Change
 

2011 Revenue

   $ 766.7      $ 634.4      $ 417.8      $ 285.5      $ (18.8   $ 2,085.6     

Organic growth

     155.1        38.3        (32.8     (8.3     11.6        163.9        7.9

Acquisitions/(divestitures), net

     39.4               (2.2                   37.2        1.8

Foreign currency translation

     (5.4     (46.5     (7.1     (0.1     0.2        (58.9     (2.9 )% 

Total change in revenue

     189.1        (8.2     (42.1     (8.4     11.8        142.2        6.8

2012 Revenue

   $ 955.8      $ 626.2      $ 375.7      $ 277.1      $ (7.0   $ 2,227.8           

 

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Industrial

Process

     Motion
Technologies
     Interconnect
Solutions
    Control
Technologies
     Eliminations    

Total

ITT

     %
Change
 

2010 Revenue

   $ 693.7       $ 547.7       $ 412.9      $ 259.4       $ (23.0   $ 1,890.7      

Organic growth

     60.7         60.2         (1.0     24.5         4.6        149.0         7.9

Acquisitions/(divestitures), net

     6.6                 (2.4                    4.2         0.2

Foreign currency translation

     5.7         26.5         8.3        1.6         (0.4     41.7         2.2

Total change in revenue

     73.0         86.7         4.9        26.1         4.2        194.9         10.3

2011 Revenue

   $ 766.7       $ 634.4       $ 417.8      $ 285.5       $ (18.8   $ 2,085.6            

 

¡  

“adjusted income from continuing operations” and “adjusted income from continuing operations per diluted share” are defined as income from continuing operations and income from continuing operations per diluted share, adjusted to exclude special items that include, but are not limited to, asbestos-related costs, transformation costs, repositioning costs, restructuring and asset impairment charges, acquisition-related expenses, income tax settlements or adjustments, and other unusual or infrequent non-operating items. Special items represent significant charges or credits, on an after-tax basis, that impact current results, but may not be related to the Company’s ongoing operations and performance. A reconciliation of adjusted income from continuing operations, including adjusted earnings per diluted share, is provided below.

 

      2012     2011     2010  

Income (loss) from continuing operations(a)

   $ 109.5      $ (576.5   $ (130.4

Legacy items and legal entity liquidation, net of tax(b)

     29.0        54.4        240.8   

Transformation and repositioning costs, net of tax(c)

     14.2        256.6          

Restructuring and asset impairment charges, net of tax

     10.4        3.0        2.1   

Bornemann acquisition-related expenses, net of tax(d)

     5.4                 

Tax-related special items(e)

     (5.2     381.7        (30.7

Interest income, net of tax

     (5.3     (1.3     (5.8

Adjusted income from continuing operations

   $ 158.0      $ 117.9      $ 76.0   

Income (loss) from continuing operations per diluted share(f)

   $ 1.16      $ (6.22   $ (1.42

Adjusted income from continuing operations per diluted share(f)

   $ 1.68      $ 1.20      $ 0.82   

 

(a) Income (loss) from continuing operations includes interest expense associated with debt that was extinguished in October 2011 of $54.2 and $73.3, for the years ended December 31, 2011 and, 2010, respectively.

 

(b) The following table provides a reconciliation of legacy items and legal entity liquidation to legacy items and legal entity liquidation, net of tax, included as a special item.

 

      2012     2011     2010  

Net asbestos-related costs

   $ 50.9      $ 100.4      $ 384.8   

Environmental insurance-related asset

     (6.7              

Cancellation of bond guarantee

            (10.0       

Other

            (4.6       

Pre-tax total

     44.2        85.8        384.8   

Tax benefit

     (15.2     (31.4     (144.0

Legacy items and legal entity liquidation, net of tax

   $ 29.0      $ 54.4      $ 240.8   

See Note 19, “Commitments and Contingencies,” to our Consolidated Financial Statements for further information regarding net asbestos-related costs and environmental insurance-related asset.

 

(c) The following table provides a reconciliation of transformation and repositioning costs to transformation and repositioning costs, net of tax, included as a special item.

 

      2012     2011     2010  

Transformation costs

   $ 13.0      $ 396.1      $   

Repositioning costs

     8.7                 

Pre-tax total

     21.7        396.1          

Tax-related transformation costs

            3.5          

Tax benefit

     (7.5     (143.0       

Transformation and repositioning costs, net of tax

   $ 14.2      $ 256.6      $   

 

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See Note 5, “Company Transformation” to the Consolidated Financial Statements for further information regarding transformation costs.

 

(d) Bornemann acquisition-related expenses, net of tax include costs to acquire and integrate Bornemann.

 

(e) The following table details significant components of the tax-related special items. See Note 6, “Income Taxes,” to our Consolidated Financial Statements for further information.

 

      2012     2011     2010  

Change in deferred tax asset valuation allowance

   $ 29.4      $ 340.7      $ (36.1

Change in uncertain tax positions

     (13.9              

Impacts of tax audit closure

     (8.2            (4.6

Return to accrual adjustment

     (9.3              

Tax basis balance sheet adjustments

     (2.7              

Charge on undistributed foreign earnings

            69.3          

Change in state tax rates

            (30.9       

Write-off of deferred tax asset

                   11.7   

Other

     (0.5     2.6        (1.7

Net tax-related special items

   $ (5.2   $ 381.7      $ (30.7

 

(f) Loss from continuing operations per share has been calculated using weighted average basic shares outstanding. Adjusted income from continuing operations per share has been calculated using weighted average diluted shares outstanding.

 

¡  

“adjusted free cash flow” is defined as net cash provided by operating activities less capital expenditures, cash payments for transformation costs, repositioning costs, net asbestos cash flows and other significant items that impact current results which management believes are not related to our ongoing operations and performance. Due to other financial obligations and commitments, the entire free cash flow may not be available for discretionary purposes. A reconciliation of free cash flow is provided below.

 

¡  

“adjusted free cash flow conversion” is defined as adjusted free cash flow divided by adjusted income from continuing operations.

 

      2012     2011     2010  

Net cash from continuing operations

   $ 247.1      $ (322.4   $ (74.2

Capital expenditures(g)

     (78.5     (84.6     (126.3

Transformation cash payments

     47.3        355.0          

Net asbestos cash flows

     20.2        22.0          

Discretionary pension contribution, net of tax

     29.2                 

Repositioning cash payments

     5.8                 

Adjusted free cash flow

   $ 271.1      $ (30.0   $ (200.5

Adjusted income from continuing operations

     158.0        117.9        76.0   

Adjusted free cash flow conversion

     172%        (25)%        (264)%   

 

(g) Capital expenditures represent capital expenditures as reported in the Consolidated Statement of Cash Flows, less capital expenditures associated with transformation and repositioning activities. Capital expenditures associated with the transformation were $3.8 and $17.7 during the years ended December 31, 2012 and 2011, respectively. Capital expenditures associated with the repositioning activities were $1.5 during the year ended December 31, 2012.

CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements and related disclosures in accordance with GAAP requires us to make judgments, estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant accounting policies used in the preparation of the financial statements are discussed in Note 1, “Summary of Significant Accounting Policies,” to the Consolidated Financial Statements. An accounting policy is deemed critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes to the estimate that are reasonably possible could materially affect the financial statements. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of ITT’s Board of Directors.

The accounting estimates and assumptions discussed below are those that we consider most critical to fully understanding our financial statements and evaluating our results as they are inherently uncertain, involve the most subjective or complex judgments, include areas where different estimates reasonably could have been used, and the use of an alternative estimate that is reasonably possible could materially effect the financial statements. We base our estimates on

 

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historical experience and other data and assumptions believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Management believes that the accounting estimates employed and the resulting balances reported in the Consolidated Financial Statements are reasonable; however, actual results could differ materially from our estimates and assumptions.

Asbestos Matters

ITT, including its subsidiary Goulds Pumps, Inc., has been joined as a defendant with numerous other companies in product liability lawsuits alleging personal injury due to asbestos exposure. These claims allege that certain products sold by us or our subsidiaries prior to 1985 contained a part manufactured by a third party (e.g., a gasket) which contained asbestos. To the extent these third-party parts may have contained asbestos, it was encapsulated in the gasket (or other) material and was non-friable. In certain other cases, it is alleged that former ITT companies were distributors for other manufacturers’ products that may have contained asbestos.

Estimating our exposure to pending asbestos claims and those that may be filed in the future is subject to significant uncertainty and risk as there are multiple variables that can affect the timing, severity, quality, quantity and resolution of claims. The methodology used to project future asbestos costs is based largely on the Company’s experience in a reference period, including the last few years, for claims filed, settled and dismissed, and is supplemented by management’s expectations of the future. This experience is compared to the results of previously conducted epidemiological studies by estimating the number of individuals likely to develop asbestos-related diseases. Those studies were undertaken in connection with an independent analysis of the population of U.S. workers across eleven different industry and occupation categories believed to have been exposed to asbestos. Using information for the industry and occupation categories relevant to the Company, an estimate is developed of the number of claims estimated to be filed against the Company over the next 10 years, as well as the aggregate settlement costs that would be incurred to resolve both pending and estimated future claims based on the average settlement costs by disease during the reference period. In addition, the estimate is augmented for the costs of defending asbestos claims in the tort system using a forecast based on recent experience, as well as discussions with the Company’s external defense counsel. The asbestos liability has not been discounted to present value due to the inability to reliably forecast the timing of future cash flows. The Company retains a consulting firm to assist management in estimating our potential exposure to pending asbestos claims and for claims estimated to be filed over the next 10 years. The methodology to project future asbestos costs is one in which the underlying assumptions are separately assessed for their reasonableness and then each is used as an input to the liability estimate. Our assessment of the underlying assumptions yields only one value for each assumption.

The liability estimate is most sensitive to assumptions surrounding mesothelioma and lung cancer claims, as together, the estimated costs to resolve pending and estimated future mesothelioma and lung cancer claims represent more than 90% of the estimated asbestos exposure, but only 17% of pending claims. The assumptions related to mesothelioma and lung cancer that are most significant include the number of new claims forecast to be filed against the Company in the future, the projected average settlement costs (including the rate of inflation assumed), the percentage of claims against the Company that are dismissed without a settlement payment, and the cost to defend against filed claims.

These assumptions are interdependent, and no one factor predominates in estimating the asbestos liability. While there are other potential inputs to the model used to estimate our asbestos exposures for pending and estimated future claims, our methodology relies on the best input available in the circumstances for each individual assumption and does not create a range of reasonably possible outcomes. Projecting future asbestos costs is subject to numerous variables and uncertainties that are inherently difficult to predict. In addition to the uncertainties surrounding the key assumptions, additional uncertainty related to asbestos claims arises from the long latency period prior to the manifestation of an asbestos-related disease, changes in available medical treatments and changes in medical costs, changes in plaintiff behavior resulting from bankruptcies of other companies that are potential defendants or co-defendants, uncertainties surrounding the litigation process from jurisdiction to jurisdiction and from case to case, and the impact of potential legislative or judicial changes.

The forecast period used to estimate our potential exposure to pending and projected asbestos claims is a judgment based on a number of factors, including the number and type of claims filed, recent experience with pending claims activity and whether that experience will continue into the future, the jurisdictions where claims are filed, the effect of any legislative or judicial developments, and the likelihood of any comprehensive asbestos legislation at the federal level. These factors have both positive and negative effects on the dynamics of asbestos litigation in the tort system and, accordingly, our estimate of the asbestos exposure. Developments related to asbestos tend to be long-cycle, changing over multi-year periods. Accordingly, we monitor these and other factors and periodically assess whether an alternative forecast period is appropriate.

We record a corresponding asbestos-related asset that represents our best estimate of probable recoveries related to the recorded asbestos liability. In developing this estimate, the Company considers coverage-in-place and other settlement agreements with its insurers, as well as a number of additional factors. These additional factors include expected levels of future cost recovery, the financial viability of the insurance companies, the method by which losses will be allocated to the various insurance policies and the years covered by those policies, the extent to which settlement and defense costs will be

 

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reimbursed by the insurance policies, and interpretation of the various policy and contract terms and limits and their interrelationships. The asbestos-related asset has not been discounted to present value due to the inability to reliably forecast the timing of future cash flows.

The Company has negotiated with certain of its excess insurers to reimburse the Company for a portion of its settlement and/or defense costs as incurred, frequently referred to as “coverage-in-place” agreements. Under coverage-in-place agreements, an insurer’s policies remain in force and the insurer undertakes to provide coverage for the Company’s present and future asbestos claims on specified terms and conditions that address, among other things, the share of asbestos claims costs to be paid by the insurer, payment terms, claims handling procedures and the expiration of the insurer’s obligations. The Company has entered into policy buyout agreements with certain insurers confirming the aggregate amount of available coverage under the subject policies and setting forth a schedule for future reimbursement payments to the Company. Collectively, these agreements are designed to facilitate an orderly resolution and collection of ITT’s insurance portfolio and to mitigate issues that insurers may raise regarding their responsibility to respond to claims.

As of December 31, 2012, the Company has entered into coverage-in-place agreements and policy buyout agreements representing approximately 58% of our recorded asset. Certain of our primary coverage-in-place agreements are expected to exhaust within the next twelve months, which may result in higher net cash outflows until excess carriers begin accepting claims for reimbursement. While there are overall limits on the aggregate amount of insurance available to the Company with respect to asbestos claims, those overall limits were not reached by the estimated liability recorded by the Company at December 31, 2012.

The timing and amount of reimbursements from our insurers will vary due to the lag between when ITT pays an amount to defend or settle a claim and when a reimbursement is received, differing policy terms, and certain gaps in our insurance coverage as a result of uninsured periods, insurer insolvencies, and prior agreements with our insurers.

The Company retains an insurance consulting firm to assist management in estimating probable recoveries for pending asbestos claims and for claims estimated to be filed over the next 10 years based on the analysis of policy terms, the likelihood of recovery provided by external legal counsel assuming the continued viability of those insurance carriers that are currently solvent, incorporating risk mitigation judgments where policy terms or other factors are not certain, and allocating asbestos settlement and defense costs between our insurers.

Based on the estimated undiscounted asbestos liability as of December 31, 2012 (for claims filed or estimated to be filed over the next 10 years), we have estimated that we will be able to recover 45% of asbestos indemnity and defense costs from our insurers. However, there is uncertainty in estimating when cash payments related to the recorded asbestos liability will be fully expended and such cash payments will continue for a number of years beyond the next 10 years due to the significant proportion of future claims included in the estimated asbestos liability and the lag time between the date a claim is filed and when it is resolved. Actual insurance reimbursements may vary from period to period and the anticipated recovery rate is expected to decline over time due to gaps in our insurance coverage, reflecting uninsured periods, the insolvency of certain insurers, prior settlements with our insurers, and our expectation that certain policies from some of our primary insurers will exhaust within the next 10 years. In the tenth year of our estimate, our insurance recoveries are currently projected to be approximately 24%. Future recovery rates may be impacted by other factors, such as future insurance settlements, unforeseen insolvencies and judicial determinations relevant to our coverage program, which are difficult to predict and subject to a high degree of uncertainty.

Our estimated asbestos liability and related receivables are based on management’s best estimate of future events largely based on past experience; however, past experience may not prove a reliable predictor of the future. Future events affecting the key assumptions and other variables for either the asbestos liability or the related receivables could cause actual costs and recoveries to be materially higher or lower than currently estimated. For example, a significant upward or downward trend in the number of claims filed, depending on the nature of the alleged injury, the jurisdiction where filed and the quality of the product identification, or a significant upward or downward trend in the costs of defending claims, could change the estimated liability, as would substantial adverse verdicts at trial that withstand appeal. A legislative solution, structured settlement transaction, or significant change in relevant case law could also change the estimated liability. Further, the bankruptcy of an insurer or settlements with our insurers, whether through coverage-in-place agreements or policy buyouts, could change the estimated amount of recoveries.

Furthermore, any predictions with respect to the variables impacting our estimate of the asbestos liability and related asset are subject to even greater uncertainty as the projection period lengthens. In light of the uncertainties and variables inherent in the long-term projection of the Company’s asbestos exposures and potential recoveries, although it is probable that the Company will incur additional costs for asbestos claims filed beyond the next 10 years, we do not believe there is a reasonable basis for estimating the number of future claims, the nature of future claims, or the cost to resolve future claims for years beyond the next 10 years at this time. Accordingly, no accrual or receivable has been recorded for any costs which may be incurred for claims asserted subsequent to 2022.

 

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Due to these uncertainties, as well as our inability to reasonably estimate any additional asbestos liability for claims which may be filed beyond the next 10 years, it is not possible to predict the ultimate cost of resolving all pending and estimated unasserted asbestos claims. We believe it is possible that the future events affecting the key factors and other variables within the next 10 years, as well as the cost of asbestos claims filed beyond the next 10 years, net of expected recoveries, could have a material adverse effect on our financial statements.

As part of our ongoing review of our estimated asbestos exposure and related receivables, each quarter we assess the most recent data available underlying the key assumptions related to mesothelioma and lung cancer (e.g., claims filed, claims settled and dismissed, acceptance rates, average settlement values), comparing the data to the expectations on which the most recent annual liability and asset estimates were based. In addition to evaluating ITT’s claims experience, the Company also considers additional quantitative and qualitative factors such as significant appellate rulings and legislative developments, and their respective effects on estimated future filings and settlement values, and trends in the tort system. Our quarterly procedures also involve a review of our assumed recovery rates, considering changes in the financial wherewithal of the insurers and the effect of settlements or other agreements with insurers. Provided the quarterly review does not indicate a more detailed evaluation of our asbestos exposure is required, each quarter, we record a net asbestos expense to maintain a rolling 10-year time horizon. In the third quarter each year we conduct a detailed study with the assistance of outside consultants to review and update, as appropriate, the underlying assumptions used to estimate our asbestos liability and related assets, including a reassessment of the time horizon over which a reasonable estimate of unasserted claims can be projected.

Revenue Recognition

Revenue is derived from the sale of products and services to customers. We recognize revenue when persuasive evidence of an arrangement exists, the sales price is fixed or determinable, collectability is reasonably assured and delivery has occurred. For product sales, other than long-term construction and production-type contracts (referred to as design and build arrangements), we recognize revenue at the time title and risks and rewards of ownership pass to the customer, which is generally when products are shipped, and the contractual terms have been fulfilled. Certain contracts with customers require delivery, installation, testing, certification or other acceptance provisions to be satisfied before revenue is recognized. In instances where contractual terms include a provision for customer acceptance, revenue is recognized when either (i) we have previously demonstrated that the product meets the specified criteria based on either seller or customer-specified objective criteria or (ii) on formal acceptance received from the customer where the product has not been previously demonstrated to meet customer-specified objective criteria.

We recognize revenue on product sales to channel partners, including resellers, distributors or value-added solution providers at the time of sale when the channel partners have economic substance apart from ITT and ITT has completed its obligations related to the sale. Revenue on service and repair contracts is recognized after services have been agreed to by the customer and rendered or over the service period.

We enter into contracts to sell our products and services, and while the majority of our sales agreements contain standard terms and conditions, certain agreements contain multiple elements or non-standard terms and conditions. Where sales agreements contain multiple elements or non-standard terms and conditions, judgment is required to determine the appropriate accounting, including whether the deliverables specified in these agreements should be treated as separate units of accounting for revenue recognition purposes, and, if so, how the transaction price should be allocated among the elements and when to recognize revenue for each element.

When a sale involves multiple deliverables, the entire fee from the arrangement is allocated to each unit of accounting based on the relative selling price of the deliverable to all other deliverables in the contract. Revenue for multiple element arrangements is recognized when the appropriate revenue recognition criteria for the individual deliverable have been satisfied. The allocation of sales price between elements may impact the timing of revenue recognition, but will not change the total revenue recognized on the arrangement. For agreements that contain multiple deliverables, we recognize revenue based on the relative selling price if the deliverable has stand-alone value to the customer and, in arrangements that include a general right of return relative to the delivered element, performance of the undelivered element is considered probable and substantially in the Company’s control. The selling price for a deliverable is based on vendor-specific objective evidence of selling price (VSOE), if available, third-party evidence of selling price (TPE), if VSOE is not available, or best estimated selling price (BESP), if neither VSOE nor TPE is available.

The deliverables in our arrangements with multiple elements include various products and may include related services, such as installation and start-up services. We allocate arrangement consideration based on the relative selling prices of the separate units of accounting determined in accordance with the hierarchy described above. For deliverables that are sold separately, we establish VSOE based on the price when the deliverable is sold separately. We establish TPE, generally for services, based on prices similarly situated customers pay for similar services from third party vendors. For those deliverables for which we are unable to establish VSOE or TPE, we estimate the selling price considering various factors including market and pricing trends, geography, product customization, and profit objectives.

 

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We recognize revenue on certain design and build projects using the completed contract method. Provisions for estimated losses, if any, on uncompleted design and build arrangements, are recognized in the period in which such losses are determined. Due to the long-term nature of the contracts, these estimates are subject to uncertainties and require significant judgment and may consider historical performance, the complexity of the work to be performed, the estimated time to complete the project, and other economic factors such as inflation.

Additionally, accruals for estimated expenses related to sales returns and warranties are made at the time products are sold. Reserves for sales returns, rebates and other allowances are established using historical information on the frequency of returns for a particular product and period over which products can be returned. Future market conditions and product transitions may require us to take actions to increase customer incentive offerings, possibly resulting in a reduction in revenue at the time the incentive is offered.

For distributors and resellers, our typical return period is less than 180 days. Warranty accruals are established using historical information on the nature, frequency and average cost of warranty claims and estimates of future costs. Our standard product warranty terms generally include post-sales support and repairs or replacement of a product at no additional charge for a specified period of time. While we engage in extensive product quality programs and processes, we base our estimated warranty obligation on product warranty terms offered to customers, ongoing product failure rates, materials usage, service delivery costs incurred in correcting a product failure, as well as specific product class failures outside of our baseline experience and associated overhead costs. If actual product failure rates, repair rates or any other post-sales support costs differ from these estimates, revisions to the estimated warranty liability would be required.

Income Taxes

Deferred income tax assets and liabilities are determined based on the estimated future tax effects of differences between the financial reporting and tax bases of assets and liabilities, applying currently enacted tax rates in effect for the year in which we expect the differences will reverse. We periodically assess the likelihood that we will be able to recover our deferred tax assets and reflect any changes to our estimate of the amount we are more likely than not to realize as a valuation allowance, with a corresponding adjustment to earnings or other comprehensive income (loss), as appropriate. The ultimate realization of deferred tax assets depends on the generation of future taxable income (including the reversals of deferred tax liabilities) during the periods in which those deferred tax assets will become deductible.

The Company assesses all available positive and negative evidence regarding the realizability of its deferred tax assets. Significant judgment is required in assessing the need for any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including the future reversal of existing taxable temporary differences, taxable income in carryback periods, prudent and feasible tax planning strategies, estimated future taxable income, and whether we have a recent history of losses. The valuation allowance can be affected by changes to tax regulations, interpretations and rulings, changes to enacted statutory tax rates, and changes to future taxable income estimates.

Beginning in 2011, the Company was in a cumulative three-year loss position, which we weighted as a significant source of negative evidence indicating the need for a valuation allowance on our net deferred tax assets. Despite income in 2012, the Company continues to be in a three year cumulative loss position. Management determined that the size and frequency of the losses from continuing operations in recent years and the uncertainty associated with projecting future taxable income supported the conclusion that a valuation allowance was required to reduce its deferred tax assets. If ITT achieves profitability in future periods, then management will evaluate whether its recent history of profitability constitutes sufficient positive evidence to support a reversal of a portion, or all, of the remaining valuation allowance. In 2012, we recorded an additional valuation allowance related to U.S. deferred tax assets primarily because of a determination that it is more likely than not that the current year temporary differences expected to reverse in future years will not be realized as the Company does not expect to be able to carryback such amounts to prior years.

Our effective tax rate reflects the impact of certain undistributed foreign earnings for which we have not provided U.S. taxes because we plan to reinvest such earnings indefinitely outside the U.S. We plan foreign earnings remittance amounts based on projected cash flow needs, as well as the working capital and long-term investment requirements of our foreign subsidiaries and our domestic operations. Based on these assumptions, we estimate the amount we will distribute to the U.S. and accrue U.S. federal taxes on these planned foreign remittance amounts. Material changes in our estimates of cash, working capital and long-term investment requirements in the various jurisdictions in which we do business could impact our effective tax rate. Our provision for income taxes could be adversely impacted by changes in our geographic mix of earnings or changes in the enacted tax rates in the jurisdictions in which we conduct our business.

The calculation of our deferred and other tax balances involves significant management judgment when dealing with uncertainties in the application of complex tax regulations and rulings in a multitude of taxing jurisdictions across our global operations. The Company is routinely audited by U.S federal, state and foreign tax authorities, the results of which could result in proposed assessments against the Company. We recognize potential liabilities and record tax liabilities for anticipated tax audit issues based on our estimate of whether, and to the extent to which, additional taxes will be due. Furthermore, we recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position

 

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will be sustained on examination by the taxing authorities, based on the technical merits of the position in consideration of applicable tax statutes and related interpretations and precedents and the expected outcome of the proceedings (or negotiations) with the taxing authorities. Tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized on ultimate settlement.

We adjust our liability for uncertain tax positions in light of changing facts and circumstances; however, the ultimate resolution of a tax examination may differ from the amounts recorded in the financial statements for a number of reasons, including the Company’s decision to settle rather than litigate a matter, relevant legal precedent related to similar matters, and the Company’s success in supporting its filing positions with the tax authorities. If our estimate of tax liabilities proves different than the ultimate outcome, such differences will affect the provision for income taxes in the period in which such determination is made.

Postretirement Plans

ITT sponsors numerous defined benefit pension and other postretirement benefit plans for employees around the world (collectively, postretirement benefit plans). Postretirement benefit obligations for domestic plans are generally determined on a flat dollar benefit formula and years of service. Foreign plan benefit obligations are primarily determined based on participant years of service, future compensation, and age at retirement or termination. The determination of projected benefit obligations and the recognition of expenses related to postretirement benefit plans are dependent on various assumptions that are judgmental and developed in consultation with our actuaries and other advisors. The assumptions involved in the measurement of our postretirement benefit plan obligations and net periodic postretirement costs primarily relate to discount rates, long-term expected rates of return on plan assets, and mortality and termination rates. Actual results that differ from our assumptions are accumulated and are amortized generally over the estimated future working life of the plan participants.

Significant Assumptions

Management develops each assumption using relevant Company experience, in conjunction with market-related data for each individual country in which such plans exist. All assumptions are reviewed with external advisors and adjusted as necessary. The table included below provides the weighted average assumptions used to estimate our defined benefit pension obligations and costs as of and for the years ended 2012 and 2011.

 

     2012     2011  
      U.S.     Int’l     U.S.     Int’l  

Obligation Assumptions:

        

Discount rate

     4.1     3.1     4.8     4.8

Cost Assumptions:

        

Discount rate

     4.8     4.8     5.7     5.0

Expected return on plan assets

     8.0     4.7     9.0     4.8

The assumed discount rates reflect our expectation of the present value of expected future cash payments for benefits at the measurement date. A decrease in the discount rate increases the present value of benefit obligations and increases net periodic postretirement cost. We base the discount rate assumption on investment yields of high-quality fixed income securities at the measurement date during the benefit payment period. The discount rates were determined by considering an interest rate yield curve comprised of high quality corporate bonds, with maturities between zero and thirty years. Annual benefit payments are then discounted to present value using this yield curve to develop a single-point discount rate matching the plan’s expected payment characteristics. Our weighted average discount rate for all postretirement benefit plan obligations, including foreign affiliate plans, at December 31, 2012 is 3.9%.

We determine our expected return on plan assets by evaluating both historical returns and estimates of future returns. Specifically, we estimate future returns based on independent estimates of asset class returns weighted by the target investment allocation and evaluate historical broad market returns over long-term timeframes based on our target asset allocation, which is detailed in Note 16, “Postretirement Benefit Plans,” to the Consolidated Financial Statements. Based on this approach, our weighted average expected return on plan assets for all postretirement benefit plans, including foreign affiliate plans, at December 31, 2012 is 8.0%.

 

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Prior to the Distribution of Exelis and Xylem, the Company’s U.S. postretirement plans participated in a master trust that invested in asset classes that historically generated asset returns in excess of the expected long-term rate of return on plan assets. With the distribution of certain postretirement benefit plans and their respective plan assets to Exelis and Xylem, we developed a new target asset allocation that is expected to generate a lower level of returns on plan assets than were realized in the past. Accordingly, in 2012, we reduced our long-term expected rate of return on plan assets. For postretirement plans that participate in the current master trust and participated in the master trust distributed to Exelis, the chart below shows actual returns compared to the expected long-term returns for our U.S. postretirement plans that were utilized in the calculation of the net periodic postretirement cost for each respective year.

 

      2012     2011     2010  

Expected long-term rate of return on plan assets

     8.0     9.0     9.0

Actual rate of return on plan assets

     11.1     (3.2 )%      14.1

For the recognition of net periodic postretirement cost, the calculation of the expected return on plan assets is generally derived using a market-related value of plan assets based on average asset values at the measurement date over the last five years. The use of fair value, rather than a market-related value, of plan assets could materially affect net periodic postretirement cost.

Assumption Sensitivity

A 25 basis point increase or decrease in the expected rate of return on plan assets, discount rate, or rate of future compensation increases, would not have a material effect on 2012 net periodic postretirement cost. We estimate that every 25 basis point change in the discount rate impacts the funded status of our postretirement benefit plans by approximately $18.2. Similarly, every five percentage point change in the fair value of plan assets impacts the funded status by approximately $12.8.

Goodwill and Other Intangible Assets

We review goodwill and indefinite-lived intangible assets for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. We also review the carrying value of our finite-lived intangible assets for potential impairment when impairment indicators arise. We conduct our annual impairment tests as of the first day of the fourth quarter. When reviewing for impairment, we may opt to make an initial qualitative evaluation which considers present events and circumstances, to determine the likelihood of impairment. If the likelihood of impairment is not considered to be more likely than not, then no further testing is performed. We perform a two-step impairment test for goodwill. In the first step, we compare the estimated fair value of each reporting unit to its carrying value. If the estimated fair value of the reporting unit exceeds the carrying value of the net assets assigned to that reporting unit, goodwill is not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds its fair value, then we must perform the second step of the impairment test in order to measure the impairment loss to be recorded, if any. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference. In our annual impairment test for indefinite-lived intangible assets, we compare the fair value of those assets to their carrying value. We recognize an impairment loss when the estimated fair value of the indefinite-lived intangible asset is less than its carrying value.

We estimate the fair value of our reporting units and intangible assets with indefinite lives using an income approach, corroborated by market multiples when appropriate. Under the income approach, we calculate fair value based on the present value of estimated future cash flows.

Determining the fair value of a reporting unit or an indefinite-lived intangible asset is judgmental in nature and involves the use of significant estimates and assumptions, particularly related to future operating results and cash flows. These estimates and assumptions include, but are not limited to, revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, assumed royalty rates, future economic and market conditions and the identification of appropriate market comparable data. In addition, the identification of reporting units and the allocation of assets and liabilities to the reporting units when determining the carrying value of each reporting unit also requires judgment. Goodwill is tested for impairment at the reporting unit level, which, based on the applicable accounting guidance, is either the operating segment or one level below (e.g., the divisions of our Control Technology segment). The fair value of our reporting units and indefinite-lived intangible assets are based on estimates and assumptions that are believed to be reasonable. Significant changes to these estimates and assumptions could adversely impact our conclusions. Actual future results may differ from those estimates. Further, had different reporting units been identified or had different valuation techniques or assumptions been utilized, the results of our impairment tests could have resulted in an impairment loss, which could have been material.

The 2012 annual goodwill impairment test indicated that the fair value of each reporting unit was significantly in excess of its respective carrying value. The reporting unit with the lowest passing margin as of the 2012 goodwill impairment test had $49.0 of goodwill and had a passing margin of 41%. Accordingly, no reporting unit with significant goodwill was considered to be at risk of failing step one of the goodwill impairment test. In order to evaluate the sensitivity of the fair

 

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value estimates on the goodwill impairment test, we applied a hypothetical 100 basis point increase to the discount rates utilized, a ten percent reduction in expected future cash flows, and reduced the assumed future growth rates of each reporting unit by 100 basis points. These hypothetical changes did not result in any reporting unit failing step one of the impairment test.

Further, our 2012 annual indefinite-lived intangible asset impairment test did not result in an impairment charge as the estimated fair value of the assets significantly exceeded their carrying values. For one indefinite-lived intangible asset, we performed a qualitative assessment of the asset’s recoverability due to the significant amount by which the asset’s fair value has historically exceeded its carrying value. As a result of this assessment, it was determined that it was not more likely than not that the asset was impaired and a quantitative test was not performed.

Environmental Liabilities

We are subject to various federal, state, local and foreign environmental laws and regulations that require environmental assessment or remediation efforts. Accruals for environmental exposures 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. Significant judgment is required to determine both the likelihood of a loss and the estimated amount of loss. Engineering studies, probability techniques, historical experience and other factors are used to identify and evaluate remediation alternatives and their related costs in estimating our reserve for environmental liabilities. Our environmental reserve of $96.1 at December 31, 2012, represents management’s estimate of undiscounted costs expected to be incurred related to environmental assessment or remediation efforts, as well as related legal fees, without regard to potential recoveries from insurance companies or other third parties. Our estimated liability is reduced to reflect the participation of other potentially responsible parties in those instances where it is probable that such parties are legally responsible and financially capable of paying their respective share of the relevant costs. Our environmental accruals are reviewed and adjusted for progress of investigation and remediation efforts and as additional technical or legal information become available, such as the impact of negotiations with regulators and other potentially responsible parties, settlements, rulings, advice of legal counsel, and other current information.

We closely monitor our environmental responsibilities, together with trends in the environmental laws. Environmental remediation reserves are subject to numerous inherent uncertainties that affect our ability to estimate our share of the costs. Such uncertainties involve incomplete information regarding particular sites and other potentially responsible parties, uncertainty regarding the nature and extent of contamination at each site, the extent of remediation required under existing regulations, our share of any remediation liability, if any, widely varying cost estimates associated with potential alternative remedial approaches, the length of time required to remediate a particular site, the potential effects of continuing improvements in remediation technology, and changes in environmental standards and regulatory requirements. While environmental laws and regulations are subject to change, the nature of such change is inherently unpredictable and the timing of potential changes is uncertain. The effect of legislative or regulatory changes on environmental standards could be material to the Company’s financial statements. Additionally, violations by us of such laws and regulations, discovery of previously unknown or more extensive contamination, litigation involving environmental impacts, our inability to recover costs associated with any such developments, or financial insolvency of other potentially responsible parties could have a material adverse effect on our financial statements.

Although it is not possible to predict with certainty the ultimate costs of environmental remediation, the reasonably possible range of our estimated environmental liability at December 31, 2012 was $76.9 to $167.1.

Recent Accounting Pronouncements

See Note 2, “Recent Accounting Pronouncements,” in the Notes to the Consolidated Financial Statements for a complete discussion of recent accounting pronouncements. There were no new pronouncements which we expect to have a material impact on our financial statements in future periods.

 

ITEM  7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a result of our global operating and financing activities, we are exposed to market risks from changes in foreign currency exchange rates, interest rates, and commodity prices, which may adversely affect our operating results and financial position. The impact from changes in market conditions is generally minimized through our normal operating and financing activities. However, we may use derivative instruments, primarily forward contracts, interest rate swaps and futures contracts, to manage some of these exposures. We do not use derivative financial instruments for trading or other speculative purposes. To minimize the risk of counterparty non-performance, derivative instruments are entered into with major financial institutions and there is no significant concentration with any one counterparty. A summary of our accounting policies for derivatives is included in Note 1, “Significant Accounting Policies,” to the Consolidated Financial Statements.

 

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Foreign Currency Exchange Rate Exposures

Our foreign currency exchange rate risk relates to receipts from customers, payments to suppliers and intercompany transactions denominated in foreign currencies. In connection with the Bornemann acquisition, we assumed certain foreign currency contracts related to forecasted transactions with third-parties. As of December 31, 2012, we had a total of ten derivative contracts in place with an aggregate notional amount of $48.0 and related net fair value of $0.4. These forward contracts are all short-term in duration, generally maturing within three months from contract date. The derivative contracts offset specific risks related to receipts from customers and intercompany transaction. Our principal currency exposures relate to the Euro, Chinese Renminbi, South Korean Won, Hong Kong Dollar, Mexican Peso, British Pound, Czech Koruna, Brazilian Real, Australian Dollar and Canadian Dollar. We estimate that a hypothetical 10% adverse movement in foreign currency rates to which we are exposed would not be material to our financial statements.

Effective January 1, 2010, Venezuela was determined to be a highly inflationary economy and we changed the functional currency of our operations in Venezuela to the U.S dollar. On February 8, 2013, Venezuela announced a devaluation of the Bolivar. Given our limited presence in Venezuela, the devaluation, as well as the highly inflationary accounting treatment has not resulted in, nor is it expected to have, a material impact on our financial statements.

Interest Rate Exposures

As of December 31, 2012, we do not have a material exposure to interest rate risk as our outstanding debt is $24.8 and a significant portion is fixed rate in nature.

In connection with the Bornemann acquisition, we assumed two interest rate swaps, both of which remain outstanding at December 31, 2012. The aggregate notional of the interest rate swaps was $7.9 and their fair value was $0.2. These interest rate swap agreements modify our exposure to interest rate risk by converting a portion of the floating-rate debt to a fixed rate. Changes in the fair value of the interest rate swaps are recorded in earnings as the interest rate swaps do not qualify for hedge accounting.

We issue commercial paper, which exposes us to changes in interest rates; however, we do not have an outstanding commercial paper balance as of December 31, 2012. We do not account for our long-term debt using the fair value option.

Commodity Price Exposures

Portions of our business are exposed to volatility in the prices of certain commodities, such as steel, gold, copper, nickel, iron, aluminum and tin, as well as specialty alloys, including titanium. Our primary exposure to commodity price volatility resides with the use of these materials in purchased component parts. We generally maintain long-term fixed price contracts on raw materials and component parts; however, we are prone to exposure as these contracts expire. We evaluate hedging opportunities to mitigate or minimize the risk of operating margin erosion resulting from the volatility of commodity prices. We estimate that a hypothetical 10% adverse movement in prices for raw metal commodities would not be material to the financial statements.

 

ITEM 8.        FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Index to Consolidated Financial Statements herein.

 

ITEM 9.        CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

 

ITEM  9A.    CONTROLS AND PROCEDURES

Attached as exhibits to the Form 10-K are certifications of the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934 (Act), as amended.

(a) Evaluation of Disclosure Controls and Procedures

The Company, with the participation of various levels of management, including the CEO and CFO, conducted an evaluation of effectiveness of the design and operation of our disclosure controls and procedures (as defined in the Rules 13a-15(e) and 15d-15(e) of the Act) as of December 31, 2012. Based on such evaluation, such officers have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective.

In 2002, the Company established a Disclosure Committee with responsibility for considering and evaluating the materiality of information and reviewing disclosure obligations on a timely basis. The Disclosure Committee meets regularly and assists the CEO and the CFO in designing, establishing, reviewing and evaluating the Company’s disclosure controls and procedures.

 

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(b) Management’s Report on Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Act. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, completely, accurately and fairly reflect the transactions and dispositions of the Company’s assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with accounting principles generally accepted in the United States of America; (iii) provide reasonable assurance that Company receipts and expenditures are made only in accordance with the authorization of management and the directors of the Company, and (iv) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the Consolidated Financial Statements. Internal control over financial reporting includes the controls themselves, monitoring and internal auditing practices and actions taken to correct deficiencies as identified.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012. Management based this assessment on criteria for effective internal control over financial reporting described in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Management’s assessment included an evaluation of the design of the Company’s internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of our Board of Directors.

For purposes of evaluating internal controls over financial reporting, management determined that the internal controls of Joh. Heinr. Bornemann GmbH (Bornemann), which the Company acquired on November 28, 2012, would be excluded from the internal control assessment as of December 31, 2012, due to the timing of the closing of the acquisition and as permitted by the rules and regulations of the U.S. Securities and Exchange Commission. For the year ended December 31, 2012, Bornemann constituted 10.3% of total assets and 0.5% of total revenues of the Company.

Based on this assessment, management determined that, as of December 31, 2012, the Company maintained effective internal control over financial reporting.

The Company’s management, including the CEO and the CFO, does not expect that our internal controls over financial reporting, because of inherent limitations, will prevent or detect all errors and all fraud. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may be inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management’s assessment, included herein, should be read in conjunction with the certifications and the report issued by Deloitte & Touche LLP (Deloitte & Touche), an independent registered public accounting firm, as stated in their report, which appears subsequent to Item 9B in this Annual Report on Form 10-K.

(c) Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during the last fiscal quarter that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

 

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ITEM  9B.    OTHER INFORMATION

Disclosure pursuant to Section 219 of the Iran Threat Reduction & Syria Human Rights Act (ITRA)

This disclosure is made pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012 (“ITRA”) which added a new subsection (r) to Section 13 of the Securities Exchange Act of 1934 requiring a public reporting issuer to disclose in its annual or quarterly reports whether it or any affiliates have knowingly engaged in specified activities or transactions relating to Iran, including activities conducted outside the United States by non-U.S. affiliates in compliance with local law.

On November 28, 2012, ITT acquired all the shares of Bornemann, a manufacturer of pumps and systems utilized in the oil & gas, marine, food and pharmaceutical industries, headquartered in Germany. In accordance with U.S. regulations prohibiting business with Iran by U.S. persons and their owned or controlled non-U.S. affiliates, Bornemann agreed in connection with its acquisition by ITT to terminate all contracts with companies in Iran, which agreement was memorialized in the Share Purchase Agreement. Bornemann sent contract termination notices having immediate effect to those companies on November 28, 2012.

Following issuance of the termination notices, Bornemann received from Oil & Energy Industries Development Q. Co. (OEID), a prepayment of approximately 670,000 for future services under one of the terminated contracts. The terminated contract involved an adaption and start-up of pump systems that Bornemann had shipped prior to its acquisition by ITT.

On December 26, 2012, the Office of Foreign Assets Control of the U.S. Department of the Treasury (OFAC) issued a General License authorizing foreign subsidiaries of U.S. companies through March 8, 2013, to wind down any ongoing transactions or dealings involving Iran that would otherwise be unlawful under ITRA Section 218, which extended the U.S. sanctions against Iran to non-U.S. entities owned or controlled by U.S. companies. Pursuant to the General License, and in an effort to resolve and mitigate the issues surrounding termination of the contract, Bornemann will be performing certain wind-down services under the terminated OEID contract. Profit from these activities will not be known until the end of the first quarter of 2013. Upon expiration of the permissible wind-down period on March 8, 2013, Bornemann will not provide any goods or services in Iran or related to the terminated contract.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

ITT Corporation

White Plains, New York

We have audited the internal control over financial reporting of ITT Corporation and subsidiaries (the “Company”) as of December 31, 2012, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in Management’s Report on Internal Control Over Financial Reporting, management excluded from its assessment the internal control over financial reporting at Joh. Heinr. Bornemann GmbH (Bornemann Pumps), which was acquired on November 28, 2012 and whose financial statements constitute 10.3% of total assets and 0.5% of revenues of the consolidated financial statement amounts as of and for the year ended December 31, 2012. Accordingly, our audit did not include the internal control over financial reporting at Bornemann Pumps. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2012 of the Company and our report dated February 27, 2013 expressed an unqualified opinion on those financial statements.

 

/S/ DELOITTE & TOUCHE LLP

   
Stamford, Connecticut    

February 27, 2013

 

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PART III

 

ITEM  10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information called for by Item 10 with respect to directors is incorporated herein by reference to the portions of the definitive proxy statement for the Company’s 2012 annual meeting of shareholders to be filed pursuant to Regulation 14A of the Exchange Act set forth under the captions “1. Election of Directors,” “Information About the Board of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Report of the Audit Committee.”

The information called for by Item 10 with respect to executive officers is set forth above in Part I under the caption “Executive Officers of the Registrant.”

ITT has adopted corporate governance principles and charters for each of its standing committees. The principles address director qualification standards, election and selection of an independent presiding director, as well as responsibilities, access to management and independent advisors, compensation, orientation and continuing education, management succession principles and board and committee self-evaluation. The corporate governance principles and charters are available on the Company’s website at http://www.itt.com/investors/governance/. A copy of the corporate governance principles and charters is also available to any shareholder who requests a copy from the Company’s secretary.

ITT has also adopted a written code of ethics, the “Code of Conduct,” which is applicable to all ITT directors, officers and employees, including the Company’s Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer and other executive officers identified pursuant to this Item 10 (collectively, the Selected Officers). The Code of Conduct is available on the Company’s website at http://www.itt.com/news/publications/. In accordance with the SEC’s rules and regulations, a copy of the code was filed as an exhibit to the 2002 Form 10-K and has been posted on our website and a copy of the code is also available to any shareholder who requests it. ITT intends to disclose any changes in or waivers from its code of ethics applicable to any Selected Officer or director on its website at www.itt.com.

Pursuant to New York Stock Exchange (NYSE) Listing Company Manual Section 303A.12(a), the Company submitted a Section 12(a) CEO Certification to the NYSE in 2012. The Company also filed with the SEC, as exhibits to the Company’s current Annual Report on Form 10-K, the certifications required under Section 302 of the Sarbanes-Oxley Act for its Chief Executive Officer and Chief Financial Officer.

 

ITEM  11.    EXECUTIVE COMPENSATION

The information called for by Item 11 is incorporated herein by reference to the portions of the definitive proxy statement referred to in Item 10 set forth under the captions “Executive Compensation” and “2012 Non-Management Director Compensation.”

 

ITEM  12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information called for by Item 12 is incorporated herein by reference to the portions of the definitive proxy statement referred to in Item 10 set forth under the captions “Stock Ownership of Directors and Executive Officers,” “Beneficial Ownership of ITT Corporation Common Stock” and “Equity Compensation Plan Information.”

 

ITEM  13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

The information called for by Item 13 is incorporated herein by reference portions to the definitive proxy statement referred to in Item 10.

 

ITEM  14.    PRINCIPAL ACCOUNTING FEES AND SERVICES

The information called for by Item 14 is incorporated herein by reference to the portions of the definitive proxy statement referred to in Item 10 set forth under the caption “2. Ratification of Appointment of the Independent Registered Accounting Firm.”

 

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PART IV

 

ITEM  15.    EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as a part of this report:

 

  1. See Index to Consolidated Financial Statements appearing on page 61 for a list of the financial statements filed as a part of this report.

 

  2. See Exhibit Index beginning on pages II-3 for a list of the exhibits filed or incorporated herein as a part of this report.

 

(b) Financial Statement Schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the Consolidated Financial Statements filed as part of this report.

 

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

ITEM    PAGE  

Report of Independent Registered Public Accounting Firm

     62   

Consolidated Income Statements for the years ended December 31, 2012, 2011 and 2010

     63   

Consolidated Statements of Comprehensive Income for the years ended December 31, 2012, 2011 and 2010

     64   

Consolidated Balance Sheets as of December 31, 2012 and 2011

     65   

Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010

     66   

Consolidated Statements of Changes in Shareholders’ Equity for the years ended December  31, 2012, 2011 and 2010

     67   

Notes to Consolidated Financial Statements:

     68   

Note 1  – Description of Business, Basis of Presentation and Summary of Significant Accounting Policies

     68   

Note 2 – Recent Accounting Pronouncements

     74   

Note 3 – Acquisitions

     74   

Note 4 – Discontinued Operations

     75   

Note 5 – Company Transformation

     79   

Note 6 – Income Taxes

     80   

Note 7 – Earnings Per Share

     83   

Note 8 – Receivables, Net

     83   

Note 9 – Inventories, Net

     84   

Note 10 – Other Current and Non-Current Assets

     84   

Note 11 – Plant, Property and Equipment, Net

     84   

Note 12 – Goodwill and Other Intangible Assets, Net

     85   

Note 13 – Accrued Liabilities and Other Non-Current Liabilities

     86   

Note 14 – Leases and Rentals

     86   

Note 15 – Debt

     87   

Note 16 – Postretirement Benefit Plans

     88   

Note 17 – Long-Term Incentive Employee Compensation

     96