ITT INDUSTRIES INC - 10-Q Quarterly Report

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

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004

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

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 1-5672

ITT INDUSTRIES, INC.

INCORPORATED IN THE STATE OF INDIANA 13-5158950
(I.R.S. Employer
Identification Number)

4 WEST RED OAK LANE, WHITE PLAINS, NY 10604
(Principal Executive Office)

TELEPHONE NUMBER: (914) 641-2000

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

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]

As of October 31, 2004, there were outstanding 92,319,013 shares of common
stock ($1 par value per share) of the registrant.

ITT INDUSTRIES, INC.

TABLE OF CONTENTS

1

PART I.

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

The following unaudited consolidated condensed financial statements have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission (SEC) and, in the opinion of management, reflect all
adjustments (which include normal recurring adjustments) necessary for a fair
presentation of the financial position, results of operations, and cash flows
for the periods presented. Certain information and note disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted within the United States have been condensed or
omitted pursuant to such SEC rules. The Company believes that the disclosures
herein are adequate to make the information presented not misleading. Certain
amounts in the prior periods' consolidated condensed financial statements have
been reclassified to conform to the current period presentation. These financial
statements should be read in conjunction with the financial statements and notes
thereto included in the Company's 2003 Annual Report on Form 10-K.

ITT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED INCOME STATEMENTS
(IN MILLIONS, EXCEPT PER SHARE)
(UNAUDITED)

- ---------------

The accompanying notes to consolidated condensed financial statements are an
integral part of the above income statements.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS
(IN MILLIONS, EXCEPT FOR SHARES AND PER SHARE)
(UNAUDITED)

- ---------------

The accompanying notes to consolidated condensed financial statements are an
integral part of the above balance sheets.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)

- ---------------

The accompanying notes to consolidated condensed financial statements are an
integral part of the above cash flow statements.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

1) RECEIVABLES, NET

Net receivables consist of the following:

2) INVENTORIES, NET

Net inventories consist of the following:

3) PLANT, PROPERTY AND EQUIPMENT, NET

Net plant, property and equipment consist of the following:

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

4) SALES AND REVENUES AND COSTS OF SALES AND REVENUES

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

The Defense Electronics & Services segment comprises $284.3 and $768.7 of
total service revenues for the three and nine months ended September 30, 2004,
respectively, and $199.0 and $530.7 of total costs of service revenues,
respectively, during the same period. The Fluid Technology segment comprises the
remaining balances of service revenues and costs of service revenues.

The Defense Electronics & Services segment comprises $207.3 and $587.1 of
total service revenues for the three and nine months ended September 30, 2003,
respectively, and $136.6 and $386.9 of total costs of service revenues,
respectively, during the same period. The Fluid Technology segment comprises the
remaining balances of service revenues and costs of service revenues.

5) COMPREHENSIVE INCOME

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

6) EARNINGS PER SHARE

The following is a reconciliation of the shares used in the computation of
basic and diluted earnings per share for the three and nine months ended
September 30, 2004 and 2003:

The amounts of outstanding antidilutive common stock options excluded from
the computation of diluted earnings per share for the three months and nine
months ended September 30, 2004 were 0.1 and 0.0, respectively. The amount of
antidilutive restricted common stock excluded from the computation of diluted
earnings per share for the three months and nine months ended September 30, 2004
was 0.1.

The amounts of outstanding antidilutive common stock options excluded from
the computation of diluted earnings per share for the three months and nine
months ended September 30, 2003 were 0.0 and 1.7, respectively.

7) STOCK-BASED EMPLOYEE COMPENSATION

At September 30, 2004, the Company has one stock-based employee
compensation plan for issuing new stock options and restricted shares. The
Company also has one stock-based employee compensation plan and two stock-based
non-employee directors compensation plans that have stock options and restricted
shares outstanding; however no new awards will be granted under these plans.
These plans are described more fully in Note 20, "Shareholders' Equity," within
the Notes to Consolidated Financial Statements of the 2003 Annual Report on Form
10-K. The Company accounts for these plans under the recognition and measurement
principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees,"
and related interpretations. Had compensation expense for these plans been
determined based on the fair value recognition provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensa-

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

tion," the Company's net income and earnings per share would have been reduced
to the following pro forma amounts:

The pro forma diluted earnings per share calculations for the three months
and nine months ended September 30, 2004 were computed using diluted average
common shares of 94.0 and 94.1, respectively. The pro forma diluted earnings per
share calculations for the three months and nine months ended September 30, 2003
were computed using diluted average common shares of 94.3 and 94.0,
respectively.

The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model and the following weighted-average
assumptions for grants in the three months and nine months ended September 30,
2004 and 2003:

The value of stock-based compensation that was recognized in selling,
general and administrative expenses within the Consolidated Condensed Income
Statements during the three month and nine month periods ended September 30,
2004 and 2003 was:

8) RESTRUCTURING AND ASSET IMPAIRMENT CHARGES

2004 RESTRUCTURING ACTIVITIES

During the third quarter of 2004, the Company recognized a $5.7 charge,
primarily for the planned severance of 76 employees, idle facility costs and
movement of production. The actions by segment are as follows:

- The Fluid Technology segment recorded $3.3 for the planned termination of
36 employees, including nine factory workers, 23 office workers and four
management employees. Other costs totaling $0.2 were also recognized
during the quarter.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

- The Motion & Flow Control segment recognized $0.5 for the planned
termination of 30 employees, including 23 factory workers and seven
office workers. The segment also recorded $0.6 for relocation and moving
costs.

- The Electronic Components segment recorded $0.4 for the planned
termination of ten employees. The terminations include eight office
workers and two management employees. The segment also recorded a $0.7
charge primarily for costs associated with moving two product lines from
Weinstadt, Germany to Shenzhen, China and one product line from Santa
Ana, CA to Nogales, Mexico and idle facility costs.

In addition to the restructuring actions announced during the third
quarter, the Motion & Flow Control segment recognized $0.1 of severance and
employee benefit costs related to actions announced during the first quarter of
2003 and $0.1 of previous restructuring charges were reversed.

During the second quarter of 2004, the Company recognized a $13.9 charge,
primarily for the planned severance of 430 employees and the recognition of
lease cancellation fees. The actions by segment are as follows:

- The Electronic Components segment recorded $4.5 of the charge for the
recognition of lease cancellation costs. Severance of $1.2 was recorded
for the planned reduction of 340 employees. The terminations include 273
factory workers, 64 office workers and three management employees. The
segment also recorded a $1.1 charge for the disposal of machinery and
equipment.

- The Fluid Technology segment recorded $2.4 for the planned termination of
45 employees, including eight factory workers and 37 office workers.
Lease commitments totaling $0.7 were recognized related to the closure of
two facilities (one in Sweden and one in Florida). Asset write-offs and
other costs totaling $0.2 and $0.1, respectively, were also recognized
during the quarter.

- The Motion & Flow Control segment recognized $2.1 for the planned
termination of 44 employees, including seven factory workers, 32 office
workers and five management employees.

- Corporate headquarters recorded $1.6 for the severance of one management
employee.

In addition to the restructuring actions announced during the second
quarter, the Motion & Flow Control segment recognized $0.3 of severance and
employee benefit costs related to actions announced during the first quarter of
2003 and the Electronic Components segment recognized $0.3 of severance and
employee benefit costs related to actions announced during the first quarter of
2004 and $0.1 of outplacement related to actions announced in 2003.

During the first quarter of 2004, the Company recognized a $5.3 charge,
primarily for the planned severance of 103 employees. The actions by segment are
as follows:

- The Fluid Technology segment recorded $2.7 for the planned termination of
50 employees, including 15 factory workers and 35 office workers. Asset
write-offs and other costs totaling $0.4 and $0.1, respectively, were
also recognized during the quarter.

- The Electronic Components segment recorded $1.7 of the charge primarily
for the planned reduction of 35 employees, including 23 factory workers,
11 office workers and one management employee.

- The Motion & Flow Control segment recognized $0.2 for the planned
termination of 16 employees, including three factory workers and 13
office workers.

- Corporate headquarters recorded $0.2 for the planned severance of one
office worker and one management employee.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

2003 RESTRUCTURING ACTIVITIES

During the fourth quarter of 2003 the Company announced actions to reduce
operating costs primarily through the reduction of headcount. The $15.4
restructuring charge primarily reflects the planned severance of 301 employees.
The actions by segment are as follows:

- The Electronic Components segment recorded $1.5 of the charge for the
planned termination of 132 employees, including 113 factory workers, 14
office workers and five management employees.

- The Fluid Technology segment recognized $12.4 of the charge for the
planned severance of 134 employees, including 39 factory workers, 90
office workers and five management employees. Lease and other costs
represent $0.3 of the charge. The segment also recorded a $0.2 charge
associated with the disposal of machinery and equipment.

- The Defense Electronics & Services segment recorded a $1.0 charge for the
planned severance of 35 employees, including seven factory workers, 19
office workers and nine management employees.

In addition to the restructuring actions announced during the fourth
quarter, the Motion & Flow Control segment recognized $0.5 of severance and
employee benefit costs related to actions announced during the first quarter and
the Electronic Components segment recognized $0.2 of outplacement related to
actions announced earlier in 2003.

During the third quarter of 2003 the Company announced actions to reduce
operating costs primarily through the reduction of headcount. The $2.6
restructuring charge primarily reflects the planned severance of 72 employees.
The actions by segment are as follows:

- The Electronic Components segment recorded $1.2 of the charge for the
planned termination of 40 employees, including 15 factory workers and 25
office workers. The segment also recorded a $0.1 charge associated with
the disposal of machinery and equipment.

- The Fluid Technology segment recognized a $0.5 charge for the planned
severance of 13 factory workers and 14 office workers. Lease and other
costs represent $0.4 of the charge.

- The Motion & Flow Control segment recorded a $0.4 charge for the planned
severance of one management employee and four office workers.

In addition to the restructuring actions announced during the third
quarter, the Motion & Flow Control segment recognized $0.2 of severance and
employee benefit costs related to actions announced during the first quarter.

During the second quarter of 2003 the Company continued its program to
reduce structural costs and increase profitability. Restructuring actions
totaling $4.7 were announced during the period. The charge primarily reflected
the planned severance of 148 employees and the cancellation of an operating
lease. The actions by segment are as follows:

- The Electronic Components segment comprises $2.7 of the charge and the
actions taken at this segment include the planned termination of six
management employees, 19 factory workers and 71 office workers.

- The Motion & Flow Control segment recognized $1.0 for the planned
severance of 50 employees, including six management employees, 31 factory
workers and 13 office workers. Lease termination fees of $0.7 and asset
disposal costs of $0.1 were also reflected in the charge.

- At Corporate Headquarters, a charge of $0.2 was recorded for the planned
termination of one management employee and one office worker.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

In addition to the restructuring actions announced during the second
quarter, the Motion & Flow Control segment recognized $1.2 of severance and
employee benefit costs related to actions announced during the first quarter.

During the first quarter of 2003 the Company recorded a $9.0 restructuring
charge primarily for the planned severance of 465 persons. Severance of $8.3
represents the majority of the charge. The actions by segment are as follows:

- The Electronic Components segment recorded $6.8 of the charge for the
planned termination of 226 persons, comprised of 101 office workers, 116
factory workers and nine management employees. Idle facility costs of
$0.3 and asset disposal costs of $0.4 were also reflected in the charge.
The actions were prompted by management's projections of continued
weakness in certain businesses.

- Corporate Headquarters recorded $1.1 of the charge for the consolidation
of administrative tasks, including the planned termination of two
management employees.

- The Motion & Flow Control segment recorded $0.4 of the charge for the
planned termination of 237 employees, comprised of 21 office workers and
216 factory workers. The charge relates to the closure of a manufacturing
facility in Arkansas. The actions will be completed during 2003 and 2004
and the total estimated charge of approximately $2.7 will be recognized
ratably over the restructuring period as the terminations become
effective. Management deemed the restructuring actions necessary to
address the anticipated loss of certain platforms during the second half
of 2003.

2003 OTHER ASSET IMPAIRMENTS

During 2003, the Company recorded a $1.4 asset impairment charge primarily
for a technology license that will not be utilized based on management's
projections of future market conditions. The applicable assets were written down
to their fair values based on management's comparison of projected future
discounted cash flows generated by each asset to the applicable asset's carrying
value. These impairments were unrelated to the Company's restructuring
activities.

The following is a rollforward of the accrued cash restructuring balances
for all restructuring plans.

During the third quarter of 2004, $0.1 of restructuring accruals related to
a 2004 restructuring action was reversed into income.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

During the second quarter of 2004, $0.1 and $0.2 of restructuring accruals
related to 2003 and 2002 restructuring actions, respectively, were reversed into
income. The reversals related to the 2003 actions primarily reflect lower than
anticipated severance costs on completed actions at the Electronic Components
segment. The reversals related to the 2002 actions represent lower than
anticipated severance costs on completed actions at the Fluid Technology
segment.

During the first quarter of 2004, $0.2 and $0.4 of restructuring accruals
related to 2003 and 2001 restructuring actions, respectively, were reversed into
income. The reversals related to the 2003 actions primarily reflect lower than
anticipated severance costs on completed actions due to favorable employee
attrition at the Electronic Components segment. The reversals associated with
the 2001 actions represent lower than anticipated closed facility costs.

At December 31, 2003, the accrual balance for restructuring activities was
$20.1. Cash payments of $24.3 and additional cash charges of $24.0 were recorded
in the first nine months of 2004. The accrual balance related to cash charges at
September 30, 2004 is $18.4, which includes $11.7 for severance and $6.7 for
facility carrying costs and other.

As of December 31, 2003, remaining actions under restructuring activities
announced in 2003, 2002 and 2001 were to close one facility and reduce headcount
by 208. During the first nine months of 2004, the Company reduced headcount by
765 persons related to all plans and experienced employee attrition, leaving a
balance of 47 planned reductions. Actions announced during the third quarter of
2004 will be substantially completed by the end of 2004. Actions announced
during the second quarter of 2004 will be substantially completed by the end of
the first quarter of 2005. Actions announced during the first quarter of 2004
are substantially completed. Actions announced during 2003 will be substantially
completed by the end of 2004. All of the actions contemplated under the 2002 and
2001 plans were substantially completed in 2003. Closed facility expenditures
and severance run-off related to the 2001 plan will continue to be incurred in
2004.

9) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The nature of the Company's business activities necessarily involves the
management of various financial and market risks, including those related to
changes in interest rates, currency exchange rates, and commodity prices. As
discussed more completely in Notes 1, "Accounting Policies", and 18, "Financial
Instruments," within the Notes to Consolidated Financial Statements of the 2003
Annual Report on Form 10-K, the Company uses derivative financial instruments to
mitigate or eliminate certain of those risks.

At September 30, 2004 and December 31, 2003, the values of the Company's
interest rate swaps were $89.5 and $81.6, including $7.5 and $4.0 of accrued
interest, respectively.

A reconciliation of current period changes contained in the accumulated
other comprehensive loss component of shareholders' equity is not required as no
material activity occurred during the first nine months of 2004 and 2003.
Additional disclosures required by SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended, are presented below.

HEDGES OF FUTURE CASH FLOWS

At September 30, 2004 the Company had four foreign currency cash flow
hedges outstanding that had no change in value during 2004. At December 31, 2003
the Company had no foreign currency cash flow hedges outstanding. There were no
changes in the forecasted transactions during 2004 regarding their probability
of occurring that would require amounts to be reclassified to earnings.

The notional amount of the foreign currency forward contracts utilized to
hedge cash flow exposures was $1.0 at September 30, 2004. The applicable fair
value of these contracts at September 30, 2004 was

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

approximately zero. There were no ineffective portions of changes in fair values
of cash flow hedge positions reported in earnings for the nine months ended
September 30, 2004 and 2003, and no amounts were excluded from the measure of
effectiveness reported in earnings during these periods.

HEDGES OF RECOGNIZED ASSETS, LIABILITIES AND FIRM COMMITMENTS

At September 30, 2004 and December 31, 2003, the Company had foreign
currency forward contracts with notional amounts of $76.1 and $81.1,
respectively, to hedge the value of recognized assets, liabilities and firm
commitments. The fair value of the 2004 and 2003 contracts were approximately
zero and $0.2 at September 30, 2004 and December 31, 2003, respectively. The
ineffective portion of changes in fair values of such hedge positions reported
in operating income during the first nine months of 2004 and 2003 amounted to
$(0.3) and $(0.2), respectively. There were no amounts excluded from the measure
of effectiveness.

The fair values associated with the foreign currency contracts have been
valued using the net position of the contracts and the applicable spot rates and
forward rates as of the reporting date.

10) GOODWILL AND OTHER INTANGIBLE ASSETS

The Company follows the provisions of Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets," which requires that
goodwill and indefinite-lived intangible assets be tested for impairment on an
annual basis, or more frequently if circumstances warrant. Annual goodwill
impairment tests were completed in the first quarters of 2004 and 2003 (as of
the beginning of the year) and it was determined that no impairment exists.

Changes in the carrying amount of goodwill for the nine months ended
September 30, 2004, by business segment, are as follows:

Information regarding the Company's other intangible assets follows:

During the first quarter of 2004, the Company completed the acquisition of
Wedeco AG Water Technology ("Wedeco"). The acquisition of Wedeco resulted in the
recognition of $194.8 of goodwill, $23.1

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

of intangibles for trade names and $46.0 for patents and customer relationships.
During the third quarter of 2004, the Company completed the acquisition of
Remote Sensing Systems. This acquisition preliminarily resulted in the
recognition of $616.1 of goodwill, $120.0 of intangible assets related to
customer relationships and $4.9 of other intangible assets.

Amortization expense related to intangible assets for the nine month
periods ended September 30, 2004 and 2003 was $4.8 and $2.0, respectively.
Estimated amortization expense for each of the five succeeding years is as
follows:

11) DISCONTINUED OPERATIONS

In September of 1998, the Company completed the sales of its automotive
Electrical Systems business to Valeo SA for approximately $1,700 and its Brake
and Chassis unit to Continental AG of Germany for approximately $1,930. These
dispositions were treated as discontinued operations. In 1998, the Company
received notifications of claims from the buyers of the automotive business
requesting post-closing adjustments to the purchase prices under the provisions
of the sales agreements. In 1999, those claims were submitted to arbitration. In
2001 and early in 2002, both claims were favorably resolved.

At September 30, 2004, the Company had automotive discontinued operations
accruals of $186.0 that are primarily related to taxes ($154.1), product recalls
($7.8), environmental obligations ($14.2) and employee benefits ($9.9). In 2004,
the Company made immaterial payments of its automotive discontinued operations
liabilities. The Company expects that it will cash settle $154.1 of tax
obligations in late 2004 or 2005.

12) PENSION AND POSTRETIREMENT MEDICAL BENEFIT EXPENSES

The components of net periodic pension cost consisted of the following:

Net periodic pension cost increased in the first nine months of 2004 as a
result of the lower discount rate adopted at year-end 2003, higher average
foreign exchange rates, lower expected returns on assets as a result of the
operation of the asset smoothing method reflecting adverse financial experience
in 2002 and 2001 and a higher amortization of actuarial losses.

The Company contributed approximately $16.7 to its various plans during the
third quarter of 2004 and $123.1 for the first nine months of 2004. Additional
contributions totaling between $2.0 and $5.0 are expected over the balance of
2004.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

The components of net periodic postretirement cost consisted of the
following:

Net periodic postretirement cost decreased in the first nine months of 2004
as a result of the higher than expected return on invested assets and lower than
expected benefit payments during 2003.

In January 2004, FASB Staff Position ("FSP") No. 106-1, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003" ("FSP No. 106-1") was issued. Subsequently, FSP
No. 106-2 was issued, which amends FSP No. 106-1 and discusses the recognition
of the effects for the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 (the Act) in the accounting for postretirement health care plans
under SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions," and in providing disclosures related to the plan required by
SFAS No. 132. The Company adopted this pronouncement effective July 1, 2004, but
is unable to conclude whether benefits of its plans are actuarially equivalent
and shall measure any effects of the Act at the next measurement date for plan
assets and obligations. See Note 19, "Employee Benefit Plans," in the Notes to
Consolidated Financial Statements of the 2003 Annual Report on Form 10-K for
discussion of postretirement benefits.

13) COMMITMENTS AND CONTINGENCIES

The Company and its subsidiaries from time to time are involved in legal
proceedings that are incidental to the operation of their businesses. Some of
these proceedings allege damages against the Company relating to environmental
liabilities, intellectual property matters, copyright infringement, personal
injury claims, employment and pension matters, government contract issues and
commercial or contractual disputes, sometimes related to acquisitions or
divestitures. The Company will continue to vigorously defend itself against all
claims. Although the ultimate outcome of any legal matter cannot be predicted
with certainty, based on present information including the Company's assessment
of the merits of the particular claim, as well as its current reserves and
insurance coverage, the Company does not expect that such legal proceedings will
have any material adverse impact on the cash flow, results of operations, or
financial condition of the Company on a consolidated basis in the foreseeable
future.

ENVIRONMENTAL

The Company has accrued for environmental remediation costs associated with
identified sites consistent with the policy set forth in Note 1, "Accounting
Policies" in the Notes to Consolidated Financial Statements of the 2003 Annual
Report on Form 10-K. In management's opinion, the total amount accrued and
related receivables are appropriate based on existing facts and circumstances.
It is difficult to estimate the total costs of investigation and remediation due
to various factors, including incomplete information regarding particular sites
and other potentially responsible parties, uncertainty regarding the extent of
contamination and the

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

Company's share, if any, of liability for such conditions, the selection of
alternative remedies, and changes in clean-up standards. In the event that
future remediation expenditures are in excess of amounts accrued, management
does not anticipate that they will have a material adverse effect on the
consolidated financial position, results of operations or cash flows.

In the ordinary course of business, and similar to other industrial
companies, the Company is subject to extensive and changing federal, state,
local, and foreign environmental laws and regulations. The Company has received
notice that it is considered a potentially responsible party ("PRP") at a
limited number of sites by the United States Environmental Protection Agency
("EPA") and/or a similar state agency under the Comprehensive Environmental
Response, Compensation and Liability Act ("CERCLA" or "Superfund") or its state
equivalent. As of September 30, 2004, the Company is responsible, or is alleged
to be responsible, for approximately 100 environmental investigation and
remediation sites in various countries. In many of these proceedings, the
Company's liability is considered de minimis. At September 30, 2004, the Company
calculated a best estimate of $101.6, which approximates its accrual, related to
the cleanup of soil and ground water. The low range estimate for its
environmental liabilities is $77.2 and the high range estimate for those
liabilities is $165.1. On an annual basis the Company spends between $8.0 and
$11.0 on its environmental remediation liabilities. These estimates, and related
accruals, are reviewed periodically and updated for progress of remediation
efforts and changes in facts and legal circumstances. Liabilities for
environmental expenditures are recorded on an undiscounted basis.

The Company is involved in an environmental proceeding in Glendale,
California relating to the San Fernando Valley aquifer. The Company is one of
numerous PRPs who are alleged by the EPA to have contributed to the
contamination of the aquifer. In January 1999, the EPA filed a complaint in the
United States District Court for the Central District of California against the
Company and Lockheed Martin Corporation, United States v. ITT Industries, Inc.
and Lockheed Martin Corp. CV99-00552 SVW AIJX, to recover costs it incurred in
connection with the foregoing. In May 1999, the EPA and the PRPs, including the
Company and Lockheed Martin, reached a settlement, embodied in a consent decree,
requiring the PRPs to perform additional remedial activities. Pursuant to the
settlement, the PRPs, including the Company, have constructed and are operating
a water treatment system. The operation of the water treatment system is
expected to continue until 2013. ITT and the other PRPs continue to pay their
respective allocated costs of the operation of the water treatment system and
the Company does not anticipate a default by any of the PRPs which would
increase its allocated share of the liability. As of September 30, 2004, the
Company's accrual for this liability was $10.4 representing its best estimate;
its low estimate for the liability is $7.0 and its high estimate is $15.9.

ITT Corporation operated a facility in Madison County, Florida from 1968
until 1991. In 1995, elevated levels of contaminants were detected at the site.
Since then, ITT has completed the investigation of the site in coordination with
state and federal environmental authorities and is in the process of evaluating
various remedies. A remedy for the site has not yet been selected. Currently,
the estimated range for the remediation is between $5.8 and $19.7. The Company
has accrued $8.3 for this matter, which approximates its best estimate.

The Company is involved with a number of PRPs regarding property in the
City of Bronson, Michigan operated by a former subsidiary of ITT Corporation,
Higbie Manufacturing, prior to the time ITT acquired Higbie. The Company and
other PRPs are investigating and remediating discharges of industrial waste
which occurred in the 1930's. The Company's current estimates for its exposure
are between $6.2 and $13.9. It has an accrual for this matter of $9.5 which
represents its best estimate of its current liabilities. The Company does not
anticipate a default on the part of the other PRPs.

In a suit filed in 1991 by the Company, in the California Superior Court,
Los Angeles County, ITT Corporation, et al. v. Pacific Indemnity Corporation et
al., against its insurers, the Company is seeking
18

ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

recovery of costs it incurred in connection with its environmental liabilities
including the three listed above. Discovery, procedural matters, changes in
California law, and various appeals have prolonged this case. Currently, the
matter is before the California Court of Appeals from a decision by the
California Superior Court dismissing certain claims of the Company. The
dismissed claims were claims where the costs incurred were solely due to
administrative (versus judicial) actions. A hearing is expected in 2005. In the
event the appeal is successful, the Company will pursue the administrative
claims against its excess insurers. During the course of the litigation the
Company has negotiated settlements with certain defendant insurance companies
and is prepared to pursue its legal remedies where reasonable negotiations are
not productive. A portion of the recoveries from the insurance settlements have
been placed in a trust and are used to reimburse the Company for its
environmental costs.

PRODUCT LIABILITY

The Company and its subsidiary Goulds Pumps, Inc. ("Goulds") have been
joined as defendants with numerous other industrial companies in product
liability lawsuits alleging injury due to asbestos. These actions against the
Company have been managed by our historic product liability insurance carriers.
These claims stem primarily from products sold prior to 1985 that contained a
part manufactured by a third party, e.g., a gasket, which allegedly contained
asbestos. The asbestos was encapsulated in the gasket (or other) material and
was non-friable. In certain other cases, it is alleged that former ITT companies
were distributors for other manufacturers' products that may have contained
asbestos.

Frequently, the plaintiffs are unable to demonstrate any injury or do not
identify any ITT or Goulds product as a source of asbestos exposure. During
2003, ITT and Goulds resolved approximately 2,000 claims through settlement or
dismissal. The average amount of settlement per plaintiff has been nominal and
substantially all defense and settlement costs have been covered by insurance.
Based upon past claims experience, available insurance coverage, and after
consultation with counsel, management believes that these matters will not have
a material adverse effect on the Company's consolidated financial position,
results of operations, or cash flows.

The Company is involved in a matter, Cannon Electric, Inc. et al. v. Ace
Property & Casualty Company et al., Superior Court, County of Los Angeles, CA.,
Case No. BC 290354. A related suit filed in New York, Pacific Employers
Insurance Company et al. v. ITT Industries, Inc. et al., Supreme Court, County
of New York, N.Y., Case No. 03600463 has been stayed in deference to the
California suit. The parties in both cases are seeking an appropriate allocation
of responsibility for the Company's historic asbestos liability exposure among
its insurers. The California action is filed in the same venue where the
Company's environmental insurance recovery litigation has been pending since
1991. In April 2004, the Company and Ace Property & Casualty Company entered
into an agreement resolving both cases as they relate to Ace Property & Casualty
Company. The Company will pursue similar agreements with several of its other
insurers. In addition, Utica National, Goulds' historic insurer, filed an action
in Oneida County, New York (Utica Mutual Insurance Co. v. Goulds Pumps, Inc.,
Oneida County, New York, Case No. 00272103), to allocate the Goulds asbestos
liabilities between insurance policies issued by Utica and those issued by
others. The venue for this matter has been changed to the County of Los Angeles
and consolidated with the above matter. The parties are currently considering a
settlement agreement similar to the Ace agreement. The Company is continuing to
receive the benefit of insurance payments during the pendency of these
proceedings. The Company believes that these actions will not materially affect
the availability of its insurance coverage and will not have a material adverse
effect on the Company's consolidated financial position, results of operations
or cash flows.

The Company is one of several defendants in a suit filed in El Paso, Texas,
Bund zur Unterstutzung Radargeschadigter et al. v. ITT Industries, Inc. et al.,
Sup. Ct., El Paso, Texas, C.A. No. 2002-4730. This Complaint, filed by both U.S.
and German citizens, alleges that ITT and four other major companies failed to

19

ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

warn the plaintiffs of the dangers associated with exposure to x-ray radiation
from radar devices. The Complaint also seeks the certification of a class of
similarly injured persons. On October 5, 2004, the Company filed an action, ITT
Industries, Inc. et al. v. Fireman's Fund Insurance Company et al., Superior
Court, County of Los Angeles, BC 322546, against various insurers who issued
historic aircraft products coverage to the Company seeking a declaration that
each is liable for the costs of defense of the El Paso matter. Management
believes that this matter will not have a material adverse effect on the
Company's consolidated financial position, results of operations or cash flows.

The Company is involved in a product liability suit filed in Superior Court
of New York, Danis v. Rule Industries et al., Sup. Ct. N.Y., C.A. No. 115975-02,
seeking damages for injuries sustained in a boat explosion. In October 2004, the
Company favorably resolved this matter.

The Company has received demands from U.S. Silica for partial indemnity
regarding personal injury actions alleging injury due to silica. In 1985, the
Company sold the stock of its subsidiary Pennsylvania Glass Sand to U.S. Silica.
As part of that transaction, the Company provided an indemnity to U.S. Silica
for silica personal injury suits. That indemnity expires in September 2005.
Costs incurred in these matters related to the defense, settlements or judicial
awards are allocated between U.S. Silica and the Company. The Company's
allocated portion is paid in part by its historic product liability carriers and
then shared pursuant to the Distribution Agreement. See "Company History and
Certain Relationships" within Part I, Item 1 of the 2003 Annual Report on Form
10-K for a description of the Distribution Agreement. Management believes that
these matters will not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.

OTHER

The Company is involved in an arbitration with Rayonier, Inc., a former
subsidiary of the Company's predecessor ITT Corporation. The arbitration
involves a claim by Rayonier stemming from the 1994 Distribution Agreement for
the spinoff of Rayonier by ITT Corporation. Rayonier seeks a portion of the
proceeds from certain settlements in connection with the Company's environmental
insurance recovery litigation. The Company believes the claim is grossly
overstated and will not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.

14) GUARANTEES, INDEMNITIES AND WARRANTIES

GUARANTEES & INDEMNITIES

In September of 1998, the Company completed the sale of its automotive
electrical systems business to Valeo SA for approximately $1,700. As part of the
sale, the Company provided Valeo SA with representations and warranties with
respect to the operations of the Business, including: Conveyance of Title,
Employee Benefits, Tax, Product Liability, Product Recall, Contracts,
Environmental, Intellectual Property, etc. The Company also indemnified Valeo SA
for losses related to a misrepresentation or breach of the representations and
warranties. With a few limited exceptions, the indemnity periods within which
Valeo SA may assert new claims have expired. Under the terms of the sales
contract, the original maximum potential liability to Valeo SA on an
undiscounted basis is $680. However, because of the lapse of time, or the fact
that the parties have resolved certain issues, at September 30, 2004 the Company
has an accrual of $7.8 which is its best estimate of the potential exposure.

In September of 1998, the Company completed the sale of its brake and
chassis unit to Continental AG for approximately $1,930. As part of the sale,
the Company provided Continental AG with representations and warranties with
respect to the operations of that Business, including: Conveyance of Title,
Employee Benefits, Tax, Product Liability, Product Recall, Contracts,
Environmental, Intellectual Property, etc. The Company also indemnified
Continental AG for losses related to a misrepresentation or breach of the
representations and

20

ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

warranties. With a few limited exceptions, the indemnity periods within which
Continental AG may assert new claims have expired. Under the terms of the sales
contract, the original maximum potential liability to Continental AG on an
undiscounted basis is $950. However, because of the lapse of time, or the fact
that the parties have resolved certain issues, at September 30, 2004 the Company
has an accrual of $14.2 which is its best estimate of the potential exposure.

Since its incorporation in 1920, the Company has 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. The Company does not have a liability recorded for the historic
indemnifications and is not aware of any claims or other information that would
give rise to material payments under such indemnities. The Company has
separately discussed material indemnities provided within the last eight years.

The Company provided three guarantees with respect to its real estate
development activities in Flagler County, Florida. Two of these guarantee bonds
were issued by the Dunes Community Development District (the District). The bond
issuances were used primarily for the construction of infrastructure, such as
water and sewage utilities and a bridge. The Company has been released from its
obligation to perform under both of these guarantees in the third quarter of
2004. The third guarantee is a performance bond in the amount of $10.0 in favor
of Flagler County, Florida. The Company would be required to perform under this
guarantee if certain parties did not satisfy all aspects of the development
order, the most significant aspect being the expansion of a bridge. The maximum
amount of the undiscounted future payments on the third guarantee equals $10.0.
At September 30, 2004, the Company has an accrual related to the expansion of a
bridge in the amount of $10.0.

In December of 2002, the Company entered into a sales-type lease agreement
for its corporate aircraft and then leased the aircraft back under an operating
lease agreement. The Company has provided, under the agreement, a residual value
guarantee to the counterparty in the amount of $44.8, which is the maximum
amount of undiscounted future payments. The Company would have to make payments
under the residual value guarantee only if the fair value of the aircraft was
less than the residual value guarantee upon termination of the agreement. At
September 30, 2004, the Company does not believe that a loss contingency is
probable and therefore does not have an accrual recorded in its financial
statements.

PRODUCT WARRANTIES

Accruals for estimated expenses related to warranties are made at the time
products are sold or services are rendered. These accruals are established using
historical information on the nature, frequency, and average cost of warranty
claims. The Company warrants numerous products, the terms of which vary widely.
In general, the Company warrants its products against defect and specific
nonperformance. In the automotive businesses, liability for product defects
could extend beyond the selling price of the product and could be significant if
the defect shuts down production or results in a recall. At September 30, 2004,
the Company has a product warranty accrual in the amount of $33.7.

PRODUCT WARRANTY LIABILITIES

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

15) ACQUISITIONS

2004 ACQUISITIONS

On August 13, 2004, the Company purchased all of the Remote Sensing Systems
("RSS") business from Eastman Kodak Company for $728.8 in cash. The RSS business
is a leading supplier of high resolution satellite imaging systems and
information services. Management believes that the acquisition of RSS will
enhance the Company's competitive position in the space payload and service
product offering industry and create a full spectrum provider with the latest
visible and infrared satellite imaging technology in the remote sensing market.

The excess of the purchase price of RSS over the fair value of net assets
acquired of $616.1 was recorded as goodwill and is reflected in the Defense
Electronics & Services segment. The Company has preliminarily assigned values to
the assets and liabilities of RSS; however, the allocation is subject to further
refinement.

The Company also spent $265.8 primarily for the following acquisitions
completed in 2004:

- WEDECO AG Water Technology ("WEDECO"), the world's largest manufacturer
of UV disinfection and ozone oxidation systems, which are alternatives to
chlorine treatment.

- Allen Osborne Associates, a leader in the development of global
positioning system receivers for both portable and fixed sites.

- Shanghai Hengtong Purified Water Development Co. Ltd. and Shanghai
Hengtong Water Treatment Engineering Co. Ltd. ("Hengtong"), a
Shanghai-based producer of reverse-osmosis, membrane and other water
treatment systems for the power, pharmaceutical, chemical and
manufacturing markets in China.

The excess of the purchase price over the fair value of net assets acquired
of $201.0 was recorded as goodwill, of which $196.0 and $5.0 are reflected in
the Fluid Technology and Defense Electronics & Services segments, respectively.

PRO FORMA RESULTS

The following unaudited pro forma financial information presents the
combined results of operations of the Company and RSS as if RSS was acquired on
January 1, 2004 and 2003. The pro forma results presented below for the three
and nine months ended September 30, 2004 combine the results of the Company for
the three and nine months ended September 30, 2004 and the historical results of
RSS from July 1, 2004 to August 12, 2004 and from January 1, 2004 to August 12,
2004, respectively. The pro forma results presented below for the three and nine
months ended September 30, 2003 combine the results of the Company for the three
and nine months ended September 30, 2003 and the historical results of RSS for
the three and nine months ended September 30, 2003. The unaudited pro forma
financial information is not intended to represent or be indicative of the
Company's consolidated results of operations that would have been reported had
RSS been acquired as of the beginning of the periods presented and should not be
taken as indicative of the

22

ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

Company's future consolidated results of operations. Pro forma adjustments are
tax effected at the Company's effective tax rate.

2003 ACQUISITIONS

During the first nine months of 2003, the Company spent $44.1 primarily for
the acquisition of the following:

- The VEAM/TEC division of the Northrop Grumman Corporation ("VEAM"). VEAM
is a designer and manufacturer of cylinder, filter and fiber optic
connectors for the military/aerospace, industrial, transit, entertainment
and nuclear markets.

- Uniservice Wellpoint Srl., a manufacturer of high quality diesel and
electric powered, vacuum primed centrifugal pumps, along with spear or
well point dewatering systems for the rental market and sale.

The excess of the purchase price over the fair value of net assets acquired
of $27.6 was recorded as goodwill, of which $23.0 and $4.6 were recorded in the
Electronic Components and Fluid Technology segments, respectively.

16) BUSINESS SEGMENT INFORMATION

Financial information of the Company's business segments for the three and
nine months ended September 30, 2004 and 2003 were as follows:

23

ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

24

ITT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(IN MILLIONS, EXCEPT PER SHARE, UNLESS OTHERWISE STATED)

17) QUARTERLY FINANCIAL PERIODS

The Company's quarterly financial periods end on the Saturday before the
last day of the quarter, except for the last quarterly period of the fiscal
year, which ends on December 31st. For simplicity of presentation, the quarterly
financial statements included herein are presented as ending on the last day of
the quarter. The presentation is consistent for all periods.

25

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

EXECUTIVE SUMMARY

THREE MONTHS

The Company produced strong operating results in the third quarter of 2004.
Revenues grew 21.3% from the comparable prior year quarter. Acquisitions and
foreign currency contributed growth of 8.9% and higher volume in all segments
produced an increase of 12.4%. We believe these results reflect the strength of
the Company's portfolio of businesses and the introduction of new products.

Operating income in the third quarter of 2004 was 21.4% higher than the
third quarter of 2003. The increase was led by the Defense Electronics &
Services segment, which was up 49.3%, and reflects higher volume at all of the
operating segments.

Diluted earnings per share were $1.16 for the third quarter and include the
impact of favorable tax rulings of $0.04 and restructuring charges of $(0.04).
Diluted earnings per share for the comparable prior year quarter were $1.16 and
include the impact of restructuring of $(0.01), discontinued operations of $0.07
and tax settlements and other special items of $0.14.

NINE MONTHS

The Company's revenues grew 17.7% from the comparable prior year period.
Higher volume in all segments contributed 10.9% and the remaining increase of
6.8% was due to acquisitions and foreign currency. These results reflect the
strength of the Company's portfolio of businesses and the introduction of new
products. Based on these results and current/projected market conditions, the
Company projects full year 2004 revenue to be between $6,600 million and $6,655
million.

Operating income in the first nine months of 2004 was 16.0% higher than the
first nine months of 2003. The increase reflects higher volume, partially offset
by acquisition integration and start up costs primarily attributable to the
acquisition of WEDECO AG Water Technology. Management projects full year 2004
segment operating margin to be between 11.1% and 11.2%.

Diluted earnings per share were $3.29 for the first nine months and include
the impact of favorable tax settlements/rulings of $0.20 and restructuring
charges of $(0.18). Diluted earnings per share for the comparable prior year
period were $3.14 and include the impact of favorable tax settlements and
related interest of $0.31, restructuring of $(0.13) and the impact of
discontinued operations of $0.15. Full year 2004 diluted earnings per share are
projected to be between $4.45 and $4.50.

THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 2003

Sales and revenues for the third quarter of 2004 were $1,667.7 million, an
increase of $292.5 million, or 21.3%, from the same period in 2003. Costs of
sales and revenues of $1,100.9 million for the third quarter of 2004 increased
$197.2 million, or 21.8%, from the comparable 2003 period. The increases in
sales and revenues and costs of sales and revenues are primarily attributable to
higher volume in the Defense Electronics & Services, Electronic Components and
Motion & Flow Control segments, contributions from acquisitions made by the
Fluid Technology and Defense Electronics & Services' segments and the impact of
foreign currency translation.

Selling, general and administrative ("SG&A") expenses for the third quarter
of 2004 were $244.6 million, an increase of $48.7 million, or 24.9%, from the
third quarter of 2003. The increase in SG&A expenses was primarily due to the
impact of foreign currency translation, increased marketing expense in all
segments, including expenses from two first quarter acquisitions and higher
general and administrative expenses. Higher general and administrative costs
reflect additional employee benefit costs, the cost of process improvement
initiatives, and increased other administrative expenses.
26

Research, development and engineering ("RD&E") expenses for the third
quarter of 2004 increased $13.2 million, or 9.6%, compared to the third quarter
of 2003. The increase is attributable to increased spending in most segments.

During the third quarter of 2004, the Company recorded a $5.8 million
restructuring charge to streamline its operating structure. The charge primarily
reflected the planned reduction of 76 persons. During the third quarter of 2003,
the Company recorded a $2.8 million restructuring charge for actions to reduce
operating costs and streamline its structure. The 2003 charge primarily
reflected the planned reduction of 72 persons. Additionally, management reviewed
the Company's remaining restructuring actions and determined that certain 2003
and 2001 actions would be completed for $1.2 million less than planned at the
Electronic Components segment. Accordingly, restructuring accruals totaling $1.2
million were reversed into income during the third quarter of 2003. Refer to the
section entitled "Status of Restructuring and Asset Impairments" and Note 8,
"Restructuring and Asset Impairment Charges," in the Notes to Consolidated
Condensed Financial Statements for additional information.

Operating income for the third quarter of 2004 was $166.1 million, an
increase of $29.3 million, or 21.4%, over the third quarter of 2003. The
increase is primarily due to improved sales and revenues at each of the segments
offset by increased SG&A and RD&E expenses. Segment operating margin for the
third quarter of 2004 was 11.3%, which was flat with the comparable 2003 period.

Interest expense was $8.6 million (net of interest income of $1.2 million)
for the third quarter of 2004. Interest income was $5.3 million (net of interest
expense of $6.0 million) for the third quarter of 2003. The $13.9 million
increase in expense from the comparable prior year period is primarily due to
interest income received from the sale of a cost based investment during 2003
that management previously believed would not be received. Upon collection, the
Company reversed the related valuation allowance into income. Additionally,
higher average debt balances during 2004 attributable to two acquisitions made
during 2004, as well as higher interest rates also contributed to the increase.

Income tax expense was $43.9 million in the third quarter of 2004, an
increase of $6.3 million from the comparable prior year period. The increase is
primarily attributable to higher taxable income.

Income from continuing operations was $109.5 million, or $1.16 per diluted
share compared to $102.5 million or $1.09 per diluted share for the third
quarter of 2003. The increase reflects the results discussed above.

During the third quarter of 2004, the Company recognized $0.3 million of
income from discontinued operations. During the third quarter of 2003, the
Company recognized $6.7 million of income from discontinued operations. The 2003
income primarily related to the receipt of a tax refund pertaining to the
Company's discontinued businesses.

Fluid Technology's sales and revenues and costs of sales and revenues
increased $55.1 million, or 9.8%, and $29.3 million, or 7.8%, respectively, in
the third quarter of 2004 compared to the third quarter of 2003. Higher organic
sales in the water/wastewater markets and fluid handling division, acquisition
revenue from the water treatment business and the impact of foreign currency
translation were the primary factors for the increases. These items were
partially offset by lower sales in the engineered process solutions business.
SG&A expenses for the third quarter of 2004 increased $20.7 million, or 20.3%,
compared to the third quarter of 2003, mainly due to the impact of foreign
currency translation, increased advertising costs, sales commissions and
administrative costs in most businesses, and costs attributable to 2004
acquisitions. During the third quarter of 2004 and the comparable prior year
quarter, the segment recorded $3.5 million and $0.9 million of restructuring
charges, respectively, mainly related to planned reductions in headcount (refer
to the section entitled "Status of Restructuring and Asset Impairments" and Note
8, "Restructuring and Asset Impairment Charges," in the Notes to Consolidated
Condensed Financial Statements for additional information). Operating income for
the third quarter of 2004 increased $2.7 million, or 3.6%, compared to the third
quarter of 2003, due to the activities discussed above.

Defense Electronics & Services' sales and revenues and costs of sales and
revenues for the third quarter of 2004 increased $184.3 million, or 41.3%, and
$135.5 million, or 52.2%, respectively, from the comparable prior
27

year period. The increases are primarily due to higher volume in the night
vision, advanced engineering systems and services businesses and acquisition
revenue from the space systems division. A change in product mix also
contributed to the increase in costs of sales and revenues. SG&A expenses
increased $14.8 million, or 51.2%, primarily due to increased employee benefit
and administrative costs, higher marketing costs and costs attributable to the
third quarter 2004 acquisition. RD&E expenses increased $10.3 million, or 9.4%,
due to increased spending in most businesses and the impact of the third quarter
2004 acquisition. Operating income for the third quarter of 2004 was $71.8
million, an increase of $23.7 million, or 49.3%, compared to the same quarter in
2003. The increase reflects the results discussed above.

Motion & Flow Control recorded sales and revenues and costs of sales and
revenues of $242.8 million and $177.5 million, respectively, during the third
quarter of 2004, reflecting increases of $19.8 million, or 8.9%, and $13.4
million, or 8.2%, from the third quarter of 2003. The increases were mainly due
to higher volume in the friction material, aerospace and spa/whirlpool
businesses and the impact of foreign currency translation. SG&A expenses
increased $0.7 million, or 3.3%, reflecting the impact of foreign currency
translation and higher administrative expenses. RD&E costs increased $1.8
million, or 20.7%, due to increased spending in all businesses. During the third
quarters of 2004 and 2003, the segment recorded $1.2 million and $0.6 million of
restructuring charges, respectively, mainly related to planned reductions in
headcount (refer to the section entitled "Status of Restructuring and Asset
Impairments" and Note 8, "Restructuring and Asset Impairment Charges," in the
Notes to Consolidated Condensed Financial Statements for additional
information). Operating income of $32.0 million was $3.3 million, or 11.5%,
higher in the third quarter of 2004, compared to the third quarter of 2003,
primarily due to the items mentioned above.

Electronic Components' sales and revenues of $178.1 million and costs of
sales and revenues of $127.0 million in the third quarter of 2004, increased
$34.3 million, or 23.9%, and $20.2 million, or 18.9%, respectively, from the
comparable prior year period. The increases reflect higher growth in the
communication, transportation and military/aerospace businesses and the impact
of foreign currency translation. SG&A expenses increased $6.1 million, or 22.3%,
due to the impact of foreign currency translation, increased marketing, employee
benefit and administrative expenses. During the third quarter of 2004, the
segment recorded a $1.1 million restructuring charge primarily relating to
planned headcount reductions and moving costs. During the third quarter of 2003,
the segment recorded a $1.3 million charge primarily for headcount reductions
and also reversed $1.2 million of restructuring accruals deemed unnecessary for
the completion of previously announced actions (refer to the section entitled
"Status of Restructuring and Asset Impairments" and Note 8, "Restructuring and
Asset Impairment Charges," in the Notes to Consolidated Condensed Financial
Statements for additional information). Operating income for the third quarter
of 2004 increased $5.7 million from the third quarter of 2003. The increase was
due to the factors discussed above.

Corporate expenses increased $6.1 million in the third quarter of 2004,
primarily due to increased costs for process improvements and other
administrative costs.

NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 2003

Sales and revenues for the first nine months of 2004 were $4,836.1 million,
an increase of $726.3 million, or 17.7%, from the same period in 2003. Costs of
sales and revenues of $3,187.0 million for the first nine months of 2004
increased $487.3 million, or 18.1%, from the comparable 2003 period. The
increases in sales and revenues and costs of sales and revenues are primarily
attributable to higher volume in all segments, contributions from acquisitions
made by the Fluid Technology and Defense Electronics & Services' segments and
the impact of foreign currency translation. Additionally, costs of sales and
revenues increased due to a change in product mix.

SG&A expenses for the first nine months of 2004 were $712.4 million, an
increase of $117.6 million, or 19.8%, from the first nine months of 2003. The
increase in SG&A expenses was primarily due to the impact of foreign currency
translation, increased marketing expense in all segments, including expenses
from two first quarter acquisitions, and higher general and administrative
expenses. Higher general and administrative costs reflect additional employee
benefit costs, the cost of process improvement initiatives, administrative
expenses related to the two first quarter acquisitions and increased other
administrative expenses.

28

RD&E expenses for the first nine months of 2004 increased $52.6 million, or
12.8%, compared to the first nine months of 2003. The increase is attributable
to increased spending in all segments.

During the first nine months of 2004, the Company recorded a $25.7 million
restructuring charge to streamline its operating structure. The charge primarily
reflected the planned reduction of 609 persons, the closure of two facilities
and lease cancellation costs. Additionally, $1.0 million of restructuring
accruals related to 2004, 2003, 2002 and 2001 restructuring actions were
reversed into income, as management determined that certain cash expenditures
would not be incurred. During the first nine months of 2003, the Company
recorded a $17.7 million restructuring charge to reduce operating costs and
streamline its operating structure. The charge primarily reflected the planned
reduction of 685 persons. Additionally, in 2003, the Company recorded an asset
impairment charge of $1.4 million primarily to write-off a technology license
that will not be utilized in the foreseeable future due to projected market
conditions. Refer to the section entitled "Status of Restructuring and Asset
Impairments" and Note 8, "Restructuring and Asset Impairment Charges," in the
Notes to Consolidated Condensed Financial Statements for additional information.
Also, during the nine months ended September 30, 2003, the Company reversed $1.2
million of restructuring accruals into income as it was determined that certain
2003 and 2001 actions would be completed for less than planned.

Operating income for the first nine months of 2004 was $450.0 million, an
increase of $62.0 million, or 16.0%, over the first nine months of 2003. The
increase is primarily due to improved sales and revenues at each of the segments
offset by increased SG&A and RD&E expenses. Segment operating margin for the
first nine months of 2004 was 10.6%, which was flat with the segment operating
margin for the comparable 2003 period.

Interest expense was $15.1 million (net of interest income of $7.3 million)
for the first nine months of 2004. The Company recognized $14.6 million of
interest income during the first nine months of 2003. The variance between
periods is primarily due to interest income of $22.1 million, related to a 2003
first quarter tax refund, and higher average debt balances in 2004, reflecting
the impact of two 2004 acquisitions.

Income tax expense was $113.8 million in the first nine months of 2004, a
decrease of $2.7 million from the comparable prior year period. The decrease is
primarily attributable to the impact of a favorable tax rulings in 2004, offset
by higher pretax income.

Income from continuing operations was $310.3 million, or $3.29 per diluted
share in the first nine months of 2004, compared to $281.3 million or $2.99 per
diluted share for the first nine months of 2003. The increase reflects the
results discussed above.

During the first nine months of 2004, the Company recognized $0.4 million
of income from discontinued operations. During the first nine months of 2003,
the Company recognized $14.5 million of income from discontinued operations. The
2003 income related to the collection of a disputed receivable related to the
Company's automotive businesses and the receipt of two favorable tax
settlements, also pertaining to the Company's discontinued businesses. Upon
collection, the Company reversed the related valuation allowances, which had
been previously established for the assets, resulting in the above mentioned
income.

Fluid Technology's sales and revenues and costs of sales and revenues
increased $206.7 million, or 12.6%, and $127.4 million, or 11.7%, respectively,
in the first nine months of 2004 compared to the first nine months of 2003.
Higher organic sales in the water/wastewater markets and industrial products
businesses, acquisition revenue from the water treatment business and the impact
of foreign currency translation were the primary factors for the increases.
These items were partially offset by lower volume in the engineered process
solutions business. SG&A expenses for the first nine months of 2004 increased
$65.2 million, or 21.1%, compared to 2003, mainly due to the impact of foreign
currency translation, increased advertising costs, sales commissions and
administrative costs in most businesses, and costs attributable to 2004
acquisitions. During the first nine months of 2004, the segment recorded a $10.1
million restructuring charge mainly related to a planned reduction in headcount
and the closure of two facilities. During the nine months ended September 30,
2003, the Company recorded a $0.9 million restructuring charge primarily for the
planned reduction in headcount (refer to the section entitled "Status of
Restructuring and Asset Impairments" and Note 8, "Restructuring

29

and Asset Impairment Charges," in the Notes to Consolidated Condensed Financial
Statements for additional information). Operating income for the first nine
months of 2004 increased $0.9 million, or 0.4%, compared to the first nine
months of 2003, due to the activities discussed above.

Defense Electronics & Services' sales and revenues and costs of sales and
revenues for the first nine months of 2004 increased $377.7 million, or 29.3%,
and $264.2 million, or 34.8%, respectively, from the comparable prior year
period. The increases are primarily due to higher volume in all businesses and
acquisition revenue from the space systems division. Additionally, a change in
product mix also contributed to the increase in costs of sales and revenues.
SG&A expenses increased $26.8 million, or 34.5%, from the comparable prior year
period, primarily due to increased employee benefit and administrative costs,
higher marketing costs and costs attributable to the third quarter 2004
acquisition. RD&E expenses increased $39.6 million, or 12.3%, from the
comparable prior year period, due to increased spending in most businesses and
the impact of the third quarter 2004 acquisition. Operating income for the first
nine months of 2004 was $176.3 million, an increase of $47.1 million, or 36.5%,
compared to the same period in 2003. The increase reflects the results discussed
above.

Motion & Flow Control recorded sales and revenues and costs of sales and
revenues of $798.1 million and $577.5 million, respectively, during the first
nine months of 2004, reflecting increases of $54.3 million, or 7.3%, and $35.5
million, or 6.5%, from the first nine months of 2003. The increases were mainly
due to higher volume in the friction materials and leisure marine businesses and
the impact of foreign currency translation, partially offset by scheduled
platform rolloffs in the fluid handling business. SG&A expenses increased $5.6
million, or 8.3%, from the comparable prior year period, reflecting the impact
of foreign currency translation and higher marketing costs and administrative
expenses in most businesses. During the first nine months of 2004 and 2003, the
segment recorded $3.8 million and $4.0 million of restructuring charges,
respectively, mainly related to planned reductions in headcount (refer to the
section entitled "Status of Restructuring and Asset Impairments" and Note 8,
"Restructuring and Asset Impairment Charges," in the Notes to Consolidated
Condensed Financial Statements for additional information). Operating income of
$112.4 million was $8.6 million, or 8.3%, higher in the first nine months of
2004, compared to the first nine months of 2003, primarily due to the items
mentioned above.

Electronic Components' sales and revenues of $531.3 million and costs of
sales and revenues of $374.7 million in the first nine months of 2004, increased
$89.0 million, or 20.1%, and $59.5 million, or 18.9%, respectively, from the
comparable prior year period. The increases reflect higher volume in all
businesses and the impact of foreign currency translation. SG&A expenses
increased $15.1 million, or 17.3%, from the comparable prior year period, due to
the impact of foreign currency translation and increased marketing, employee
benefit and administrative expenses. During the first nine months of 2004, the
segment recorded a $10.0 million restructuring charge primarily relating to
planned headcount reductions and lease cancellation costs. During the first nine
months of 2003, the segment recorded an $11.5 million restructuring charge
primarily relating to planned headcount reductions and reversed $1.2 million of
restructuring accruals into income as management deemed certain 2003 and 2001
actions would be completed for less than originally planned. Additionally, the
segment recorded a $1.4 million asset impairment charge mainly to write-off a
license agreement for technology, which will not be utilized in the foreseeable
future due to projected market conditions (refer to the section entitled "Status
of Restructuring and Asset Impairments" and Note 8, "Restructuring and Asset
Impairment Charges," in the Notes to Consolidated Condensed Financial Statements
for additional information). Operating income for the first nine months of 2004
increased $12.8 million from the first nine months of 2003. The increase was due
to the factors discussed above.

Corporate expenses increased $7.4 million in the first nine months of 2004,
primarily due to costs associated with process improvements and an increase in
other administrative costs. Additionally, during the first nine months of 2004
and 2003, $1.8 million and $1.3 million of restructuring costs, respectively,
were recognized primarily for headcount reductions (refer to the section
entitled "Status of Restructuring and Asset Impairments" and Note 8,
"Restructuring and Asset Impairment Charges," in the Notes to Consolidated
Condensed Financial Statements for additional information).

30

STATUS OF RESTRUCTURING AND ASSET IMPAIRMENTS

2004 RESTRUCTURING ACTIVITIES

During the third quarter of 2004, the Company recognized a $5.7 million
charge, primarily for the planned severance of 76 employees, idle facility costs
and movement of production. The actions by segment are as follows:

- The Fluid Technology segment recorded $3.3 million for the planned
termination of 36 employees, including nine factory workers, 23 office
workers and four management employees. Other costs totaling $0.2 million
were also recognized during the quarter.

- The Motion & Flow Control segment recognized $0.5 million for the planned
termination of 30 employees, including 23 factory workers and seven
office workers. The segment also recorded $0.6 million for relocation and
moving costs.

- The Electronic Components segment recorded $0.4 million for the planned
termination of ten employees. The terminations include eight office
workers and two management employees. The segment also recorded a $0.7
million charge primarily for costs associated with moving two product
lines from Weinstadt, Germany to Shenzhen, China and one product line
from Santa Ana, CA to Nogales, Mexico and idle facility costs.

As of September 30, 2004, the Company had made $2.0 million of payments
attributable to the 2004 third quarter restructuring actions. Future
restructuring expenditures will be funded with cash from operations,
supplemented, as required, with commercial paper borrowings.

The projected future cash savings from the restructuring actions announced
during the third quarter of 2004 are approximately $2 million during 2004 and
approximately $24 million between 2005 and 2009. The savings primarily represent
lower salary and wage expenditures and will be reflected in "Costs of Sales and
Revenues" and "Selling, General and Administrative Expenses."

In addition to the restructuring actions announced during the third
quarter, the Motion & Flow Control segment recognized $0.1 million of severance
and employee benefit costs related to actions announced during the first quarter
of 2003 and $0.1 million of previous restructuring charges were reversed.

During the second quarter of 2004, the Company recognized a $13.9 million
charge, primarily for the planned severance of 430 employees and the recognition
of lease cancellation costs. The actions by segment are as follows:

- The Electronic Components segment recorded $4.5 million of the charge for
the recognition of lease cancellation costs. Severance of $1.2 million
was recorded for the reduction of 340 employees. The terminations include
273 factory workers, 64 office workers and three management employees.
The segment also recorded a $1.1 million charge for the disposal of
machinery and equipment.

- The Fluid Technology segment recorded $2.4 million for the termination of
45 employees, including eight factory workers and 37 office workers.
Lease commitments totaling $0.7 million were recognized related to the
closure of two facilities (one in Sweden and one in Florida). Asset
write-offs and other costs totaling $0.2 million and $0.1 million,
respectively, were also recognized during the quarter.

- The Motion & Flow Control segment recognized $2.1 million for the
termination of 44 employees, including seven factory workers, 32 office
workers and five management employees.

- Corporate headquarters recorded $1.6 million for the severance of one
management employee.

As of September 30, 2004, the Company had made $3.1 million of payments
attributable to the 2004 second quarter restructuring actions. Future
restructuring expenditures will be funded with cash from operations,
supplemented, as required, with commercial paper borrowings.

The projected future savings from the restructuring actions announced
during the second quarter of 2004 are approximately $4 million during 2004,
including $0.1 million of non-cash savings, and approximately

31

$38 million between 2005 and 2009, including $0.9 million of non-cash savings.
The savings primarily represent lower salary and wage expenditures and will be
reflected in "Costs of Sales and Revenues" and "Selling, General and
Administrative Expenses."

In addition to the restructuring actions announced during the second
quarter, the Motion & Flow Control segment recognized $0.3 million of severance
and employee benefit costs related to actions announced during the first quarter
of 2003 and the Electronic Components segment recognized $0.3 million of
severance and employee benefit costs related to actions announced during the
first quarter of 2004 and $0.1 million of outplacement related to actions
announced in 2003.

During the first quarter of 2004, the Company recognized a $5.3 million
charge, primarily for the planned severance of 103 employees. The actions by
segment are as follows:

- The Fluid Technology segment recorded $2.7 million for the planned
termination of 50 employees, including 15 factory workers and 35 office
workers. Asset write-offs and other costs totaling $0.4 million and $0.1
million, respectively, were also recognized during the quarter.

- The Electronic Components segment recorded $1.7 million of the charge
primarily for the planned reduction of 35 employees, including 23 factory
workers, 11 office workers and one management employee.

- The Motion & Flow Control segment recognized $0.2 million for the planned
termination of 16 employees, including three factory workers and 13
office workers.

- Corporate headquarters recorded $0.2 million for the planned severance of
one office worker and one management employee.

As of September 30, 2004, the Company had made $4.9 million of payments
attributable to the 2004 first quarter restructuring actions. Future
restructuring expenditures will be funded with cash from operations,
supplemented, as required, with commercial paper borrowings.

The projected future savings from the restructuring actions announced
during the first quarter of 2004 are approximately $5 million during 2004 and
$27 million between 2005 and 2009, including $0.5 million in non-cash savings.
The savings primarily represent lower salary and wage expenditures and will be
reflected in "Costs of Sales and Revenues" and "Selling, General and
Administrative Expenses."

The following table displays a rollforward of the restructuring accruals
for the 2004 restructuring programs (in millions):

2003 RESTRUCTURING ACTIVITIES

During the fourth quarter of 2003 the Company announced actions to reduce
operating costs primarily through the reduction of headcount. The $15.4 million
restructuring charge primarily reflects the planned severance of 301 employees.
The actions by segment are as follows:

- The Electronic Components segment recorded $1.5 million of the charge for
the planned termination of 132 employees, including 113 factory workers,
14 office workers and five management employees.

- The Fluid Technology segment recognized $12.4 million of the charge for
the planned severance of 134 employees, including 39 factory workers, 90
office workers and five management employees. Lease and

32

other costs represent $0.3 million of the charge. The segment also
recorded a $0.2 million charge associated with the disposal of machinery
and equipment.

- The Defense Electronics & Services segment recorded a $1.0 million charge
for the planned severance of 35 employees, including seven factory
workers, 19 office workers and nine management employees.

The projected future cash savings from the restructuring actions announced
during the fourth quarter of 2003 are approximately $12 million during 2004 and
$53 million between 2005 and 2008. The savings primarily represent lower salary
and wage expenditures and will be reflected in "Costs of Sales and Revenues" and
"Selling, General and Administrative Expenses".

During the first nine months of 2004, the Company had made $9.3 million of
payments attributable to the 2003 fourth quarter restructuring actions. Future
restructuring expenditures will be funded with cash from operations,
supplemented, as required, with commercial paper borrowings.

In addition to the restructuring actions announced during the fourth
quarter of 2003, the Motion & Flow Control segment recognized $0.5 million of
severance and employee benefit costs related to actions announced during the
first quarter and the Electronic Components segment recognized $0.2 million of
outplacement related to actions announced earlier in 2003.

During the third quarter of 2003 the Company announced additional actions
to reduce operating costs primarily through the reduction of headcount. The $2.6
million restructuring charge primarily reflects the planned severance of 72
employees. The actions by segment are as follows:

- The Electronic Components segment recorded $1.2 million of the charge for
the planned termination of 40 employees, including 15 factory workers and
25 office workers. The segment also recorded a $0.1 million charge
associated with the disposal of machinery and equipment.

- The Fluid Technology segment recognized a $0.5 million charge for the
planned severance of 13 factory workers and 14 office workers. Lease and
other costs represent $0.4 million of the charge.

- The Motion & Flow Control segment recorded a $0.4 million charge for the
planned severance of one management employee and four office workers.

The projected future cash savings from the restructuring actions announced
during the third quarter of 2003 are approximately $4 million during 2004 and
$15 million between 2005 and 2008. The savings primarily represent lower salary
and wage expenditures and will be reflected in "Costs of Sales and Revenues" and
"Selling, General and Administrative Expenses."

During the first nine months of 2004, the Company made $0.5 million of
payments attributable to the 2003 third quarter restructuring actions. Future
restructuring expenditures will be funded with cash from operations,
supplemented, as required, with commercial paper borrowings.

In addition to the restructuring actions announced during the third quarter
of 2003, the Motion & Flow Control segment recognized $0.2 million of severance
and employee benefit costs related to actions announced during the first quarter
of 2003.

During the second quarter of 2003 the Company continued its program to
reduce structural costs and increase profitability. Restructuring actions
totaling $4.7 million were announced during the period. The charge primarily
reflected the planned severance of 148 employees and the cancellation of an
operating lease. The actions by segment are as follows:

- The Electronic Components segment comprises $2.7 million of the charge
and the actions taken at this segment include the planned termination of
six management employees, 19 factory workers and 71 office workers.

- The Motion & Flow Control segment recognized $1.0 million for the planned
severance of 50 employees, including six management employees, 31 factory
workers and 13 office workers. Lease termination fees of $0.7 million and
asset disposal costs of $0.1 million were also reflected in the charge.
33

- At Corporate Headquarters, a charge of $0.2 million was recorded for the
planned termination of one management employee and one office worker.

The projected future cash savings from the restructuring actions announced
during the second quarter of 2003 are approximately $8 million during 2004 and
$31 million between 2005 and 2008. The savings primarily represent lower salary
and wage expenditures and will be reflected in "Costs of Sales and Revenues" and
"Selling, General and Administrative Expenses."

During the first nine months of 2004, the Company made $0.6 million of
payments attributable to the 2003 second quarter restructuring actions. Future
restructuring expenditures will be funded with cash from operations,
supplemented, as required, with commercial paper borrowings.

In addition to the restructuring actions announced during the second
quarter, the Motion & Flow Control segment recognized $1.2 million of severance
and employee benefit costs related to actions announced during the first quarter
of 2003.

During the first quarter of 2003 the Company recorded a $9.0 million
restructuring charge primarily for the planned severance of 465 persons.
Severance of $8.3 million represents the majority of the charge. The actions by
segment are as follows:

- The Electronic Components segment recorded $6.8 million of the charge for
the planned termination of 226 persons, comprised of 101 office workers,
116 factory workers and nine management employees. Idle facility costs of
$0.3 million and asset disposal costs of $0.4 million were also reflected
in the charge. The actions were prompted by management's projections of
continued weakness in certain businesses.

- Corporate Headquarters recorded $1.1 million of the charge for the
consolidation of administrative tasks, including the planned termination
of two management employees.

- The Motion & Flow Control segment recorded $0.4 million of the charge for
the planned termination of 237 employees, comprised of 21 office workers
and 216 factory workers. The charge relates to the closure of a
manufacturing facility in Arkansas. The actions will be completed during
2003 and 2004 and the total estimated charge of approximately $2.7
million will be recognized ratably over the restructuring period as the
terminations become effective. Management deemed the restructuring
actions necessary to address the anticipated loss of certain platforms
during the second half of 2003.

The projected future cash savings from the restructuring actions announced
during the first quarter of 2003 are approximately $8 million during 2004 and
$38 million between 2005 and 2008. The savings primarily represent lower salary
and wage expenditures and will be reflected in "Costs of Sales and Revenues" and
"Selling, General and Administrative Expenses."

During the first nine months of 2004, the Company made $1.9 million of
payments attributable to the 2003 first quarter restructuring actions. Future
restructuring expenditures will be funded with cash from operations,
supplemented, as required, with commercial paper borrowings.

34

The following table displays a rollforward of the restructuring accruals
for the 2003 restructuring programs (in millions):

During the first nine months of 2004, $0.3 million of restructuring
accruals related to 2003 restructuring actions were reversed into income. The
reversals primarily reflect lower than anticipated severance costs on completed
actions due to favorable employee attrition at the Electronic Components
segment.

During the second half of 2003, $3.5 million of restructuring accruals
related to current year programs were reversed into income as a result of
quarterly reviews of the Company's remaining restructuring actions. The
reversals primarily reflect lower than anticipated severance costs on completed
actions due to favorable employee attrition at the Electronic Components
segment. Additionally, certain actions were not completed as they were no longer
deemed feasible. The Company also reversed other non-cash charges totaling $0.2
million.

During the first nine months of 2004 headcount was reduced by 172 persons
and the Company experienced employee attrition, leaving a balance of 17 planned
reductions related to the 2003 restructuring plans. In addition, one facility
remains to be closed related to the 2003 restructuring plans. Actions announced
during 2003 will be substantially completed by the end of 2004.

2003 OTHER ASSET IMPAIRMENTS

During 2003, the Company recorded a $1.4 million asset impairment charge
primarily for the write-off of a technology license that will not be utilized
based on management's projections of future market conditions. The applicable
assets were written down to their fair values based on management's comparison
of projected future discounted cash flows generated by each asset to the
applicable asset's carrying value. These impairments were unrelated to the
Company's restructuring activities.

DISCONTINUED OPERATIONS

In September of 1998, the Company completed the sales of its automotive
Electrical Systems business to Valeo SA for approximately $1,700 million and its
Brake and Chassis unit to Continental AG of Germany for approximately $1,930
million. These dispositions were treated as discontinued operations. In
connection with the sale of these businesses, the Company established accruals
for taxes of $972.7 million, representation and warranty and contract purchase
price adjustments of $148.8 million, direct costs and other accruals of $102.0
million and environmental obligations of $16.1 million.

In 1998 and 1999, the Company received notifications of claims from the
buyers of the automotive businesses requesting post-closing adjustments to the
purchase prices under the provisions of the sales agreements. During 1999, those
claims were submitted to arbitration. In 2001 and early in 2002, both claims
were favorably resolved.

35

The following tables display a rollforward of the automotive discontinued
operations accruals from January 1, 2002 to September 30, 2004 (in thousands):

In 2003, the Company reassessed its obligations related to the disposal of
the automotive businesses and determined that it would spend $2.2 million less
on the disposition, related to favorable spending on professional fees and
adjustments to its environmental exposures. Based on this assessment, $2.2
million was reversed into the 2003 Consolidated Income Statement under income
from discontinued operations.

At September 30, 2004, the Company has automotive discontinued operations
accruals of $186.0 million that primarily relate to the following: taxes $154.1
million -- which are related to the original transaction and are recorded in
Accrued Taxes; product recalls $7.8 million -- related to nine potential product
recall issues which are recorded in Accrued Expenses; environmental obligations
$14.2 million -- for the remediation and investigation of groundwater and soil
contamination at thirteen sites which are recorded in Other Liabilities;
employee benefits $9.9 million -- for workers compensation issues which are
recorded in Accrued Expenses. In 2004, the Company made immaterial payments for
matters attributable to the automotive discontinued operations. The Company
expects that it will cash settle $154.1 million of tax obligations in late 2004
or 2005. The Company projects that it will spend between $0.5 million and $1.0
million in 2004 related to its remaining automotive obligations.

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOW OVERVIEW

The Company provided $249.6 million of cash from operating activities
during the first nine months of 2004. Net income generated from continuing
operations of $310.3 million, which includes $146.0 million of depreciation and
amortization, and increases in accrued and deferred taxes and accounts payable
and accrued
36

expenses of $59.8 million and $56.2 million, respectively, were the primary
factors for this performance. Increases in accounts receivable and inventory of
$142.4 million and $51.5 million, respectively, reflecting increased sales
volume, partially offset the cash generated from operations. Additionally, a
$100.0 million prepaid pension contribution also partially offset the cash
provided from operations.

During the first nine months of 2004, the Company also spent $994.6 million
on acquisitions, $131.5 million on the repurchase of common stock, $100.2
million on capital expenditures, $46.1 million on dividend payments and $52.1
million on the repayment of long-term debt. These actions were financed
primarily with short term debt, cash from operating activities, and cash
received from exercised stock options.

The Company projects cash from operating activities to be between $485.0
million and $535.0 million for the twelve months ended December 31, 2004.

Cash Flows: Cash provided by operating activities during the first nine
months of 2004 was $249.6 million, or a $19.6 million decrease over the first
nine months of 2003. The decrease is primarily attributable to tax payments of
$54.0 million in 2004 (versus $55.6 million of tax receipts in 2003) and
increased inventory levels. A $100.0 million prepaid pension contribution in
2004 compared to a $200.0 million prepaid pension contribution in the first nine
months of 2003 partially offset these declines in cash provided from operations.

Status of Restructuring Activities: Restructuring payments during the
first nine months of 2004 totaled $24.3 million and were comprised of $10.0
million of expenditures for the 2004 plans and $14.3 million of expenditures for
the 2003, 2002 and 2001 restructuring plans. All future payments are projected
to be paid with future cash from operating activities supplemented, as required,
by commercial paper borrowings.

Additions to Plant, Property and Equipment: Capital expenditures during
the first nine months of 2004 were $100.2 million, an increase of $3.2 million
from the first nine months of 2003. The increase was seen across several
operating segments.

Acquisitions: On August 13, 2004 the Company purchased all of the Remote
Sensing Systems ("RSS") business from Eastman Kodak Company for $728.8 million
in cash. The RSS business is a leading supplier of high resolution satellite
imaging systems and information services. Management believes that the
acquisition of RSS will enhance the Company's competitive position in the space
payload and service product offering industry and create a full spectrum
provider with the latest visible and infrared satellite imaging technology in
the remote sensing market.

The excess of the purchase price of RSS over the fair value of net assets
acquired of $616.1 million was recorded as goodwill and is reflected in the
Defense Electronics & Services segment. The value of a significant portion of
assets and liabilities has been determined; however, the allocation is subject
to further refinement.

The Company also spent $265.8 million primarily for the following
acquisitions completed in 2004:

- WEDECO AG Water Technology ("WEDECO"), the world's largest manufacturer
of UV disinfection and ozone oxidation systems, which are alternatives to
chlorine treatment.

- Allen Osborne Associates, a leader in the development of global
positioning system receivers for both portable and fixed sites.

- Shanghai Hengtong Purified Water Development Co. Ltd. and Shanghai
Hengtong Water Treatment Engineering Co. Ltd. ("Hengtong"), a
Shanghai-based producer of reverse-osmosis, membrane and other water
treatment systems for the power, pharmaceutical, chemical and
manufacturing markets in China.

The excess of the purchase price over the fair value of net assets acquired
of $201.0 million was recorded as goodwill, of which $196.0 million and $5.0
million are reflected in the Fluid Technology and Defense Electronics and
Services segments, respectively.

37

During the first nine months of 2003, the Company spent $44.1 million
primarily for the acquisition of the following:

- The VEAM/TEC division of the Northrop Grumman Corporation ("VEAM"). VEAM
is a designer and manufacturer of cylinder, filter and fiber optic
connectors for the military/aerospace, industrial, transit, entertainment
and nuclear markets.

- Uniservice Wellpoint Srl., a manufacturer of high quality diesel and
electric powered, vacuum primed centrifugal pumps, along with spear or
well point dewatering systems for the rental market and sale.

The excess of the purchase price over the fair value of net assets acquired
of $27.6 million was recorded as goodwill, of which $23.0 million and $4.6
million were recorded in the Electronic Components and Fluid Technology
segments, respectively.

Sale of Investment: During the third quarter of 2003, the Company sold its
investment in a defense related business for $43.5 million.

Divestitures: During the first nine months of 2004, the Company generated
$5.1 million of cash proceeds primarily from the sale of two properties. In the
first nine months of 2003, the Company generated $9.3 million of cash proceeds
primarily from the sale of plant, property and equipment. This is primarily due
to the sale of land for $7.3 million at Defense Electronics & Services.

Financing Activities: Debt at September 30, 2004 was $1,462.4 million,
compared with $602.4 million at December 31, 2003. Cash and cash equivalents
were $253.9 million at September 30, 2004, compared to $414.2 million at
December 31, 2003. The change in debt and cash levels primarily reflects
borrowings to finance the acquisition of RSS and WEDECO, and the $100 million
prepaid pension contribution made during the first quarter of 2004. In March
2004, the Company arranged an additional revolving credit agreement of $0.4
billion to accommodate additional acquisitions. As a result, the maximum amount
of borrowing available under the Company's revolving credit agreements, which
provide back-up for the Company's commercial paper program, at September 30,
2004, was $1.4 billion. Borrowing through commercial paper and under the
revolving credit agreements may not exceed $1.4 billion in the aggregate
outstanding at any time.

Status of Automotive Discontinued Operations: In 2004, the Company made
immaterial payments for matters attributable to its automotive discontinued
operations. Tax obligations of $154.1 million are expected to be resolved in
late 2004 or 2005. In addition, the Company projects between $1.0 million and
$4.0 million of annual spending related to its remaining automotive obligations.
All payments are forecast to be paid with future cash from operations,
supplemented as required, with commercial paper borrowings.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States, requires management to make
estimates and assumptions that affect the reported value of assets and
liabilities and the disclosure of contingent assets and liabilities.

The Company has identified three accounting policies where estimates are
used that require assumptions or factors that are of an uncertain nature, or
where a different estimate could have been reasonably utilized or changes in the
estimate are reasonably likely to occur from period to period.

ENVIRONMENTAL: Accruals for environmental matters are recorded on a site
by site basis when it is probable that a liability has been incurred and the
amount can be reasonably estimated. The Company calculates the liability by
utilizing a cost estimating and weighting matrix that separates costs into
recurring and non-recurring categories. The Company then uses internal and
external experts to assign confidence levels based on the site's development
stage, type of contaminant found, applicable laws, existing technologies and the
identification of other potentially responsible parties. This methodology
produces a range of estimates, including a best estimate. At September 30, 2004,
the Company's best estimate is $101.6 million, which approximates the accrual
related to the remediation of ground water and soil. The low range estimate for
environmental liabilities is $77.2 million and the high range estimate is $165.1
million. On an annual basis the Company spends between $8.0 million and $11.0
million on its environmental remediation liabilities. These estimates, and
related accruals, are reviewed periodically and updated for progress of
remediation efforts and
38

changes in facts and legal circumstances. Liabilities for environmental
expenditures are recorded on an undiscounted basis.

The Company is currently involved in the environmental investigation and
remediation of approximately 100 sites, including certain instances where it is
considered to be a potentially responsible party by the United States
Environmental Protection Agency ("EPA") or similar state agency.

At present, the Company is involved in litigation against its insurers for
reimbursement of environmental response costs. Recoveries from insurance
companies or other third parties are recognized in the financial statements when
it is probable that they will be realized.

In the event that future remediation expenditures are in excess of the
amounts accrued, management does not anticipate that they will have a material
adverse effect on the consolidated financial position, results of operations or
liquidity of the Company.

For additional details on environmental matters see Note 13, "Commitments
and Contingencies," in the Notes to the Consolidated Condensed Financial
Statements.

EMPLOYEE BENEFIT PLANS: The Company sponsors numerous employee pension and
welfare benefit plans. These plans utilize various assumptions in the
determination of projected benefit obligations and expense recognition related
to pension and other postretirement obligations. These assumptions include:
discount rates, expected rates of return on plan assets, rate of future
compensation increases, mortality, termination, and health care inflation trend
rates, some of which are disclosed in Note 19, "Employee Benefit Plans," within
the Notes to Consolidated Financial Statements of the 2003 Annual Report on Form
10-K.

KEY PENSION ASSUMPTIONS

The Company determines its expected return on plan assets assumption by
evaluating both historical returns and estimates of future returns.
Specifically, the Company analyzes the Plan's actual historical annual return on
assets over the past 10, 15, 20 and 25 years; makes estimates of future returns
using a Capital Asset Pricing Model; and evaluates historical broad market
returns over the past 75 years based on the Company's strategic asset
allocation, which is detailed in Note 19, "Employee Benefit Plans," in the Notes
to Consolidated Financial Statements of the 2003 Annual Report on Form 10-K.

Based on the approach described above, the Company estimates the long-term
annual rate of return on assets for domestic pension plans at 9.0%. For
reference, the Company's actual geometric average annual return on plan assets
for domestic pension plans stood at 10.1%, 11.2%, 11.8%, and 12.6%, for the past
10, 15, 20, and 25 year periods, respectively. The Company's weighted average
expected return on plan assets for all pension plans, including foreign
affiliate plans, at December 31, 2003, is 8.86%.

The Company utilizes the assistance of its plan actuaries in determining
the discount rate assumption. As a service to its clients, the plan actuaries
have developed and published an interest rate yield curve to enable companies to
make judgments pursuant to EITF Topic No. D-36, "Selection of Discount Rates
Used for Measuring Defined Benefit Pension Obligations and Obligations of Post
Retirement Benefit Plans Other Than Pensions." The yield curve is comprised of
AAA/AA bonds with maturities between zero and thirty years. The plan actuaries
then discount the annual benefit cash flows of the Company's pension plan using
this yield curve and develop a single-point discount rate matching the plan's
characteristics.

At December 31, 2003, the Company lowered the discount rate on all of its
domestic pension plans, which represent about 90% of the Company's total pension
obligations, from 6.50% to 6.25%. The Company's weighted average discount rate
for all pension plans, including foreign affiliate plans, at December 31, 2003,
is 6.18%.

39

At December 31, 2003, the Company also lowered its expected rate of future
compensation increases for its domestic plan participants to 4.5%, from 5.0%,
based on recent historical experience and expectations for future economic
conditions.

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 periodically with third party
actuarial consultants and adjusted as necessary.

PENSION PLAN ACCOUNTING AND INFORMATION

The Company's strategic asset allocation target for its U.S. domestic plans
apportions 70% of all assets to equity instruments and the remaining 30% to
fixed income instruments. At December 31, 2003, the Company's actual asset
allocation was 68.5% in equity instruments, 21.6% in fixed income instruments
and 9.7% in hedge funds, with the remainder in cash and other.

On an annual basis, the Company's long-term expected return on plan assets
will often differ from the actual return on plan assets. The chart below shows
actual returns versus the expected long-term returns for the Company's domestic
pension plans that are utilized in the calculation of the net periodic benefit
cost. For more information, please see Note 19, "Employee Benefit Plans," in the
Notes to Consolidated Financial Statements of the 2003 Annual Report on Form
10-K.

The Company's Defense Electronics & Services segment represents
approximately 50% of the active U.S. Salaried Plan participants. As a result,
the Company has sought and will continue to seek reimbursement from the
Department of Defense for a portion of its pension costs, in accordance with
government regulations. U.S. Government Cost Accounting Standards (CAS) govern
the extent to which pension costs are allocable to and recoverable under
contracts with the U.S. Government. Reimbursements of pension costs are made
over time through the pricing of the Company's products and services on U.S.
Government contracts.

Funding requirements under IRS rules are a major consideration in
determining the amount of contributions we make to our pension plans. The
Company contributed $206.3 million to our domestic pension plans during 2003,
and an additional $117.9 million in the first nine months of 2004. Of these
amounts, $200.0 million and $100.0 million, respectively, have been contributed
to the domestic Salaried Retirement Plan. As a result, the Company does not
expect to face any material minimum required contributions to any of its
domestic pension plans for the balance of 2004 and 2005 under current IRS
requirements.

Depending on market conditions and recently passed revisions to the IRS
contribution requirements, the Company estimates that it may be required to make
additional contributions between zero and $400.0 million in 2006.

FUNDED STATUS

Funded status is derived by subtracting the value of the projected benefit
obligations at December 31, 2003 from the end of year fair value of plan assets.
The Company's U.S. Salaried Pension Plan represents approximately 80% of the
Company's total pension obligation, and therefore the funded status of the

40

U.S. Salaried Pension Plan has a considerable impact on the overall funded
status of the Company's pension plans.

During 2003, the Company's U.S. Salaried Pension Plan assets grew by $647.0
million to $2,989.2 million at the end of 2003. This increase primarily
reflected return on assets of $659.0 million, and Company contributions of
$200.0 million, offset by payments to plan beneficiaries of $206.8 million.

Also during 2003, the projected benefit obligation for the U.S. Salaried
Pension Plan increased by $152.0 million to $3,448.8 million. The increase
included the $104.3 million impact of a 25 basis point decline in the discount
rate at year-end. This was partially offset by the $(28.3) million impact of a
50 basis point decrease in the expected rate of future compensation increases.
As a result, the funded status for the Company's U.S. Salaried Plan improved by
$495.4 million to $(459.6) million at the end of 2003. Funded status for the
Company's total pension obligations, including foreign and affiliate plans,
improved by $452.6 million to $(871.3) million at the end of 2003.

Funded status at the end of 2004 will depend primarily on the actual return
on assets during the year and the discount rate at the end of the year. The
Company estimates that every 25 basis points change in the discount rate impacts
the funded status of the U.S. Salaried Pension Plan, which represents about 80%
of the Company's pension obligations, by approximately $104 million. Similarly,
every five percentage point change in the actual 2004 rate of return on assets
impacts the same plan by approximately $150 million.

MINIMUM PENSION LIABILITY

SFAS No. 87, "Employers' Accounting for Pensions" ("SFAS No. 87"), requires
that a minimum pension liability be recorded if a plan's market value of assets
falls below the plan's accumulated benefit obligation.

In 2002, the combination of a decline in the discount rate and a decline in
assets caused several of the Company's plans to be in a deficit position.
Accordingly, during 2002, the Company recorded a total after-tax reduction of
$765.5 million to its total shareholders' equity. It is important to note that
these actions did not cause a default in any of the Company's debt covenants. As
a result of the improved financial markets in 2003, the Company recorded a total
after-tax increase of $182.5 million to its shareholders' equity at year-end
2003.

Future recognition of additional minimum pension liabilities will depend
primarily on the rate of return on assets and the prevailing discount rate.

PENSION EXPENSE

The Company uses the market-related value of assets method, as described in
paragraph 30 of SFAS No. 87, for the calculation of pension expense. This method
recognizes investment gains or losses over a five-year period from the year in
which they occur. In addition, in accordance with paragraph 32 of SFAS No. 87, a
portion of the Company's unrecognized net actuarial loss is amortized and this
cost is included in the net periodic benefit cost.

The Company recorded $33.0 million of net periodic pension cost ($35.4
million after considering the effects of curtailment losses) into its
Consolidated Income Statement in 2003, compared with pension income of $10.4
million in 2002. The 2003 net periodic pension cost reflected benefit service
cost of $73.3 million and interest cost on accrued benefits of $256.5 million,
offset by the expected return on plan assets of $327.0 million. In addition, the
2003 pension expense included $23.5 million of amortization of past losses, up
from $3.2 million in 2002. The primary drivers behind the increase in the net
periodic pension cost were the effect of the change in the discount rate, the
effect of the lowered assumption as to expected return on assets and the
increase in amortization of past losses in 2003.

In 2004, the Company expects to incur approximately $70 million of pension
expense that will be recorded into its Consolidated Income Statement. The
increase in pension expense is primarily due to the effect of the change in
discount rate and higher amortization of past losses. See Note 12, "Pension and

41

Postretirement Medical Benefit Expenses," in the Notes to Consolidated Condensed
Financial Statements for additional details, including pension expense incurred
during the first nine months of 2004.

REVENUE RECOGNITION: The Company recognizes revenue as services are
rendered and when title transfers for products, subject to any special terms and
conditions of specific contracts. For the majority of the Company's sales, title
transfers when products are shipped. Under certain circumstances, title passes
when products are delivered. In the Defense Electronics & Services segment,
certain contracts require the delivery, installation, testing, certification and
customer acceptance before revenue can be recorded. Further, some sales are
recognized when the customer picks up the product.

The Defense Electronics & Services segment typically recognizes revenue and
anticipated profits under long-term, fixed-price contracts based on units of
delivery or the completion of scheduled performance milestones. Estimated
contract costs and resulting margins are recorded in proportion to recorded
sales. During the performance of such contracts, estimated final contract prices
and costs (design, manufacturing, and engineering and development costs) are
periodically reviewed and revisions are made when necessary. The effect of these
revisions to estimates is included in earnings in the period in which revisions
are made. There were no material revisions to estimates in the covered periods.

Accruals for estimated expenses related to warranties are made at the time
products are sold or services are rendered. These accruals are established using
historical information on the nature, frequency and average cost of warranty
claims and estimates of future costs. Management believes the warranty accruals
are adequate; however, actual warranty expenses could differ from estimated
amounts. The accrual for product warranties at September 30, 2004 and 2003 was
$33.7 million and $41.5 million, respectively. See Note 14, "Guarantees,
Indemnities and Warranties," in the Notes to Consolidated Condensed Financial
Statements for additional details.

ACCOUNTING PRONOUNCEMENTS

In December 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 132 (revised December 2003), "Employers' Disclosures About Pensions and
Other Post Retirement Benefits." This revised SFAS retains the disclosure
requirements of SFAS No. 132. Additionally, the pronouncement requires
additional disclosures regarding the types of plan assets, investment strategy,
measurement dates, plan obligations, cash flows and components of net periodic
benefit cost recognized during interim periods for defined benefit pension plans
and other defined benefit post retirement plans. The Company adopted this
pronouncement effective December 31, 2003. Adoption did not have a material
impact on the financial statements of the Company.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and hedging activities under SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.
149 clarifies the circumstances under which a contract with an initial net
investment meets the characteristics of a derivative as discussed in SFAS No.
133. In addition, SFAS No. 149 clarifies when a derivative contains a financing
component that warrants special reporting in the statement of cash flows. SFAS
No. 149 is effective for contracts entered into or modified after June 30, 2003,
and for hedging relationships designated after June 30, 2003. The adoption of
this standard did not have a material effect on the Company's financial
statements.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 requires certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity to be classified
as liabilities. The provisions of SFAS No. 150 were effective for financial
instruments entered into or modified after May 31, 2003 and to all other
instruments that exist as of the beginning of the first interim financial
reporting period beginning after June 15, 2003. The Company did not have any
financial instruments that met the provisions of SFAS No. 150; therefore, the
adoption of this standard did not have a material effect on the Company's
financial statements.
42

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 requires unconsolidated variable
interest entities to be consolidated by their primary beneficiaries if the
entities do not effectively disperse the risks and rewards of ownership among
their owners and other parties involved. The provisions of FIN 46 are applicable
to all variable interest entities created after January 31, 2003 and variable
interest entities in which an enterprise obtains an interest after that date.
For variable interest entities created before January 31, 2003, the provisions
were effective December 31, 2003. The Company did not create or obtain any
variable interest entities during 2003. The Company elected early adoption of
the provisions of FIN 46 related to variable interest entities created prior to
January 31, 2003 as of July 1, 2003. The adoption of this interpretation did not
have a material effect on the Company's financial statements. In December 2003,
the FASB issued a revision to Interpretation No. 46; however, it had no impact
on ITT's adoption.

In January 2004, FASB Staff Position ("FSP") No. 106-1, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003" ("FSP No. 106-1") was issued. Subsequently, FSP
No. 106-2 was issued, which amends FSP No. 106-1 and discusses the recognition
of the effects for the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 (the Act) in the accounting for postretirement health care plans
under SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions," and in providing disclosures related to the plan required by
SFAS No. 132. The Company adopted this pronouncement effective July 1, 2004, but
is unable to conclude whether benefits of its plans are actuarially equivalent
and shall measure any effects of the Act at the next measurement date for plan
assets and obligations. See Note 19, "Employee Benefit Plans," in the Notes to
Consolidated Financial Statements of the 2003 Annual Report on Form 10-K for
discussion of postretirement benefits.

RISKS AND UNCERTAINTIES

ENVIRONMENTAL MATTERS

The Company is subject to stringent environmental laws and regulations that
affect its operating facilities and impose liability for the cleanup of past
discharges of hazardous substances. In the United States, these laws include the
Federal Clean Air Act, the Clean Water Act, the Resource Conservation and
Recovery Act, and the Comprehensive Environmental Response, Compensation and
Liability Act. Management believes that the Company is in substantial compliance
with these and all other applicable environmental requirements. Environmental
compliance costs are accounted for as normal operating expenses.

In estimating the costs of environmental investigation and remediation, the
Company considers, among other things, regulatory standards, its prior
experience in remediating contaminated sites, and the professional judgment of
environmental experts. It is difficult to estimate the total costs of
investigation and remediation due to various factors, including incomplete
information regarding particular sites and other potentially responsible
parties, uncertainty regarding the extent of contamination and the Company's
share, if any, of liability for such problems, the selection of alternative
remedies, and changes in cleanup standards. When it is possible to create
reasonable estimates of liability with respect to environmental matters, the
Company establishes accruals in accordance with accounting principles generally
accepted within the United States. Insurance recoveries are included in other
assets when it is probable that a claim will be realized. Although the outcome
of the Company's various remediation efforts presently cannot be predicted with
a high level of certainty, management does not expect that these matters will
have a material adverse effect on the Company's consolidated financial position,
results of operations, or cash flows. For disclosure of the Company's
commitments and contingencies, see Note 21, "Commitments and Contingencies" in
the Notes to Consolidated Financial Statements of the 2003 Annual Report on Form
10-K.

FORWARD-LOOKING STATEMENTS

Certain material presented herein consists of forward-looking statements
which 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. Such factors include general

43

economic and worldwide political conditions, foreign currency exchange rates,
competition and other factors all as more thoroughly set forth in Item 1.
Business and Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Forward-Looking Statements in the ITT Industries,
Inc. Form 10-K Annual Report for the fiscal year ended December 31, 2003 and
other of its filings with the Securities and Exchange Commission, to which
reference is hereby made.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information called for by Item 3 is provided in Note 9, "Derivative
Instruments and Hedging Activities" in the Notes to Consolidated Condensed
Financial Statements herein. There has been no material change in the
information concerning market risk as stated in the Company's 2003 Annual Report
on Form 10-K.

ITEM 4. CONTROLS AND PROCEDURES

(a) The Chief Executive Officer and Chief Financial Officer of the Company
have evaluated the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end
of the period covered by this report. 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 identifying, on a
timely basis, material information required to be disclosed in our reports filed
or submitted under the Exchange Act.

(b) 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.

PART II.
OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The following should be read in conjunction with Note 13 to the unaudited
interim consolidated condensed financial statements in Part I of this Report, as
well as Part I Item 3 of our Annual Report on Form 10-K for the year ended
December 31, 2003.

The Company and its subsidiaries from time to time are involved in legal
proceedings that are incidental to the operation of their businesses. Some of
these proceedings allege damages against the Company relating to environmental
liabilities, intellectual property matters, copyright infringement, personal
injury claims, employment and pension matters, government contract issues and
commercial or contractual disputes, sometimes related to acquisitions or
divestitures. The Company will continue to vigorously defend itself against all
claims. Although the ultimate outcome of any legal matter cannot be predicted
with certainty, based on present information including the Company's assessment
of the merits of the particular claim, as well as its current reserves and
insurance coverage, the Company does not expect that such legal proceedings will
have any material adverse impact on the cash flow, results of operations, or
financial condition of the Company on a consolidated basis in the foreseeable
future.

The Company voluntarily disclosed to the United States Department of State
a number of violations of the licensing provisions of the Arms Export Control
Act and its implementing regulations and cooperated fully with the Department of
State in reviewing all of these violations. None of the violations appear to
have been the result of willful conduct by any ITT employee to intentionally
circumvent U.S. laws and regulations. The Company has signed a Consent Agreement
settling all disclosed violations which became effective upon the signing of an
Order by the Assistant Secretary of State for Political-Military Affairs on
November 1, 2004. The Consent Agreement provides for a $3.0 million cash civil
penalty payable to the Department of State. The Consent Agreement also includes
an additional civil penalty of $5.0 million to be spent by ITT Industries for
internal remedial export compliance improvements over the five-year term of the
Consent Agreement. Management believes that this matter will not have a material
adverse impact on the Company's consolidated financial position, results of
operations or cash flows.
44

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES, USE OF PROCEEDS AND ISSUER
PURCHASES OF EQUITY SECURITIES

ISSUER PURCHASES OF EQUITY SECURITIES

- ---------------

(1) All share repurchases were made in open-market transactions. None of these
transactions were made pursuant to a publicly announced repurchase plan.

(2) Average price paid per share is calculated on a settlement basis and
excludes commission.

No share repurchases were made pursuant to a publicly announced plan or
program. The Company's strategy for cash flow utilization is to pay dividends
first and then repurchase Company common stock to cover option exercises made
pursuant to the Company's stock option programs. The remaining cash is then
available for strategic acquisitions and discretionary repurchases of the
Company's common stock.

ITEM 6. EXHIBITS

(a) See the Exhibit Index for a list of exhibits filed herewith.

45

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

ITT Industries, Inc.

(Registrant)

By /s/ ROBERT J. PAGANO, JR.
------------------------------------
Robert J. Pagano, Jr.
Vice President and Corporate
Controller
(Principal accounting officer)

November 5, 2004

46

EXHIBIT INDEX