ITT INDUSTRIES INC - 10-Q Quarterly Report

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

FORM 10-Q

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 April 30, 2005, there were outstanding 92,290,613 shares of common
stock ($1 par value per share) of the registrant.
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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 in the United States of America have been
condensed or omitted pursuant to such SEC rules. The Company believes that the
disclosures made 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 2004 Annual Report on
Form 10-K.

ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

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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)

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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)

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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 $312.4 and $235.1 of
total service revenues for the three months ended March 31, 2005 and 2004,
respectively, and $216.6 and $161.9 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

7

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 months ended March 31, 2005
and 2004:

Options to purchase 1,773,140 shares of common stock at an average price of
$90.91 per share were outstanding at March 31, 2005 but were not included in the
computation of diluted EPS, because the options' exercise prices were greater
than the annual average market price of the common shares. These options expire
in 2012.

Options to purchase 9,500 shares of common stock at an average price of
$75.28 per share were outstanding at March 31, 2004 but were not included in the
computation of diluted EPS, because the options' exercise prices were greater
than the annual average market price of the common shares. These options expire
in 2014.

The amount of antidilutive restricted common stock excluded from the
computation of diluted earnings per share for the three months ended March 31,
2005 and 2004 was zero.

7) STOCK-BASED EMPLOYEE COMPENSATION

At March 31, 2005, the Company has one stock-based employee compensation
plan that is issuing new options and restricted shares of common stock. The
Company also has one stock-based employee compensation plan and two stock-based
non-employee director's compensation plans that have options and restricted
shares outstanding, but will not be issuing additional stock-based compensation.
These plans are described more fully in Note 20, "Shareholders' Equity," within
the Notes to Consolidated Financial Statements of the 2004 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

8

ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

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

The Company used the binomial lattice option pricing model to calculate the
fair value of all options granted during the first quarter 2005 as of the
applicable grant dates. During 2004, 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 ended
March 31, 2005 and 2004: dividend yield of 0.79% and 1.40%, respectively;
expected volatility of 23.00% and 25.84%, respectively; expected life of 4.6 and
6 years; and risk-free interest rates of 4.00% and 3.66%, respectively.

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 periods ended March 31, 2005 and 2004 was $0.7
and $0.1, respectively.

8) RESTRUCTURING AND ASSET IMPAIRMENT CHARGES

2005 RESTRUCTURING ACTIVITIES

During the first quarter of 2005, the Company recognized a $19.4
restructuring charge. New actions represent $18.6 of the charge. Other costs
totaling $0.8 relate to actions announced prior to 2005. The 2005 actions by
segment are as follows:

- The Fluid Technology segment recorded $6.5 primarily for the termination
of 105 employees, including 33 factory workers, 62 office workers and 10
management employees. The charge reflects a reduction in structural
costs.

- The Electronic Components segment recorded $6.5 of the charge primarily
for the reduction of 155 employees, including 36 factory workers, 101
office workers and 18 management employees. These actions reflect the
reorganization of the segment and a consolidation of functions.

- The Motion & Flow Control segment recognized $5.0 for the termination of
115 employees, including 49 factory workers, 58 office workers and 8
management employees. The headcount reductions relate to the closure of
one facility, the transfer of production of selected products from France
to Holland, the outsourcing of selected functions to Eastern Europe, and
the consolidation of other functions.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

Additionally, lease cancellation costs of $0.2 and other costs of $0.4
were recorded during the first quarter.

2004 RESTRUCTURING ACTIVITIES

During 2004, the Company recognized $38.8 of restructuring charges. Of this
amount, $37.7 related to new actions announced during 2004, primarily the
planned severance of 1,319 employees and lease cancellation costs. Additionally,
$1.1 of expenditures were incurred relating to actions announced prior to 2004.

The actions announced during 2004 by segment are as follows:

- The Fluid Technology segment recorded $17.7 for the planned termination
of 211 employees, including 52 factory workers, 155 office workers and
four management employees. Additionally, $0.7 of lease costs, $0.6 of
asset write-offs and $0.7 of other costs were also recognized during the
2004.

- The Electronic Components segment recorded a $4.5 charge for the
recognition of lease cancellation costs and $4.5 charge for the planned
termination of 972 employees, including 883 factory workers, 84 office
workers and five management employees. The segment also recorded $1.1 and
$0.8 for the disposal of machinery and equipment, and other costs,
respectively.

- The Motion & Flow Control segment recorded $4.6 for the planned
termination of 133 employees, including 47 factory workers, 77 office
workers and nine management employees. Other cost totaling $0.7 were also
recognized during 2004.

- Corporate headquarters recorded $1.8 for the planned termination of one
office worker and two management employees.

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

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, 2004, the accrual balance for restructuring activities was
$22.7. Cash payments of $10.8 and an additional restructuring charge of $19.4
were recorded in the first three months of 2005. The accrual balance at March
31, 2005 is $31.0, which includes $25.2 for severance and $5.8 for facility
carrying costs and other.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

As of December 31, 2004, remaining actions under restructuring activities
announced in 2004 and earlier were to reduce headcount by 685. During the first
three months of 2005, the Company announced the additional planned termination
of 375 people, and reduced headcount by 212 persons related to all plans,
leaving a balance of 848 planned reductions. Actions announced during the first
quarter of 2005 will be completed by the end of the third quarter of 2005.
Actions announced during 2004 will be substantially completed by the end of the
of 2005. Future restructuring expenditures will be funded with cash from
operations, supplemented, as required, with commercial paper borrowings.

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, "Summary of Significant Accounting
Policies", and 18, "Financial Instruments," within the Notes to Consolidated
Financial Statements of the 2004 Annual Report on Form 10-K, the Company uses
derivative financial instruments to mitigate or eliminate certain of those
risks.

At March 31, 2005 and December 31, 2004, the values of the Company's
interest rate swaps were $82.1 and $84.9, including $7.7 and $3.3 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 three months of 2005 and 2004.
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 March 31, 2005 the Company had no foreign currency cash flow hedges
outstanding. At December 31, 2004 the Company had one foreign currency cash flow
hedge outstanding with a notional amount of $0.1.

HEDGES OF RECOGNIZED ASSETS, LIABILITIES AND FIRM COMMITMENTS

At March 31, 2005 and December 31, 2004, the Company had foreign currency
forward contracts with notional amounts of $114.7 and $93.3, respectively, to
hedge the value of recognized assets, liabilities and firm commitments. The fair
value of the 2005 and 2004 contracts were $(1.2) and $(0.4) at March 31, 2005
and December 31, 2004, respectively. The ineffective portion of changes in fair
values of such hedge positions reported in operating income during the first
three months of 2005 and 2004 amounted to $0.1 and $(0.1), 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 2005 and 2004 (as of
the beginning of the year) and it was determined that no impairment exists.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

Changes in the carrying amount of goodwill for the quarter ended March 31,
2005, 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"). As of March 31, 2005, intangible assets
related to the acquisition of WEDECO include $237.1 of goodwill, $12.0 of
intangibles for tradenames, $21.4 of proprietary technology, $18.8 of customer
relationships and $5.6 of patents and other. During the third quarter of 2004,
the Company completed the acquisition of Remote Sensing Systems ("RSS"). As of
March 31, 2005, intangible assets related to the acquisition of RSS include
$598.3 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 three month
periods ended March 31, 2005 and 2004 was $4.6 and $0.7, respectively.

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

11) DISCONTINUED OPERATIONS

AUTOMOTIVE -- 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 adjust-

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

ments 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 March 31, 2005, the Company had automotive discontinued operations
accruals of $188.6 that are primarily related to taxes ($154.1), product recalls
($7.8), environmental obligations ($14.1) and employee benefits ($12.6). During
the first quarter of 2005, the Company made immaterial payments of its
automotive discontinued operations liabilities. The Company expects that it will
cash resolve $154.1 of tax obligations in 2005.

NS&S -- DISCONTINUED OPERATIONS

In the fourth quarter of 2004, the Company decided to sell its Network
Systems & Services (NS&S) business. NS&S produces robust structured cabling and
intelligent high-speed network solutions. After a comprehensive review of the
Company's expected future profitability and market participation, the Company
believed that NS&S would provide greater value for an organization whose primary
focus is the networking market.

Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Longed-Lived Assets," ("SFAS 144") requires the
Company to classify the assets and liabilities of the disposal group as held for
sale and to classify the results of operations of the component as discontinued
operations.

12) PENSION AND POSTRETIREMENT MEDICAL BENEFIT EXPENSES

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

Net periodic pension expense increased in the first quarter of 2005 as a
result of the lower discount rate adopted at year end 2004, higher average
foreign exchange rates, a higher amortization of actuarial losses and an
increase in costs associated with the 2004 acquisition of RSS.

The Company contributed approximately $106.9 to its various plans during
the first quarter of 2005. Additional contributions totaling between $15.0 and
$35.0 are expected over the balance of 2005.

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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 consist of the
following:

Net periodic expense increased in the first quarter of 2005 as a result of
lower discount rates and an increase in the assumed rate of medical inflation
adopted at year end 2004 and the inclusion of costs associated with the 2004
acquisition of RSS.

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 "Medicare Modernization 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 was unable to conclude whether
benefits of its plans are actuarially equivalent based on the proposed
regulations released in August 2004. Currently, the Company is analyzing the
effect of the Medicare Modernization Act on the Company's plans based on the
final regulations issued at the end of January 2005 and has not taken any action
at this time to reflect the Medicare Modernization Act changes. In addition, it
was assumed that the adoption of this pronouncement did not affect demographic
factors used to determine plan assets and obligations at December 31, 2004, the
Company's measurement date. See Note 19, "Employee Benefit Plans," in the Notes
to Consolidated Financial Statements of the 2004 Annual Report on Form 10-K for
discussion of postretirement benefits.

13) COMMITMENTS AND CONTINGENCIES

The Company and its subsidiaries are from time to time 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, 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. Accruals have been established where the outcome of the matter is
probable and can be reasonably estimated. 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.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

ENVIRONMENTAL

The Company has accrued for environmental remediation costs associated with
identified sites consistent with the policy set forth in Note 1, "Summary of
Significant Accounting Policies" in the Notes to Consolidated Financial
Statements of the 2004 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 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 March 31, 2005, the Company is responsible, or is alleged to
be responsible, for approximately 80 environmental investigation and remediation
sites in various countries. In many of these proceedings, the Company's
liability is considered de minimis. At March 31, 2005, the Company calculated a
best estimate of $98.0, which approximates its accrual, related to the cleanup
of soil and ground water. The low range estimate for its environmental
liabilities is $72.9 and the high range estimate for those liabilities is
$160.8. 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 March 31, 2005, 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 $5.5 and $19.3. The Company
has accrued $8.1 for this matter, which approximates its best estimate.

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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 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 $5.7 and $13.5. It has an accrual for this matter of $9.2 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 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.

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 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
2004, ITT and Goulds resolved in excess of 4,200 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 two actions, Cannon Electric, Inc. et al. v. Ace
Property & Casualty Company ("ACE") et al. Superior Court, County of Los
Angeles, CA., Case No. BC 290354, and Pacific Employers Insurance Company et
al., v. ITT Industries, Inc., et al., Supreme Court, County of New York, N.Y.,
Case No. 03600463. The parties in both cases are seeking an appropriate
allocation of responsibility for the Company's historic asbestos liability
exposure among its insurers. The California action is filed in the same venue
where the Company's environmental insurance recovery litigation has been pending
since 1991. The New York action has been stayed in favor of the California suit.
ITT and ACE have successfully resolved the matter and the Company is working
with other parties in the suit to resolve the matter as to those insurers. In
addition, Utica National, Goulds' historic insurer, has requested that the
Company negotiate a coverage in place agreement to allocate the Goulds' asbestos
liabilities between insurance policies issued by Utica and those issued by
others. 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.

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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 Company is one of several defendants in a suit filed in El Paso, Texas,
Bund zur Unterstutzung Radargeschadigter et al. v. ITT Industries 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 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. Numerous motions are currently pending before the
Court. A hearing on class certification is expected in late 2005. 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, C.A. No. B.C.
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. The parties have an agreement in principle to
resolve this matter whereby the Company will continue to receive the cost of
defense of this matter from the insurers. Management believes that the El Paso
suit will not have a material adverse effect on the Company's consolidated
financial position, results of operations or cash flows.

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 1, Item 1 of the 2004 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. On May 2, 2005 the
arbitrator issued an award directing the Company to make a payment to Rayonier.
The Company has filed an appeal of the award in the United States District Court
for the Southern District of New York, C.A. No. 05-CV-4322 (CLB). The award, if
enforced, 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 March 31, 2005 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,
17

ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

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 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 March 31, 2005 the Company has an accrual of $14.1
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 guaranty 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 March 31, 2005, 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
March 31, 2005, the Company does not believe that a loss contingency is probable
and therefore does not have an accrual recorded in its financial statements.

The Company has a number of individually immaterial guarantees outstanding
at March 31, 2005, that may be affected by various conditions and external
forces, some of which could require that payments be made under such guarantees.
The Company does not believe these payments 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.

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 March 31, 2005, the
Company has a product warranty accrual in the amount of $40.4.
18

ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

PRODUCT WARRANTY LIABILITIES

15) ACQUISITIONS

During the first three months of 2004, the Company spent $243.0 primarily
for the acquisitions of the following:

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

- 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.

As of March 31, 2005, the excess of the purchase price over the fair value
of net assets acquired of $238.9 is recorded as goodwill.

OTHER 2004 ACQUISITIONS

On August 13, 2004, the Company purchased all of the RSS business from
Eastman Kodak for $736.9 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.

As of March 31, 2005, the excess of the purchase price of RSS over the fair
value of net assets acquired of $598.3 is recorded as goodwill and is deductible
for tax purposes. The entire goodwill balance 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.

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. The pro forma results presented below for 2004 combine the
results of the Company for 2004 and the historical results of RSS from January
1, 2004 to March 31, 2004, respectively. 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 2004 and should not be taken as indicative of
the Company's future

19

ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

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

16) BUSINESS SEGMENT INFORMATION

Unaudited financial information of the Company's business segments for the
three months ended March 31, 2005 and 2004 were as follows:

20

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 2005 quarterly financial periods end on the Saturday after
the last day of the quarter, except for the last quarterly period of the fiscal
year, which ends on December 31st. During 2004, the Company's quarterly
financial periods ended on the Saturday before the last day of the quarter,
except for the last quarterly period of the fiscal year, which ended on December
31st. For simplicity of presentation, the quarterly financial statements
included herein are presented as ending on the last day of the quarter.

21

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

RESULTS OF OPERATIONS

EXECUTIVE SUMMARY

The Company enjoyed strong operating performance in the first quarter of
2005. Revenues grew 24.6% from the comparable prior year quarter. Higher volume
in all segments contributed 13.1% of the growth and acquisitions and foreign
currency contributed 11.5% of the growth. These results reflect the strength of
the Company's portfolio of businesses and the introduction of new products.
Based on these results and current and projected market conditions, the Company
forecasts full year 2005 revenue between $7,435 million and $7,630 million.

Operating income in the first quarter of 2005 was 16.8% higher than the
first quarter of 2004. The increase reflects higher volume, partially offset by
increased restructuring costs and additional marketing and administrative costs
associated with the 2004 acquisitions of the Remote Sensing Systems business and
WEDECO AG Water Technology. The Company forecasts full year 2005 segment
operating income to be between approximately $840 million and $885 million.

Diluted earnings per share were $1.24 for the quarter and includes the
impact of favorable tax settlements (and related interest income), $0.36,
restructuring $(0.14) and discontinued operations (0.11). Diluted earnings per
share for the comparable prior year quarter were $0.94 and include the impact of
favorable tax settlements, $0.5, and restructuring and other $(0.04). Full year
2005 diluted earnings per share are forecasted to be between $5.10 and $5.25.

THREE MONTHS ENDED MARCH 31, 2005 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2004

Sales and revenues for the first quarter of 2005 were $1,883.1 million, an
increase of $372.0 million, or 24.6%, from the same period for 2004. Costs of
sales and revenues of $1,287.7 million for the first quarter of 2005 increased
$284.3 million, or 28.3%, from the comparable 2004 period. The increases in
sales and revenues and costs of sales and revenues are primarily attributable to
higher volume in all segments, contributions from two 2004 acquisitions made by
the Defense Electronics & Services and Fluid Technology segments and the impact
of foreign currency translation. The increase in costs of sales and revenues
also reflects a change in product mix in the Defense Electronics & Services
segment.

Selling, general and administrative ("SG&A") expenses for the first quarter
of 2005 were $270.9 million, an increase of $42.9 million, or 18.8%, from the
first quarter of 2004. The increase in SG&A expenses was primarily due to
increased marketing expense in all segments, including expenses from two 2004
acquisitions, higher general and administrative expenses and the impact of
foreign currency translation. Higher general and administrative costs reflect
additional employee benefit costs, the cost of process improvement initiatives,
administrative expenses related to two 2004 acquisitions and increased
expenditures for tax planning initiatives.

Research, development and engineering ("RD&E") expenses for the first
quarter of 2005 increased $8.2 million, or 5.7%, compared to the first quarter
of 2004. The increase is attributable to increased spending in all segments.

During the first quarter of 2005, the Company recorded a $19.4 million
restructuring charge to streamline its operating structure. The charge primarily
reflects severance costs for the planned termination of 375 employees. During
the first quarter of 2004, the Company recorded a $5.3 million restructuring
charge. The charge primarily reflected the planned reduction of 103 employees.
Additionally, $0.6 million of restructuring accruals related to 2003 and 2001
restructuring actions were reversed into income during the first quarter of
2004, as management determined that certain cash expenditures would not be
incurred. 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.

22

Operating income for the first quarter of 2005 was $152.3 million, an
increase of $21.9 million, or 16.8%, over the first quarter of 2004. 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 quarter of 2005 was 9.2%, or 60 basis points below the comparable prior
year quarter. The variance in segment operating margin is primarily attributable
to increased restructuring charges.

Interest expense during the first quarter of 2005 was $20.1 million, an
increase of $9.8 million, or 95.1% from the comparable prior year period. This
increase reflects higher interest rates and higher debt balances (reflecting
2004 acquisitions). Additionally, the Company recognized $14.2 million of
interest income during the first quarter of 2005 compared to $9.2 million during
the first quarter of 2004. The increase of $5.0 million, or 54.3%, primarily
reflects the recognition of interest income associated with tax settlements
related to prior year tax filings.

During the first quarter of 2005 income tax expense was $14.2 million,
$22.5 million, or 61.3% less than the applicable prior year period. The variance
primarily reflects the recognition of tax settlements totaling approximately $30
million relating to prior year tax filings. Partially offsetting these items is
the increase in taxable income during the first quarter of 2005 compared to the
first quarter of 2004.

Income from continuing operations was $127.2 million, or $1.35 per diluted
share compared to $89.0 million or $0.94 per diluted share for the first quarter
of 2004. The increase reflects the results discussed above.

During the first quarter of 2005, the Company recognized a $10.7 million
loss from discontinued operations compared to a loss of $0.1 million in the
comparable period. The 2005 loss primarily relates to losses and asset write
downs associated with the Company's Network Systems & Services business.
Additional costs related to other discontinued operations also contributed to
the charge.

Fluid Technology's sales and revenues and costs of sales and revenues
increased $64.7 million, or 11.3%, and $37.1 million, or 9.7%, respectively, in
the first quarter of 2005 compared to the first quarter of 2004. Higher 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. SG&A for the first
quarter of 2005 increased $18.9 million, or 15.2%, compared to 2004, mainly due
to increased advertising costs, sales commissions and administrative costs in
most businesses, foreign currency translation and costs attributable to a 2004
acquisition. During the first quarter of 2005, the segment recorded a $6.5
million restructuring charge related to activities to reduce structural costs.
During the first quarter of 2004, the segment recorded a $3.2 million
restructuring charge mainly related to a planned reduction in headcount.
Additionally, during 2004, $0.2 million of restructuring accruals were reversed
into income as closed facility costs were less than initially anticipated (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 quarter of 2005 increased $3.3 million, or 6.3%, compared to the first
quarter of 2004 due to the activities discussed above.

Defense Electronics & Services' sales and revenues and costs of sales and
revenues for the first quarter of 2005 increased $269.2 million, or 53.1%, and
$218.8 million, or 69.7%, respectively, from the comparable prior year period.
The increases are primarily due to higher volume in the night vision,
communications, electronic warfare and systems businesses. Contributions from a
third quarter 2004 acquisition also contributed to the increase in revenues.
Additionally, a change in product mix also contributed to the increase in costs
of sales and revenues. SG&A expenses increased $16.7 million, or 51.1%,
primarily due to increased employee benefit and administrative costs, higher
marketing costs and costs associated with a third quarter 2004 acquisition. RD&E
expenses increased $4.6 million, or 4.1%, primarily due to increased spending in
the segment's services businesses. Operating income for the first quarter of
2005 was $77.8 million, an increase of $29.1 million, or 59.8%, compared to the
same quarter in 2004. The increase reflects the results discussed above.

Motion & Flow Control recorded sales and revenues and costs of sales and
revenues of $297.6 million and $216.1 million, respectively, during the first
quarter of 2005, reflecting increases of $23.6 million, or 8.6%, and

23

$17.5 million, or 8.8%, from the first quarter of 2004. The increases were
mainly due to higher volume in the friction material businesses and the impact
of foreign currency translation partially offset by volume declines in the fluid
handling business. SG&A expenses were flat with the comparable prior year
period. During the first quarters of 2005 and 2004, the segment recorded $5.6
million and $0.2 million of restructuring charges, respectively, mainly related
to actions to reduce operating costs (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 $38.6 million was $0.5 million,
or 1.3%, lower in the first quarter of 2005 compared to the first quarter of
2004 primarily due to the items mentioned above.

Electronic Components' sales and revenues of $173.7 million and costs of
sales and revenues of $124.8 million in the first quarter of 2005, increased
$16.3 million, or 10.4%, and $15.6 million, or 14.3%, respectively, from the
comparable prior year period. The increases reflect higher volume in most
businesses and the impact of foreign currency translation. Additionally, a
change in product mix also contributed to the increase in costs of sales and
revenues. SG&A expenses increased $0.4 million due to increased marketing, and
the impact of foreign currency translation. During the first quarters of 2005
and 2004, the segment recorded $7.3 million and $1.7 million of restructuring
charges, respectively, relating to planned actions to reduce structural costs.
Additionally, during 2004, $0.4 million of restructuring accruals were reversed
into income reflecting lower than anticipated severance costs (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 quarter of 2005 decreased $6.2 million, or 84.9%, from the first
quarter of 2004. The decrease was due to the factors discussed above.

Corporate expenses increased $3.8 million in the first quarter of 2005,
primarily due to costs related to process improvement initiatives in 2005,
employee benefit costs and tax increased expenditures for tax planning
initiatives.

STATUS OF RESTRUCTURING AND ASSET IMPAIRMENTS

2005 RESTRUCTURING ACTIVITIES

During the first quarter of 2005, the Company recognized a $19.4 million
restructuring charge. New actions represent $18.6 million of the charge. Other
costs totaling $0.8 million relate to actions announced prior to 2005. The 2005
actions by segment are as follows:

- The Fluid Technology segment recorded $6.5 million primarily for the
termination of 105 employees, including 33 factory workers, 62 office
workers and 10 management employees. The charge reflects a reduction in
structural costs.

- The Electronic Components segment recorded $6.5 million of the charge
primarily for the reduction of 155 employees, including 36 factory
workers, 101 office workers and 18 management employees. These actions
reflect the reorganization of the segment and a consolidation of
functions.

- The Motion & Flow Control segment recognized $5.0 million for the
termination of 115 employees, including 49 factory workers, 58 office
workers and 8 management employees. The headcount reductions relate to
the closure of one facility, the transfer of production of selected
products from France to Holland, the outsourcing of selected functions to
Eastern Europe, and the consolidation of other functions. Lease
cancellation costs of $0.2 million and other costs of $0.4 million were
also recorded during the first quarter.

As of March 31, 2005, the Company had made $1.7 million of payments
attributable to the 2005 first 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 first quarter of 2005 are approximately $15.8 million during 2005 and
$127.5 million between 2006 and 2010. The savings

24

primarily represents lower salary and wage expenditures and will be reflected in
"Costs of Sales and Revenues" and "Selling, General and Administrative
Expenses".

2004 RESTRUCTURING ACTIVITIES

During 2004, the Company recognized $38.8 million of restructuring charges.
Of this amount, $37.7 million related to new actions announced during 2004,
primarily the planned severance of 1,319 employees and the lease cancellation
costs. Additionally, $1.1 million of expenditures were incurred relating to
actions announced prior to 2004.

The actions announced during 2004 by segment are as follows:

- The Fluid Technology segment recorded $17.7 million for the planned
termination of 211 employees, including 52 factory workers, 155 office
workers and four management employees. Additionally, $0.7 million of
lease costs, $0.6 million of asset write-offs and $0.7 million of other
costs were also recognized during the 2004.

- The Electronic Components segment recorded a $4.5 million charge for the
recognition of lease cancellation costs and $4.5 million charge for the
planned termination of 972 employees, including 883 factory workers, 84
office workers and five management employees. The segment also recorded
$1.1 million and $0.8 million for the disposal of machinery and
equipment, and other costs, respectively.

- The Motion & Flow Control segment recorded $4.6 million for the planned
termination of 133 employees, including 47 factory workers, 77 office
workers and nine management employees. Other cost totaling $0.7 million
were also recognized during 2004.

- Corporate headquarters recorded $1.8 million for the planned termination
of one office worker and two management employees.

During the first quarter of 2005, the Company made $7.9 of payments
attributable to the 2004 restructuring plans.

The projected future cash savings from the restructuring actions announced
during 2004 are approximately $30 million during 2005 and approximately $130
million between 2006 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."

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

25

During the first quarter of 2004, $0.2 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 first quarter of 2005, headcount was reduced by 49 persons and
the Company experienced employee attrition, leaving a balance of 635 planned
reductions related to the 2004 restructuring plans.

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.

The following tables display a rollforward of the automotive discontinued
operations accruals from January 1, 2003 to March 31, 2005 (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 March 31, 2005, the Company has automotive discontinued operations
accruals of $188.6 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
$14.1 million -- for the remediation and investigation of groundwater and soil
contamination at thirteen sites which are recorded in Other Liabilities;
employee benefits $12.6 million -- for workers compensation issues which are
recorded in Accrued Expenses. In 2005, the Company made immaterial payments for
matters attributable to the automotive discontinued operations. The Company
expects that it will settle $154.1 million of tax obligations in late 2005. The
Company forecasts that it will spend between $1.0 million and $4.0 million in
2005 related to its other remaining automotive obligations.

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOW OVERVIEW

The Company generated $12.4 million of cash in operating activities. Net
income from continuing operations plus depreciation and amortization contributed
$182.7 million of cash flow. Additionally, higher level of accounts payable and
accrued expenses contributed $53.1 million of cash flow. The primary operating
uses of cash flow were the funding of higher levels of accounts receivable and
inventory ($107.4 million), reflecting higher sales volume, and the $100 million
pre-funding of pension contributions. Reductions of accrued and deferred taxes
of $10.6 million and restructuring payments totaling $10.8 million were also
uses of cash flow.

In addition to the $12.4 million of cash generated from operating
activities, the Company also used additional short term debt of $179.3 million
and proceeds from the issuance of stock of $35.7 million to fund $82.4 million
of common stock repurchases, $33.2 million of dividend payments, and $30.4
million of capital expenditures.

Cash Flows: Cash generated from continuing operating activities during the
first three months of 2005 was $12.4 million, or a $126.8 million improvement
over the first quarter of 2004. The improvement is primarily attributable to a
$67.4 million reduction in the funding of accounts receivable and a $53.1
million increase in accounts payable and accrued expenses versus a $5.4 million
decrease in the applicable prior year liability balances. A $38.2 million
increase in income from continuing operations also contributed to the
improvement in cash flow. Partially offsetting these items was the $10.6 million
reduction in accrued and deferred taxes (versus a $21.7 million increase during
the comparable 2004 period) and a $18.1 million increase in inventory levels
(versus a $2.6 million liquidation during the comparable 2004 period).

Status of Restructuring Activities: Restructuring payments during the
first quarter of 2005 were $10.8 million, including $1.7 million related to the
2005 plan and $9.1 million related to earlier plans. Restructuring payments
during the first three months of 2004 totaled $9.5 million and were comprised of
$1.7 million of expenditures for the 2004 plan and $7.8 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.

27

Additions to Plant, Property and Equipment: Capital expenditures during
the first three months of 2005 were $30.4 million, an increase of $1.5 million
from the first three months of 2004. The increase was primarily due to increased
spending in the Defense Electronics & Services segment.

Acquisitions: During the first three months of 2004, the Company spent
$243.0 million primarily for the acquisitions of the following:

- WEDECO, the world's largest manufacturer of UV disinfection and ozone
oxidation systems, which are alternatives to chlorine treatment.

- 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.

Divestitures: During the first three months of 2005 the Company generated
$3.6 million of cash from the sale of one property. In the first quarter of
2004, the Company generated $2.6 million of cash proceeds primarily from the
sale of two properties.

Financing Activities: Debt at March 31, 2005 was $1,440.6 million,
compared with $1,272.0 million at December 31, 2004. The change in debt levels
primarily reflect the funding of the repurchase of common stock (net of proceeds
from the issuance of common stock), dividend payments, and capital expenditures.
Cash and cash equivalents were $336.3 million at March 31, 2005, compared to
$262.9 million at December 31, 2004. The change in cash levels primarily
reflects increased debt levels and cash generated from operating activities.

At March 31, 2005, the Company had $1.4 billion of revolving credit
agreements, which provide back-up for the Company's commercial paper program.
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: During the first quarter of
2005, 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 2005. In addition, the Company forecasts 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, by commercial paper borrowings.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements, in conformity with generally
accepted accounting principles, 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 March 31, 2005, the
Company's best estimate is $98.0 million, which approximates the accrual related
to the remediation of ground water and soil. The low range estimate for
environmental liabilities is $72.9 million and the high range estimate is $160.8
million. On an annual basis the

28

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 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 80 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.
The determination of projected benefit obligations and the recognition of
expenses related to pension and other postretirement obligations are dependent
on assumptions used in calculating these amounts. These assumptions include:
discount rates, expected rates of return on plan assets, rate of future
compensation increases, mortality, termination, 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 2004 Annual Report on Form
10-K) and other factors.

KEY 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 2004 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 12.1%,11.2%, 12.6% and 12.7%, 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, 2004, is 8.89%.

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, 2004, the Company lowered the discount rate on most of its
domestic pension plans, which represent about 90% of the Company's total pension
obligations, from 6.25% to 6.00%. The Company's weighted average discount rate
for all pension plans, including foreign affiliate plans, at December 31, 2004,
is 5.94%. Also, at December 31, 2004, the Company lowered the discount rate on
its postretirement welfare

29

plans from 6.25% to 5.75% and increased the medical trend rate for 2005 to 10%
decreasing ratably to 5% in 2010.

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

With respect to its qualified U.S. defined benefit pension plans and one of
its retiree medical plans, the Company has set up a U.S. Master Trust to pay
future benefits to eligible retirees and dependents.

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, 2004, the Company's actual asset
allocation was 66.2% in equity instruments, 16.4% in fixed income instruments
and 9.9% 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. Please see Note 19, "Employee Benefit Plans," in the Notes to Consolidated
Financial Statements of the 2004 Annual Report on Form 10-K for more
information.

The Company's Defense Electronics & Services segment represents
approximately 60% 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, and therefore, are recognized in the Defense Electronics &
Services segment's net sales.

Funding requirements under IRS rules are a major consideration in making
contributions to our pension plan. With respect to its qualified pension plans,
the Company intends to contribute annually not less than the minimum required by
applicable law and regulations. The Company contributed $120.1 million to the
U.S. Master Trust in 2004, and an additional $102.4 million in the first quarter
of 2005. As a result, the Company will not face material minimum required
contributions to its U.S. Salaried Plan in 2005 and 2006, under current IRS
contribution rules. Furthermore, we currently estimate that we will not make
significant additional contributions to the Company's U.S. Salaried Pension Plan
during the remainder of 2005.

Assuming that current IRS contribution rules continue to apply in the
future, and barring major disruptions in the equity and bond markets, the
Company estimates that it will not be required to make mandatory contributions
in the 2006 to 2007 timeframe.

30

FUNDED STATUS

Funded status is derived by subtracting the value of the projected benefit
obligations at December 31, 2004 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 U.S.
Salaried Pension Plan has a considerable impact on the overall funded status of
the Company's pension plans.

During 2004, the Company's U.S. Salaried Pension Plan assets grew by $575.4
million to $3,564.6 million at the end of 2004. This increase primarily
reflected return on assets of $474.3 million, Company contributions of $100.0
million and the addition of $235.0 million in assets as a result of the
acquisition of RSS, offset by payments to plan beneficiaries of $233.6 million.

Also during 2004, the projected benefit obligation for the U.S. Salaried
Pension Plan increased by $458.2 million to $3,907.6 million. The increase
included the $126.4 million impact of a 25 basis point decline in the discount
rate at year-end and the assumption of $260.0 million in liabilities as part of
the acquisition of RSS. As a result, the funded status for the Company's U.S.
Salaried Plan improved by $116.6 million to $(343.0) million at the end of 2004.
Funded status for the Company's total pension obligations, including foreign and
affiliate plans, improved by $105.5 million to $(754.9) million at the end of
2004.

Funded status at the end of 2005 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 point 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 $126 million. Similarly,
every five percentage point change in the actual 2005 rate of return on assets
impacts the same plan by approximately $178 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 shareholders' equity. As a result of the improved
financial markets in 2003 and 2004, the Company recorded total after-tax
increases to its shareholders' equity of $182.5 and $81.8 million at year-end
2003, and 2004, respectively. It is important to note that these actions did not
cause a default in any of the Company's debt covenants.

Future recognition or reversal 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 $62.1 million of net periodic pension cost ($65.4
million after considering the effects of curtailment losses and settlements)
into its Consolidated Income Statement in 2004, compared with pension cost of
$33.0 million ($35.4 million including curtailments) in 2003. The 2004 net
periodic pension cost reflected benefit service cost of $87.9 million and
interest cost on accrued benefits of $267.9 million, offset by the expected
return on plan assets of $344.2 million. In addition, the 2004 pension expense
included $43.3 million of amortization of past losses, up from $23.5 million in
2003. The primary drivers behind the

31

increase in the net periodic pension cost were the effect of the change in the
discount rate, the increase in amortization of past losses in 2004 and the
inclusion of RSS in the cost from the date of acquisition.

In 2005, the Company expects to incur approximately $93.0 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, higher amortization of past losses and the full year impact of
the RSS acquisition.

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 March 31, 2005 and 2004 was $40.4
million and $35.8 million, respectively. See Note 14, "Guarantees, Indemnities
and Warranties," in the Notes to Consolidated Condensed Financial Statements for
additional details.

ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123 (revised 2004) "Share-Based Payment" ("SFAS 123R") which is a
revision of SFAS No. 123, "Accounting for Stock-Based Compensation." This
statement eliminates the option of using the intrinsic value method of
accounting for employee stock options (historically utilized by the Company),
which generally resulted in the recognition of no compensation cost. The
provisions of the SFAS No. 123R require the recognition of employee services
received in exchange for awards of equity instruments based on the grant-date
fair value of the awards as determined by option pricing models. The calculated
compensation cost is recognized over the period that the employee is required to
provide services per the conditions of the award. SFAS No. 123R is effective for
the Company on January 1, 2006. The adoption of this statement will not have a
material impact on the Company's financial statements.

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs -- an
amendment of ARB No. 43, Chapter 4" ("SFAS No. 151"). This statement clarifies
the criteria of "abnormal amounts" of freight, handling costs, and spoilage that
are required to be expensed as current period charges rather than deferred in
inventory. In addition, this statement requires that allocation of fixed
production overheads to the costs of conversion be based on the normal capacity
of the production facilities. SFAS No. 151 is effective for the Company July 1,
2005. The Company is currently in the process of determining the impact of this
statement on the Company's financial statements.

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

32

Act of 2003 (the "Medicare Modernization 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 was unable to conclude whether
benefits of its plans are actuarially equivalent based on the proposed
regulations released in August 2004. Currently, the Company is analyzing the
effect of the Medicare Modernization Act on the Company's plans based on the
final regulations issued at the end of January 2005 and has not taken any action
at this time to reflect the Medicare changes. In addition, it was assumed that
the adoption of this pronouncement did not affect demographic factors used to
determine plan assets and obligations at December 31, 2004, the Company's
measurement date. See Note 12, "Employee Benefit Plans," for discussion of
postretirement benefits.

In December 2004, the FASB issued FSP 109-1, "Application of FASB Statement
No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of 2004 ("FSP
109-1")." The American Jobs Creation Act of 2004 (the "AJCA") provides for a tax
relief for U.S. domestic manufacturers. FSP 109-1 states that tax benefit should
be recorded in the year in which it can be taken in the Company's tax return
rather than reflecting a deferred tax asset in the period the AJCA was enacted.
FSP 109-1 was effective upon issuance. Adoption of FSP 109-1 did not have a
material effect on the Company's financial statements.

In December 2004, the FASB issued FSP 109-2, "Accounting Disclosures
Guidance for the Foreign Earnings Repatriation Provision within the American
Jobs Creation Act of 2004 ("FSP 109-2"). The Foreign Earnings Repatriation
Provision Within the Act (the "Provision") provides a special limited-time
dividends received deduction on the repatriation of certain foreign earnings to
a U.S. taxpayer. FSP 109-2 states that a company should recognize the income tax
effect related to the Provision when it decides on a plan for reinvestment or
repatriation of foreign earnings. At this time, the Company does not expect to
elect to apply this provision of the AJCA.

In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations (an interpretation of FASB Statement
No. 143)" (the "Interpretation"). This Interpretation provides clarification
with respect to the timing of liability recognition for legal obligations
associated with the retirement of tangible long-lived assets when the timing
and/or method of settlement of the obligation are conditional on a future event.
The Company is currently evaluating the potential impact of the Interpretation.

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
33

Company's commitments and contingencies, see Note 21, "Commitments and
Contingencies" in the Notes to Consolidated Financial Statements of the 2004
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
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, 2004 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 2004 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 in 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, 2004.

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.

34

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.

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.

35

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)

May 10, 2005

36

EXHIBIT INDEX

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

* Management compensatory plan

42