Welcome to ITT's 2015 Second Quarter Results Conference Call. Today is Friday, July 31, 2015. And starting the call from ITT today is Melissa Trombetta, Vice President, Investor Relations. She is joined by Denise Ramos, Chief Executive Officer and President; and Tom, Scalera, Chief Financial Officer. Today's call is being recorded and will be available for a replay beginning at 12:00 P.M. Eastern Daylight Time. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Melissa Trobetta. You may begin.

Thank you, Laurie. I'd like to highlight that this morning's presentation, press release and reconciliations of GAAP and non-GAAP financial measures can be found on our website at itt.com/ir. Please note that any remarks we make about the future expectations, plans, prospects and other circumstances set out in our Safe Harbor Statement constitute forward-looking statements for purposes of the Safe Harbor provision. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including those discussed in ITT's Form 10-K as well as our other public SEC filings. We undertake no obligation to publically update any forward-looking statements whether as a result of new information, future events or otherwise. Forward-looking statements made on this call should be evaluated together with the risks and uncertainties that affect our business, particularly those disclosed in our SEC filings. So, let's now turn to slide number 3, where Denise will discuss our results.

Good morning, everyone. I appreciate you joining us as we announce our financial results for the second quarter of 2015. Q2 was yet another strong operating quarter for ITT where we continued our track record of delivering solid results despite the persistent headwind from foreign exchange, global oil and gas markets and general and industrial markets. Despite these top line challenges in the quarter, we never lost our focus on strong execution, which his reflected in both our adjusted segment operating margins of 15.2% and our solid adjusted earnings per share of $0.69. Throughout the quarter, we maintained our operational intensity. And we improved our adjusted segment gross margins by 140 basis points. This significantly contributed to the growth of our adjusted segment operating margins, which expanded 110 basis points to 15.2%, the second consecutive quarter of record margin for ITT. This expansion was driven by momentum from our ongoing LEAN transformation, restructuring savings from actions we have taken in our industrial process and interconnect solutions businesses, and supply chain benefits. And we were able to achieve these results, while at the same time, investing in our strategic growth initiatives and absorbing the disruption impacts from our ICS business due to the relocation of certain North American operations. When we made the decision to invest in strengthening our culture about a year-and-a-half ago, we were confident then that it would unlock potential at ITT. And what we are realizing today is that our culture is having an even greater impact when combined with our lean transformation. The level of accountability and collaboration is magnified when you put these two forces together. And that has allowed us to collectively overcome challenges and create value for our shareholders. So, before I continue, I would just like to thank everyone on the ITT…

Thanks, Denise. Now, let's turn to slide 5 for a detailed review of our second half results. In Q2, total revenue declined 5%, but organic revenue increased 1% after adjusting for foreign exchange and the net impact of the Hartzell Aerospace acquisition and the industrial product line divestiture that the Control Technologies team executed this quarter. Motion Technologies led the way with exceptional 9% organic revenue growth, fueled by our global automotive brake pad business as well as our KONI shock absorber business. These businesses were up 12% and 5%, respectively. It is important to note that after a soft first quarter, our automotive independent aftermarket grew 14% in the quarter due an anticipated shift in our customer's buying pattern. Industrial Process also delivered solid 4% organic growth in the quarter. This growth reflected a 13% increase in the aftermarket that was driven by parts in Latin America and the Middle East and a 33% increase in project pumps. The project growth reflected our strong performance on global oil and gas projects that were already in backlog, partially offset by difficult prior year chemical market comparisons and weak market conditions in Asia. Our short-cycle baseline pump and valve businesses were down 25% in the quarter due to weaker-than-expected market conditions in North America, compounded by a difficult prior year comparison. ICS's organic revenue declined 14% due to delayed shipments related to the disruptions in our North American operations, weaker-than-expected demand across major geographies, and significant declines in our high margin book-and-bill upstream oil and gas business. And, finally, Control Technologies was up 1% in total but declined 10% organically excluding the impact of the Hartzell acquisition, foreign exchange, and an industrial product line divestiture. The organic decline is mainly due to the timing of commercial aerospace shipments, softness in the…

The floor is now open for questions. [Operator Instructions] Our first question comes from the line of Mike Halloran of Robert Baird.

Good morning, everyone.

Good morning, Mike.

Good morning, Mike.

So, let's talk about the IP margins to start out here. Very strong in the second quarter, certainly seems above what you guys were thinking originally. How does that play out on the back half of the year here when you have changing mix as well as continued, if not greater volume pressures working through? Are we going to get some drawback in that margin level as we work forward or is it the right run rate to work off of relative to whatever revenue levels you guys see?

Thanks for the question, Mike. We are very pleased with the benefits that we're seeing at IP right now. We've been working on a transformation in that business for a period of time now. It's been very targeted, and it's been very strategic. And we've been setting it up for the long-term growth of this business. The first thing that we did is we reorganized it into three verticals, and that has created a lot of efficiency and benefits by being able to get people focused in those specific areas that we've got. We've also embarked upon restructuring and realignment in that business based on what's been happening with the oil price decline. So, we've closed about 10 production facilities and sales offices. We've reduced head count by about 13% over the past year, year and a half. And we've been really focusing in these new verticals around taking reductions in our material cost and then driving further productivity through enhanced project management skills that we've had. We've also - and one of those verticals is the aftermarket vertical. And because of the work that we've been doing with the installed base over the past five years or so and now the focus that we've got on the aftermarket, we're being able to capture some market share in the aftermarket because of that focus and also through some new technologies that we're coming to market with. And so, we're just leveraging the large project installed base that we've got. So, a lot of what you're seeing in the IP margins in the second quarter is reflective of this work that we've been doing and the focus in the cost reductions that we've had. So, we're very pleased with seeing that new level of margins in IP. Now, I'll turn it over to Tom. And with that backdrop then, Tom, why don't you talk about how we see the margin sequencing in the back half?

Sure. Yes. Mike, we're looking into the back half with a more difficult pricing environment and probably some unfavorable mix particularly when we look at the baseline pump order rates coming out of Q2. So, while we're operating at a high level with sustained productivity gains and additional compounding benefits from restructuring, some of that lift is going to be offset primarily by mix and price in Q3 and Q4. But I think what we've done in Q2 is establish the solid operational foundation. That may be kind of our high watermark for the year, but we still expect to be generating solid year-over-year margins as we progress through the back half of the year. But I would say Q2 is probably our high point based on the mix we saw then.

All right. That makes sense. So, maybe down sequentially but still having healthy gains year-over-year because of all the things Denise talked about. So, then, on the ICS side, I certainly heard the comments about profitability in the second half of the year being relatively comparable to the first half of the year.

Now, let's move forward a little bit and as you work through those changes in the fourth quarter and you get the new facilities up and running to the way you wanted to, are we talking about a relatively immediate snapback to the run rate that you guys have established before you guys made the move from California down to Mexico, or is it going to take a little bit more time than that? Just kind of thinking about what the cadence can look like as we get towards 2016 there.

Sure. We do expect 2016 is going to have much improved margins from what we're seeing today. In the first quarter and in the second quarter, these disruptions that we've had have taken us down to the margin levels that we have today. And without those disruptions, we would've been averaging margins of about 14% or so in that business which was very good. We have been targeting mid to high-teens margins in that business, and so we still end up targeting that. The turnaround that we've got there, this is a very complex move. We are basically taking three locations and we're moving out of Santa Ana into Nogales, Mexico and into Irvine where the headquarters will be. The Nogales facility that we've got is going to be a North American manufacturing center of excellence for Santa Ana. This move needed to take place. And the reason it needed to take place is we had so much inefficiencies in the way that that business was being operated that this was a long-term fix to be able to take care of that. So, we are fixing that through doing some talent upgrades. We've been moving some machining capacity down to Nogales. We've been improving our production planning capabilities down there. And the goal is to make Nogales a much more efficient operation than what it would've been in the past. And so, it's going to take us some time to do that since this was a very complex move. But as we get into 2016, we should start seeing more of the benefits flowing through and then hopefully get back to those margins that we had targeted in the past.

And then last one for me here. Could you just talk about what the cadence of the orders and end-market trends in your more process-driven markets look like through the quarter? Are you getting a sense that things are stabilizing from an order perspective at a new bottom in some of those markets? Or do you think that there's more deterioration that's still happening, specifically, more oil and gas, chemical, those types of markets?

When we look sequentially through Q2 and we look at IP, things didn't change much from month to month. So, we did not see any major changes, any trends that would say that it's going up or it's going down. When people ask about our oil prices stabilizing, that will be great if they are, but I don't think it's prudent for us to bank on that right now. We're not going to plan for that. We're going to continue to drive productivity actions within that IP business, because they're so volatile, there's so many dynamics and changes that are occurring in the oil markets right now that it is hard to call. So, I think we've got to be prudent. We've got to continue to go after cost actions, because these oil prices can continue to fluctuate.

Thank you.

And I will just add to that...

Go ahead, sorry.

Sorry, Mike. Just add to Denise's comments also on chemical and general industrial markets. It was fairly consistent but it was below our expectations for the quarter. So that was another factor. As we look through the orders and through the results in Q2, we're assuming that that levels of chemical and industrial stay consistent with what we've seen in the first half. We're not expecting ramp ups in the second half beyond what we already see in backlog.

So, in other words, sequentially stable at low levels is what you've implied in your more short cycle driven businesses in the back half of the year?

Exactly. And I think, previously, we're expecting a little bit of less maybe like others, but we just haven't seen indicators at this point, so we're not going to get ahead of the markets. We're just going to project based on what we know and see today.

Perfect. I appreciate it. Thank you as always.

Thanks, Mike.

Thanks, Mike.

Your next question comes from the line of Shannon O'Callaghan of UBS. Shannon O’Callaghan: Morning.

Hey, Shannon.

Good morning, Shannon. Shannon O’Callaghan: So, can you just give us a little flavor in terms of China, auto obviously been - they're very topical. You guys have won a lot of penetration there, but the end market outlook is not what it once was. Can you give a little sense of how that all shakes out for you guys and what - if China auto is a down market, what does that mean for you and what is your business doing in that kind of an environment?

In China right now, we have about 12%, 13% market share, and we've been growing our presence there. We've been growing our business in China. I still feel very strongly that there are good fundamentals in China, so that has not - in my mind that has not changed. The portfolio that we have and where we go to market is really focused in the premium segment. And so, we're focused on more new platform introductions, SUVs, and that part of the market in China is growing faster than when you look at the lower end of the range. And so, we are in that sweet spot and in that strong position within China. And we continue to drive opportunities to have cost reductions and localize our supply base, which really helps from a margin perspective in China. Saying all of that, we are cognizant of what's happening in the automotive industry in China. While there has been somewhat of a slowdown, we've taken that into account in our numbers, but we're still growing our China business. On a full-year basis, we expect to grow at about 30%. And so, it's still a high growth area for us. And when you look at the investments that we've been making in our Wuxi facility, we've been pacing and sequencing that. So, we are not getting ahead of demand in that market, and we are doing this in a very modular way where we have an existing facility. And as we see visibility into this platform, that's when we add incremental capacity in that facility. So, we still feel very good about China, very good about the fundamentals that are there. We're going to continue to take market share, and it is a strategic area for us for the future. Shannon O’Callaghan: And do you have a view kind of past this year as you know what platforms you're on for next year and that kind of thing, how much you think you should outgrow the market just based on platform penetration?

That's a great question, Shannon. Our run rate, I think - our 10-year run rate has been 2.5% globally, or 2.5 times the market globally. And I think our trajectory in China has been well in access of that. Keep in mind, we are just powering up in China. So, we are getting well entrenched with our R&D capabilities and really testing and gaining better relationships with our customers using the same model that we've had in Europe. So, the goal, I would say, for the longer term is to continue to drive the kind of market growth that we've driven in Europe because we're applying the same model effectively. So, I don't have an exact number for you. I think the team clearly plans out with about three to five years of visibility based on the platforms that we're competing on, the ones that we've already won. And I think we'll continue to target growth rates that are well in excess of the market certainly as we're gaining share in China. Shannon O’Callaghan: And then just on Industrial Process. You have this lag between backlog and what the orders are actually doing this quarter. Obviously, it's a good revenue result off the prior backlog. When does the - if you think about the back half, how did the current order trends translate into actual revenues? I mean, when do you see your sharpest decline? Does it show up in 3Q or does it end up showing up more in 4Q or 1Q next year?

Yeah. It's a good point, Shannon. And I think we'll see some of that starting in Q4 and then trailing into the first half of next year. Now, typically, our project backlog is 6 to 12 months. So, we'll start to see some year-over-year impacts, certainly Q4 last year was a very strong quarter for us as well. So, we would start to kind of expect that this order decline on projects starts to impact us in Q4 and then certainly into the first half of next year, which is I think why we're continuing to drive incremental restructuring, resetting the businesses again, similar to our Motion Technologies business, and the platform visibility we have. The backlog visibility that we have in Industrial Process business project category, in particular, allows us to plan out restructuring cost actions. And we do expect some nice year-over-year restructuring carryover from the actions that we've already put in place. And we're continuing to drive actions to make sure that as we see that play through into the first half of next year from a revenue perspective that we have the right cost structure, the right footprint, the right head count in place to be able to address those impacts. Shannon O’Callaghan: Okay. Great. Thanks.

Your next question comes from the line of Matt Summerville of Alembic Global Advisors.

Hey. Good morning.

Good morning.

I wanted to revisit a couple of things in ICS. I guess, coming from your first quarter call, I would have guessed that the magnitude of impact was going to get a little better as supposed to a little worst. And I guess that it's kind of a complex move, but I guess I'm just trying to understand that if there's execution issues kind of beyond what you've talked about, is the management team that you put in place there I think was roughly a year and a half to two years ago, is still the right group of people. And I guess, what's your expectation for full-year disruption cost now?

Yeah. You know the challenge with this is that it has unfolded to be a much bigger, more complex move than what we had anticipated. So, yes, there are execution challenges associated with this. Important to note that we have been changing out some of the people in the organization as we've been going through this. We recognize that our workforce needed to have more trainings and different leaders. And so, we've been making some of those changes as we've been going through this transition. But the team is really focused on it. We've also taken some people from other parts of ITT, and we're supporting that team. Within ICS, they've taken some good operations people from their other locations to put down there in order to sort through some of these challenges. And it really just ended up being a more complex situation than what was anticipated at the beginning of this.

Yeah, Matt, and the way we're thinking about disruption for the back half of the year is, typically, our nature, if we haven't seen a turn yet, we're going to assume that it carries. So, we're kind of taking the disruption that we've seen on a year-to-date basis and kind of imputing that into the back half of the year. Recognizing that, we put restructuring actions online in Q2 which impact about 6% of the workforce for ICS. So, we are taking actions to get the right cost structure to align with the right footprint and the right processes. And that's going to set us up, we think, certainly nicely as we go into 2016 where we have these kind of impacts fully behind us. But we're going to keep walking through it systematically. And just keep in mind in the background that the oil and gas business and ICS has a very big impact on the profitability. It's a high margin, upstream, short-cycle business that is facing a very difficult market condition. So, in addition to Nogales, we are continuing to see upwards of about a 30% decline in that very important business within their connectors portfolio. So, it's just another point I want to raise.

And then just lastly, if you can maybe recap the restructuring costs that you're taking in 2015, the savings you expect to get this year from actions either done last year or during the current year, and then what is the carryover into 2016 based on your current plans.

Sure. Yeah. We're still on track with our previous guidance to deliver $40 million to $45 million of restructuring actions in 2015. We do have - what we're projecting right now is incremental savings rolling off of the announced actions running into 2016 of about $15 million to $20 million of incremental savings. So, we are getting and a lot of that is going to be concentrated in Industrial Process and in our ICS segments as well. So, we have some nice carryover going into 2016. We also have some additional actions that are going to help us in the second half of 2015 offset some of the top line pressures we're seeing. But that's kind of where we are now, Matt, and as we keep watching conditions in markets unfold, we'll constantly assess if we want to do more to stay ahead of any of the pressures we see mounting for 2016. But right now, we're holding it at $40 million to $45 million of actions this year.

Great. Thanks, guys.

Thanks, Matt.

Thanks, Matt.

Our next question comes from the line of Brian Konigsberg of Vertical Research Partners.

Yes. Hi. Good morning.

Hey, Brian.

Good morning.

Maybe you just talk a little bit more about Motion Tech win in the U.S. with this new Detroit 3 platform. When will you anticipate to see that start to contribute to the top and bottom lines. And it sounds like this is in a more - a bit of a share gain story as well. I mean, could this be a growth driver similar to what we're seeing out of China given kind of the platforms that you've been winning recently?

We are very excited about North America that has been one of our growth platforms for Motion Technologies as we've articulated to you. And so, this win that we had will really take about 18 to 24 months in order for us to start seeing the production associated with that. What we really like about this win that we had is we continue to build the North American business, and we're doing it with more complex brake pads. So, this is a copper-free brake pad which is higher technology. It's also on the front axle, which means there's higher performance associated with that. So, we're winning because of the strength that we have within our technology capabilities and how we go to market with that and work with our customers. So, we like this. It's building our business in North America. North America will be a strong platform for us as you think about the future for Motion Technologies. And what we really have now then are three businesses, the European business, the China business and then the North American business. So, we're very excited about it.

Great. And maybe just - can you talk about the change in asbestos. So, it sounds like you're able to change strategy on legal. Is there anything else that you think that could transpire? Obviously, there's been a lot going on, on the legal front there where the liability can be eroded further. And does this change? And as it kind of grinds lower, does it provide you any more flexibility from a strategic standpoint.

In terms of asbestos, it's a great change for us in terms of defense cost. And so, we're very, very happy with now being able to optimize how we handle our defense cost within our specifiability. We go through on an annual basis in Q3 a re-measurement of that, but we look at it every quarter just to make sure that we don't see any major changes or movements that's happening in the asbestos world, and we monitor that. If there was anything that we saw that resulted in a significant change or significant movement, we would identify that. So, we've not seen that to-date, but we did - when we entered into this new agreement from a defense standpoint, that's when we went in and we reduced the liability over the long term associated with the reduced cost that we're going to have from a defense standpoint.

And I would say too, Brian, we have a great legal team that work the strategy. We've got a lot of folks all across ITT that are part of our risk center of excellence that are constantly assessing strategies to improve our cash and our situation. This is a nice add to our capacity because it reduces the net asbestos liability by $101 million, so it's a nice incremental benefit, and I think that's the way we're looking at it. This is something that was within our control to go out and make happen, and the team did a great job of capturing it. So, it's a positive from a capacity perspective and from a cash flow perspective as well.

Okay. If I could just sneak in one last one, just on IP, so conceptually, with the price declines that you're booking in backlog today and all the restructuring that you're doing. I know you don't want to get into specifics on 2016 at this point, but maybe just conceptually, can you talk about the trajectory of the margin opportunity next year? Is the severity in price declines you think that is going to be, I guess, overshadowing the additional opportunities you have on the restructuring side? And do you still see a path where margin is going to expand next year even with the volume in price pressures that are coming your way?

Yeah. On the price side, at the beginning of the year when we came up with our guidance, we thought very hard about price and what was going to happen from an IP perspective in the marketplace. We've not changed those expectations. We factored in about a 10% to 15% decline in price. But I think what's important to note here is that we're being very disciplined with how we approach these projects and how we price these projects, recognizing that there are different dynamics and different things that the customers are looking for. Saying all of that, we're monitoring it very, very closely. We're monitoring what's happening with our backlog and with the volume levels that we're anticipating into 2016. And we are looking at what cost actions we need to take and what restructuring we need to take in order to be successful in 2016.

Great. Thank you.

Thank you.

Our next question comes from the line of Nathan Jones of Stifel.

Good morning, everyone.

Good morning, Nathan.

Hey, Nathan.

Just going back to guidance here for a minute. I think, Tom, on the last call you were saying that 2Q earnings was expected to be about flat like last year which gives you about a 10% in 2Q. Doing a little math while I'm on the phone here, it looks like your expectation for profitability in Interconnect is probably down about $0.15 for the full year. And with the $0.05 reduction in guidance, that would imply to me that the weak effect in half markets just basically offset with the actions you're taking internally. Is that a fair way to characterize it?

It's a way to think about it, Nathan. I mean, I think the way we're looking at it is a strong first half performance, additional productivity and restructuring kind of carrying into the back half, that's going to offset all of the ICS reset that you're mentioning because we are just kind of staying in line with what we've seen from a year-to-date basis as we project the back half at ICS. And then we'll cover a portion of the volume drop, so taking the volume down by 1.5 percentage points at the mid, that drop on that revenue we've partially covered with other actions that we have in place. But that's how we kind of think of the guide, to guide a reset.

Okay. And then in IP, I think about 30% of that business goes through distribution. Can you talk about what impacts you're seeing from destocking in the channel, whether that was an impact on 2Q, if it continues into the back half?

Yeah. We've definitely have been riding the destock and restock express here. So, I think in Q1, we did see some nice restocking. In Q2, we've been seeing, what I would say, is more destocking. So, we kind of netted out a little bit below where we expected. It was hard to really extrapolate what we saw in the first quarter. And we certainly saw things kind of normalize out in Q2. So, as we go into the back half, it's kind of hard to say exactly where the channel is right now. I could tell you we're working very closely with our distribution partners. We've got a great North American distribution network, and we're very tied with them on their forecasting and planning. But I think in this kind of market environment, it's been a little bit more erratic than we anticipated. But if I had to call it, Q1 was some restocking and Q2 feels like it's destocking. And we'll assume that something similar happens in the back half of the year.

That's helpful. And just a clarification, Denise. When you were talking about the 10% to 15% decline in prices, that's specifically on the project business within IP?

Generally, it's on the project side, Nathan. That's where we're seeing most of it. Yes.

All right. Thanks very much for taking my questions.

Thanks, Nathan.

Thanks, Nathan.

Your next question comes from the line of Joe Ritchie of Goldman Sachs.

Thank you. Good morning, everyone.

Good morning, Joe.

Good morning, Joe.

I guess, maybe just going back to ICS for a second. Denise, how would you handicap ring-fencing VP issues to this year? And then, as you kind of look into next year also thinking about just getting back to that 13% to 14% margin, is that feasible?

Well, we have a lot of actions underway right now, Nathan (sic) [Joseph] (58:15) to be able to do that. And I've mentioned those when we're looking at the production side of this, the supply chain issues that we have just becoming more efficient associated with that. So, that is definitely our goal, and we've been making a lot of changes internally in order to be able to get there. So, the goal is to do that, and we'll just see if we're successful at that. We're executing very hard against that.

Okay. But at a minimum rate, a lot of the costs and the headwinds that are really depressing margins this year go away in 2016, that's a fair statement, correct?

Yeah. I would say, Joe, the only kind of carryover might be the oil and gas upstream market pressure that they're going to have to ride through. So, operationally, we have a good line on where these disruption costs are coming from, and we're certainly working to address those this year with the plan to minimize, if not eliminate, those going into 2016 and then just look at the market conditions at that point in our key markets: aerospace, defense, and oil and gas. But the one I'd say we're watching in 2016 is upstream oil and gas. But clearly, that would be coming off of a pretty tough 2015 as a baseline.

Okay. Great. Then I guess, Tom, maybe following up on just the margin differential. We've talked about this in the past. There seems to be a pretty big gap between the margins that you're earning in Mexico as opposed to California. Can you just kind of talk us through longer term what that opportunity looks like as you transfer a lot of production down there?

Yeah. I mean, I think our plans are still the same as they've been, Joe, to move this business into mid to high-teens range. I think the efficiency improvements that we're driving - we've been in Nogales for a number of years. We have had a very successful operation in Mexico. We're adding additional complexity into the environment there, and they're going to come up to speed on it. They're going to learn, and we're going to get the right folks in there to kind of run that operation efficiently. So, what we've always projected around ICS's long-term margin profile is unchanged by this particular period of time, but we do need to get through it. And I think we're making good progress. But it's still the right efficiency level to drive for our customers and to make sure that we continue to produce at a high level, and that will give us the margins that we think are consistent with what other top players are doing in the industry.

Okay. Thanks, guys.

Thanks, Joe.

Thanks, Joe.

Ladies and gentlemen, I do apologize but we have reached the allotted time for questions and answers. Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.