ITT INDUSTRIES INC - 10-Q Quarterly Report

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

FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 1-5672

ITT INDUSTRIES, INC.

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

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

TELEPHONE NUMBER: (914) 641-2000

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

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

As of October 31, 2003, there were outstanding 92,271,319 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 within the United States 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 2002 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 statements.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

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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 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 receivables consist of the following:

2) INVENTORIES

Net inventories consist of the following:

3) PLANT, PROPERTY, AND EQUIPMENT

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

The Defense Electronics & Services segment comprises $175.4 and $469.3 of
total service revenues for the three and nine months ended September 30, 2002,
respectively, and $113.0 and $288.3 of total costs of service revenues,
respectively, during the same period. The Fluid Technology segment comprises the
remaining balances of service revenues and costs of service revenues.

5) COMPREHENSIVE INCOME

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

6) EARNINGS PER SHARE

The following is a reconciliation of the shares used in the computation of
basic and diluted earnings per share for the three months and nine months ended
September 30, 2003 and 2002:

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

The amounts of outstanding antidilutive common stock options excluded from
the computation of diluted earnings per share for the three months and nine
months ended September 30, 2002 were each less than 0.1.

7) STOCK-BASED EMPLOYEE COMPENSATION

As of September 30, 2003 and 2002, the Company had two stock-based employee
compensation plans and two stock-based non-employee director's compensation
plans, which are described more fully in Note 20, "Shareholders' Equity," within
the Notes to Consolidated Financial Statements of the 2002 Annual Report on Form
10-K. Additionally, a third stock-based employee and non-employee director
compensation plan was adopted by the Company during the second quarter of 2003.
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 cost for these plans been
determined based on the fair value recognition provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," the Company's net income and earnings per share would have been
reduced to the following pro forma amounts:

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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 fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model and the following weighted-average
assumptions for grants in the three months and nine months ended September 30,
2003 and 2002:

The value of stock-based compensation that was recognized in selling,
general and administrative expenses within the Consolidated Condensed Income
Statements during the three month and nine month periods ended September 30,
2003 and 2002 was:

8) RESTRUCTURING AND ASSET IMPAIRMENT CHARGES

As discussed in the "Accounting Pronouncements" section of Management's
Discussion and Analysis of Financial Condition and Results of Operations, the
Company recorded restructuring charges related to 2003 actions in accordance
with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." Restructuring actions initiated prior to January 1, 2003 were
recorded in accordance with the guidelines of Emerging Issues Task Force Issue
No. 94-3, "Liability Recognition for Certain Employee Benefits (including
Certain Costs Incurred in a Restructuring)."

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

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

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

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

The projected future cash savings from the restructuring actions announced
during the third quarter of 2003 are approximately $1 during 2003 and $21
between 2004 and 2008. The savings primarily represents lower salary and wage
expenditures and will be reflected in costs of sales and revenues and selling,
general and administrative expenses.

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

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

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

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

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

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

The projected future cash savings from the restructuring actions announced
during the second quarter of 2003 are approximately $4 during 2003 and $41
between 2004 and 2008. The savings primarily represents lower salary and wage
expenditures and will be reflected in costs of sales and revenues and selling,
general and administrative expenses.

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

During the first quarter of 2003 the Company recorded a $9.0 restructuring
charge primarily for the planned severance of 465 persons. Severance of $8.3
represents the majority of the charge.

Listed below, by business segment, is background information on the 2003
first quarter restructuring charge.

The restructuring actions initiated by the Electronic Components segment
include the planned termination of 226 persons, comprised of 101 office workers,
116 factory workers and nine management employees, and the disposal of certain
machinery and equipment. The actions were prompted by management's projections
of continued weakness in certain businesses.

The $1.1 charge taken at Corporate Headquarters represents the
consolidation of administrative tasks and includes the planned termination of
two management employees.

The actions within the Motion & Flow Control segment include the planned
termination of 237 employees, comprised of 21 office workers and 216 factory
workers. The charge relates to the closure of a manufacturing facility in
Arkansas. The actions will be completed during 2003 and 2004 and the total
estimated charge of approximately $2.6 will be recognized ratably over the
restructuring period as the terminations become effective. Management deemed the
restructuring actions necessary to address the anticipated loss of certain
platforms during the second half of 2003.

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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 projected future cash savings from the restructuring actions announced
during the first quarter of 2003 are approximately $5 during 2003 and $56
between 2004 and 2008. The savings primarily represents lower salary and wage
expenditures and will be reflected in costs of sales and revenues and selling,
general and administrative expenses.

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

At December 31, 2002, the accrual balance for restructuring activities was
$16.3. Cash payments of $14.9 and additional cash charges of $17.1 were recorded
in the first nine months of 2003. Also, management reviewed the Company's
remaining restructuring actions and determined that certain 2003 and 2001
actions would be completed for $1.2 less than planned at the Electronic
Components segment. Accordingly, restructuring accruals totaling $1.2 were
reversed into income during the third quarter of 2003. The accrual balance at
September 30, 2003 is $17.3, which includes $13.8 for severance and $3.5 for
facility carrying costs and other.

As of December 31, 2002, remaining actions under restructuring activities
announced in 2001 and 2002 were to close three facilities and reduce headcount
by 256. During the first nine months of 2003, the Company closed two facilities.
In addition, headcount was reduced by 575 persons related to all plans and the
Company experienced employee attrition, leaving a balance of 331 planned
reductions (including the 2003 plans). Actions announced during the first nine
months of 2003 will be completed by the first quarter of 2004. All of the
actions contemplated under the 2002 and 2001 plans will be completed by the
close of 2003. Closed facility expenditures related to the 2001 plan will
continue to be incurred in 2003 through 2006. Future restructuring expenditures
will be funded with cash from operations, supplemented, as required, with
commercial paper borrowings.

OTHER ASSET IMPAIRMENT CHARGE

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

9) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The nature of the Company's business activities necessarily involves the
management of various financial and market risks, including those related to
changes in interest rates, currency exchange rates, and commodity prices. As
discussed more completely in Notes 1, "Accounting Policies," and 18, "Financial
Instruments," within the Notes to Consolidated Financial Statements of the 2002
Annual Report on Form 10-K, the Company uses derivative financial instruments to
mitigate or eliminate certain of those risks.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

At September 30, 2003 and December 31, 2002, the values of the Company's
interest rate swaps were $96.1 and $97.0, including $8.1 and $4.0 of accrued
interest, respectively.

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

HEDGES OF FUTURE CASH FLOWS

At September 30, 2003 the Company had six foreign currency cash flow hedges
that had appreciations of $0.1 during 2003. At December 31, 2002, there were no
foreign currency cash flow hedges outstanding. There were no changes in the
forecasted transactions during 2003 regarding their probability of occurring,
which would require amounts to be reclassified to earnings.

The notional amount of the foreign currency forward contracts utilized to
hedge cash flow exposures was $2.5 at September 30, 2003. The fair value of
these contracts at September 30, 2003 was $0.1. There were no ineffective
portions of changes in fair values of cash flow hedge positions reported in
earnings for the nine months ended September 30, 2003 and 2002, respectively,
and no amounts were excluded from the measure of effectiveness reported in
earnings during these periods.

HEDGES OF RECOGNIZED ASSETS, LIABILITIES AND FIRM COMMITMENTS

At September 30, 2003 and December 31, 2002, the Company had foreign
currency forward contracts with notional amounts of $73.9 and $109.1,
respectively, to hedge the value of recognized assets, liabilities and firm
commitments. The fair values of these contracts were $(0.2) and $0.6 at
September 30, 2003 and December 31, 2002, respectively. The ineffective portion
of changes in fair values of such hedge positions reported in operating income
during the first nine months of 2003 and 2002 were $(0.2) and $0.0,
respectively. There were no amounts excluded from the measure of effectiveness.

10) GOODWILL AND OTHER INTANGIBLE ASSETS

As of January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets," which addresses the financial accounting and reporting
standards for the acquisition of intangible assets outside of a business
combination and for goodwill and other intangible assets subsequent to their
acquisition. This accounting standard requires that goodwill and
indefinite-lived intangible assets be tested for impairment on an annual basis,
or more frequently if circumstances warrant, and that they no longer be
amortized. The provisions of the standard also require the completion of a
transitional impairment test in the year of adoption, with any impairments
identified treated as a cumulative effect of a change in accounting principle.
In connection with the adoption of SFAS No. 142, the Company completed a
transitional and initial goodwill impairment test at its 12 identified reporting
units and determined that no impairment exists. Both tests were conducted in the
first quarter of 2002. The Company also conducted its annual impairment test in
the first quarter of 2003 (as of the beginning of the year) and 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 nine months ended
September 30, 2003 by operating segment are as follows:

Information regarding the Company's other intangible assets follows:

Amortization expense related to intangible assets for the nine month
periods ended September 30, 2003 and 2002 was $2.0 and $0.8, respectively.
Estimated amortization expense for each of the five succeeding years is
approximately $3 per year.

11) DISCONTINUED OPERATIONS

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

At September 30, 2003, the Company had automotive discontinued operations
accruals of $188.3 that primarily relate to taxes ($154.1), product recalls
($7.9), environmental obligations ($14.5), employee benefits ($9.9) and other
($1.9). In 2003, the Company has spent approximately $1.7. The Company expects
that it will cash settle $154.1 of tax obligations in 2004 or 2005.

12) 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 (including toxic tort, property damage, and remediation),
intellectual property matters (including patent, trademark and copyright
infringement, and licensing disputes), personal injury claims (including
injuries due to product failure, design or warnings issues, asbestos exposure,
or other product

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

liability related matters), 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.

ENVIRONMENTAL

The Company has accrued for environmental remediation costs associated with
identified sites consistent with the policy set forth in Note 1, "Accounting
Policies," within the Notes to Consolidated Financial Statements of the 2002
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 September 30, 2003, the Company is responsible, or is alleged
to be responsible, for approximately 105 environmental investigation and
remediation sites in various countries. In many of these proceedings, the
Company's liability is considered de minimis. At September 30, 2003, the Company
calculated a best estimate of $109.0, which approximates its accrual, related to
the cleanup of soil and ground water. The low range estimate for its
environmental liabilities is $81.0 and the high range estimate for those
liabilities is $174.0. On an annual basis the Company spends between $11.0 and
$14.0 on its environmental remediation liabilities.

The Company is involved in an environmental proceeding in Glendale,
California relating to the San Fernando Valley aquifer. The Company is one of
numerous PRPs who are alleged by the EPA to have contributed to the
contamination of the aquifer. In January 1999, the EPA filed a complaint in the
United States District Court for the Central District of California against the
Company and Lockheed Martin Corporation, United States v. ITT Industries, Inc.
and Lockheed Martin Corp. CV99-00552 SVW AIJX, to recover costs it incurred in
connection with the foregoing. In May 1999, the EPA and the PRPs, including the
Company and Lockheed Martin, reached a settlement, embodied in a consent decree,
requiring the PRPs to perform additional remedial activities. Pursuant to the
settlement, the PRPs, including the Company, have constructed and are operating
a water treatment system. The operation of the water treatment system is
expected to continue until 2013. ITT and the other PRPs continue to pay their
respective allocated costs of the operation of the water treatment system and
the Company does not anticipate a default by any of the PRPs which would
increase its allocated share of the liability. As of September 30, 2003, the
Company's accrual for this liability was $10.9 representing its best estimate;
its low estimate for the liability is $7.4 and its high estimate is $16.4.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

ITT 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 been investigating the site in coordination with state and federal
environmental authorities. A remedy for the site has not yet been selected.
Currently, the estimated range for the costs of the additional investigation and
the anticipated remediation is between $6.2 and $20.4. The Company has accrued
$10.8 for this matter, which approximates its best estimate.

The Company is involved with a number of PRPs regarding property in the
City of Bronson, Michigan operated by a former subsidiary of ITT, Higbie
Manufacturing, prior to the time ITT acquired Higbie. ITT 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 $3.1
and $6.4. It has an accrual for this matter of $4.4 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 late 2003 or early 2004. In the event the appeal is successful,
the Company will pursue the administrative claims against its excess insurers.
During the course of the litigation the Company has negotiated settlements with
certain defendant insurance companies and is prepared to pursue its legal
remedies where reasonable negotiations are not productive. A portion of the
recoveries from the insurance settlements have been placed in a trust and are
used to reimburse the Company for its environmental costs.

PRODUCT LIABILITY

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

Frequently, the plaintiffs are unable to demonstrate any injury or do not
identify any ITT or Goulds product as a source of asbestos exposure. During
2003, ITT and Goulds resolved approximately 2,000 cases 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 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 for several years.

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ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

Both actions have been stayed to allow the parties to negotiate an acceptable
allocation arrangement. The Company is continuing to receive the benefit of
insurance payments during the pendency of these actions. The Company believes
that these actions will not materially affect the availability of its insurance
coverage and will not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.

The Company is one of several defendants in a suit filed in El Paso, Texas
Bund zur Unterstutzung Radargeschadigter et al. v. ITT Industries 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. The Company's insurers are on notice of this matter
and are contributing to the costs of defense. Management believes that this
matter will not have a material adverse effect on the Company's consolidated
financial position, results of operations or cash flows.

The Company has received notice of a product liability suit filed in
Superior Court of New York, Danis v. Rule Industries et al., Sup.Ct. N.Y., C.A.
No. 115975-02, seeking damages for injuries sustained in a boat explosion. The
suit contains a number of causes of action against various defendants including
the boat manufacturer, the marina operator, and individuals working at the
marina. As to the Company, the Complaint alleges that a fume detector,
manufactured by ITT's subsidiary Rule Industries, Inc. prior to the date the
Company acquired Rule, malfunctioned. The Company's insurer has accepted the
defense of this matter. Management believes that this matter will not have a
material adverse effect on the Company's consolidated financial position,
results of operations, or cash flows.

The Company 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 Company's 2002 Annual Report
on Form 10K 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 has received a Notice of Claim from Rayonier, Inc., a former
subsidiary of the Company's predecessor ITT Corporation. This claim stems from
the 1994 Distribution Agreement for the spin-off of Rayonier by ITT Corporation
and seeks an allocation of proceeds from certain settlements in connection with
the Company's environmental insurance recovery litigation. The parties are
seeking a resolution of this matter through arbitration. The Company believes
the claim is grossly overstated and will not have a material adverse effect on
the Company's consolidated financial position, results of operations or cash
flows.

13) 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 that business, including: Conveyance of Title,
Employee
17

ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

Benefits, Tax, Product Liability, Product Recall, Contracts, Environmental,
Intellectual Property, etc. The Company also indemnified Valeo SA for losses
related to a misrepresentation or breach of the representations and warranties.
With a few limited exceptions, the indemnity periods within which Valeo SA may
assert new claims have expired. Under the terms of the sales contract, the
original maximum potential liability to Valeo SA on an undiscounted basis is
$680. However, because of the lapse of time, or the fact that the parties have
resolved certain issues, at September 30, 2003 the Company has an accrual of
$7.9 which is its best estimate of the potential exposure.

In September of 1998, the Company completed the sale of its brake and
chassis unit to Continental AG for approximately $1,930. As part of the sale,
the Company provided Continental AG with representations and warranties with
respect to the operations of that business, including: Conveyance of Title,
Employee Benefits, Tax, Product Liability, Product Recall, Contracts,
Environmental, Intellectual Property, etc. The Company also indemnified
Continental AG for losses related to a misrepresentation or breach of the
representations and warranties. With a few limited exceptions, the indemnity
periods within which Continental AG may assert new claims have expired. Under
the terms of the sales contract, the original maximum potential liability to
Continental AG on an undiscounted basis is $950. However, because of the lapse
of time, or the fact that the parties have resolved certain issues, at September
30, 2003 the Company has an accrual of $14.5 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 seven 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 would be required to
perform under these guarantees if the District failed to provide interest
payments or principal payments due to the bond holders. The maximum amount of
the undiscounted future payments on these guarantees equal $28.9. At September
30, 2003, the Company does not believe that a loss contingency is probable for
these guarantees and therefore does not have an accrual recorded in its
financial statements. 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 September 30, 2003, the Company has an accrual
related to the expansion of the bridge in the amount of $10.0.

In December of 2002, the Company entered into a sales-type lease agreement
for its corporate aircraft and then leased the aircraft back under an operating
lease agreement. The Company has provided, under the agreement, a residual value
guarantee to the counterparty in the amount of $44.8, which is the maximum
amount of undiscounted future payments. The Company would have to make payments
under the residual value guarantee only if the fair value of the aircraft was
less than the residual value guarantee upon termination of the agreement. At
September 30, 2003, the Company does not believe that a loss contingency is
probable and therefore does not have an accrual recorded in its financial
statements.
18

ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

PRODUCT WARRANTIES

Accruals for estimated expenses related to warranties are made at the time
products are sold or services are rendered. These accruals are established using
historical information on the nature, frequency, and average cost of warranty
claims. The Company warrants numerous products, the terms of which vary widely.
In general, the Company warrants its products against defect and specific
nonperformance. In the automotive businesses, liability for product defects
could extend beyond the selling price of the product and could be significant if
the defect shuts down production or results in a recall. At September 30, 2003,
the Company has a product warranty accrual in the amount of $41.5.

PRODUCT WARRANTY LIABILITIES

14) BUSINESS SEGMENT INFORMATION

Unaudited financial information of the Company's business segments for the
three months and the nine months ended September 30, 2003 and 2002 were as
follows:

19

ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

20

ITT INDUSTRIES, INC. AND SUBSIDIARIES

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

21

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

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 2002

Sales and revenues for the third quarter of 2003 were $1,375.2 million, an
increase of $140.1 million, or 11.3%, from the same period for 2002. Costs of
sales and revenues of $903.7 million for the third quarter of 2003 increased
$104.9 million, or 13.1%, from the comparable 2002 period. The increases in
sales and revenues and costs of sales and revenues are primarily attributable to
higher volume in the Defense Electronics & Services and Fluid Technology
segments, contributions from acquisitions made by the Fluid Technology and
Electronic Components segments and the impact of foreign currency translation. A
change in product mix in the Defense Electronics & Services and Electronic
Components segments also contributed to the increase in costs of sales and
revenues.

Selling, general and administrative ("SG&A") expenses for the third quarter
of 2003 were $195.9 million, an increase of $25.3 million, or 14.8%, from the
third quarter of 2002. The increase in SG&A expenses was primarily due to
increased marketing expense in all segments, and higher general and
administrative expenses. Higher general and administrative costs reflect
additional employee benefit costs, the cost of process improvement initiatives
and increased other administrative expenses.

Research, development and engineering ("RD&E") expenses for the third
quarter of 2003 increased $6.5 million, or 5.0%, compared to the third quarter
of 2002. The increase is attributable to increased spending in all segments.

During the third quarter of 2003, the Company recorded a $2.8 million
restructuring charge for actions to reduce operating costs and streamline its
structure. The charge primarily reflected the planned reduction of 72 persons.
Additionally, management reviewed the Company's remaining restructuring actions
and determined that certain 2003 and 2001 actions would be completed for $1.2
million less than planned at the Electronic Components segment. Accordingly,
restructuring accruals totaling $1.2 million were reversed into income during
the third quarter of 2003. During the third quarter of 2002, management reversed
$1.7 million of restructuring accruals as it was determined that the Company's
remaining actions would be completed for less than planned at the Fluid
Technology and Motion & Flow Control segments. Refer to the section entitled
"Status of Restructuring and Asset Impairments" and Note 8, "Restructuring and
Asset Impairment Charges," in the Notes to Consolidated Condensed Financial
Statements for additional information.

Operating income for the third quarter of 2003 was $136.8 million compared
to $136.7 million for the third quarter of 2002. The increase is primarily due
to increased sales and revenues at most of the segments, offset by increased
SG&A and RD&E expenses. Additionally, the third quarter of 2003 reflects $1.6
million of net restructuring charges and the comparable prior year period
reflects a $1.7 million reversal of restructuring charges. Segment operating
margin, for the third quarter of 2003 was 11.1%, or 1.2% below the segment
operating margin for the comparable 2002 period. The decrease reflects changes
in product mix in the Electronic Components segment, 2003 restructuring charges
in the Fluid Technology, Electronic Components and Motion & Flow Control
segments and the impact of 2002 Fluid Technology acquisitions, which produced
operating margins below the segment average. Higher operating margins in the
Defense Electronics & Services segment partially offset these items.

Interest income of $5.3 million (net of interest expense of $6.0 million)
for the third quarter of 2003 increased $10.9 million from the $5.6 million
interest expense in the comparable prior year period. The variance between years
is primarily due to the collection of interest income from a cost based
investment that management had previously believed would not be received. Upon
collection, the Company reversed the related valuation allowance into income.
Additionally, a favorable tax settlement contributed to the variance in interest
income from the comparable prior year period.

Income tax expense was $37.6 million in the third quarter of 2003, an
increase of $26.0 million from the comparable 2002 period. The increase is
primarily due to a $61.2 million tax refund received during the third
22

quarter of 2002, of which $30.6 million was reflected as a reduction of tax
expense. A $5.9 million tax refund received in the third quarter of 2003,
partially offset the difference.

Income from continuing operations was $102.5 million, or $1.09 per diluted
share compared to $120.4 million or $1.28 per diluted share for the third
quarter of 2002. The decline reflects the results discussed above.

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

Fluid Technology's sales and revenues and costs of sales and revenues
increased $79.4 million, or 16.4%, and $54.4 million, or 16.9%, respectively, in
the third quarter of 2003 compared to the third quarter of 2002. Higher organic
sales in the water/wastewater markets and industrial pumps businesses,
acquisition revenue from the water/wastewater and engineered valves businesses,
and the impact of foreign currency translation were the primary factors for the
increases. SG&A for the third quarter of 2003 increased $13.0 million, or 14.6%,
compared to 2002, mainly due to both increased marketing expenses in the
water/wastewater business and increased administrative costs in most businesses.
During the third quarter of 2003, the segment recorded a $0.9 million
restructuring charge mainly related to a planned reduction in headcount.
Additionally, during the third quarter of 2002, management reviewed the
remaining restructuring actions and reversed $1.0 million of the segments
restructuring accruals that were deemed unnecessary (refer to the section
entitled "Status of Restructuring and Asset Impairments" and Note 8,
"Restructuring and Asset Impairment Charges," in the Notes to Consolidated
Condensed Financial Statements for additional information). Operating income for
the third quarter of 2003 was up $9.4 million, or 14.5%, compared to the third
quarter of 2002 due to the activities discussed above.

Defense Electronics & Services' sales and revenues and costs of sales and
revenues for the third quarter of 2003 increased $62.4 million, or 16.3%, and
$46.9 million, or 22.1%, respectively, from the comparable prior year period.
The increases are primarily due to higher service revenue reflecting Middle East
support and increased revenue from the communications business, partially offset
by lower volume in the night vision business. The increase in costs of sales and
revenues also reflects a change in product mix. SG&A expenses increased $3.7
million, or 14.7%, reflecting higher marketing expenses and increased employee
benefit and administrative costs. RD&E expenses increased $4.2 million, or 4.0%,
due to increased spending in the communications and services businesses.
Operating income for the third quarter of 2003 was $48.1 million, an increase of
$7.6 million, or 18.8%, compared to the same quarter in 2002. The increase
reflects the results discussed above.

Motion & Flow Control recorded sales and revenues of $223.0 million during
the third quarter of 2003, reflecting an increase of $2.6 million, or 1.2%, from
the comparable prior year period. The increase was mainly due to increased sales
in the friction materials and leisure marine businesses and the impact of
foreign currency translation, partially offset by volume declines in the
automotive fluid handling business. Costs of sales and revenues of $164.1
million were flat with the comparable prior year period. SG&A expenses increased
$3.3 million, or 18.8%, reflecting higher marketing costs in all businesses and
other operating expenses. RD&E expenses were flat with the comparable 2002
period. During the third quarter of 2003, the segment recorded a $0.6 million
restructuring charge mainly related to a planned reduction in headcount.
Additionally, during the third quarter of 2002, management reviewed the
segment's remaining restructuring actions and reversed $0.7 million of
restructuring accruals that were deemed unnecessary (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
$28.7 million was $1.0 million, or 3.4%, lower in the third quarter of 2003
compared to the third quarter of 2002, primarily due to the items mentioned
above.

Electronic Components' sales and revenues of $143.8 million decreased $3.4
million, or 2.3%, in the third quarter of 2003, and costs of sales and revenues
of $106.8 million, increased $5.8 million, or 5.7%, from the comparable prior
year period. The decrease in sales reflects continued weakness in the
telecommunications and commercial aerospace markets, partially offset by the
contribution from an acquisition, the impact of
23

foreign currency translation and growth in the transportation and consumer
businesses. Product mix issues primarily contributed to the increase in costs of
sales and revenues. SG&A expenses increased $4.4 million due to increased
marketing, employee benefit and administrative expenses. During the third
quarter of 2003, the segment recorded a $1.3 million restructuring charge
primarily relating to planned headcount reductions and reversed $1.2 million of
restructuring accruals into income as management deemed certain 2003 and 2001
actions would be completed for less than originally planned (refer to the
section entitled "Status of Restructuring and Asset Impairments" and Note 8,
"Restructuring and Asset Impairment Charges," in the Notes to Consolidated
Condensed Financial Statements for additional information). Operating income for
the third quarter of 2003 decreased $14.9 million, or 90.9%, from the third
quarter of 2002. The decline was due to the factors discussed above.

Corporate expenses increased $1.0 million in the third quarter of 2003,
primarily due to costs related to process improvement initiatives and increased
employee benefit costs.

NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 2002

Sales and revenues for the first nine month of 2003 were $4,109.8 million,
an increase of $368.8 million, or 9.9%, from the same period for 2002. Costs of
sales and revenues of $2,699.7 million for the first nine months of 2003
increased $264.3 million, or 10.9%, from the comparable 2002 period. The
increases in sales and revenues and costs of sales and revenues are primarily
attributable to higher volume in the Defense Electronics & Services and Fluid
Technology segments, contributions from acquisitions made by the Fluid
Technology and Electronic Components segments and the impact of foreign currency
translation. Product mix changes in the Electronic Components segment also
contributed to the increase in costs of sales and revenues.

Selling, general and administrative expenses for the first nine months of
2003 were $594.8 million, an increase of $71.7 million, or 13.7%, from the first
nine months of 2002. The increase in SG&A expenses was primarily due to
increased marketing expense in all segments and higher general and
administrative expenses. Higher general and administrative costs reflect
additional employee benefit costs, the cost of process improvement initiatives
and increased other administrative expenses.

Research, development and engineering expenses for the first nine months of
2003 increased $22.6 million, or 5.8%, compared to the first nine months of
2002. The increase is attributable to increased spending in all segments.

During the first nine months of 2003, the Company recorded a $17.7 million
restructuring charge to reduce operating costs and streamline its structure. The
charge primarily reflects the planned reduction of 685 persons. Additionally,
management reviewed the Company's remaining restructuring actions and determined
that certain 2003 and 2001 actions would be completed for $1.2 million less than
planned at the Electronic Components segment. Accordingly, restructuring
accruals totaling $1.2 million were reversed into income during the third
quarter of 2003. The Company also recorded an asset impairment charge of $1.4
million primarily to write-off a technology license that will not be utilized in
the foreseeable future due to projected market conditions. During the nine
months ended September 30, 2002, the Company reversed $1.7 million of
restructuring accruals into income as it was determined that certain 2001
actions would be completed for less than planned. Refer to the section entitled
"Status of Restructuring and Asset Impairments" and Note 8, "Restructuring and
Asset Impairment Charges," in the Notes to Consolidated Condensed Financial
Statements for additional information.

Operating income for the first nine months of 2003 was $388.0 million
compared to $397.4 million for the first nine months of 2002. The decrease is
primarily due to increased SG&A and RD&E expenses and net restructuring and
asset impairment charges of $17.9 million, partially offset by increased sales
and revenues at each of the segments. Additionally, the Company recorded a $1.7
million reversal of restructuring charges in 2002. Segment operating margin, for
the first nine months of 2003 was 10.7%, or 1.1% below the segment operating
margin for the comparable 2002 period. The decrease reflects changes in product
mix in the Electronic Components segment and 2003 restructuring and asset
impairment charges in the Fluid Technology, Electronic Components and Motion &
Flow Control segments. The impact of 2002 Fluid Technology

24

acquisitions, which produced operating margins below the segment average during
2003, also contributed to the decrease.

Interest income was $14.6 million (net of interest expense of $22.7
million) for the first nine months of 2003. The Company recognized $27.5 million
of interest expense during the first nine months of 2002. The variance between
years is primarily due to interest income of $32.3 million, related to two 2003
tax settlements, and the collection of interest income from a cost based
investment that management had previously believed would not be received. Upon
collection, the Company reversed the related valuation allowance into income.

Income tax expense was $116.5 million in the first nine months of 2003, an
increase of $27.5 million from the comparable 2002 period. The increase is
primarily due to a $61.2 million tax refund received during 2002, of which $30.6
million was reflected as a reduction of tax expense.

Income from continuing operations was $281.3 million, or $2.99 per diluted
share, for the first nine months of 2003 compared to $284.8 million or $3.05 per
diluted share for the first nine months of 2002. The decrease reflects the
results discussed above.

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

Fluid Technology's sales and revenues and costs of sales and revenues
increased $204.7 million, or 14.3%, and $143.0 million, or 15.1%, respectively,
in the first nine months of 2003 compared to the first nine months of 2002.
Higher organic sales in the water/wastewater markets, acquisition revenue from
the water/wastewater and engineered valves businesses and the impact of foreign
currency translation were the primary factors for the increases. Softness in the
industrial pumps, engineered valves and building trades businesses partially
offset these factors. SG&A for the first nine months of 2003 increased $38.6
million, or 14.3%, compared to 2002, mainly due to both increased marketing
expenses and increased administrative costs in the water/wastewater markets.
During the first nine months of 2003, the segment recorded a $0.9 million
restructuring charge mainly related to a planned reduction in headcount.
Additionally, the segment reversed $1.0 million of restructuring accruals in
2002 that management deemed unnecessary (refer to the section entitled "Status
of Restructuring and Asset Impairments" and Note 8, "Restructuring and Asset
Impairment Charges," in the Notes to Consolidated Condensed Financial Statements
for additional information). Operating income for the first nine months of 2003
was up $19.7 million, or 10.6%, compared to the first nine months of 2002 due to
the activity discussed above.

Defense Electronics & Services' sales and revenues and costs of sales and
revenues for the first nine months of 2003 increased $121.6 million, or 10.4%,
and $82.0 million, or 12.1%, respectively, from the comparable prior year
period. The increases are primarily due to higher service revenue reflecting
Middle East support and classified programs, partially offset by lower volume in
our night vision and radar businesses. SG&A expenses increased $8.7 million, or
12.6%, primarily due to higher marketing expenses and increased employee benefit
and administrative costs. RD&E expenses for the first nine months of 2003
increased $14.5 million, or 4.7% due to increased spending in most businesses.
Operating income for the first nine months of 2003 was $129.2 million, an
increase of $16.4 million, or 14.5%, compared to the same period in 2002. The
increase reflects the results discussed above.

Motion & Flow Control recorded sales and revenues and costs of sales and
revenues of $743.8 million and $542.0 million, respectively, during the first
nine months of 2003, reflecting increases of $35.7 million, or 5.0%, and $14.5
million, or 2.7%, from the first nine months of 2002. The increases were mainly
due to increased sales in the marine and friction material businesses and the
impact of foreign currency translation, partially offset by volume declines in
the automotive fluid handling business. SG&A expenses increased $2.8 million, or
4.3%, reflecting higher marketing costs in most businesses and other operating
expenses. RD&E expenses were $2.9 million, or 12.1% higher than the comparable
2002 period as spending increased in most businesses.

25

During the first nine months of 2003, the segment recorded a $4.0 million
restructuring charge mainly related to a planned reduction in headcount.
Additionally, the segment reversed $0.7 million of restructuring accruals in
2002 that management deemed unnecessary (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 $103.8 million was $10.8
million, or 11.6%, higher in the first nine months of 2003 compared to the first
nine months of 2002, primarily due to the items mentioned above.

Electronic Components' sales and revenues of $442.3 million and costs of
sales and revenues of $315.2 million in the first nine months of 2003, increased
$8.8 million, or 2.0%, and $26.9 million, or 9.3%, respectively, from the
comparable prior year period. The increases reflect the contribution from an
acquisition and the impact of foreign currency translation, partially offset by
weaknesses in the telecommunication and commercial aerospace markets. Product
mix issues also contributed to the increase in costs of sales and revenues. SG&A
expenses increased $14.9 million due to increased marketing, employee benefit
and administrative expenses, including the impact of a 2003 first quarter
acquisition. During the first nine months of 2003, the segment recorded an $11.5
million restructuring charge primarily relating to planned headcount reductions
and reversed $1.2 million of restructuring accruals into income as management
deemed certain 2003 and 2001 actions would be completed for less than originally
planned. Additionally, the segment recorded a $1.4 million asset impairment
charge mainly to write-off a license agreement for technology, which will not be
utilized in the foreseeable future due to projected market conditions (refer to
the section entitled "Status of Restructuring and Asset Impairments" and Note 8,
"Restructuring and Asset Impairment Charges," in the Notes to Consolidated
Condensed Financial Statements for additional information). Operating income for
the first nine months of 2003 decreased $48.4 million, or 93.1%, from the first
nine months of 2002. The decline was due to the factors discussed above.

Corporate expenses increased $7.9 million in the first nine months of 2003,
primarily due to costs related to process improvement initiatives, a $1.3
million restructuring charge for planned headcount reductions (refer to the
section entitled "Status of Restructuring and Asset Impairments" and Note 8,
"Restructuring and Asset Impairment Charges," in the Notes to Consolidated
Condensed Financial Statements for additional information) and increased
administrative expenses.

STATUS OF RESTRUCTURING AND ASSET IMPAIRMENTS

2003 RESTRUCTURING ACTIVITIES

As discussed in the "Accounting Pronouncements" section of Management's
Discussion and Analysis of Financial Condition and Results of Operations, the
Company recorded restructuring charges related to 2003 actions in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities." Restructuring actions
initiated prior to January 1, 2003 were recorded in accordance with the
guidelines of Emerging Issues Task Force Issue No. 94 - 3, "Liability
Recognition for Certain Employee Benefits (including Certain Costs Incurred in a
Restructuring)."

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

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

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

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

26

The projected future cash savings from the restructuring actions announced
during the third quarter of 2003 are approximately $1 million during 2003 and
$21 million between 2004 and 2008. The savings primarily represents lower salary
and wage expenditures and will be reflected in costs of sales and revenues and
selling, general and administrative expenses.

As of September 30, 2003, the Company had made $0.3 million of payments
attributable to the 2003 third quarter restructuring actions. Future
restructuring expenditures will be funded with cash from operations,
supplemented, as required, with commercial paper borrowings.

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

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

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

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

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

The projected future cash savings from the restructuring actions announced
during the second quarter of 2003 are approximately $4 million during 2003 and
$41 million between 2004 and 2008. The savings primarily represents lower salary
and wage expenditures and will be reflected in costs of sales and revenues and
selling, general and administrative expenses.

As of September 30, 2003, the Company had made $1.4 million of payments
attributable to the 2003 second quarter restructuring actions. Future
restructuring expenditures will be funded with cash from operations,
supplemented, as required, with commercial paper borrowings.

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

During the first quarter of 2003 the Company recorded a $9.0 million
restructuring charge primarily for the planned severance of 465 persons.
Severance of $8.3 million represents the majority of the charge.

Listed below, by business segment, is background information on the 2003
first quarter restructuring charge (in millions).

The restructuring actions initiated by the Electronic Components segment
include the planned termination of 226 persons, comprised of 101 office workers,
116 factory workers and nine management employees,

27

and the disposal of certain machinery and equipment. The actions were prompted
by management's projections of continued weakness in certain businesses.

The $1.1 million charge taken at Corporate Headquarters represents the
consolidation of administrative tasks and includes the planned termination of
two management employees.

The actions within the Motion & Flow Control segment include the planned
termination of 237 employees, comprised of 21 office workers and 216 factory
workers. The charge relates to the closure of a manufacturing facility in
Arkansas. The actions will be completed during 2003 and 2004 and the total
estimated charge of approximately $2.6 million will be recognized ratably over
the restructuring period as the terminations become effective. Management deemed
the restructuring actions necessary to address the anticipated loss of certain
platforms during the second half of 2003.

As of September 30, 2003, the Company had made $3.5 million of payments
attributable to the 2003 first quarter restructuring actions. Future
restructuring expenditures will be funded with cash from operations,
supplemented, as required, with commercial paper borrowings.

The projected future cash savings from the restructuring actions announced
during the first quarter of 2003 are approximately $5 million during 2003 and
$56 million between 2004 and 2008. The savings primarily represents 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 2003 restructuring programs (in millions):

During the third quarter of 2003, $0.8 million of restructuring accruals
related to current year programs were reversed into income as a result of
quarterly reviews of the Company's remaining restructuring actions. The
reversals primarily reflect lower than anticipated severance costs on completed
actions and favorable employee attrition at the Electronic Components segment.

During the first nine months of 2003 headcount was reduced by 415 persons
and the Company experienced employee attrition, leaving a balance of 243 planned
reductions related to the 2003 restructuring plans. Actions announced during the
first nine months of 2003 will be completed by the first quarter of 2004.

2003 OTHER ASSET IMPAIRMENTS

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

2002 RESTRUCTURING ACTIVITIES

During the fourth quarter of 2002, the Company recorded a $9.6 million
restructuring charge primarily for the closure of two facilities and the
severance of 292 persons. Severance of $8.5 million represents a majority of the
charge and lease payments and other costs represent the remainder.

28

Listed below, by business segment, is background information on the 2002
restructuring plan (in millions).

The actions within the Fluid Technology segment represent a reduction of
its cost structure that management deemed necessary in response to continued
weakness within certain of the segment's markets. Planned measures include the
closure of one facility in Fairfield, N.J. and the termination of 147 persons,<