ITT Inc. (ITT) Q4 2013 Earnings Report, Transcript and Summary

Welcome to ITT’s 2013 Fourth Quarter and Full Year Results and 2014 Outlook Conference Call. Starting the call today from ITT is Melissa Trombetta, Director of 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 replay beginning at 12:00 PM Eastern Standard Time. At this time, all participants have been placed in a listen-only mode, and the floor will be opened for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Melissa Trombetta. You may begin.

Thank you, Laurie. Good morning, and welcome to ITT's fourth quarter 2013 investor review. 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. I’d also like to note that our CFO, Tom Scalera is joining us by phone as his close family member has passed away unexpectedly this week and he is with his family in Rochester. Thank you, Tom, for being with us today. Please note that any remarks we make about future expectations constitute forward-looking statements under 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 10-K and other public SEC filings. So, let's now turn to slide number three where Denise will discuss our results.

Good morning, everyone. Thank you for joining us as we announce our exceptional financial results for the fourth quarter and full year of 2013 and provide our solid 2014 guidance. I’m very pleased with our performance this year, thanks to our dedicated ITT employees all around the world. 2013 marks our second year as a standalone company, and this is the second year that we have delivered premier performances. As you saw in our press release this morning, we delivered some extraordinary results in Q4 and 2013. So let me share some of the 2013 highlights. Total revenue, up 12%; organic revenue, up 6% with all four businesses contributing to the growth; adjusted segment operating margin, up 100 basis points or 160 points excluding Bornemann; adjusted segment operating income, up 21%; and adjusted EPS of $2.02 per share, up 20%. This comprehensive growth directly reflects the power of our diversified and balanced portfolio, as well as our ongoing commitment to build a stronger, more focused multi-industrial company. A big driver of our success in delivering on our commitment has been our focus and investment in our people who are at the centre of the ITT way, which is the business model that we launched two years ago to define how we grow, how we differentiate with customer and how we create value for stakeholders. With our people at the centre and with the ITT way guiding us, 2013 marks another year where we have been able to successfully build on our four pillars of strategic growth, market expansion, customer focus, operational excellence and capital deployment. I'd like to highlight several of those achievements for you this morning. In 2013, we delivered against our key market expansion initiatives by growing 20% in the highly profitable after market, driven by our large installed base in industrial process as well as our in auto brake pad business at Motion Technologies, which experienced a significant increase this year due to pent-up demand. We're also growing impressive 18% in emerging markets and 6% in North America. This year we further intensified our focus on differentiating with our customers by taking actions such as exceeding our customers' expectations of on-time delivery with improved performances across the majority of our businesses, expanding our industrial process research and development in Seneca Falls, New York and building a new R&D center in Wuxi, China focused on friction materials for automotive. As a validation that our efforts with our customers are paying off, I am very happy to report that our Motion Technologies business recently signed a long-term strategic agreement with Continental, our largest customer for aftermarket brake pads. The new 10-year agreement will renew and extend our existing relationships to supply our premium line of private label brake pads to Continental. The agreement will also add a second production line that will provide Continental exclusive trademark rights to market and sell the highly trusted [Galfer] brand in the aftermarket. Over time, this agreement will open up new geographical areas allowing us to expand with this important customer. A sincere congratulation to the Motion Technologies' team on this important development. Providing a differentiated customer experience leads me to my next pillar; operational excellence. In order to consistently provide a premier customer experience, we have to create an environment of continuous operational improvement with the goal of becoming a lean enterprise. So another highlight from me this year was the commitment and progress we have made in our lean transformation, while I am pleased to report that each business is exceeding the comprehensive target we've established. Also in 2013, we designed and built our new state-of-the-art South Korea Oil and Gas facility with advanced lean capabilities. This facility has become our eastern hemisphere energy center of manufacturing and R&D excellence, and will play a key role in advancing our global energy strategy. The operational improvements at Interconnect Solutions are in part due to the focus on operational excellence across the entire organization, but they are also part of the ongoing turnaround of that business. In 2013, we made significant progress in improving our operational efficiencies at ICS with an intense focus on meeting our customer needs through better quality and on-time delivery. These improvements helps us deliver the 6% organic revenue growth and almost doubling of their adjusted segment operating margins. As a result of our focus on operational excellence and our commitment to lean, we delivered a second year of over $100 million in growth productivity savings. This year also benefited from restructuring actions we took in 2012 and 2013 that contributed to over $17 million of savings this year. And our last pillar, capital deployment. This year we continued our track record of balanced and effective capital deployment by self funding major organic investments that extend our global reach and capabilities, while providing meaningful returns to shareholders. Our organic investments includes many of the investments I just discussed that helped drive our customer focus and operational excellence pillars forward, our new South Korea facility, the expansion of our Seneca Falls facility, as well as the build out of our aftermarket reach and capabilities. We have also started to expand our production in our Wuxi, China Automotive facility that came online at the end of 2012 due to the current demand visibility resulting in from recent platform win. As a result of these investments, we have seen tremendous growth in these markets. For example, our automotive brake pads business in China is up over 50% this year. And our global oil and gas industrial pump business is up over 20%. We also returned capital to shareholders in 2013 in the form of our solid dividend and $85 million of share repurchases. So you can see we have accomplished quite a bit in 2013. Turning to slide four, let's briefly focus on our fourth quarter results. We delivered total revenue growth of 17% and organic revenue growth of 13% that reflected growth in each of our four segments. Motion Technologies delivered 25% organic revenue growth that reflected both global OEM strengths from recent share gains and platform win, market growth and a 54% increase in aftermarket sale. The aftermarket strength was in part due to our strong OEM performance over the last several years, which is now entering the dealer service cycle. The aftermarket growth also reflects restocking in the independent aftermarket channel due to pent-up demand in Europe caused by the difficult economic condition that had contributed to reduced miles driven and delayed vehicle maintenance. Interconnect Solutions delivered another quarter of double-digit organic growth, up 10%. This growth reflects strength in global aerospace and defense, which was up 18%; as well as oil and gas connectors, which were up 15%. Part of the growth we are experiencing in these markets is the winning back of share that we lost before we started the turnaround. These gains were partially offset by declines in non-strategic product lines we are deemphasizing as we refocus the strategic strength of our harsh environment connector business. Organic revenue at Industrial Process accelerated 9% due to mining which was up 44%, mostly driven by growth in the Latin American region. Chemical markets were also up nicely in the quarter at 17%. These strong results continue to be diluted by ongoing softness in our North American short-cycle base pump business as well as in industrial valves. In the quarter we also experienced delays in the timing of several lower margin oil and gas project pump shipments which we expect to shift in the first half of 2014. ITT’s total orders increased 11% in the quarter. And excluding the solid performance from Bornemann pumps, organic orders were up 8%. Motion Technologies whose organic orders grew 34% drove the growth this quarter. Their performance reflected auto platform wins in Europe and China, aftermarket volumes most of which shipped in the fourth quarter and strong wins at KONI in our shock absorber business. Orders in Interconnect Solutions were up 7% on key wins in aerospace, defense and oil and gas connectors which reflects some early benefits from our new strategic end market focus. Total Industrial Process orders increased 4% and 1% on an organic basis during the quarter. Oil and gas growth was up 17% globally. The oil and gas performance included a $12 million Saudi Arabia project that was awarded to us in part because of our new Korea facility capability. But similar to the revenue trend we experienced in the second half of 2013, we are continuing to see softness in our base pump and industrial valve orders. Due to the strong orders in global oil and gas in Latin and North American mining during 2013, and despite the softness in the base pump and valve businesses, Industrial Process is ending the year with total backlog of over $680 million, which is an increase of 8% since the beginning of the year. Q4 adjusted segment operating income of $83 million exceeded our expectations and increased 29% primarily due to increased volumes and strong net operating productivity from global supply chain efficiencies and proactive restructuring actions. These gains help self-fund our organic investments this quarter. Fourth quarter adjusted EPS of $0.49 exceeded expectations and was 32% higher than prior year due to the strong segment operating results, a lower effective tax rate and share count that more than offset higher corporate costs related to internal investments. While we are extremely pleased with how we performed throughout 2013, we recognized that the oil and gas project shipment delays in Q4 and the order softness in our high margin base pump and industrial valve businesses will negatively impact our operating margins in the first half of 2014 and our Industrial Process business. In addition, we did experience exceptional growth in the second half of 2013 due to automotive aftermarket restocking that we do not anticipate will continue into 2014. So, now let’s turn our attention to 2014 on slide five, where I will share with you our strategic framework and high level guidance. For 2014, we expect to continue our solid momentum from 2013, and are providing a balanced revenue outlook that reflects solid total and organic revenue growth of 4% to 6%. We expect 70 basis points to 90 basis points of segment margin expansion driven by volume increases, as well as the impact of our ongoing lean transformation and benefit from the prior year restructuring action and the ICS transformation. We also expect adjusted EPS guidance mid-point to be up 13% due to our intense focus on lean and other internal actions. Looking at our markets, we expect strong performance in emerging markets with growth of approximately 9%, and we expect developed markets to grow approximately 4%. Included in these market expectations is aftermarket expansion of approximately 6% in 2014. The growth in our aftermarket is a reflection of the project growth that we have experienced over the last several years now entering into the replacement cycle for our Industrial Process segment. We believe a differentiated experience for our customers is key to our long-term success. Therefore, we are committing to increase our R&D spending by 8% with a focus on new product development in targeted growth markets, as well as product line expansions for next-generation opportunities. This increased investment will help ensure a continuing flow of innovative high-quality product and expand our competitive position in the markets we serve. We will also continue to refocus our customer-facing resources to deliver tighter coordination between engineering, marketing and sales function that interact directly with our valued customers. This will help our goal of enhanced customer responsiveness and improved on-time delivery. In 2014, we are targeting another significant year of productivity savings by furthering our lean transformation, leveraging our global strategic sourcing group and realizing benefits from prior year restructuring actions. During the year, we expect to take additional restructuring and realignment actions totaling to $30 million, largely at Interconnect Solutions, as we accelerate our connectors' turnaround. Finally, we expect another year of strategic balance and effective capital deployment. We expect to make significant investments in our core markets and capabilities. Areas like the rebalancing and expanding of our global auto break pad production capacity, global oil and gas footprint and aftermarket capture, lean transformation and IT and capability building investments, these targeted investments will build on our already strong foundation and will drive our growth into the future. We'd also look to advance our portfolio growth strategy by continuing to build our M&A pipeline, which has been gaining momentum as we entered 2014. So I’m very excited about 2014 and the continued momentum that the ITT way and our people are generating on a daily basis. And before I pass it along to Tom, I would just like to thank our 9,400 valued employees around the world for their continued hard work and commitment to ITT. It is because of our dedicated employees that we are able to continue to create ongoing long-term value for all of our stakeholders. So now, I’ll turn it over to Tom to discuss our 2014 guidance in greater detail.

Thank you, Denise. Let's now turn to slide six to discuss our 2014 guidance. As Denise mentioned, we expect total and organic revenue growth of 4% to 6%. The 2014 growth will be driven by strength in our core markets of oil and gas, chemical and industrial pumps and share gains in global automotive. Also contributing to our 2014 revenue growth will be another strong year of expansion in emerging markets where our 9% growth will be driven by oil and gas projects in South America, in Middle East and Asia and automotive growth in China. Sequentially second half revenue will be slightly higher than first half revenue, primarily due to the timing of large project shipments in Industrial Process. We expect strong net operating productivity and restructuring benefits to fuel 70 basis points to 90 basis points expansion in adjusted segment operating margin. This expansion is tied to improve volumes, our ongoing lean transformation, realized benefits from restructuring actions and benefits from the ICS turnaround. And keep in mind that the 2014 segment operating margin range of 13.7% to 13.9% includes the funding for 100 basis points of strategic growth investments. Sequentially, we expect the second half segment operating margins to be over 100% basis points higher than the first half. This shift reflects first half mix pressures in Industrial Process that are tied to softer base pumps and valves combined with increased shipments of larger complex projects. In addition, we expect improved operational execution and higher restructuring savings in the second half of 2014, which will contribute to our sequential margin expansion. Our 2014 adjusted EPS range of $2.23 to $2.33 represents 13% growth at the midpoint and is in line with our long-term premier growth range of 10% to 15%. As is our practice, we do not provide quarterly guidance due to the lumpiness and long cycle nature of our Industrial Process segment. So based on current indicators, we expect upto 55% of our adjusted EPS to be delivered in the second half of 2014. The biggest drivers of the second half strength are the timing of projects shipments in Industrial Process, the recovery of base line pumps and the timing of restructuring benefits. I’d also like to note that our 2014 free cash flow conversion rate will be less than 80% due to another round of accelerated organic growth investments. Our integrated strategic planning process continues to identify significant organic growth opportunities like those that have contributed to our over 7% average organic revenue growth since 2011. These investments include the expansion of Industrial Process, global engineering, R&D and aftermarket capabilities. The expansion and rebalance of our global auto brake pad production, the lean retransformation and various capability building investments. As a result of these organic opportunities, we expect 2014 capital expenditures to increase nearly 20% to over 5.5% of revenue. These organic growth investments will continue to generate strong returns, while we remained disciplined in the expansion of our acquisition pipeline. Before we turn to the next slide, I’d also like to point out that we'd provided our current projections for the major 2014 special items that are excluded from our adjusted guidance. Please note that all of these amounts are on a pre-tax basis. For notice practice we are forecasting 2014 charges of $60 million to $65 million. The restructure in the alignment we are anticipating $30 million of action that are primarily related to the footprint optimization at ICS. Finally, we expect to wrap-up our post and repositioning cost in 2014 with approximately $9 million of cost implementation in internal capabilities. So now let's turn to the revenue outlook by end market on slide seven. In 2014 we expect revenue and energy market to be up 13% driven by global oil & gas strengths and Industrial Process. This growth will be powered by the Bornemann acquisition and ongoing organic investments that expanded our global capabilities, our aftermarket reach and our product portfolio. As a result of these investments, we expect the benefit from both conventional and unconventional projects with a broader global portfolio of upstream, midstream and downstream capabilities. The chemical and industrial pump market is expected to generate low to mid-single-digit growth in 2014 due to our solid backlog entering the year and increasing project activity in North America. In largest markets of automotive rail and transportation, we expect mid-single-digit growth due to the automotive market share gains in North America and China, which will be diluted by a deceleration in our European auto growth rates. In 2013, we grew our European auto business by close to 15% due to significant market share gains and the restocking of the aftermarket. As a result, we are assuming OEM growth rates that are two times the anticipated European auto production rates of 1% to 2% and flat aftermarket growth. For our aerospace and defense markets we expect to grow low-single-digits in 2014, while we plan for our commercial aerospace components business to continue to outpace the markets and drilling a low-double-digit range. This performance is going to be partially offset by defense softness and the retrofit aerospace programs that is ending in 2014. For our general industrial markets we expect second half acceleration to full year growth at approximately 6%. This growth will be driven by steady recovery at an Interconnect Solutions and by our Control Technologies focused on working directly with customers to provide differentiated solutions and select industrial markets. And finally, finishing up with mining, the year forecasting mining to be up mid-single-digits in 2014 due to the solid backlog entering the year. We still view growth in this market as very project-specific with no clear indication of a sustained change in the level of capital spending in the near-term. On slide eight we provided our 2014 revenue outlook by geography. We expect to deliver total revenue growth of approximately 4% in North America. This includes solid revenue growth in oil and gas, chemical and industrial, and mining projects, expanded automotive market share, strong aerospace components and general industrial growth. These things are expected to be diluted by weak defense conditions, the impact of an aerospace program is ending in 2014 and the deliberate exit of non-strategic product line in our Interconnect Solutions segment. We are forecasting Europe to be up in the 4% range reflecting solid oil and gas growth in Bornemann pumps as well as our expanding presence in Russia. Our automotive break pad business will also contribute to the growth due to market share gains and modest European market production rates that will offset annual price headwind. Finally, emerging markets are expected to grow 9% reflecting oil and gas expansion and significant automotive share gains in China. On slide nine we’ll review our segment operating margin guidance. In 2014 we are expecting adjusted segment operating margins to expand 70 basis points to 90 basis points, which will bring us in the range of 13.7% to 13.9%. This growth will be fueled by increased volumes, operational improvements primarily from our entity-wide lean transformation, and expanded global strategic sourcing. In addition, we are expecting 50 basis points of incremental benefits from restructuring actions. The largest segment margin improvement in 2014 is expected to be at ICS due to the pervasive benefits of the turnaround. We will use our operational strength to offset inflation and respond to 100 basis points of organic growth investments in 2014. We also expect that our margins will be negatively impacted by pricing dynamics in the global auto markets as well as the negative mix in larger pump projects, lower automotive aftermarket content and the ramp down of our high margin aerospace program. Now, let's wrap-up on slide 10, where we summarized our 2014 annual guidance in the form of high level adjusted EPS volume. We expect 2014 adjusted EPS to grow 13% at the midpoint of our $2.23 to $2.33 range. This growth reflects the ICS turnaround and continued momentum in global auto and oil and gas markets. A large portion of our adjusted EPS growth will be driven by strong productivity gains and operational improvements. In 2014 we will once again deliver significant productivity saving by leveraging the ITT way to drive incremental lean Six Sigma and global sourcing initiatives. This productivity also reflects over $14 million in incremental savings from the 2013 and planned 2014 actions that are primarily related to the turnaround of our Interconnect Solutions business. As we have successfully done in the past, we will once again reinvest a healthy portion of this year's productivity back into our long-term strategic growth initiatives. This year's $0.22 of investment will be focused on key areas that support our long-term vision of the company, namely the China automotive growth, global oil and gas extension, global aftermarket capture, our lean transformation, targeted R&D and strategic capability building. Unallocated corporate and other expenses are expected to increase over 2013 levels to approximately $55 million to $60 million due to the expansion of our global lean resource capabilities along with IT system upgrades and lean capability building. In addition, we are wrapping a strong prior year of investment returns to certain assets, and we are expecting higher compensation, environmental and insurance cost in 2014. The special effective tax rate that we've assumed in our 2014 adjusted EPS guidance is 29%. The lower rate reflects a favorable geographic mix of income and the implementation of international tax strategies, including incentives related to the new Korean oil and gas facility. We also expect the average 2014 diluted share count to be around 92.5 million shares. While we don't provide quarterly guidance, I did want to provide some insights into our preliminary Q1 expectations. In Q1 we expect top line growth that is generally in line with our annual ranges, while the Q1 margins will be in line with the prior year due to volume growth at Motion Technologies and the ICS turnaround benefits that will be offset by high project content that the loose Industrial Process margins during the seasonally low quarter. Q1 corporate costs are also expected to be higher than the prior year, partially offset by a lower tax rate in share count that are in line with our annual guidance. In summary, we believe our 2014 guidance is balanced for the potential headwinds and tailwinds we see today and reflects a return environment. We will focus our efforts on delivering the productivity that is within our control and generating strong returns on our organic investments that are aligned with our strategic vision and are driven by the ITT way. So now let me turn it back to Laurie to start the Q&A session.

The floor is now opened for questions. [Operator Instructions] Your first question comes from the line of Mike Halloran of Robert W. Baird. Mike Halloran - Robert W. Baird & Co.: Good morning, everyone.

Good morning, Mike.

Good morning, Mike. Mike Halloran - Robert W. Baird & Co.: So just let's for start on, the Industrial Process group and talk about two things. One, maybe you could talk about what you are seeing on the shorter cycle pumps. Where the pressure is coming from and what do you think that can look like as we walk through the year here. And any signs that that demand is coming back?

Sure. Let me take that. What we saw in 2013 is we really saw a slowdown in MRO spending which was, we believe, impacted by the economic uncertainty in the U.S. We also believe that there was -- has been destocking of the inventory. As we now head into 2014, we look closely at industrial production from the macroeconomic perspective, it tend to be a leading indicator. We see -- typically see a six month lag associated with that. But as we enter into 2014, we are still seeing some muted expectations in here. IP in general, when we look at what’s happening in January, it started out slow with our orders. We're beginning -- we’ve seen the baseline improve slightly, but not enough yet to call positive trends on that. So it is going to impact the first quarter for IP, it will impact the first half, so we expect to see some improvement, modest improvement as we go through to the back half of the year.

Yeah, Mike. Mike Halloran - Robert W. Baird & Co.: Go ahead.

Just add on that first, second might be our overall growth expectations for those baseline pumps is low single-digits for the year. So we expect it to start out very slowly and gain momentum, but the early indicators as you all explaining have been very sluggish in early January, negative in 2013 as well. Mike Halloran - Robert W. Baird & Co.: That makes sense. And then conversely, on the larger project that touched kind of the oil and gas, the chemical side. Obviously, some pretty nice momentum on the Bornemann piece. What’s the quoting and bidding activity look like? Are you starting to see any projects of scale get push forward here, and what’s the momentum look like as you go through the year?

Yeah. We’re seeing, just because the quote activity continues to be extremely strong, in fact if you look back over the last three years or so, it's probably the highest level of quote activity that we’ve seen in the past three years. So when we look at the oil and gas projects that we’ve got there, we’re seeing a significant project pipeline in the Middle East and then in Latin America. When we look at on the petrochemical side of things, we’re starting to -- we’re seeing quite a few of projects in North America in the Gulf Coast region, so a lot of projects in the pipeline. We’re seeing a lot of bid activity that’s taking place. And we think that it’s going to break here within the next four to six months or so.

And Mike, as we’re looking at these projects out into the future, they are larger and more complex type projects as we move up the complexity scale on our business. And as you know, those have the tendency to move margins relative our medium and small-sized projects or aftermarket capture. So we’re going to, as the year goes and moving into next year continue to see a high concentration of projects with high grade complexity which will lay on our margins relative to perhaps what we'd even see in 2013. Mike Halloran - Robert W. Baird & Co.: Make sense. And then last one from me. Maybe just talk a little bit about the pipeline for deals that you’re seeing today in multiples. How are they look and then where the focus is if that focus has changed at all from your perspective?

The pipeline, we’re continuing to gain momentum with that pipeline where we’ve been focused. We’ve been focused on the pump side of the business. We've been looking at valves. We’re focused in aerospace and we’re focused on some products on the industrial side around energy absorption. Those tend to be the highest focus areas for us, which is where we see a lot of growth going out in to the future. It’s a pretty competitive marketplace out there. And we’re being selective. We’re looking at things that will make a lot of sense for our business. Again, we’re seeing lot more in terms of the pipeline that we've got in front of us, but it is very competitive pricing as a lot of people going after some of these good markets. Mike Halloran - Robert W. Baird & Co.: Great. Appreciate the time and good luck with everything, Tom.

Thanks Mike.

Your next question comes from the line of Matt Summerville of KeyBanc.

Morning. With respect to Motion Tech, can you talk about the incremental revenue potential that maybe associated with this new renewed and what sounds like more a better agreement with Continental? And then, perhaps what your expectation is from growth in auto in China? And I apologize, if you already gave that.

Sure. In terms of the Continental agreement, right now we sell our brake pads under their [inaudible] brand and what we were able to do is to secure a new aftermarket contract with them which is a ten year contract. So we’re basically extending the relationship that we've had with them. In terms of the impact in 2014, we see this that the bonds will be basically stable with the prior year. Now I remember, there was a lot of strength in the prior year. So this is an extension of that relationship, but we extended it longer than what we’ve had in the past, which is a good thing. The new line that we’re going to start -- that they're going to start marketing is a lower tier brake pad. It’s going to be have branded with the [Galfer] name with it. We’re just going to begin to ramp that up in 2014. Now that’s going to target the new geographies that the current [RK] brand does not target. So we're looking at new geographies such as Spain, France, Eastern Europe, the U.K. with that. So we don’t believe there is going to be cannibalization that’s going to take place between the two different lines because these are very different markets that are served. So, it’s going to ramp up. We won’t reach to where we think that will get in probably for about three years or so. So we see a little bit of volume coming through in 2014, but it’s going to build as you get into 2015 and 2016. And then you asked the question about China. And the question on China was that related to sales and what we're expected to grow in China?

Yeah. In particular and just sticking with Motion Tech coming off of, I think you grew 70% or 80% in 2012. It’s sounding like you grew another 50% this past year. So I’m kind of looking at what you are thinking for '14?

Sure. We grew 54% in full year 2013. We are looking to grow at about 15% in 2014 and we expect that to be at about three times the market. So remember, we are lapping a much higher volume in 2014 than we had in 2013, but still very, very good growth rate and exceeding the market in China. So 15% is what we are expecting in 2014.

And then just a couple on IP, can you maybe articulate a little bit more on what you are seeing specifically with Bornemann on the upstream side? How the backlog in that business looks on a relative basis year-on-year? And whether or not you are starting to see margin improvement? So, just kind of a Bornemann update would be helpful.

Sure. We're very pleased with that acquisition. Long-term strategic value that we identified when we were buying Bornemann has really been validated for us. Now in 2013, we did have some customer specific challenges with them. So we had a customer that went into bankruptcy and we had some large projects that got delayed out of 2013 into 2014. But at the same time, we’ve been realizing some of the synergies that we had identified at the time of the acquisition. We’ve been leveraging facilities, we’ve accelerated our lean transformation at Bornemann, we’ve been doing cross-selling, and we exceeded a small, a very small breakeven product line there. Actually we're ending the year with a higher, more profitable backlog and much better operating foundation. Tom, do you want to talk about the financials?

Yeah. Denise shaded on the key points of the revenue shift out of 2013 into 2014 for some of these large projects. And as you know, Bornemann deals with the higher end of complexity on the upstream side what we really seeing as you look over the model and our financial expectations over the two year window that by the end of 2014 we'll be on-track where we expected to be financially. [inaudible] play through and I guess that that is certainly the nature of the Bornemann business to have some lumpy ebbs and flows, but we are encouraged by the order, visibility, the backlog. Obviously, the market strength of this brand is very unique. I think what is fundamentally different is the amount of focus we have on improving the operational foundation of this company. We accelerated the lean transformation in the Bornemann; Denise mentioned that with a fairly significant decision. They really start to hit at the operating flows of this business and bringing more discipline and regulator in underneath. The strong order book I think will give us better profitability as we move forward. And we are encouraged by what we are seeing in the aftermarket at Bornemann. We have picked up the momentum there. We are expecting about 14% increase in the aftermarket compared to what we saw in 2013. On a percent of total revenue that growth will be diluted because we expect a significant year of our large project growth at Bornemann primarily in upstream oil and gas, as you know.

Thanks a lot, guys.

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

Good morning, Denise, Tom, Melissa, and condolences too.

Thank you, Nathan.

If I could just ask, you mentioned this in pricing headwinds in the break pad business, could you elaborate a bit more on where that’s coming from?

Yes, sure Nathan. It, on an annual basis, is part of our ongoing relationships in the automotive industry. We assume anywhere from 1% to 3% annual pricing headwind. And it varies by contract and the nature of that relationship and the geographies involved. But it's a fairly global 1% to 3% assumed decline at this point in the year. We work hard to obviously try to offset that. But when you look into the inside the Motion Technologies' expectation for 2014 the volume growth, if you will, the number of brake pads we're going to produced, it's going to be at least one to or three points higher than the organic revenue expectation that we ultimately expect to deliver at this point.

And just a follow-up on previous question, the new geographies that you are looking to open up with the distribution agreement with continental, can you quantify the market opportunities for you there?

We haven’t really fully put that out yet, Nathan. We'll see and this is the second tier line force. So, way that I would kind of calibrate its going to be a fraction of what we have in the premier line which was the main contract that we extended. So what I would expect over time as a gradual ramp up in the next two years. I think what it gives us is a larger geographic opportunity that it's a new break pad launch and it will be hard for us I think at this point to put too money specifics around how much, when and where, but I think it's a nice opportunity for very successful Motion Technologies' team to work with our partners at Continental to see how they can open up these other markets. So I would say it's a very small percentage of the major contract, but it is a nice opportunity for us to extend the opportunities for that business. And just lastly on the core Continental contract, as Denise mentioned, that’s -- locking up that agreement for upto ten years is a very positive way for us to lock in a cash flow certainly in a very important contract relationship we have. So we are very pleased about the certainty. We always have to perform and that’s always part of any agreement that the certainty and visibility that that contract gives us from a cash flow perspective is something we are very excited about as well.

Okay. And just on growth investments, looking at 100 basis point, $65 million, and it's wonderful that you have always growth in geographic expansion opportunities in front of you. And how long do you think they we are going to out of maintain these kind of level of investment? What would be a run rate kind of two, three, four years down the track? Is this kind of big investments going through the pipe and will settle down at the lower level in the future, how do you think about that?

Now before Tom answers, let me just say from a strategic perspective. These are very important investments for us to continue the growth trajectory that we’ve been seeing demonstrated already in the IP business, when you think about some new facilities in Korea and Seneca Falls and then you think about our new Wuxi facility in China and you see correlate that to these high level of growth rates that we’ve being seeing in these businesses. And then the aftermarket, in the aftermarket content that we are going after is very important to us because the last couple of years we’ve been seeding the project business in IP and then being able to capture that aftermarket we have to make sure that we have the right infrastructure in place in order to really capture that aftermarket because that's a key component of the profitability and the value creation in the Industrial Process business. So, all these things that we are doing from a strategic perspective, is laying a very solid foundation for out into the future to continue to have these types of growth rates that we have. So that’s why we saw a lot of capital investment being made in 2013. We're also seeing a significant amount of capital investment being into 2014. Now Korea is online, up and running; Seneca Falls, the expansion there for our oil and gas business will be up and running mid-year this year; and then the Wuxi, this is an expansion of that facility that started in 2012. And so, we are going to be spending against that into 2014 some of that may spillover into 2015. We're also in friction going to be expanding the break pad capacity in some of our other facilities. We're going to be rebalancing. So we’ve got some new prices coming in. And as you can imagine, what the growth that we’ve seen that’s why we need to invest in these new break pads that we have. So that’s just the way that we think about it from a portfolio perspective, and why we are making and spending a significant amount of our cash in these organic investments which are less risky investments because it's building off of the base business that we have today. So with that Tom, do you want to answer more the financial side?

Yes, sure. And Nathan, when you are looking side, other kind of investment categories, so Denise gave a nice overview of the strategic investments of the $0.22. It does really aligned around those key areas that she talked about. But we have other areas of investment that we're focused on. Still there is kind of a wind down of our repositioning activities post-bid as we stabilize and put in place some key systems and capabilities, primarily HR and IT related. That work really does ramp down at the end of 2014. It should be completely done at the end of this year with maybe minor tail into next year. We're also seeing significant investment with $28 million of restructuring in 2013 and the similar size number from restructuring perspective and realignment in 2014. So those are our two other areas of investment where we are seeing some additional SG&A cost placed there as above. So once we reestablished the ICS footprint, we'd optimize that footprint in that business. We will have kind of made a lot of the foundational restructuring actions in the two or three years since then. We will have completed the bulk of the repositioning work very shortly. So those investments are going to start to come down. And I think as we grow, we'll be able to leverage this internal capability to really drive additional growth force on a global basis with minimal continuing investments in some of these areas. I'd say one area that we will continue to invest is IP, we are going to continue to target it in systematically investment system capabilities to support the growth strategy. But I do think we are going to see some real leveraging in opportunities in the investments in the next couple of years once we cleared the 2014 cycle.

The nice part about these investments is you are already beginning to see the payoff with these. So when you see the growth in oil and gas, when see the growth in China with our Wuxi facility, Tom talked about the restructuring investments that we're making at ICS, you are seeing that, you've seen the results of that in the margins, in the higher margins that we're being able to generate in ICS and the growth that we're experiencing. And then from a lean perspective and the money we're spending on lean, you see that coming through in the productivity benefits that we're experiencing. So it's nice to see the correlation between the investment and the payoff and the returns that you are getting from it.

That's great color. Thank you very much.

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

Yes, hi good morning and condolences to Tom. Actually just following up on that one question just with the CapEx component, so I mean it sounds like a lot of the investments are going to start winding down in '14 and some trickle into '15, but I know your maintenance CapEx is $30 million to $40 million obviously very high in '13 which is actually higher than I think you initially thought it would be 14.5% of sales is pretty elevated. Should we think that there is a fairly significant step down in spending in '15 on the CapEx side?

Yeah I think that's the right operating assumption Brian. When we look into the 2014 spending and really kind of about 25% of our CapEx is kind of -- well it's about 12% of our CapEx of 2014 is tied to maintenance and ongoing requirements, which is about half of what you'd normally expect because we have a significant increase in organic CapEx activities in 2014. So generally speaking over the last couple of years it's been about 25% of the CapEx that's our normal operating run rate going in the maintenance activity, 75% going into growth and productivity, the numbers get a little bit skewed this year in 2014 because we have a significant increase in our productivity and our growth initiatives around CapEx, but really if you normalize there, I would say we would expect the CapEx spending as a percent of revenue to step down significantly next year. As Denise mentioned we will have Korea up and running, falls up and running, the Wuxi expansion will be largely behind us. A lot of the internal capabilities would have been built. So I would expect a meeting step down in CapEx next year and maintenance to kind of stay for us on a longer-term basis around 25% of our CapEx. But I would see it coming down as much as 150 basis points to 200 basis points as we go into next year.

Okay. And then just on the restructuring, so you actually exceeded I think your initial plan at $28 million in 2013 you are talking about another $30 million of restructuring expense in '14. But you are only seeing -- I think you’ve taken only $14 million of benefits related to those actions in '14. I am just curious why it's so low and how should we think about the carry over in 2015 as well?

Yeah I think there is a correlation between those two data points. A lot of the benefits from the 2014 actions will actually start to build in the back half of the year. So we are going to have a significant carry-over into 2015 from the 2014 action. So that is probably the data point that’s required to balance out the equation. We did have a good solid year of savings that we built into the baseline in 2013. So the year-over-year savings reflect carry-over from '13, some of the benefits from '14 but the 60%, 70% of the benefits from the 2014 action because they relate to the ICS footprint optimization those savings are not going to be fully realized until we complete some of the transfers and some of the more complex activities that we have planned for 2014.

And I thought to just sneak one last in. So the commentary on industrial process and the oil & gas chemical markets seems fairly positive with the amount of project work you are seeing. It doesn’t seem like you are going to get a ton of that growth or the revenue growth in '14, but it seems like you could see a step change in the order profile in the backlog in that business. Is that the right way to look at it and it should be feeding the 2015 revenue profile?

When we are expecting that to happen. So we expect that these projects get released beginning mid-year so that those going to fit into those backlog, which is going to then help propel the 2015 number. So that is the correct way to think about it.

All right. Thank you very much.

All right. Thank Brian.

Our final question comes from the line of John Inch of Deutsche Bank.

Thanks good morning everyone.

Good morning, John.

Good morning. Now I apologize if you sort of touched on some of the stuff. But can I ask you a year ago you thought there would be $0.26 of net productivity benefit and now you are saying about $0.39. What is the mapping? So a year ago was a $100 million I think Denise and Tom and what's the gross productivity for starters this year that maps to $0.39?

It's going to be well in access of the current year John probably closer between a $110 million to $120 million on the gross side and really the uptick is going to be tied to obviously the incremental restructuring savings, which are a part of that number and the productivity that we are driving primarily at ICS where we are still seeing significant step function improvements in the underlying productivity of that business that’s going to drive our results to even higher levels in 2014 at least in 2013.

Right and so the next question is sort of the longer term runway, because obviously when ITT separated, right it was sort of expected that you might have a couple of years of pretty high productivity but then it would taper off. It sort of sounds like that's not actually the case if anything it's in fact increasing. So may be if you could give me a little color or give us a little color in terms of what you are -- I realize you got this stuff going on at ICS, there is a lot of heavy lifting still to do. But what's your thought process Tom and Denise these towards sort of the trajectory of productivity beyond 2014?

I’ll give some thoughts and then let Denies comment. It feels like the foundational work that we are doing, the underlying nature the transformation which are very comprehensive rebuilding the foundation of the operations and taking the lean transformation, which is a very significant set of activity across ITT and really focusing the organization on building sustainable improvements in productivity. I would say in all of those areas were ahead of probably around internal expectations coming out of the spin. So I think we continue to see a strong opportunity pipeline, but I am actually encouraged by the strength of the foundation that we've been building which is going to allow us to keep going after additional wave of productivity and I think we have a lot of opportunity within these businesses. The only slight offset right now which is purely from a margin perspective is the growth that we are seeing in the industrial process projects. That cycle is extending longer. That's a long term positive because we are growing our installed base for the future, which will generate future aftermarket, but reducing the prolonged project expansionary period, which puts some pressure on margin productivity indicators, but the type of pressure that we want to have because it really sets up the long term future of the business. Denise is there anything you want to add to this.

The only thing I would add is that the lean transformation that is really taken root in this company and where there used to be facilities we would say well how much more could you extract in terms of productivity. We’re finding that there is quite a bit that we can extract in terms of productivity. So as we’ve experienced growth in many of our markets, and that has translated into growth in these facilities, there is this constant renewal that you need to have around productivity and being able to drive productivity and so I think that those benefits are going to be there for an extended period of time for us.

Can I ask you then on restructuring, so we’re going to up the restructuring from $28 million to $30 million, is this level -- I realize you were talking about '14 or '15, but as you kind of look at overall trajectory is this level likely to be sustained through '15 or just it being to kind of ramp down?

I would say John at this point, although we constantly score the opportunities as we go through different activities we'll constantly look for opportunities to improve our performance, but at this space in the game, I would expect a meaningful step down in 2015 from a restructuring perspective, we will have reestablished the operating footprint for a number of our businesses by the end of 2014, but we'll some additional work to do here and there, but I would expect more of a step down than a ramp up in 2015.

Okay. So if you are stepping down doesn’t that really suggest then it's sort of hard to make the case that you’re calling the step out as one time. You’ve been far enough away from the spin, I guess the point is if you are stepping down, shouldn’t we think about transitioning to kind of more of quality earnings presentation that includes just would be called maintenance restructuring and what’s your view out there?

No I think we’re very close to that point John, we’ve been able to get these first wave of kind of reestablishing the operating footprint and the efficiencies that we think are essential for the long-term growth and helping these businesses and we do think that 2015 would be the year where we would start to look at exactly the same putting the restructuring in as more continuous improvement type investment. So that is our intention. We do want to just see how the actions in 2014 play out and make sure that there is not another wave of activity that we miss, but the expectation is that in very short order, we get back in line with what would be continuous improvement type restructuring, which would revert back to the normal operations we would not call out. So that has been our plan certainly to get back by 2015 to including those and we just have a little more work to do to make sure that we are through that. As it relates to repositioning and kind of the post spin activities, those will certainly be done by the end of 2014. So that wave of investment related to the spin will certainly go away in 2015.

And then just talking about the businesses for a second, so chemical is doing well but the baseline is still weak, chemical doing well, sort of consistent what [Pete] said. You remind me a baseline like I thought a chunk of baseline was legacy chemical. So that sort of implies that there's some verticals in baseline that are exceptionally weak right. So can you just tell what sort of reconcile those two? Maybe I’m wrong, maybe there isn’t much chemical in baseline, just thought -- I thought there was.

No, there is. So baseline gets included quite a bit in the chemical sector that we have there; and so what’s good for us is on the petrochemical side of things and the projects related with that where we’ve seen the weakness is more on the baseline piece which goes into what I call general chemical type activities. And also in the Industrial Process piece of it, more general industry, that’s what we’ve been seeing the softness and it’s been in North America. That’s where our baseline business is.

The general industrial is weak. That’s sort of a message, right?

General industrial has been weak, yes.

Yeah.

And as margins pressure and puts them in [inaudible] as you increase projects and decrease the base business.

Are there obvious verticals though in baseline ex-petrochemical that are particularly sort of weak. I mean I don't know if you sell baseline pumps to mining or its something like that?

No, they all going into more of the chemical side of the business than the general industrial side of the business, that’s where the baseline pumps go. That’s where we’ve seen the weakness.

And just lastly, then it looks like we’re moving towards the approval of the Keystone pipeline, if you remind me I don’t think ITT has a ton of exposure on the IP side, but it probably helps Bornemann, I think it helps repetitive pipeline infrastructure. Could you just remind me if that project gets approved, how IP actually could benefit?

Yeah. I think it really depends on what that means in terms of what’s going to happen in the Gulf Coast region and the investments that are going to be made in the Gulf Coast region associated with that. When you look today at the oil and gas business that we've got, about 50% is upstream, 15% is midstream and 35% is downstream. So depending on which one of those sectors ends up getting impacted by that Keystone pipeline that will impact our numbers at that point.

Right. So exactly it could have benefit to at least 50% of that business?

Yeah. That's right.

Got it. Okay, thanks.

All right. Thanks John.

Thank you. That does conclude the Q&A portion of today's call. I will now return the call to Denise Ramos for any additional or closing remarks.