Melissa Trombetta - Vice President of Investor Relations Denise L. Ramos - Chief Executive Officer, President and Director Thomas M. Scalera - Chief Financial Officer and Senior Vice President.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division Nathan Jones - Stifel, Nicolaus & Company, Incorporated, Research Division John G. Inch - Deutsche Bank AG, Research Division.

Welcome to ITT's Second Quarter 2014 Earnings Conference Call. Starting the call today from ITT is Melissa Trombetta, Vice President, Investor Relations. She is joined by Denise Ramos, Chief Executive Officer and President; and Tom Scalera, Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 12 p.m.

Eastern daylight time. [Operator Instructions] It is now my pleasure to turn the call over to Melissa Trombetta. You may begin..

Thank you. Good morning, and welcome to ITT's Second Quarter 2014 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.

During the course of this call, we will make forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. No forward-looking statements can be guaranteed and actual results may differ materially from those projected.

We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise. Forward-looking statements made on this call should be evaluated together with the risks and uncertainties that affect our business, particularly those disclosed in our SEC filings.

So now let's turn to Slide #3, where Denise will discuss our results..

focus market expansion; differentiated customer experience; operational excellence; and effective capital deployment. These are the 4 pillars of our long-term growth strategy. And our results this quarter are an indication that we are executing in the right areas. So looking at our market expansion.

In Q2, we delivered strong performance in both the emerging and the developed markets. Emerging markets were up 9% organically, and developed markets were up 7% due to strong oil and gas project pump shipments in North America and Europe, and automotive aftermarket growth.

A key element to our strategy is to intensify our focus on differentiating with our customers. To do that, we are extending the lean concept far beyond manufacturing to improve service and responsiveness on the front end. We are already starting to see the benefits of these actions in our improved on-time delivery measures.

Further demonstrating our commitment to our customers, I'm very excited to participate in next week's grand opening ceremony of our newly expanded Seneca Falls New York Pump Facility, which is our energy center of manufacturing excellence for the Western Hemisphere.

This investment allows us to optimize our manufacturing capabilities by leaning out the existing facility and it also creates a state-of-the-art testing facility to better accommodate our global customers as we expand our product portfolio of high pressure, high horsepower pumps for the oil and gas, petrochemicals and mining markets.

And I'm happy to report that our customers are recognizing the quality of our premier customer experience efforts. During the quarter, KONI was recognized as an A supplier by 2 of its customers for outstanding performance in the rail market.

And Interconnect Solutions was recently honored by Arrow Electronics as the 2013 largest North American growth supplier in the connectors segment. These awards further validate the effectiveness of the turnaround work we've done at both of these businesses. Moving onto our next growth driver, operational excellence.

We had another solid quarter of productivity in Q2. We generated $27 million of gross savings. This is a result of our lean transformation, leverage of our global strategic sourcing and benefits from restructuring actions.

We continue to capture opportunities to improve efficiency, and during the quarter, we took additional restructuring actions totaling $4 million related to Interconnect Solutions and the integration of Bornemann.

I would also like to take a moment to highlight the outstanding results at KONI in Motion Technologies as a result of their ongoing turnaround action. In Q2, KONI delivered organic revenue, up 14%, organic order growth, up 49% and adjusted segment operating margin, up 480 basis points to over 14%.

And finally, our last strategic focus area, capital deployment. We had another quarter of balanced capital deployment.

The organic investments we made during the quarter, were focused on rebalancing and expanding our global auto brake pad production capacity, expanding our energy Center of Excellence in Seneca Falls, and building out our aftermarket reach and capabilities.

These targeted investments continue to help us build on our already strong foundation and will drive profitable long-term organic growth. So I'm very pleased with our performance to date, and the continued momentum that our people are generating on a daily basis.

I'm also very excited about the way we are sustaining that momentum by fostering a healthy, high-performing culture at ITT. When we made the decision to invest in strengthening culture about a year ago, we were confident that it would unlock untapped potential.

As a result of our efforts to date, we are already seeing greater collaboration and problem solving for our customers, and the evidence is in our quarterly performance. Before I pass it over to Tom, I would just like to thank everyone for their dedication and commitment to ITT. I'll now turn it over to Tom..

Thanks, Denise. Now let's turn to Slide 5 for a detailed review of our second quarter results. In Q2, we had total revenue growth of 9% and organic revenue growth of 8%, after adjusting for foreign exchange and acquisitions.

Motion Technologies led the way with exceptional 11% organic revenue growth fueled by our global automotive brake pad business, as well as our KONI shock absorber business. These businesses were up 10% and 14%, respectively. Industrial Process also grew nicely this quarter, up 8% organically.

This growth included a 21% increase in global oil and gas projects and a 24% increase in Latin American mining that was partially offset by weakness in Europe and Asian industrial pumps.

Control Technologies also delivered solid organic top line growth of 5%, as strength in our energy absorption business and our commercial aerospace components more than offset end-of-life program headwinds. Shifting to orders.

Organic orders increased 8% this quarter, driven by strength in global automotive friction, global rail shock absorbers and oil and gas and chemical pumps. These gains were partially offset by an 8% decline in our Interconnect Solutions business due to defense weakness and a decline in handheld device connectors.

Q2 adjusted segment operating income of $93 million increased 17% primarily due to increased volumes and strong net operating productivity from our ongoing lean transformation and accelerated benefits from our turnaround actions at ICS and KONI.

These benefits more than funded incremental strategic investments in the lean transformation and aftermarket expansion. For the quarter, our adjusted EPS of $0.60 per share exceeded expectations and was 18% higher than the prior year.

Our EPS improvement reflected the 17% growth in segment operating income, lower interest expense and a lower effective tax rate, which is now at 27.2% year-to-date. These benefits were partially offset by an increase in corporate that reflected prior year favorability, increased incentive costs and incremental investments in internal capabilities.

Turning to our total revenue growth by end market on Slide 6. Transportation was up 8% in the quarter. Global automotive revenue grew 10% due to aftermarket expansion in Europe, OEM market growth and share gains in China, and some favorable timing in North America.

Rail was an important contributor to this quarter posting a 28% increase largely due to KONI. This strength was partially offset by aerospace and defense, which was up only 2% despite strong commercial aerospace component demand.

Revenue in the energy market was up 17%, driven by a 21% increase in oil and gas and Industrial Process related to large projects, most notably in North America, Europe and the Middle East. Growth in oil and gas reflects the strength of our ongoing investments to expand our global capabilities, our aftermarket reach and our product portfolio.

Lastly, our broader industrial markets were up just 1% in Q2. This was due to mining growth of 24% and general industrial strength of 7% that offset a decline of 4% in chemical and industrial pumps, due to lower project activity in Asia Pacific. Now let's turn to our revenue by geography on Slide 7.

Revenue in the United States and Canada grew 9% in total, due to an increase in oil and gas project pumps and short-cycle base pumps that supply the chemical market. In addition, we had favorable timing in our automotive brake pads and solid growth in our KONI shock absorber businesses, up 27%.

In Europe, we delivered 7% total revenue growth, mostly driven by the automotive aftermarket. Strength in the independent aftermarket channel and benefits from the strong OEM growth over the last several years, that is now entering the dealer service cycle, are the aftermarket performance drivers.

These gains were partially offset by defense connectors and general industrial pumps. Total revenue in emerging markets grew 9%, driven by 20% growth at Motion Technologies and 6% growth at Industrial Process. Motion Technologies performance reflects 28% growth in our China automotive friction business due to market growth and share gains.

And the Industrial Process performance reflects solid oil and gas activity in the Middle East and increased mining activity in Latin America, that was partially offset by weakness in chemical projects in Asia Pacific. Turning to Slide 8. Here you will see that segment operating margins expanded 100 basis points to 14.1%.

As we've highlighted, this expansion was largely the result of strong operational execution that was driven by various lean transformation actions, expanded global strategic sourcing and significant benefits from the turnaround activities at ICS and KONI. These results also reflect strong volume growth across all of our businesses.

These gains self-funded the 60 basis points of organic investments, and more than offset 20 basis points of foreign exchange and the negative pricing impacts from constant automotive industry pressures, as well as the unfavorable mix impact due to a significantly higher weighting of large pump projects.

And finally let's turn to Slide 9 for our 2014 guidance update. As you've heard this morning, we are pleased with our strong first half results and the momentum that we have generated from the powerful combination of current execution and long-term investment. So let me provide some additional insights into our revised full year guidance.

As a result of the continued automotive growth at Motion Technologies, particularly in Europe and China, and momentum at KONI, we're raising our full year revenue guidance. So our new organic revenue growth guidance is now 5% to 6% for 2014.

From an adjusted EPS perspective, we are raising our guidance to a new range of $2.38 to $2.46 per share, a $0.10 increase at the midpoint which reflects a growth rate of 20% versus 2013. And as a reminder, at 20%, this is the same growth rate that we generated last year.

Adjusted EPS guidance reflects -- largely reflects the stronger performances at Motion Technologies, partially offsetting some of that momentum is the higher weighting of large project activity in our Industrial Process business, which will have a negative mix impact on our results.

From a non-operational standpoint, we projected $0.03 benefit from our newly forecasted effective tax rate of 27.2%. The lower rate once again reflects planning benefits and a favorable mix of foreign income. And the remaining $0.07 of the $0.10 raise is operationally driven.

It is important to note that we expect to incur about -- a $5 million increase in restructuring and realignment costs in the second half versus the first half, as we now estimate our full year restructuring and realignment actions to be about $35 million this year as we further the Interconnect Solutions transformation and the Bornemann integration.

Finally, while we do not provide quarterly guidance, I would like to provide some color into our Q3 and second half expectations. Q3 revenue is expected to be up slightly on a sequential basis compared to Q2, but with a lower growth rate versus the prior year.

The sequential improvement is driven by increased oil and gas and chemical activity in North America and Asia, and continued strength in the European automotive aftermarket, partially offset by declines in our defense and handheld device connector markets. Also in the third quarter, we expect adjusted segment operating margins to be in line with Q2.

We expect sequential improvement in the Industrial Process margins, however they are forecasted to be down versus the prior year due to a continuation of the higher weighting of project shipments and increased strategic investments. In addition, we expect a sequential decline in Motion Technologies margins due to a Q2 legal settlement favorability.

In the second half, we do expect a nice sequential increase in total adjusted segment operating margins versus the first half. This increase is mostly related to increased volume in the shorter-cycle base pumps and aftermarket, higher margin project activity and higher productivity.

This expansion is partially offset by the seasonally lower volumes at Motion Technologies. In the second half, we also expect an increase in corporate costs compared to the first half and the prior year, due to incremental investments in internal capabilities and higher environmental costs.

And we expect our effective tax rate and share count to be consistent with the first half. So now let me turn it back over to Lori to begin the Q&A session..

[Operator Instructions] Your first question comes from the line of Matt Summerville of KeyBanc..

First, with respect to Industrial Process, can you guys put some numbers around what the mix was between project aftermarkets in Q2 and again, put some numbers around how you expect that to evolve in the back half?.

Yes, sure, Matt. The project business from a revenue perspective increased 20% for us in Q2. And what that's doing is it's shifting the weighting about 3 points up on the project side relative to where we were last year. And that actually is coming out of our mix on the aftermarket side.

So that general trend is going to continue into the back half of the year. Projects are going to be up versus last year on a mix perspective about 3 points and aftermarket, let's see, as we progress through the year.

Actually it starts to come back a little bit in the second half of the year, but really the story here is that the weighting on projects is going to be higher as the year progresses..

And then with respect to the Interconnect business, can you talk about what you've accomplished thus far in terms of the restructuring actions there? What the run rate of benefit you're seeing is? And what still needs to be done to sort of "fix" the business?.

Sure. Well, as you know, we've been realigning that business to focus on 4 main end markets, all aligned around harsh environment connectors. So we took the front end and we've put 4 GMs in place, one for aerospace and defense, one for transportation and industrial, one for oil and gas, and then one for medical.

And we've put teams around those folks with P&L accountability to go drive that business in each one of those segments. So that's been on the front end. From an operational perspective, what we've been doing is we're continuing to advance our footprint optimization. So last year, we moved some manufacturing that we had in the facility in the U.K.

into Germany and to a subcontractor in Poland. This year, what we announced was moving from our Santa Ana facility into our Nogales, Mexico facility and consolidating those 2 facilities.

So what really we've been doing is we've been combining our manufacturing footprint and creating Centers of Excellence in primary regions that are aligned with these basic end-markets that we have. Also in alignment with that, we've been doing a lot around lean.

So we have a lot of focus in each one of these facilities around leaning out the operations, making it more efficient, making it more effective and that's what you're really seeing in terms of the results that we're having in the margin improvement that you're seeing there.

So it's the benefits of the restructuring, and it's this lean activity that's been taking place. And really driving lean in a very transformative way into these businesses that we've got. So we've been looking at this from a global perspective and operating it from that perspective.

We also, as part of this, we're end-of-life-ing some product lines that we have. And so that will continue this year and probably into next year. And so we've been pruning the portfolio to make sure that we're targeting with those right products that will mean the most to our customers..

And then just one quick follow-up on that, Denise.

Margins, 14%-or-so in Q2, are you willing to revisit that mid-teens target you laid out 1 year or 2 ago?.

Well, one of the things that we believe is that over time, where -- we should be operating this business in the high-teens, but that's going to take us some time to get there because we need to get some volume growth on the top line.

So the front-end folks that we've got in place now in these GM roles, really need to drive the business and we need to improve there in order to get more of that benefit that's going to flow through from a margin perspective.

But the benefits that we're seeing from an operational perspective, we expect will continue to gradually increment up as we go throughout the next couple of quarters and into next year. But the other real benefit is going to be when we get that top line growing.

We've got some challenges on the top line right now as I've indicated with the end-of-life, and then the defense market is not serving us well right now, and then with the handheld devices, we've got that also.

But you look at some of the other end markets like oil and gas, some transportation and industrial and on the aerospace side, and we're actually doing very well..

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

Denise, in your comments, you talked about accelerating and extending the lean transformation.

Can you talk about what it is you’re accelerating and where it is you're extending that versus where you had planned to be at this point?.

Sure. We've been doing a lot of work, Nathan, as you know, on the lean transformations from a manufacturing perspective in all of the facilities that we've got.

And so we've had a process in place for the past 1.5 years or 2 years that we've been really working on getting our factories, or the key factories that we see going forward, in a very lean way.

What we're now doing is we're expanding this lean transformation beyond just the factory floor into more of a lean enterprise, which means we're going across the whole value stream and looking at the front end and making sure that it's linked appropriately through the manufacturing cycle, all the way to the end customer.

And so it's really when you link those things together that you get the big benefit from a productivity perspective, especially when you've got some of these highly engineered complex products that we do. The front end is particularly important. And we have a lot of work to do to get that front end more synchronized from a manufacturing perspective.

So we were in the early stages for our lean transformation. We've been doing again a lot of the work around the -- manufacturing the facilities, but when you expand it out, that's where we're going to be able to get some more incremental benefits..

It sounds like you're ahead of schedule from maybe when you started this a couple of years ago.

How far ahead of schedule are you on leaning out within the 4 walls and now moving on to the more lean enterprise focus and looking at that front end?.

I think we still have a lot of opportunity there. So we've had some nice margin improvement and I know that, and that's being reflective -- that's reflected in the numbers that we've seen here. But I still think that we've got a nice way to go with that.

So I wouldn't say it all that we're anywhere through with this, and also, it's just continuous improvement, we have to continually drive it. So I'm pleased with the results. We've done a nice job as an organization. The whole organization has rallied around this and we're seeing the benefits particularly with our customers.

And the on-time delivery and the quality, and all the metrics that we look at for lean with on-time delivery, quality, productivity, working capital, inventory levels, we're seeing some of those benefits flowing through. So, yes, we're ahead of where I thought we would be, but we still have a long way to go..

Yes, Nathan, and I would kind of add to that, that we're just really powering up some of the bigger investments that are the anchors in the manufacturing part of the lean transformation. So the Korea facility is just coming online this year. The Seneca Falls expansion, grand opening is on Monday.

And those are 2 big drivers of a lean manufacturing environment, certainly in the highly engineered complex pump world that we're in. We're also really, getting at the ICS opportunities related to the restructuring and then moving into a more lean manufacturing environment. So a lot of these activities are just really now starting to come online.

The last area I would mention is the Wuxi operations in Motion Technologies. That facility is also kind of ramping up and starting to utilize that lean layout and that more efficient manufacturing capabilities to generate growth going forward.

So kind of like where we are right now in that long-term build-out of a more efficient manufacturing environment. And then to Denise's point, that connects very nicely to a much more integrated front end, down the road..

So you can tell by Tom's comments, he's touched on all the value centers, even within our Control Technologies business we're concentrated in 2 primary manufacturing centers, one in Valencia, and one in -- Valencia, California and one in Orchard Park, New York.

And so what we've done is when we looked at it across from an ITT perspective, we're concentrating our manufacturing in those areas that make the most sense for us, so that we can be lean, that we can be efficient and so that we can be effective..

And just one more for me on growth investments, which are obviously bearing fruit with the very strong organic growth. The slides had 60 basis points of margin invested in growth investments.

Where do you see that going? How much further opportunity is there to invest money in that long term -- those long-term growth initiatives? Do you see that coming down? Accelerating? Staying where it is over the next, say, 1 year or 2?.

No Nathan. I think it probably stays in a fairly similar ranges on a go forward basis.

This investment cycle has really been the key driver of our organic growth and kind of where we are in the evolution of these businesses as we invest in one opportunity, we see the benefits of that opportunity it's opening up some additional growth ideas for us to go after with the next wave.

So we're kind of moving through -- a lot of these initial investments were start-ups and bringing these facilities online and powering them up.

But then as we look at some investments and front-end capabilities and other activities as part of that lean transformation that we talked about, I think we probably have another 1 year or 2, where we would stay at this kind of run rate because it's an opportunity-rich environment but I think we're in right now, as we're building the long-term capabilities out for these businesses..

Well, it's always a high ROIC investment internally, so that's good news..

That's right, that's right..

[Operator Instructions] Your next question comes from the line of John Inch of Deutsche Bank..

Just a quick -- just to clarify a couple of things.

So the motion legal settlement, Tom, what was it and what is the financial significance?.

Yes, John. It's something that we accrued at the end of last year, and we were able to resolve the matter in a more beneficial way than we initially thought just based on the good work of our legal teams. That that gave us some, a couple of hundred basis points of favorability.

If you look at the Motion Tech margins, they were very strong in Q2 and that was the benefit of, particularly, of that legal settlement. We always have some offsetting activities, from a reserve perspective, in the other value centers.

So I think on a net segment margin basis it kind of gets washed out by other activities, but it was a little bit larger in Motion Tech this quarter and it was a legal matter that ended up more favorably than we had anticipated last year..

In other words, you're saying when you see some of these one-time benefits, you're offsetting them with -- like a pull forward of actions. But it sounds like on a net basis, there was a benefit.

So was it -- I'm sorry, I'm not trying to -- I don't really understand, was it 200 basis points of benefit or was it less than that?.

Yes, yes, John. For Motion Tech, there was about 200 basis points of benefit for that matter in Q2, at the segment operating level -- across all the value centers, we think they were kind of actions that went the other direction that largely offset at the ITT level, so there's much less of an impact at the ITT margins.

But for Motion Tech, you can see that they had really strong margin expansion that was partially attributable to the settlement. But....

So it does sound like EPS for ITT wasn't unduly benefited from this settlement?.

Correct. And then at the Corporate line too we also had additional items. So on net -- the ins and outs of kind of balancing all those pluses and minuses, to your point, John, it didn't have an impact in a meaningful way at the ITT level..

What about the handheld device issue, if we could flesh that out a little bit.

Is that a specific customer? Is it contract item lumpiness or is it sort of -- are you guys seeing broad handheld softness? Maybe little more color on what's going on there for that segment?.

John, that was really specific to one large customer that we've had for a long period of time, and so we're trying to diversify that connector business right now into other applications. But that's not offsetting the impact that we're seeing from the one large customer that we've had. So we've had this for a period of time now..

And I think, Denise made the point earlier about end-of-life products within the connectors business.

We also talked about it in the Control Technology business and I think as we go towards a more focused end-market strategy, we'll be able to have those market leaders build a more diversified base of customers and opportunities so that we don't get impacted as often by 1 or 2 events as we're kind of seeing play through the portfolio over the last couple of years..

And it's important to know that as you look at the back half of this year, ICS is going to be weighed down somewhat because of this connector issue with the handheld device. The defense business, which is falling off, which is having some challenges after we really have had some nice growth in ICS and defense, and then the end-of-life programs.

So what is -- again, it's part of rebalancing the portfolio and getting the portfolio where it needs to be and better positioned for the long term..

That make sense. So Denise and Tom, one of the concerns of this earnings season is that it seems that your industrial peers, given that they have not been seeing top line for a little while here are beginning to hit a wall and sort of run out of productivity as evidenced by their earnings misses or guide downs.

You guys -- you seem to have the opposite problem, perhaps with the exception of ICS, which is going to have a little more economic exposure, so I'm curious if you think the ICS margin performance may in fact be close to that wall with the absence of top line? You mentioned actually the top line point in, I think, a previous caller's question.

I'm just -- how are you thinking about this, Denise?.

Well, with ICS, John, as we continue into the back half of the year, some of the productivity benefits that we're getting from the restructuring, we're going to see more of them flowing through in the back half of the year. So I do think that there is some gradual continued improvement in the ICS margin in the back half of this year.

It's more long term when you look at margins in 2015 and 2016, that we would like to see some top line growth, which is why we've been looking at the portfolio and figuring out where are those markets that are most important and that have the biggest growth going forward..

Maybe one more. Roper commented that deal capacity or ability to get things done, I guess, given sort of sideways to down market seems to be improving. Are you guys looking perhaps at M&A, which is always sort of on everyone's thought process here.

Are you looking at M&A perhaps as things get -- perhaps a little bit better, either maybe in Canada the energy patch or something like that.

Just -- has anything changed just in the last quarter given the market gyrations?.

No, John, nothing's really changed. When we think about the long-term growth for this company, acquisitions is a key component of it. And so we've been targeting pumps, we've been targeting valves, aerospace is a nice place for us, there are some industrial applications that will be nice places for us.

So we've been really working the pipeline as just a natural part of our evolution as an organization. We've gotten smarter about our strategy, we've gotten our operations working better, we've been investing organically and now from an M&A perspective, we're really targeting doing some acquisitions as we go out into the future.

But as you know, these things can be tough to time as to when it actually happens. But our strategy around M&A has not really changed..

Your next question is a follow-up from Nathan Jones of Stifel..

You talked about chemical and industrial pumps having negative growth. I think there's an expectation out there that, that improves maybe later in the year or earlier next year.

Can you talk about what your outlook for that market is currently?.

Yes, sure, Nathan. From a top line perspective, we did see a little softness in Asia Pacific region in Q2, and our baseline business came back nicely during the quarter, but our aftermarket was weak for really the first half of Q2, and just started to pick up in the second half of Q2. So the chemical market had a lot of moving pieces.

North America's sales benefited from the baseline strength in particular, but the project activity is starting to gain momentum, and we're seeing some of that strength in our orders in North America, chemical in particular. So the revenue was down slightly. Asia Pacific was the key driver in that respect.

But we are seeing some gaining momentum in our order book, both on baseline pumps, building momentum and aftermarket a little more slowly, and then some of the larger products are starting to come online..

Is it fair to say that your bidding activity is picking up?.

Yes, I think that's fair to say. We did have some nice wins that came through in the quarter in North American chemical. And we would expect the pacing of activity around the chemical market in North America to stay solid, especially when we combine it with our baseline pumps which are at a smaller size and complexity than our petrochemical pumps..

You also talked about the second half having a higher pump project mix than you had expected.

Is that -- what's behind that? Is that the slower aftermarket? Is it the higher orders of pumps? How is that fleshing out?.

It's really a factor of the aftermarket, Nathan. We got a slow start in the aftermarket the first part of this year.

It really has just picked up in the last 6 or 7 weeks, and so we're expecting to continue to have some nice order growth rate in the aftermarket in the back half, but because it started out slow, we do expect that we're going to see more projects in the back half of the year than maybe we had thought when we entered the year because of the slowness in that.

The baseline has been good for us. It actually picked up in around the April, May timeframe. So we started out slow in that business too, but that's also improved for us.

So as we get into the back half, while we've got some growth coming from projects that were out of the backlog in 2013, we're also going to see some improvement in the aftermarket in the baseline..

And just one clarification on a question John asked. You said you expected some incremental improvement in the back half in Interconnect margins.

Is that incremental improvement from the 2Q margin that you're talking about?.

Yes, it's from Q2 first half. We were going to see improvement in the -- if you look at the first half versus the second half, we expect to see improvement in the second half versus the first half..

And I would say, Nathan, it would be a modest improvement and the real variable is around defense and handheld connectors, the orders were down in Q2. Those are higher-margin projects for us -- products for us.

So depending on how that trend line plays through, that will be one of the mix items we'll be watching in the second half from this jumping off point..

Your next question is a follow-up from Matt Summerville of KeyBanc..

Just a couple more on Motion. I just want to make sure I understand how we should be thinking about seasonality. You mentioned kind of normal seasonality heading into Q3, I think, Tom. We're hearing from some of our other companies that the European guys are not planning on either, one, shutting down or not shutting down for that long.

So are you, therefore, expecting a more muted seasonal impact than you what maybe otherwise would've experienced?.

Yes. I think that's the right way to characterize it, Matt. It is more muted for 2 reasons. One, I think the European rates are picking up a little bit in the back half of the year.

Also, our business now, with strength in China and North America and some production start activities in Q3, are going to give us a little bit more than what we've typically expected in Q3, given the European shutdown. So I think the way you phrase it, Matt, is the right way to think about it..

The other thing that we're going to benefit from in Q3 is the new independent aftermarket line that we started up at the first part of this year, the Galfer line. We're going to see some incremental sales associated with that in Q3.

So we saw some inventory being built in Q1, we're also going to be seeing that flowing through in Q3, which is going to help our Q3..

And then maybe an update -- same business.

Where are you with kind of optimizing where you're making the brake pads versus where you're selling them? And what is now your productive capacity in China?.

Matt, we're really powering up in China. So we're right on track with our expectations, probably slightly ahead -- putting capacity online in China.

And that production right now, given the strength that we're seeing in the top line, that production is almost exclusively going to the China market, and what we've been doing then is rebalancing our global footprint and really bringing the Czech Republic facility up, which is handling a lot of this aftermarket growth very effectively.

And we've been bringing on some new automation into our other European operations and generating significant improvements in our utilization of the equipment, really in our core production areas.

So Czech Republic is really helping us ramp-up aftermarket, and we're looking at other opportunities to even bring OEM production into the Czech Republic, which gives us another alternative production capability in Europe. But right now, China is on track in Wuxi, and we've made some significant investments.

If you look at the CapEx this year, it has been largely weighted towards Motion Technology investments, it's the highly automated operation and we're continuing to kind of bring the state-of-the-art equipment into the right operating footprint.

So we have a more balanced capability to produce in Europe or in China, to feed the global demand that we've been seeing..

What is your expectation full year CapEx, Tom, for '14? And what would you sort of guesstimate that number looks like for '15?.

Right now, we're targeting, probably north of 5% of sales from an overall CapEx perspective across ITT. So we have some additional, significant investments in the back half of the year that are going to be coming online. It's going to moderate down.

I think some of the activities around Industrial Process, in Korea and Seneca Falls in particular, will come down in 2015. So I would expect that number to come down. One of the issues is Motion Technologies is a highly automated business, and it's capital intensive. The ROIC on that business as you can see is phenomenal.

So we'll continue to invest in the capacity and the capability required to grow Motion Tech and realize some of the strength that we have been generating down the road. So I'd say the rest of the businesses are coming down into more normalized ranges between 2% and 3% of revenue.

I'd say, Motion Technology is based on how we continue to grow that business, it could stay at elevated levels and kind of pull the overall ITT number up even into next year, based on how we see the growth playing out.

And then lastly, I would add just on CapEx, we're continuing to invest in our IT infrastructure, that's another area in 2015 where we'll have some elevated investments as well. But I would expect it to step down certainly from where we plan 2014 to end..

Your next question is a follow-up from John Inch of Deutsche Bank..

So my question is also in the context of investment spending. And I realize that this elevated investment spending is a function of the legacy of the company, Denise, that you took over.

If you add up all the puts and takes and Tom, I think we've talked about this, does this investment spending effectively peak next year? Because one of the questions that I certainly get for ITT has been on kind of the cash flow and the lack of cash flow, which seems to really be driven just by this elevated investment spending.

So really, I mean, if you add up all this puts and takes is this peaking next year? And the corollary question would be that would imply you're going to actually have a lot of cash in your hands and, Denise, if -- going back to the M&A point, if some of this stuff just doesn't come through for timing or whatever, what are your thoughts toward capital allocation? Because you guys already have a very debatably over-capitalized balance sheet..

Yes. So I'll start with the investment piece, John. 60 basis points, it's about $17 million, $20 million of investment per year. And those are just very targeted strategic investments that are going to help us grow the end market. So that level of investment has been kind of really generating significant returns.

So I don't necessarily see that level of investment changing significantly in either direction, a couple of million here and there. From a cash flow perspective though, I would expect our CapEx to come down.

We're seeing the repositioning, all the kind of spin-related activities around repositioning, those dollars are coming down dramatically as we kind of further distance ourselves from those activities. Restructuring is, from an expense perspective, is certainly elevated this year as we kind of transform the footprint.

Some of that cash will kind of bleed into next year. But I would think as you look across CapEx, restructuring, and kind of repositioning activities, those dollars and those expenses will be coming down in 2015 from where they are in 2014. And then you would expect a more significant step down into 2016, certainly from a cash perspective.

So that will help the overall cash flow in total..

So then John, as we generate more cash and less use for it, organically into the businesses, our priority still remains to do M&A.

We always look at it, we look at the next couple of years, we look at the cash flow, we look at our pipeline, we have regular processes around reviewing the pipeline, but we're still pretty bullish on the fact that we can grow this business through acquisitions in many of these businesses that we have.

So that continues to remain our focus but we always evaluate it..

And just based on what you're describing and as you distance yourself from restructuring, maybe it's a Melissa question, but are you guys going to be prospectively looking to include restructuring charges in the presentation of earnings, say, beyond 2014, or how are you thinking about it?.

Yes, we continue to think about it, John. I think what we want to do is really take a fresh look at the end of the year based on kind of where we are, and really, to Denise's point earlier, we do want to accelerate as many of these actions as we can. We want to make sure that we're sequencing them and pacing them the right way.

So our kind of goal is to get a really clean view of what's out there over the next couple of years when we exit 2014 and I think going into 2015, we'll have a clear view on where we are. But the idea and the objective is to bring as much of those activities into this year as we can.

We accelerated our restructuring by $5 million in our most recent guidance there, so the goal is to keep getting as much of this behind us, and then I think, it'll be much more obvious how we kind of position the adjustment going forward. But we'll certainly, talk more about that when we get into probably Q3 and Q4.

We'll give more insights there, John..

At this time, there are no further questions. I will now return the call to Denise Ramos for any additional or closing remarks..

Well, let me just thank everyone for joining us on the call today. As you've heard this morning, we are very pleased with our Q2 performance and how we've been able to once again deliver on our commitments and move our strategy forward.

This is the result of focus and strong execution and it will continue to create ongoing long-term value for all of our stakeholders. So I look forward to updating you on our progress next quarter. Until then, thanks, very much..

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day..