Illinois Tool Works Inc (ITW) 2002 Q2 法說會逐字稿

Good afternoon and welcome to the ITW 2002 second-quarter earnings release conference.

All participants will be able to listen only until the question and answer session.

This conference is being recorded at the request of ITW.

If you have any objection, you may disconnect at this time.

I would like to introduce our host, Mr. John Brooklier.

Sir, you may begin when ready.

Thank you, Mary.

Good afternoon, everyone.

As noted my name is John Brooklier.

I'm ITW's vice president of industrial relations.

I'm here with Jon Kinney, ITW's CFO.

We're pleased that you could join us for today's second-quarter conference call.

By now, you should have received our second-quarter earnings release information.

To put it simply, we are very pleased with our performance in the second quarter.

We see a number of very good things happening at ITW, and in our end markets, that are seemingly being ignored by the equity markets.

First, we continue to see sequential improvement in our base business.

We were at minus 2% base for Q2, and that compares to a minus 6 base in the first quarter and a minus 9 base in Q4 of 2001.

As important, our operating margins continue to improve.

As you saw in today's release, total company operating margins were 17.6% for the second quarter.

That's 100 basis points higher than a year ago.

I believe you will agree with us that when we say 80/20 is alive and well at ITW, we mean it.

We believe there are very few companies worldwide who can match us on our margin performance.

In summary, we remain cautiously optimistic about our prospects for the third quarter and full year and our focus is on the extent and sustainability of recovery in our end markets in North America and on the international side.

Let me go over today's agenda which is similar to what we've done in the past.

Jon Kinney will join us in just a few moments to give you an overview of the second quarter.

I will then come back to give you additional color on our performance for our four manufacturing segments.

Jon will then discuss our third-quarter and full-year forecasts.

Finally, we'll open the call to your questions.

Since this is an open call, please note that today's focus is on our second quarter and first-half results, and our forecast for the third quarter and full year.

Any questions not related to these topics will result in me asking the operator to move on to the next question.

As usual, I'm asking each person to just ask one question, and one follow-up question, so we can accommodate everyone who has an inquiry within a reasonable period of time.

If you'd like to get back on the line to ask an additional question, please feel free to do so.

A couple other housekeeping items.

I would like to remind everyone that statements regarding the company's earnings estimates contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including, without limitation, statements regarding the company's 2002 forecast.

These statements are subject to certain risks, uncertainties, and other factors which could cause actual results to differ materially from those anticipated, including, without limitation, the following: One, a downturn in the construction, automotive, general industrial, food, retail, or real estate markets; number two, deterioration in global and domestic business and economic conditions, particularly in North America, Europe, and Australia; number three, an interruption in or reduction in introducing new products into the company's product lines; and four, an unfavorable - unfavorably prolonged environment for making acquisitions or dispositions, domestic and international, including adverse accounting or regulatory requirements and market value of candidates.

Finally, one final piece of business.

The telephone replay for this conference call is good through midnight of August - on August 1.

The playback number is 402-998-0805.

No pass code necessary.

Let me now introduce Jon Kinney, who will take you through second-quarter results.

Good afternoon, everyone.

John Brooklier and I were just recently in Europe and met with 26 institutional investors.

He had me on this trip.

This was five days, five or six meetings a day, four different countries, and he told me it was all in preparation for today's conference call.

As usual, in these meetings, we talked a bit about our current operating conditions, but more importantly, we talked about the core long-term strategies of our company.

Since I probably won't be meeting with each of you in the near future, let me take a few minutes now to just summarize some of our discussions in Europe.

First, of course, we discussed our decentralized management style and how it provides a solid foundation for our over 600 entrepreneurial management teams.

We also discussed our innovative products and their ability to solve customer problems and the foundation they provide for market penetration.

And as you might have guessed, we spent a fair amount of time discussing the 80/20 process and how it is used in planning and organizing the business units.

80/20 assures business focus and simplicity, and the resulting operational and financial improvements that we look for from our companies.

Our successful acquisition program, which is double the size of ITW over the last few years, was also discussed.

And assurances were given that the program isn't broken.

We are in a slow period for acquisitions, but we, as we'll discuss later, have a continuing strong backlog of candidates.

And one of my favorite subjects we talked about our long-term double-digit earnings growth with approximately 25% of that earnings growth coming from base business growth, 25% coming from acquisitions, and 50% coming from margin improvement.

Given the large contribution made by margin improvement, we discussed our continued potential to increase margins in the future.

ITW has spent over 150 million in restructuring over the past three years, and another 50 to 60 million is forecasted for this year.

This positions us well to capitalize on operating leverage as the company continues to recover.

In addition, half of ITW's revenues were acquired in the last few years, and margins on those revenues are approximately 10%.

This leaves plenty of room for improvement, given the other half of ITW is operating at 18%.

And these - this 18% was 2001, which was a pretty heavy recession for ITW.

Lastly, we talked about something that's as common as breathing air at ITW, and that's our realistic accounting.

There are lots of things I could point to to support this position, such as our inventory, receivable, and depreciation policy.

But the most compelling argument is the relationship of our free cash flow to income.

We define free cash flow as cash from operations, less working capital, and capital expenditures.

For the past five years, cumulative free cash was close to a hundred percent of our cumulative net income.

This leaves little room for accounting magic.

I believe that all of you need regular updates on our current financial and operating status, and believe it or not, I'm going to get to that here in a moment.

But I also believe that we should not lose sight of what makes ITW a solid, long-term investment.

And my comments to this point have really been addressing that issue, that we are a solid, long-term investment.

Let me now turn to our current operating quarter's performance.

The highlights for the quarter are as follows:

Revenues increased 1% over last year.

This is 5 points better than the first quarter's minus 4% decline.

Operating margins improved a hundred basis points over last year.

This is a continuation of the margin improvement that started last quarter.

Income per share from continuing operations was up plus 5%, compared to last quarter's minus 4.

Free cash flow continued strong at $256 million, or 90 - 97% of income from continuing operations.

And lastly, our return on invested capital was 17% for the quarter, or 120 basis points higher than last year.

In short, the improvements that started in the first quarter were continued in the second.

Turning to the income statement, the plus 1 revenue increase, which was 5 points better than last quarter's minus 4, the source of that improvement was, first, the base business revenues declined minus 2 in the second quarter compared to a minus 6 in the first quarter.

Second, revenues increased 3% due to acquisitions, compared to 4% last quarter.

And third, translation had no effect in the second quarter compared to a minus 1 in the first quarter.

In short, our five-point improvement resulted from a 4-point improvement in the base business and a 1-point improvement in translation.

By geography, the base business decline was minus 2.

The base business decline of minus 2 was made up of minus 2 in North America and minus 3 internationally.

In North America, the minus 2% decline represented a 4% improvement over the first quarter's minus 6.

Internationally, the minus 3 decline was 4 points better than the first quarter's minus 7% decline.

In short, both North America and international base businesses experienced improvement.

John will provide more details when he discusses our manufacturing operating segments.

Turning to operating margins, we gained a hundred basis points in the second quarter.

This was prove - this improvement was in spite of our second-quarter base revenues being 2% below last year.

I believe this is a clear sign that 80/20 efforts are working.

Included in our second-quarter operating income is $12 million of restructuring costs.

Excluding restructuring and a 20% - or 20 basis point dilution from acquisitions, our margins were up 170 basis points.

In addition, if base revenues were even with 2001, margins on the base business would be 18.2%, compared to last year's 16.6 or 160 basis point improvement.

This calculation assumes that we are able to gain strong operating leverage as revenues recover.

This quarter continued to demonstrate our ability to increase margins on down revenues, so I believe it's clear that we can achieve very strong operating leverage on the up side.

Before I leave margins, let me update you on [Premark's] progress.

Excluding the consumer segment, [Premark] margins were 12.8% in the second quarter of 2001.

On a sales decline of minus 4%.

This quarter's margins were 15%, or a 220 basis point improvement, at had revenues not declined, we believe margins would have been closer to 15.8%.

Keep in mind that [Premark] started at 9% and is targeted to achieve 18% by 2004.

In our leasing and investment segment, income was above last year due to income generated by our leverage lease transactions completed earlier this year.

In the in the non-operating dear carry, interest expense was up, due to a higher debt resulting from the April issuance of a $250 million preferred debt securities.

Other income and expense improved 3.9 million, mainly due to lower losses on disposition of assets.

Finally, on the tax front, we increased the effective tax rate for the year to 35%.

This required moving the second-quarter tax rate to 36%, because we had estimated the first quarter - during the first quarter, we had estimated the year at 34%.

The increase was mainly due to slower than expected implementation of certain tax planning strategies.

We may implement these strategies prior to year end, and to the extent there are current-year benefits, they will be reflected in a lower rate.

Turning to the balance sheet, our inventory months on hand continued at two months, and our DSO was 57 days.

Our debt to cap was 20.9%, and excluding our leasing and investment segment, it was 12.8%.

Our cash position grew, mainly due to slower acquisition activity and higher debt levels.

Capital expenditures for the quarter were 71 million, and depreciation expense was 69 million.

Our free cash flow continues strong.

Free cash for the quarter was 256 million.

This is 97% of our income from continuing operations, and reflects continued earnings improvement and solid asset management.

For the quarter, acquisitions of 57 million, investments of 60 million, and dividends of 67 million were below our free cash by 72 million.

This excess cash, and the cash from increased debt levels resulted in our cash balance growing 204 million.

We increased our debt levels through a structured debt offering in connection with tax planning that's been in the works for over a year.

Although there was not a current need for cash, we believe our acquisition program activity will be picking up and also we believe our current - or the current long-term rates are attractive.

Finally, on the acquisition front, we acquired six companies in the second quarter, with total revenues of 56 million.

Although activity continued slow for the quarter, our backlog of potential acquisitions grew significantly.

By segment, the number of acquisitions are as follows: Engineered products, North America, one; engineered products, international, one; specialty systems, North America, two; specialty systems, international, two.

Now, John will finish up the review of the manufacturing segments.

Thanks, Jon.

Before I give you additional color on our four manufacturing segments, I want to update you on some key economic data that we continually track and we've discussed in prior conference calls.

This data, which we believe continues to be encouraging, serves as a proxy for the health of our various end markets.

We believe we continue to see a slow but steady industrial manufacturing recovery in North America.

On the international side, things appear to be bouncing around a bit more, and we are less certain of a sustainable recovery.

Here are some key data points.

First of all, the institute for supply management index, formerly as the national association of purchasing managers or the NAPM number continue to improve.

The ISM number - index rose to 56.2% in June.

That's an improvement from May's number of 55.7% and April's 53.9%.

May I remind you that any number above 50 indicates growth in the order index.

Secondly, U.S. industrial production data, excluding technology, is also showing slow but steady improvement.

The number was .5% - minus .5% in June, versus a minus 1.9 in May and a minus 2.1% in April.

By the way, the June performance for industrial production is the best comp since October of 2000.

Internationally, the numbers are somewhat mixed.

The Euros own manufacturing sector, which is similar to the PMI index in the U.S., came in at 51.8% in June.

That's a slight improvement from 51.5% in May.

Similar to the U.S., any number above 50 indicates growth.

Another key number is Euros own industrial production.

That number was minus 1.6% in April, compared to a minus 2.4% in March.

That compares very favorably to the minus 4.4% in December.

That's the good news.

The more pessimistic news is by country, the numbers are somewhat less encouraging.

Most importantly, German industrial has weakened, coming in at minus 3.4% in May versus a minus 1.9% in April.

Industrial production in France, which was essentially flat in May weakened fractionally from the prior month.

We are seeing various signs of strengths and weaknesses [inaudible] and will keep you updated throughout our monthly reports on what's going on on the international side.

Now, let's review our four manufacturing segments.

First of all, North America engineered products.

Revenues were plus 4 for the second quarter.

That consists of plus 1 from base, and plus 3 from acquisitions.

Again, plus 1 from base, plus 3 from acquisitions.

As many of you know, construction and auto are the two biggest pieces of the segment and their performance continued to be anywhere from good to very good.

Construction revenues were flat with the prior-year period and auto revenues grew 10%.

The biggest surprise was the rebound we saw in Q2 for the industrial segment within engineered products.

These businesses - and they're made up of consumer appliance components, electronic products and packaging, resealable packaging, and engineered polymers and MRO products - showed revenue and operating income improvements during the quarter.

Focusing on construction, as already noted, revenues were flat in Q2.

We continue to see the same general trends that have been in place for a number of quarters, and that is, commercial construction remained relatively weak while new housing and renovation rehab were strong contributors.

ITW businesses serving the commercial sector were down some 10% in Q2, which is modestly better than the last three quarters, but still - still down.

We don't expect the commercial sector to rebound significantly until companies have a higher degree of visibility and confidence that the economy is improving.

At that point, we will then start to see companies expand capex budgets and commercial construction should come back.

Moving to new housing, this sector continues to be strong.

Led by our [Paslow] business, revenues grew at a 5% rate versus last year.

New housing starts have been bouncing around lately, coming in at a minus 3 in June versus a plus 8 to plus 10 in May.

We certainly expected that May start rate to moderate as the year progresses.

Even with the June numbers, the seasonally adjusted build rate is a healthy 1.4 million units.

We continue to attribute the relative good health in new housing to historically new interest rates and the reinvestment of equity assets into the housing market.

Finally, our remodeling, rehab piece of the construction - and those are the products we sell through box stores such as Home Depot and Lowe's - generated top-line growth of some 5%, thanks to demand for [Pavlow] cordless nailers as well as [Buildex] and [Ramset] fastening systems.

Moving to auto, base business revenues were plus 10 in Q2.

Our auto performance continues to benefit from a stronger than expected build environment by the big 3, and our traditionally strong product penetration into platforms.

In Q2, the light vehicle - and that includes cars and light trucks - the build rate for those cars and light trucks for the big 3 was plus 6, and that's the same as Q1.

Digging a little deeper, GM has been leading the pack with a 15% build rate increase in Q2, and that compares to a plus 3 for Ford and a minus 6 for Daimler Chrysler.

The better than expected build environment in the quarter was due to better sales, which we believe have been propped up by a continuing incentive such as rebates and special financing.

We still don't know how long this will last, but the latest build forecast out of Detroit is a plus 8 for Q3 and a minus 2 for Q4.

So they're anticipating some moderation in builds as the inner progresses.

That would result in a full-year build of plus 5.

If you recall, we were anticipating a 4% decline for full-year 2000 in builds.

The remaining bit of good news is that the big 3 cars and trucks were at 63 days on hand, in terms of inventories for June.

That's still at the historically low end of inventories for GM, Ford, and Chrysler, so that continues to be good news.

More good news in the segment.

Our industrial-based businesses.

I mentioned them before.

Units such as industrial plastics and metals, engineered polymers, and fluid products, mini-grip zip pack and electronic related products were a collective minus 4 in the second quarter.

That's in terms of revenues.

A minus 4 in revenues.

That compares very favorably to minus 15 in Q1 and minus 20 to 25 in Q4 of last year.

Obviously, we've seen increased demand in various end markets, and that's helped both top-line and operating income.

Moving into the second segment, international engineered products, revenues were plus 3 for Q2.

That consists of plus 1 from base and plus 2 from acquisitions.

Again, plus 1 from base, plus 2 from acquisitions.

Jon mentioned earlier translation was at zero for the first time in a number of years.

So that's going to be of help to us.

Similar to North America, the major business groups in the segment are construction, auto, and industrial.

We had mixed results in Q2.

Base business revenues for construction and industrial were positive, while auto revenues were down modestly.

Different than what we saw in North America.

In construction, base business was plus 1 for the quarter as strength in Australian and European businesses was offset by some weaker Wilson art revenues.

Our Australian construction revenues were up some 6 pertains as [Paslow] and build ex-products continued to take advantage of strong housing renovation and rehab opportunities.

The split in Australia by the way is two-third housing and renovation rehab and only one-third commercial.

In European construction, the major soft spots continue to be Germany, while strength M and A from France, Belgium, Denmark, Spain, and Portugal.

Wilson Art revenues were down about 5% for the quarter, some of that attributable to ongoing 8/20 and some of that attributable to weaker end market demand.

Looking ahead, we continue to believe the European construction market will be down in the 2 to 3% range and that Australia/Asia will be flat for the year.

Thus far, we've been right on target with Europe and probably a little bit more pessimistic than necessary regarding Australia.

The other contributor to this segment is the industrial grouping of businesses.

Similar to North America, these businesses serve a wide array of end markets and customers with plastic components, electronic products, and polymers and MRO products.

Collectively, these businesses produced a top-line growth of about 7% for the quarter, and had even more impressive income gains.

Finally, auto businesses in Europe experienced a 4% decline in base business revenues for the quarter, due to a fall-off in auto builds.

Auto OEMs in Europe, which includes everyone from Mercedes to Fiat collectively started Q2 builds decline in the 10% range.

We've seen some further weakening in auto production in the beginning of the third quarter, so we don't expect the build environment to get significantly better anytime soon.

Now, let's move over to the longer lead time systems side of what we do.

In North America, specialty systems, revenues were zero for Q2, and that consists of a minus 5 from the base and plus 5 from acquisitions.

Again, minus 5 from base, plus 5 from acquisitions.

Second-quarter performance in this segment showed sequential improvement from Q1, and that was partially due to an improvement in our finishing and industrial packaging businesses.

Our finishing businesses were down about 5% in Q2 compared to a much more dramatic minus 15 to minus 20 in Q1.

And our industrial packaging businesses declined 5% in Q2 versus a 9 to 10% drop in Q1.

In industrial finishing, the spray paint businesses benefitted from some increased component sales to auto OEMs, Chrysler in particular.

On the industrial packaging side, customers are ordering more consumables, and an example of that would be a pickup in orders for plastic and steel strap in our signal business.

But even though the consumable pass-through has improved somewhat, our capital machinery remains relatively soft.

This is certainly in line with weak capex expenditures by customers.

On food equipment, food equipment business improved its top line to about minus 5% from Q2 from a minus 6, minus 7 in the prior quarter.

We continue to see some sluggishness in both the food service, which is the restaurant side of their world, and the food retail, which is the super market side of what they do.

Food service, which accounts for 50% of the revenues in food equipment, continue to see some weakness in sales to upper tier restaurants, the so-called white tablecloth purveyors.

Food retail, about 25% of the business, is still awaiting a real rebound, a capital retrofit, investment for super market chains that has consolidated over the past two to three years.

Another plus was the top-line growth of the welding business in the quarter at 5% growth, welding continued to benefit from equipment, especially component orders from customers in the oil and pipeline as well as ship-building end markets.

Finally, on our last manufacturing segment, international specialty systems, revenues were minus 3 for the quarter.

That's made up of minus 6 from the base, plus 3 from acquisitions.

Again, minus 6 from base, plus 3 from acquisitions.

Translation was at zero.

Similar to North American specialty systems, revenue performance in Q2 mirrored the lack of capex investment dollars from companies in Europe, Austrailia, and Asia.

Even so, we actually saw improvement from the two biggest pieces in this segment, and that would be packaging and food equipment.

In packaging, base revenues were down 6% in Q2 versus down 10/11 in Q1.

This was principally due to improvement in some of our industrial packaging units, [Signode] in particular, and our packaging systems which make stretch film and paper shipping kinds of products.

Food equipment base revenues were minus 7 in Q2 versus minus 9 in Q1.

More importantly, 80/20 efforts by food equipment continues to push operating income and operating margins up to higher levels.

Operating income grew double-digit and operating margins were up more than 300 basis points from the year earlier period in food equipment.

In total, this was the only segment to produce a margin decline, and at the 12.6% operating margin was a hundred basis points lower than Q2 of last year and that was largely due to restructuring and acquisition dilution, which offset base business gains.

In fact, restructuring projects in the quarter accounted for approximately 80% of the margin decline in this segment during Q2.

This concludes my remarks, so let me reintroduce Jon Kinney who will walk you through our third-quarter and full-year forecast.

Jon?

Thanks, John.

Our forecast for the year's income per share is forecasted to be within a range of $3.02 to $3.22.

This forecast is based on a recovering worldwide economy, with positive growth in the second half of the year.

Overall, the base revenue growth is forecasted to be in a range of plus 2 to minus 2.

Other assumptions underlying this forecast are: Exchange rates holding at today's levels, acquired revenues in the range of 200 to 600 million, restructuring costs in the range of 50 to 60 million, and a tax rate of 35%.

Overall, if we hit the midpoint of this range, full-year income from continuing operations of $3.12 per share would be 10% higher than last year on a consistent reporting basis.

We believe this would be solid performance in a zero-growth environment.

As you know, our first-half results were better than expected by about 4 cents a share.

However, we have only increased our forecasts for the year by 2 cents per year.

The reason for the second-half reduction was mainly due to our conservative forecast of slower than expected improvement in our capital goods revenues in both North America and international operations.

The effect of this base business revenue reduction was about 4 cents a share.

This reduction was softened by an increase in earnings forecast for our leasing and investment segment of about 2 cents a share, as a result of new investments made in the first half of the year.

For our third quarter, we are forecasting income per share from continuing operations to be within a range of 75 to 85 cents per share.

The low end of this range assumes a minus 2% decline in base revenues, and the high end reflects a plus 2%.

If we hit the midpoint of this range of 80 cents per share, we will be 13% higher than last year, in spite of a flat revenue base.

Okay.

John, back to you.

Thank you, Jon.

That concludes our formal remarks, so we'll now open the call to questions.

Thank you, sir.

If you would like to ask a question, please press star 1 on your telephone keypad.

You will be announced prior to asking your question, and you may withdraw your question at any time by pressing star 2.

Once again, to ask a question, please press star 1.

And our first question is from John inch at Merrill Lynch.

Thank you.

Good afternoon.

I want to understand the acquisition contribution.

Have you guys been deliberately slowing the rate with which you've been acquiring, or has it been more a function of the market?

It's been more a function of the market.

In so far as pricing, Jon, or just-targeting or what.

It's more pricing.

We've got - we've got pretty substantial - as large as I've seen it backlog of acquisition candidates.

Reaching agreement on pricing is - is what's really pushed things out a bit, I believe.

And your sense is on the part of the seller, there's an increasing willingness to meet your price, or is it because of the stock market, or what's changing in the - that you think acquisition or the pace of acquisition can increase from current levels?

The increase in our backlog of acquisitions is what makes me believe that.

Okay.

So you're not paying more, or anything like that?

No.

No, no, no.

Okay.

My follow-up then is: We're hearing, you know, rumors of [Precore] prospectively been sold near term.

I'm just wondering, not to comment on that specifically but maybe just the businesses that were prospectively going to be sold at [Premark].

Can you just give us an update on the timing or your activity level there?

Yes.

Well, we've been through, you know - and again, all the data has been distributed out.

We've gotten pricing back.

We've gone through a second round of asking for bids on these businesses.

We're in that final process of narrowing that down, and so on and so forth.

And from everything I heard, the sales will occur this year.

Whether it's third quarter or early fourth quarter, it's hard to say, but we've got due diligence activity to go through yet, and some audit work and so on and so forth.

But it's - it's looking with some degree of certainty to be a this-year event.

Would it be too soon to call for maybe a possible gain from these transactions?

Too soon to call.

We - we have not expected a gain here, or a loss.

You know, we are expecting, in total, to probably be relatively close.

Thank you.

Gary McManus, J. P. Morgan.

Hi, guys.

Hi, Gary.

Hey, can you tell me - first of all, could you go through - you know, in the first quarter Q, you know, it was disclosed that a hundred million dollar - you know, I guess two separate transactions with the German telecom company.

Just go through why you did that and is there more of those type of transactions possible?

And what kind of sales and profits would you expect in the leasing and investments, taking into this - into account this acquisition?

Yeah.

We - as you know, we last quarter and a little bit more in this quarter, we purchased some infrastructure assets for mobile telephone networks from two different telecom companies, and then we leased the assets back to them.

The telecom companies - and I don't know that this is clear, but they entered into a payment undertaking agreement with a number of banks who will make all the payments under the lease contracts.

The telecom companies deposited with these banks 95% of the proceeds from the sale of the assets, and kept 5% for their own use, so we - we think we're in a pretty solid footing here relative to risk.

ITW is going to get in excess of a 16% after-tax return on investment, and that's the primary motivation for doing it, and we - we don't - we don't have a plan for L and I. These are pretty opportunistic in nature.

We - as you might expect - get lots of offers made to us, given our - both our tax situation, as well as our cash situation, but we're very circumspect about what really fits that risk/return profile, and this was one that did, even though the telecom industry is in some tough times now.

We think the structure of this deal really keeps the risk profile, you know, pretty low.

And in terms of forward earnings for our L and I, they're about the same as this quarter for the next two quarters.

We don't expect any significant gains on sales of assets at this point, and so the run rate is about what you see.

So I want to make sure I'm clear on this.

You had - it says you had a hundred million cash investment during the first quarter.

Did you make additional cash investment in the second quarter in this kind of or any other kind of leasing transaction?

Yeah.

It was about $45 million in the second quarter.

That was to a deal we did in Portugal, Gary.

And when you talk about televisions of 57 million in the quarter, you're excluding this 45 million.

Yes, that's right, that's right.

So when I look at the cash flow, when I think of the acquisition amount for the second quarter, I should add the two, 57 plus 45?

Yes, that's true.

That's true.

The total investments in leasing and investment were 60 million, 45 of it was this and the other were more minor type activity in different areas that they're in.

I'm sorry.

So 60 million - I'm just - I mean just from a cash flow perspective, when I get the 10-Q -

Yep.

- what kind of number should I expect on the acquisition side?

You should expect to see the 56 million that we referenced, and then you will see the other line item is investments on leasing and investment, for leasing and investment, of about 60 million.

Right.

Okay.

And that's just - that's for the second quarter.

Okay.

Just real quick, you know, you talked year-over-year change in the base business.

Can you talk a bit sequentially, you know, how things are going?

I mean, are - you know, just describe what's going on in the end markets, not on a year-over-year basis.

I'm wondering whether the comps got easier here in the second quarter, let's say, versus the first, or are you seeing sequential improvement in a broad-base in your various end markets

Gary, it's John Brooklier.

We - you know, it's still pretty early in the third quarter to draw any conclusions, so - but through the first two quarters, we certainly have seen sequential improvement, more so in North America than on the international side, and some of it has been pickup in end markets and some of it has been easier comps.

There's no question.

But there's certainly a discernible pickup in end markets.

I referenced auto, I referenced welding, I referenced some of the pass-through on the consumable stuff, on the industrial packaging side.

So we're seeing that.

I think it's harder to call on the international side.

The first and second quarter international certainly got better, but we're not so sure that that is sustainable as what we think we might be seeing in North America right now.

Okay.

Great.

Thank you very much.

Uh-huh.

Harriet Baldwin, Deutsche Banc.

Good afternoon.

Harriet.

Talk about specialty systems.

I know it sounds like you've gotten more conservative in thinking about your customers' possible capital expenditures.

Is that based just on trying to be more conservative, or is there any specific thing that's happened over the last couple of months that's caused you to do that, in terms of customer activity, or is it more based on everybody - you know, there's a loss of corporate confidence and, gee, they probably won't spend as much?

Well, I think it's - it's probably a combination of both.

You know, first of all, we are pretty conservative here, I think you would agree.

But, you know, be that as it may, I think from a - from a capex side, as we - as we looked out at some of these GDP numbers, you know - I guess I should say industrial production numbers, particularly in Germany, biggest economy in Europe, you know, we're not seeing a lot of free-up of capex there.

And then part of our thesis on second-half recovery was a pickup - at least a partial pickup in terms of capex expenditures, probably led by North America and then followed by - on the international side.

We think it's going to take a little bit longer on the North American side, and probably a little bit longer than that on the international side.

So we're hearing some qualitative things on the international side right now that we're certainly not seeing any pickup on capex.

And that's kind of what triggers the process in our business units.

I mean, they provide us a forecast going out, clearly, with a hard look at the next quarter, and if they're not seeing any recovery on the capital spending side or getting the feedback from their customers that things are going to be release Ed in the next quarter, they back away from that forecast, and that's - that's what's happened this quarter.

Our - our takedown has primarily been in the specialty systems capital foods area.

And it sounds like maybe a little bit more of a push-out in international than in North America at this point?

It looks to be that way, yeah.

Yeah.

But again, you know, these - you know, we're looking at it in a short term vacuum.

But, you know, absent any more information, we're going to try to - we're going to be a little bit more conservative.

That makes sense.

Can't argue with conservatism in this market.

We love it.

Yeah.

Talk a little bit about your building market assumptions imbedded in 2002.

It sounds like you're assuming that residential will maintain current levels and commercial might weaken a little bit or not.

No, I think quite the contrary.

I think that we expect housing, new housing to come down as the year progresses.

I'm talking North America now, Harriet.

Right.

New housing to come down, to moderate as the year progresses.

Renovation rehab probably to stay where it is, still relatively healthy.

You know, not gangbusters but in that plus 5, maybe plus 6 range.

Commercial, we're not counting on for any kind of recovery this year.

Be great if it happened, and that's certainly an opportunity - you know, a leverage opportunity for us, but it's certainly not built into any of our forecasts we're looking at.

Great.

I think those are my two questions.

Okay.

Andrew Casey, Prudential.

Good morning - good afternoon.

Sorry.

Good afternoon, Andy, how are you.

Thanks, John.

In terms of - first, sequentially through the quarter, I guess this is trying to clarify Harriet and Gary's question.

Did you see sequential pickup?

I know it was probably spotty in North America, but did it sequentially pick up during the quarter?

You mean sequentially month to month or quarter to quarter?

Month to month.

Probably, if we went back and looked at all the numbers, it probably weakened a little bit towards the end of the second quarter in total company.

Okay.

We're looking at base business numbers, so I think the beginning of the quarter was probably a little bit stronger than the end of the quarter, but I wouldn't say there's a dramatic swing from beginning to end of the quarter.

Okay.

And then second question is: Some of the companies that have reported out today have reported receiving a letter from the SEC about potentially looking at financials in the past.

Can you comment on what you think right now, first?

Did you receive a letter like that, and then second, do you think there's any potential for restatement?

No, we have not received a letter.

And from a - from a pure accounting standpoint, I don't expect any restatement.

I mean, the SEC has their way of interpreting things.

There's always issues.

I mean, anytime we haven't been reviewed for five or six years and lots of things have transpired since then, the accounting for goodwill, the segment reporting, you know, there's those types of issues.

And - which we've never heard from the SEC on, and so we may hear something and they may agree or disagree, but nothing substantive that would affect our earnings or our cash flow type numbers that we've reported.

Maybe some classification issues or disclosure issues, but sort of that -

We expect -

And we do expect to get a letter, more than likely.

They've - they went on record back in December, I believe, that they're going to review all the Fortune 500 companies, so we certainly are on that list, and if we didn't get a letter, hooray, hooray, but we kind of expect to hear some questions.

Okay.

But you think you're pretty clean?

Yep.

Thanks.

Robert McCarthy, R.W. Baird.

Good morning - good afternoon, gentlemen.

Good afternoon, Robert.

Minor housekeeping, I think, is the way I'd characterize this.

Well, maybe not.

Currency had no effect in the second quarter.

Jon, do you have a ballpark on what it would contribute, top and bottom-line, second half, at current rates?

Yeah.

We - it's going to contribute about a penny a share in the next two quarters plus, if things hold.

Maybe not as they are right now, because, you know, we're - we got a one-month lag on our international.

So maybe it could be another penny on top of that, but we're talking, you know, about that 6% range, and that's what we've got built into our forecast, but unfortunately, the - the change in the tax rate offset the impact of that.

So -

Which is the second thing I wanted to ask you about.

Can you be a little more expansive about what we're talking about?

A - as you know, a one-point change in tax rate is about a $10 million difference.

Yep.

That's right.

And that's about the magnitude that we're looking at on the structuring that we're working on, and I don't want to really say too much more about it.

I mean, it's nothing that -

We're talking about some kind of structured investment that could have an effect on your tax rate?

No, no.

No, it's not an investment.

It's an internal organization structure that we're working on.

Oh, I see.

It's not an investment.

Okay.

And then just to - I just want to confirm that I heard you right.

When you were talking about acquisition backlog -

Yes.

- and compared - I mean, we'll forget [Premark] for the time being but compared with in the past when you've - you know, you've had quarters when you acquired, you know, 300, 350 million in revenue.

You did say that your backlog right now is as large as you've ever seen it?

Yeah - well, as I look at my list here, maybe there was - the fourth quarter of '99 was just a little bit higher, but -

Okay.

But you - it's in the same league?

It's a strong backlog and there's -

All right.

Good.

Thanks.

Okay.

Kevin Silverman, Chicago capital management.

Good afternoon, gentlemen.

Kevin.

I just wanted to ask if you could characterize your - in your key North American businesses, your market share trends and/or pricing trends.

I'm guessing that you have some competitors that maybe aren't holding up as well as you and just wondered if you could offer some color regarding the dynamics of the marketplace right now.

I'll beg off on the market share question because I don't want to - I don't want to go to debtor's prison, via our lawyers, but I will address the whole issue of pricing.

Pricing generally speaking is not a big issue with us.

We haven't gotten a whole lot of pricing in a lot of our businesses in North America.

Particularly, in, you know, areas like auto.

In fact, that's been - that's been - we've seen pricing decreases over the last number of years.

So pricing isn't a big part of the growth equation with us.

It really - our growth is really more predicated on penetration, our ability to take market share, and our ability to really carve out some nice niches in these - in those respective end markets.

Is it fair to say there's no pricing at all in your revenues versus year over year at this point?

No, we - and John's right in all that he said.

We do have the ability to generally pass on raw material price increases, and we do, so there is - there is price in our revenues, and, you know, we're - we're right into that right now with steel prices moving up and we are working on price changes and so on and so forth.

Some markets easier than others.

But, you know, we get that much.

But the rest has got to come from productivity.

There's not - there's no big markup on wage increases and so on and so forth.

Okay.

Thank you.

Dean Drake, Goldman Sachs.

Hi.

Good afternoon.

I'd just like a clarification on - to make sure I understand the changes to the inputs on the guidance for '02, and just going back to what - where we were last quarter, and it looked like you're still using the same bands of base business, minus 2 to plus 2, same acquisition revenues, looks like restructuring you may do a little less, and the tax rate is a point difference.

So based upon that, where - what's the kind of rationale in narrowing the range for the year now?

Well, the range got narrowed because we got - we have two quarters of actual.

Okay.

Right?

So we don't - half of the problem is known.

And so we have two other quarters that we feel more comfortable about the year, knowing half of it, than we did at the beginning of the year.

That's the reason for the narrowing.

And then as I mentioned, the - we've - I imagine that the expectation could have been that we would have given guidance at the midpoint of 314 versus 312, and as we said, we would have, but we did come off of our base business.

We had expected the original forecast called for a 2% growth in the - in the third quarter, and in our business units in their re-forecasting have backed away from that, as we mentioned, primarily in the capital goods portion of our business.

So - and that cost us 4 cents.

But then our leasing and investment segment, they also re-forecasted for now knowing what the earnings flow would be on the - on the leverage lease investments and that added a - added two cents to the second half.

So we're net - we're net down 2 cents from where logic would say we should be, based on, you know, changing conditions.

Okay.

And then as you see customers kind of being hesitant on the capex side, where do you stand today and expect to end out the year on your capex plans?

The number we gave -

Yeah, our capex plans are -

Still 300?

Yeah.

They're -

Dean, we said capex for the quarter was 71 million.

Right.

So if you do a run rate on that, it's about, what, 280?

Right.

It could be, you know, that 280 to 300 million range.

It's more than last year, I believe, as things improve here.

That was the anticipation that things would be improving as we put our plan together.

And we've got some - we've got some significant programs around 80/20 at a few of our newly acquired businesses that have some very healthy paybacks and some - you know, 20, $30 million in expenditures.

So -

That would be the largest? 20 to 30?

Out of that - out of those initiatives?

Yeah.

That's a large one for us.

Okay.

Very large.

Okay.

Thank you.

Sure.

Walt [Liptak], McDonald Investments.

Hi, good afternoon, guys.

Walter?

I know that in your gross margin, there's a lot of, you know, you've got 600 businesses that roll into that number, but it was up over a hundred basis points year over year, and I wonder, you know, with - it seems with raw materials going up, and continued pricing pressure, that we'd see kind of a flat gross margin.

Could you provide any, you know, light on what might be going on at the gross margin line?

Sure.

There's - well, there's the reverse leverage, right?

Less negative revenue decline, right, than Q1.

Q1, our base revenues were down 6%, and so you've got very strong negative leverage in the first quarter, and then in the next quarter, revenues are only down 2%, so you don't have as much negative leverage, and then you couple that with, you know, we've talked about this $150 million worth of restructuring costs over the last few years.

We have been taking out of our - what we call our period costs, our overhead structure in manufacturing and distribution, we've been taking those costs down also.

So we've got the benefits of both of those going for us.

Okay.

So volume-related.

Volume related.

And traditionally the gross margins run in kind of the 35 to 36% range.

Do you anticipate getting back there as volumes groove over the next couple of years?

You bet.

Okay.

And then this is, I guess, kind of a nit, but in your accounts receivable, you know, sequentially, accounts receivable was up a hundred million or 7% on the sales decline.

What was that related to?

I got to say it's the acquisition impact.

You know, the - the - oh, wait a minute.

Let's go -

You're saying receivables are up from last quarter?

Right.

Yes.

Yeah.

In -

We have higher absolute sales in our second quarter than we do in our first quarter, even though - the base business is a year-over-year comparison.

Right, right.

Right?

But if you look from quarter to quarter, you would see our revenues up significantly.

And that's what's driving the sales - or the receivable increase for the quarter.

Okay.

Fair enough.

Thank you.

Okay.

Jeffrey Gardner, Invesco.

Hey, John.

How are you.

Good.

How are you.

I'm good.

Hey, just looking at your David policy, I've noticed that you guys have increased dividend over the last five years at about a 16% rate, which is higher than your earnings growth.

Are you guys going to kind of keep that trend going on a go-forward basis?

We have a policy to keep our dividends within a range of a three-year trailing average, and so, you know, we don't - we don't think of it in terms of necessarily percentage increase but trying to stay within our - within our own policy guidelines.

And what, specifically, is the policy guideline?

The three-year trailing the net income average, isn't it?

Right, right.

Okay.

And then the little bit of debt increase on the balance sheet -

Yes.

- I got the impression through your previous comments that it was a result of making keeping your powder dry for acquisitions?

Well, we also had a $250 million debt offering in the quarter.

It was private placement.

It was a structured deal.

It was related to tax planning activity.

And we've been working on it for a year or so, and long-term debt and the rates were good and even though we didn't need the cash at the moment, we thought we'd get the deal done.

Okay.

But current leverage, we should expect that ratio to probably pretty much stay around low 20%?

Yeah.

It - you know what really drives it, of course, is acquisitions.

Yeah.

We - to the extent that we stay within our free cash, yeah, it would be at 20%.

If we're pretty opportunistic on our acquisition front, so if we went over that, we're willing to push that into the 30 - 30 to mid-30% range.

Thanks a lot.

Sure.

We have a follow-up question from John inch.

Yeah.

I was wondering, is it possible to assess how much or what percent of the company has actually not been showing a pickup, and how that maybe compares to other periods, as you've entered the early phases of cycle expansion?

It would require a separate study.

No, but -

Yeah.

Well, maybe can you then just talk about the businesses that - basically you're saying the larger capital goods businesses aren't showing a pickup yet.

Is that how I read it?

Yeah.

And John - John's been doing some thinking on this.

Why don't you -

Yeah.

John, if you - you know there were about 24% construction and about 16% auto.

People would say there's 40% of your revenues tied to those two end markets.

But you also know that 40% of that 24% construction is commercial, which is, you know, has not done anything over the last year, and roughly about 40, 45% of our auto is in international, which is weaker right now.

So I did some quick calculations, and that - if you take those two end markets, we got about 24%, or roughly 25% of our total revenues are operating at a - at a high level.

And by "high level," I mean revenue growth in the 5 to 10% range.

So that leaves you with about 75% of the businesses that are in markets where we're either flat, revenues are flat, or weak, which I would define as, you know, down 5 to 10%.

Right.

So, I mean I've been sort of noodling with this based on the whole concept of this whole perceived cyclicality issue, and people say where do you get the business of construction has been so strong and auto has been strong.

Well, you know, our answer is if you really dissect auto and you dissect construction, you've got - you've only got about 25% of your revenues that are operating at, let's call them, peak levels right now.

You got 75% that are at different levels, at lower levels.

So - and of that 75%, I would - I would probably venture a guess that, you know, the majority of that is on the capital - you know, the capital side.

Right.

Okay.

The other question I had for you, if you were, John, to look at your backlog, is there a way to profile that in terms of geography?

Is that principally North America?

Is it spread around the world?

And the follow-up to that was Asia seems to be getting better.

What's the impact on ITW in terms of your Asian businesses?

Have you seen anything and should we expect any kind of up side from your Asian businesses?

Let me take that one first, and then Jon can talk a little bit about acquisition backlog.

The Asian business, remember we develop international presence when we follow our customers, okay?

So our Asian business is principally predicated on customers in Asia who are principally involved on the electronics side.

We have a - you know, an Asian business that does a lot of electronic component packaging.

We've seen that business improve over the last six months.

Still negative but not as negative as it was before.

So we don't think that in Asia, per se, that, you know - we're not looking at Asia, per se, as a place to geographically try to penetrate.

We're just trying to follow our customers.

We don't have a big presence in Asia, John, and I don't anticipate that growing dramatically over the next year or so.

So it's relatively small, but what we have there is improving - has improved over the last couple quarters.

And then your backlog. 00:59:47 00:59:47 >> JON KINNEY: And you were talking backlog on 00:59:49 acquisitions? 00:59:49 00:59:49 >> ANALYST: Yeah.

Just where are you looking at, 00:59:52 North America, Europe, is it any different than 00:59:56 historical. 00:59:56 00:59:56 >> JON KINNEY: It's not much different than 00:59:57 historical.

The major portion of the dollars are 00:59:59 probably North America, but as I am just scanning the list here, there's a number of European companies a South American company, Taiwan, Italy.

Yeah, we've got - sounds - kind of looks like two-thirds/one-third.

Not much different than we are.

Right.

Thank you.

Sure.

Robert McCarthy.

Sorry.

I wasn't quick to - quick enough to the mute button.

Could you - John, you made some comments about food equipment margins being up a lot in Europe.

Could you -

Yeah.

Could you give us a little tour of food equipment versus Wilson Art?

You know, North America versus international?

What - you know, what are the main drivers of what, you know, is behind the strong improvement in [Premark] margins that Mr. Kinney summarized at the beginning of the call?

You want - you want to split them up between Wilson Art and food equipment?

Yeah.

Yeah.

I mean, we know that in food equipment North America, they've been at the 80/20 process a lot longer.

Right.

Than virtually any of the other units in the company.

Yeah.

So is - with base down 5, their margins should be up strongly.

Their margins are up strongly.

Okay.

Okay?

We also know that Wilson Art margins, which in North America were at a higher level than food equipment when we acquired [Premark], they - they've taken a little bit longer to integrate some of the 80/20 programs, but they're to the point now where they've done some pretty significant 80/20 programs and we've seen pretty dramatic improvement from them also.

Their margins are also up.

In North America?

In North America.

And what did their top line do in the quarter in North America?

Top line, at Wilson Art, was actually a little weaker.

Yeah, down maybe about 5%.

Right.

So down, but margins up?

Margins up.

Okay.

And on the international side, we know that food equipment internationally has done a really good job of really thinning product line.

They've done a great job of product line simplification, throwing a lot of product out that was not making any money for them that was contributing to overhead structure.

How much of the 7% base decline in that could be explained by 80/20?

Rob, I -

Just a few percent.

I'm sorry?

Just a few percent.

Okay.

Quite often what we find, you know, when you do a 80/20 list, 20% of the products, 80% of the revenue.

You know, 40% of the products, 2% of the revenue.

Right.

And so then Wilson Art on international?

Wilson Art international, the margins have actually gotten a little better.

They were starting negative margins -

Right.

They're, you know - they're positive now.

Okay.

Positive margins.

But they're Stilwell below what we expect margins to be for a company.

Okay.

A couple housekeeping.

You gave us 69 million for depreciation in the quarter.

Is that depreciation only, or D and A?

No, it's depreciation only.

Okay.

And so then we take the amortization number off the income statement?

Yes.

Okay.

And what kind of rate are you paying on this new debt issue?

In the neighborhood of 6-and-a-half, 6 and three-quarters, I believe.

Term?

10-year.

Okay.

Thank you.

We have no further questions at this time.

Okay.

Everybody, thank you very much for joining us, and I look forward to talking to you later - many of you later this afternoon.

Talk to you later.

Bye.

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