Illinois Tool Works Inc (ITW) 2002 Q3 法說會逐字稿

Welcome to the ITW 2002 third 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 company's request.

If anyone has an objection, you may disconnect at this time.

I would now like to introduce our moderator John Brooklier, Vice President of Investor Relations.

Sir, you may begin.

Thanks, Phil.

Good afternoon, everyone and welcome to our third quarter conference call.

I'm John Brooklier VP of Investor Relations.

Joining me here today is Jon Kinney, our CFO.

We're both pleased that you could join us today.

By now you should have received our third quarter earnings release information.

In a nutshell, we are very, very pleased with our performance in the third quarter, even though our end markets are mixed at this point in time.

I'll address the dichotomy between our short lead time and longer lead time products when I address our segments in a few minutes.

A couple comments, though, even with our mixed markets we continue to see sequential improvement in our base business.

We were at zero base business revenues for the recently completed third quarter.

That compares to a minus 6 base in Q1 and a minus 2 percent base in Q2.

As important, our operating margins continue to improve in the third quarter.

Total company margins were at 16.5percent for Q3 and that's 140 basis points higher than a year ago.

We continue to work our 80/20 process in all of our business both new and old and that process is at the heart of our improving operating margins.

The lessen encouraging news is that we reduced our fourth quarter and full year earnings estimates due to less than expected recovery in our end markets associated mainly with our systems and consumable products.

While business in the CAPEX related segments has improved from earlier this year, they have not recovered as much as we originally expected when we forecasted our earnings ranges at earlier points this year.

Jon Kinney will cover this topic in more detail a little bit later when he talks about our full year forecast.

Here is the agenda for today's call.

It's similar to what we've done in the past.

Jon Kinney will join you in a few minutes to give you a financial overview of the third quarter, I will then give you additional color on our performance for our manufacturing segments.

John will then return to discuss our fourth quarter and full year forecast.

Finally we'll open the call to your questions and let me repeat some long-standing rules we've put in place.

This is an open call.

Please note that today's focus is on our third quarter and nine month results and our forecast for Q4 in the full year.

Any questions not related to these topics will result in the asking the operator to move on to the next question. and also I'm asking each person to ask just one question with one follow-up question so we can accommodate everyone who has a question within a reasonable period of time.

Another housekeeping item.

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 and uncertainties and other factors which could cause actual results to differ materially from those anticipated, including without limitation the following risks.

Downturn in the construction automotive general industrial food retail and service or real estate markets, number two, deterioration in global and domestic business and economic conditions particularly in North America Europe and Australia.

Three interruption in or reduction in introducing new products into the company's product line, four, unfavorably prolonged environment for making acquisition or disposition domestic and international, including adverse accounting regulatory requirements and market value [inaudible].

Finally one piece of business, the telephone replay of this conference call is good through midnight on October 31 and from two weeks roughly two weeks from today. the play back number is 402-220-3466, no pass code necessary.

Now per usual, I'll turn the call over to Jon Kinney.

Jon?

Thanks, John.

Good afternoon, everyone.

I'd like so to start my discussion with some highlights on the quarter.

John covered those.

I might be a little bit repetitive, but I think it bears repeating.

First our revenues increased 4 percent over last year.

This is 800 basis points better than the first quarter and 300 basis points higher than the second quarter.

Operating margins improved 140 basis points over last year despite flat year over year revenues.

Income per share from continuing operations excluding good will amortization was up 11 percent. the year to date improvement was 5 percent.

Pre-cash flow continued strong at 340 million for the quarter and 800 million for the year.

This represents a 114 percent of our income from continuing operations.

Return on invested capital also improved.

We hit 15.6 percent for the quarter, that's 230 basis points higher than the same period last year.

In short, we are significantly improving our financial performance in spite of slower than expected growth in the world economy and slower than expected acquisition activities.

Now to the details.

Starting my review with the income statement, our year's 4 percent revenue growth was 300 basis points higher than the second quarter.

This was the result of three factors.

First, our base business revenue growth for the third quarter was zero.

This was 200 basis points higher than the second quarter.

Second, translation increase third quarter revenues -- revenue growth by 300 basis points.

This was 300 basis points higher than the second quarter in which translation had no effect.

And third, revenues in the third increased 1 percent due to acquisitions.

This was 200 basis points lower than the second quarter.

In short, our 300 basis point improvement in revenue growth between the third and the second quarter was due to the net effect of a 200 basis point improvement in the base business of 300 basis point improvement in translation and a negative 200 basis points resulting from decline attributed to slower acquisition activity.

By geography, our zero growth for the quarter was made up of a 1 percent decline in North America and flat revenues internationally.

In North America, the 1 percent decline represents 100 basis point improvement over the second quarter.

Internationally, the flat revenues were 300 basis points better than the second quarter.

In short, both North America and international base businesses experience mild improvement in the third quarter versus second quarter results.

Turning to margins, we gained 140 basis points in the third quarter.

This improvement was in spite of zero base revenue growth.

Included in our third quarter operating margin is 10 million of restructuring costs.

Excluding restructuring costs, our margins up 180 basis points.

This quarter continued to demonstrate our ability to increase margins without growth in the base business revenues.

Before I leave margins let me update you on Premark's (ph)progress.

On a sales decline of 5 percent this quarter's margin were 12.9 percent or 100 basis points higher than last year.

Had revenues not declined we believe margins would have been closer to 14.2 percent.

Keep in mind that Premark (ph) started at 9 percent operating margins when it was acquired in 1999 and is targeted to achieve 18 percent margins at the end of 2004.

We are well on our way to achieving this goal.

In our leasing and investment segment, our third quarter income last year was lower than the second quarter.

This was mainly due to losses associated with disposals of property in the third quarter.

In the non-operating area, interest expense was down mainly due to a year to date re-class of about $5 million between interest income and interest expense.

The adjustment was made in connection with an error in interest classification by our operating units within our pan-European cash pool.

By the way, this had no effect on the bottom line, just the re-class between again interest expense and interest income.

Excluding this adjustment our net interest costs are down year over year by about 7 percent mainly driven by lower debt levels.

Other operating expenses are up 3.6 million, mainly due to higher exchange losses.

Finally, our effective tax rate for the quarter was held at 35 percent.

Turning to the balance sheet, our inventory month on hand continued in the two month range and our DSO was 58 days.

Our debt to total cap was 19.8 percent and, excluding the leasing and investment segment, it was down to 12 percent.

Our cash position grew mainly because our strong pre-cash flow from our operations exceeded our acquisition and investment activity.

Pre-cash for the quarter was 340 million.

This is 139 percent of our quarterly income from continuing operations and reflects continued earnings improvement and solid asset management.

During the quarter we spent 14 million on acquisitions, 59 million on debt reduction, and 67 million on dividends.

Our free cash from operations exceeded these expenditures by 200 million.

This excess, coupled with the positive effect of effect of translation, increased our cash position by 235 million for the quarter.

Capital expenditures for the quarter were 60 million and depreciation expense was 72 million.

Finally, on the acquisition front, we acquired four companies in the quarter with total revenues of 32 million.

Year to date we have closed 16 deals with revenues of 122 million.

Our current backlog would allow us to end the year in the range of 200 to 600 million of acquired companies.

By segment, the number of acquisitions were as follows: We had one in engineered products North America, one in engineered products international, none in specialty systems North America, and two in specialty systems international.

Before I leave the acquisitions, let me update you on our divestitures of our consumer segment.

We currently have signed agreements on West Bend and Precor.

These deals are forecasted to close between the end of October and mid November.

Florida Tile is still in stages of negotiation.

We hope to close this deal by year-end.

We are currently estimating a slight overall gain or loss on these transactions.

Now John Brooklier will finish our review of the quarterly with a discussion of our manufacturing segments.

Thank you, Jon.

Before I give you some additional color on our manufacturing segments, let me update you on some key economic data that we track on a regular basis and we shared with you before.

This data which is generally mixed serve as a proxy for the health of our very, very diversified end markets.

First of all, the Institute for Supply Management now known as ISM formerly known as Napem (ph), continued to move downward. the September ISM reading of 49.5 percent fell below the 50 percent line of growth, no growth for the first time since January of this year.

You may recall the ISM number was above 56 percent in June.

ISM's recent downward trend give us less comfort as we try to predict fourth quarter end market activity especially on our systems side of the business.

Another data point US industry production excluding technology.

It's showing product evident improvement but still negative growth through August.

The August reading came in at minus 0.4 percent, that's a slight improvement from minus 0.7 percent in July.

While we have seen slow but steady sequential improvement in this number since the beginning of the year r, it still underscores why our industrial systems and consumable businesses still remain relatively weak.

Remember, these ITW businesses generally track with industrial production and don't have the ability to penetrate customers' products like we can on the engineered products side of our businesses.

Finally, internationally the numbers remain mixed and difficult to define.

On the one hand, the Euros purchasing manager index which is similar to the ISM index, dropped for the second month in a row.

It was 48.9 percent in September versus a reading of 50.8 in August and 51.6 in July.

Similar to North America, anything under 50 indicates no growth.

The other data is more positive.

Euros zone industrial production was 0.2 positive zero.2 in July versus minus 0.9 in June and 0.4 percent in December 2001.

If we look at it by key countries, Germany France and the UK all reported negative industrial numbers in July but all were less negative in the prior month.

Let me take you into our segments and we'll start with North America engineered products.

First of all, as we do an overview of the revenues, the revenues were plus 3 for Q 3 and that consists of plus 3 from the base and no contributions from acquisitions.

So plus 3 from base, zero from acquisitions.

As most of you know, construction in auto are the two biggest contributors to this segment and their performance was mixed.

To simplify everything, construction revenues were declined due to weak commercial construction in market.

And our auto improved thanks to robust OEM build environment and our ability to penetrate by putting more products on light vehicles.

Let's take a look at construction first.

As a total group, construction base business revenues were minus 3.

This was primarily due to the fact that our commercial construction businesses, which, in aggregate, represent about 40 percent of our North American construction revenues, continued to struggle.

Our commercial construction business has declined some 15 percent in the quarter.

Remember, these businesses serve diverse end markets such as construction from warehouses, office buildings, office furniture, manufactured housing and recreational vehicles.

All of these end markets have been down considerably over the past number of quarters and prospects for real improvement don't look particularly promising right now.

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

At that point hopefully you'll start to see companies expand CAPEX budgets and this should help commercial.

Secondly, moving to new housing, this sector continued to show growth in the third quarter even though new housing starts moderated a bit to plus 3 percent growth in August.

Our new housing construction sales were up 3 to 4 percent in the quarter and we expect housing starts to stay at a relatively healthy 1.55 to 1.6 million build rate for the year.

Once again, low interest rates continue to be the underpinning for the new housing sector.

Finally, in construction our remodeling rehab piece of construction and those are the products we sell through the big stores like Home Depot and Lowe's generated 15 percent top line growth in the quarter thanks to continued customer demand for our Paslode, Buildex, Ramset, Red Head and Wilson air products.

Looking ahead, we expect new housing to moderate somewhat in Q4 and renovation/ rehab to stay strong.

Moving to auto, the third quarter was an award terrific.

Base business revenues for the quarter grew 12 percent as we continue to benefit from stronger than expected build rate in North America and our demonstrated product penetration.

In the third quarter, builds for light vehicles and that consists of cars and light trucks were up 10 percent.

That's a the strongest build rate of the year and' no question that the Big 3 continue to benefit in sales based incentives 0 percent financing and factory rebates.

Chrysler and Ford led the Big 3 for the quarter with 17 and 15 percent increases respectively.

That's Chrysler up 17, Ford up 15.

GM's build rate was up 4 percent for the quarter.

Looking ahead we anticipate Big 3 builds to run at plus 3 percent for Q4 which would total 6 percent for the full year.

The other good news is the Big 3 cars and trucks were historically low 53 days on hand at the end of August.

More specifically GM was at 45 days Ford at 57 days and Chrysler at 63 days.

We also had good news coming from our industrial products based businesses in the engineering products segment.

Base business were at plus 4 for the third quarter which compared very favorably with a minus 4 percent revenue decline in Q2 and a 15 percent drop in Q1.

Positive revenue contributions from units such as Mini-Grip (ph) Zip-Pak, industrial plastics and metals, and fluid products and MRO products were enough to offset declines from our electronic opponent packaging business.

The pick-up and customer demand was mainly for short lead time products which are either project selling which would be the case of receivable food packaging projects for Mini-Grip (ph) Zip-Pak or appliance related orders which would be in the case of fast exit unit which offers industrial plastic metal products.

Looking ahead, we expect performance to weaken in Q4 mainly due to fall off in order related to appliance orders and robust demand for MRO products used by manufacturers.

Turning to our second segment, international engineered products, revenues were plus 15 for the quarter, plus 15 for the quarter and the components of growth were plus 4 from the base, plus 2 from acquisition, and plus 9 from currency.

As you can see and as Jon has already mentioned we finally got a full quarter's effective positive currency translation particularly as the Euro continued to strengthen against the dollar.

Similar to North America the principal businesses in the segment are construction, auto and industrial.

We had across the board positive revenue contributions from all of these businesses.

When you break them down in construction, base business was plus 3 in the quarter thanks to contributions from both our Australian and European businesses.

Our Australian construction businesses were up 10 percent and as both the Paslode and Buildex units as well as businesses associated with our [inaudible] Ramset acquisition, the one we made in May of 2000, all combined to take advantage of the stronger new housing and renovation rehab opportunities.

In Europe, base revenues grew 1 percent as top line gains in France, Belgium, Holland, and Spain and Portugal began were mitigated by weaker construction environment in general and poor end market demand in Germany.

Wilsonart revenues were down 2 percent and that was mostly attributable to maybe ongoing 80/20 product lines simplification activities.

Looking ahead, we continue to believe the European construction base revenues will remain soft.

That is flat to slightly negative in Q4 and then Australia will remain strong anywhere from plus 5 to plus 10.

Automotive business in Europe plus 3 in Q3 even though auto builds were still negative in the quarter.

Auto OEMs in Europe, which for us includes everyone from Mercedes to Fiat, saw their collective build rate improve to a minus 2 in Q3 from minus 3 in Q2.

Thanks to the slightly better build rate in Q3 for BMW, Ford and Citron (ph), as well as our platform penetration quarterly automotive revenues were positive for the first time this year.

With auto builds expected to be at minus 4 for the full year we are cautiously optimistic about growth prospects in Q4.

And the other contributor to the segment is the industrial grouping of businesses.

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

Collectively these businesses produce base revenue growth of about 6 percent.

We expect these businesses to produce less impressive results in Q4 due to some weakening end market demand.

Now we'll go over to the systems side of what we do.

North America specialty systems, revenues were minus 1 in Q3.

Revenues minus 1, and that consist of minus 3 from the base offset by plus 2 from acquisition.

So minus 3 from base, plus 2 acquisitions.

While the third quarter revenue performance in this segment showed sequential improvement from Q2 when the base was at minus 5 and Q1 when the base was at minus 8, we still did not experience the recovery in base revenues we had anticipated some six months ago.

Generally speaking, the lack of CAPEX investment by companies in general and our customers in particular have made for a more difficult recovery in our North America industrial systems businesses.

Case in point.

Our food equipment industrial packaging, welding, marking and decorating and finishing businesses all had base revenue declines in the third quarter anywhere from minus 1 to minus 6 percent.

Earlier this year we had expected all these businesses to be in positive revenue to territory in the third and fourth quarters of 2002.

While our food equipment business improved its base revenues to minus 3 for Q3 from a minus 5 in Q2, we continued to see sluggishness in both the food service and restaurant side of what they do and food retail that's the supermarket side of the business.

Food service which accounts for 50 percent of North American revenues in food equipment continue to see weakness in sales associated with the white table cloth or upper end restaurants.

That's due to the weak economy, lack of business travel, and slower hotel bookings.

Food retail, that's about 25 percent of the North American food equipment revenues, is still awaiting the real rebound in capital retrofit investment from supermarket chains that have consolidated over the past 2 to 3 years.

We saw some small retrofit projects come to us in Q3, but nothing that suggests a meaningful trend shift.

But even with the weaker top line there were still some very good news coming out of food equipment in North America.

Thanks to the benefits of past and present 80/20 programs, operating income increased 30 percent in the quarter and operating margins improved 340 basis points.

In industrial packaging, our significant note operation saw business improve marginally to minus 7 base revenue to minus 11 in Q2.

But we believe that was driven more by customers ordering consumable products rather than the machinery side o fwhat they sell.

In market demand for steel, textile, corrugated box, lumber and brick and mortar, all remain relatively weak in Q3.

Our welding businesses, welding business actually declined -- actually experienced its first negative base revenue number in 2002 moving to a minus 2 percent revenue decline versus a plus 5 in Q2.

Distributor demand from welding can customers serving the oil and pipeline and the shipbuilding sectors cooled in the third quarter.

Finally, our finishing also known as our paint spray business, was minus 1 base in Q3 which was slight improvement from Q2.

They have benefited somewhat from limited capital projects from auto OEMs, but demand from their office furnished customers, continues to be very, very weak.

Finally our last segment, international specialty systems, revenues were plus 9 for the quarter and that consists of minus 3 from base, plus 3 from acquisitions and plus 9 from currency.

Again, minus 3 base, plus 3 acquisitions, plus 9 currency.

Similar to our engineered products international segment, the big swing in the segment with currency translation, beyond that the lack of CAPEX investments by international based companies continues to constrain our revenue base growth.

In our industrial packaging category base revenues for this category were flat versus last year and was actually a good achievement given that our largest business signaled industrial packaging produced a minus 5 base business in Q3.

Similar to North America signal revenues were driven more by plastic and steel strap consumables and small application tools rather than large capital machinery.

Any real improvement in signal business in Q4 would be directly tied to an increase in capital investment by international based customers.

Let's take a look at food equipment on the international side.

Base revenues were down 7 percent, and that's similar to the past couple quarters.

As I said before and I'll say again, revenue fall off is due as much to 80/20 as it is to weaker end market demand.

The good news continues to be the operating income story.

Like I said on the North American side, 80/20 programs on the international side including product line simplification, segmenting and reconfiguring manufacturing processes, improved operating income by some 40 percent and operating margins by more than 400 basis points.

Finally, our finishing business saw base revenues improve 8 percent in the quarter as these units took advantage of better than expected auto build rates.

We anticipate vehicle builds will not be as strong as Q4 finishing revenues will be anywhere from flat to slightly down.

That concludes my remarks on segments.

I'll reintroduce Jon Kinney who will walk you through our fourth quarter and full year forecast.

Thanks, John.

To save the best for last, I was told the long time ago that it's very, very difficult to predict a turning point and as we look at our quarterly forecast and we've been going back to when we reviewed our quarterly plan, the fourth quarter was one of those turning points that we had forecasted a while back and was the strongest growth period in the quarter in the neighborhood of 6 to 7 percent positive.

We were believing that could happen for all the reasons that one might expect, namely that this would be we would be well into the recovery at this point and, on top of that, the fourth quarter by far was our lowest quarter in 2001 and in 2002 we even experienced the negative on our fourth quarter.

So there were lots of reasons for believing that it could happen. and it wasn't until late in this quarter that our operating units in re-forecasting their look at the quarter, in light of third quarter experience took a significant shift downward.

So, we are faced with a downward revision here, and it's based on a slower than expected base business growth in the fourth quarter and a somewhat higher restructuring and pension cost.

We are revising our income per share forecast downward for the full year and the fourth quarter.

Our revised forecast for the year is 295 to 305.

The base revenue growth supporting the forecast is expected to be in the range of minus two and a half percent to minus 1 and a half percent.

Other assumptions underlying the forecast include exchange rates holding at today's levels, required revenues in the $200 to $600 million range.

Restructuring costs in the range of 55 to 60 million, and a tax rate of 35 percent.

Overall if we hit the mid point of this range, full year income from continuing operations of $3 a share would be 5 percent higher than last year on a consistent reporting basis.

We continue to believe that this would be solid performance in light of a negative 2 percent revenue decline on the base business.

For the fourth quarter we are forecasting income per share from continuing operations to be within a range of 67 to 77 cents per share.

The low end of this range assumes no growth and the high end assumes a plus 4 percent on the base.

In addition, the quarter includes approximately $20 million of restructuring costs, as you may recall, the last two quarters have been in the $10 million range and the first quarter was close to 20 million.

So this is not an easy cost to forecast, but as we are seeing the project at this point it's looking closer to 20 than it is 10.

And in addition to that, we have $5 million of higher pension costs.

These higher costs are offsetting some of that operating leverage that we're getting from the 2 percent base revenue growth.

If we hit the mid point of this range for 72 cents a share, we will be 8 percent higher than last year on a consistent reporting basis and margins will continue to show year over year improvement.

Okay, John, back to you.

That concludes our formal remarks.

So, let's open the call to questions now.

Thank you.

At this time we would like to begin the formal question and answer session.

If you would like to ask a question, please press the star 1 on your touch tone phone. to withdraw your question, press the star 2.

Again to ask a question, press star 1.

First question is from (inaudible) from Merrill Lynch.

Thank you.

Good morning or afternoon.

Jon, firstly, Jon Kinney, I didn't understand what you said in acquisitions.

You said 200 to 600 million this year?

Actually that's in light of the backlog that we have it could be as high as 600 in total.

Sorry, what's your year do date run rate acquisitions on the sales line?

We have 200, about 200 million.

You're saying if all your deals close in the backlog you would end up with 600 million?

Right.

Okay.

Can you just -- my question, then, is to sort of talk a little bit about what's been happening on the acquisition front, because you're probably further behind than many of us would have anticipated at this point in the year in terms of getting deals completed.

Realistically, how should we be thinking about, you know, kind of fourth quarter contribution and sort of the run rate going forward?

Is there some reason that acquisitions perhaps are not going to be contributing what we would have thought only a few months ago?

Our current acquisition activity -- I think I mentioned last time we had a a very strong backlog and we backed away from one of the larger acquisitions in that because we didn't -- we are disciplined buyers.

There's no doubt about that.

If we're not seeing a way to add value with an acquisition, we're not going to go forward with it.

I mean, we could, as you know, be incremental to earnings per share until we're blue in the face.

All we have to do is get something that exceeds a 4 percent after tax return, but that's not about where we're at.

We have seen periods, I mean acquisitions historically at this company have been up and down from year to year and from quarter to quarter.

If I go back to the last recessionary period, acquisitions in '91 were off 40 percent and in '92 they were off 80 percent only to be followed by a 375 percent gain year over year in '92 to '93 in business in terms of cash spent.

So this is, you know, from a short term perspective, yes, acquisitions add to the bottom line and nowhere near as much as incremental revenue growth.

We continue to have a strong, you know, backlog of companies that need work on them that have been acquired in the past, and we continue to remain an inquisitive company.

We have both the resources and the experience and we still have a fair backlog of companies to look at.

You're saying things are lumpy versus you're backing away because the purchase price or anything like that?

You know, it's a combination of purchase price, due diligence work, things that have come up that have said, this is not a type of thing we want to get into.

Or you know, it may have initially passed some of the product scope issues that we generally look at, but for other reasons just didn't work for us.

Again, no reason structurally why acquisitions on an averaged basis are going to be slowing for the foreseeable future?

I don't believe so.

We've targeted in the range of 800 million a year to get us to that 15 percent growth rate that we target over the, you know, five- year horizon. and we've -- we in the '98, '99 and 2000 period we ran very close to 800 million and even had a $900 million period. and that excludes Premark (ph), right?

Which was 3 billion.

So, we've had a -- last year closer to 600, this year maybe 2, 300, if we're lucky maybe a little bit more than that.

But I can see a better environment coming.

We've had slow periods in the past, so we're not overly concerned at this point.

Just last thing, your guidance in the fourth quarter assume incremental acquisitions?

Yes, but there's not much income in that.

Thank you.

Next question is from Larry Robbins (ph) of [inaudible] Capital.

Hi.

I think you mentioned in the fourth quarter you thought tension expense would be a nickel higher.

Did I hear that right and could you comment on ' 03 if you have any preliminary estimate as to the year on year impact?

Yes, we believe 5 million higher.

We have reduced our earnings assumptions on our pension plans by about 2 points so to date we've absorbed, I want to say, $8 million -- ; is that right?

No, excuse me, closer to 15 million and another 5 million in the fourth quarter.

So to date this year we've, we've increased our pension costs close to $20 million.

When you talk about the 2 points, is that a return on finances assumptions?

Yes.

So what is your current return on finances?

We believe it's going to be 8.5, 8.6, 8.7.

We combine it with all the European operations, so it's going to be in that range.

Okay.

Then in terms of a year on year impact is it headwind or tailwind for 2003, do we have an estimate as to whether there will be a significant change for the 3VO2 on the pension (inaudible)?

I believe that we'll probably hold in that eight and a half range.

There shouldn't be a year over year impact of any consequence.

Thank you.

This doesn't address discount rates which we haven't modified, but we'll be looking at, both of these issues during this quarter.

Okay.

Thanks.

Yep.

Our next question is from Harriet Baldwin (ph) from Deutsche Bank (ph).

Good afternoon.

Jon, I was wondering Jon Kinney, what had changed from the September 16th confirmation of the year's outlook to today?

You mentioned some (inaudible)of re-forecasting.

Was it simply getting the numbers added up?

Have you seen some negative inflections through September in some of your markets that you think are sustainable?

It's more the latter -- the former. the end of September we get a re-forecasted fourth quarter.

We have potential for modifying our forecast during the month, but it was in the month of September that a lot of businesses took their fourth quarter forecast down.

That was the primary driver.

And then secondarily as this quarter has rolled out and on into October, the number of restructuring projects really started piling up.

We had a number of pending projects and even more discussions with some of our group controllers about what the quarter holds.

So, we already know it's going to be 15 million and we think it could be 5 million on top of that -- I mean 15 million where we have projects in hand.

So this is -- we're still well within -- we're within that range where we gave guidance in restructuring about 60 million for the year and that's where it looks like it's going to be end up.

It's going to be heavier this quarter.

So the combination of those two things are what led to the reduction in the forecast.

Harriet, I would also add, you know that a we track the monthly numbers in the third quarter, that August, September -- August has gone down and we weren't quite sure directionally even which way September was going to be.

So we were trying to get a handle on September in the third quarter let alone trying to forecast Q4.

Right. and as a follow-up, what areas would you say you have the one or two areas you have the most confidence for your Q4 outlook looks pretty firm versus which ones are murkiest from this point, the third week of October?

I would say we have high degree of confidence in our shorter lead time (in) the automotive, construction that relates to new housing, construction that relates to renovation/rehab.

Some of the industrial stuff within those segments, let's say we have less degree of confidence and most of the systems capital machinery kinds of businesses where we're just not seeing the recovery we thought we were going to see.

And it looks like pricing might have gotten hit on construction at the end of the quarter for particularly engineered products North America.

Is that accurate, or were there just some restructuring costs that hit?

No, there were -- let me look here for a minute.

It was a combination of things.

We did have -- that's the minus 8 - minus point 8 on margin decline.

Point 6 of that was restructuring and our base business was down minus point 4 and that was driven by a combination of reduced construction demand on the commercial side as well as we had a new product in our construction area where we have had some warranty claims that started up in the fourth quarter and, as the year has gone on, those claims have accelerated so we recorded about a $6 million increase in our warranty reserves and that hurt margins.

And at this point, the product is off the market and we think we're covered on the warranty side.

Great.

Thanks.

That's my share of questions.

Next question is from Jeff Sprauge (ph) from Salomon Smith Barney.

Hi, good afternoon.

I was wondering if we could get a little bit more detail on the pension.

John, I'm a little unsure why the pension expense would be the same in '03 as it is in '02 presuming you've got further erosion in the actual rate of return on the plan asset.

Did you mean to say the headwind amount would be the same or the actual dollar of expense is the same?

If you follow what...

The dollar of expense will be about the same in the two quarters.

No, when I look out into '03...

Oh, into '03.

Right.

Well, the major driver here is we reduce that earnings level two points and year over year, if we go into next year with no reduction, then those assumptions, our pension costs between years should be about the same.

Yeah, but you've got -- you'll have -- I mean your actual return on plan assets was negative 17 percent in '01.

Presumably it's negative in '02.

So just applying it to the lower asset base it sounds like you have a higher pension expense.

But that's not the way the accounting works.

The accounting is, you know, the P&L charge is based on plan assumptions.

Yeah, the plan assumptions on the actual funded status of the plan, though, right?

Shouldn't the asset balance go down -

The asset base is down.

Right.

That could have an impact, too, but we'll be looking at funding in this fourth quarter also.

Oh, okay.

We have not been able to fund our pension for a year or two, at a minimum a year or two, because we couldn't get a tax deduction.

Given the funding status today, I think we will be able to put money into the fund.

Okay.

So that's a possibility in '02, then?

That's a possibility, that's right.

And could you update us if there's any change in the other post retirement expenses that's been running 40, you know, 48, 50 million a year last couple of years?

Yeah, we haven't -- we at least look at the potential of funding our retiring/medical.

We at least know we could do it with tax deductibility and would work just like a pension plan which is a very economic way to cover those types of costs, but we're still exploring it and that's another avenue I think that viability is in the 300 million range.

Okay.

Great. and then just a second question area.

When you look at automotive in '03, do you have a sense in terms of how revenues could grow relative to whatever the production builds are?

In other words, do you have visibility, good visibility on your penetration gains for '03?

Jeff, we think that the builds in North America next year are going to be down 6 to maybe 8 percent, somewhere in that range.

That's our plan assumption right now.

Given that, we know that we've been able to penetrate product penetration on car on average at about 8 to 9 percent.

So in that kind of environment we would probably have marginal revenue increase, not much, but either flat to up slightly.

Great.

Thanks a lot.

Our next question is from Andrew Casey (ph) from Prudential Securities.

Good afternoon.

Hello, Andrew.

Just I guess to revisit the potential funding or post retirement and pension, can you give us a sense, you mentioned 300 million range, I'm not sure if that was post retirement and pension, or tax deductibility or if that's just one.

That's post retirement.

We haven't sat down with the actuaries yet with the pension.

In a couple weeks we're doing that.

OK.

No ballpark you can give us on that?

Not at this point.

I'd be pulling out of the air to do that.

OK.

On (inaudible)...

Andy?

Hello?

Phil?

Yes, sir.

We lost the last question.

If he can just press star 0 one more time or star 1.

Hello?

Hello, Andy?

Can you hear me now?

Yeah.

Sound like a commercial.

We can hear you.

It's actually a land line.

That's what happens when you're not on a cell phone.

I wish.

On the end markets, which ones during the quarter were burst?

Packaging kind of did a reversal head quarter, but which ones are actually getting weaker, if you will?

I would say that the commercial construction piece in North America got worse and the -- a variety of systems businesses in North America and on the international side also got, if not worse, they didn't -- they got incrementally worse, but didn't get -- didn't live up to our expectations in terms of the kind of improvement we were expecting from them.

But on the absolute level it was commercial construction in North America and some of our industrial packaging business and welding, actually welding got a little bit worse, too, that's correct.

They've been running positive for the first couple quarters.

Third quarter they were minus 5.

Right.

Okay. and so far that hasn't freed up any re-discussion of discounted cash flow assumptions for acquisitions from the sale side?

I don't think so.

No.

Thanks.

Next question comes from Walter Liptak (ph).

Good afternoon, guys.

Hi Walter.

The systems business, given that they're weak, the margin improvement was impressive.

As we go into the fourth quarter and into next year, even with this diminished outlook for capital goods, are the third quarter margins sustainable or is there up side [inaudible]?

I think that they are -- and I'm checking here.

Let me do a very quick overview on the systems business.

Our assumption is that margins will continue to improve and our expectation is that margins will be -- should be in the vicinity in terms of improvement where they were this quarter, on the North American side.

On the international side our expectation is that margins will continue to improve also.

On the cash side business, I want to make sure I'm correct.

None of the divestitures, the discontinued ops, there's no cash in yet from those?

That's correct.

Year-end the cash flow you're generating, you're manufacturing debt to capital net of cash is going to be close to zero, right?

Well, our net debt, yeah.

We're not going to go off the market and buy back.

But our net debt, net of cash position is going to be pretty low.

In the past you talked about, you know, maybe doing the stock repurchase.

Is there any discussion internally of doing something like that in lieu of acquisition?

Not at this point.

Okay.

Thanks.

Again, to ask your question please press star 1 on your touch phone.

Touch tone phone.

Our next question is from Wendy Kaplan (ph) from Wachovia Securities.

Hi, thank you.

Your working capital as a percentage of sales is in the 22-24 percent range.

Can you speak to the opportunities to lower the need of working capital?

Well, as I mentioned, our two principal working capital items are inventories which are about two months on hand, and we do have businesses that perform at one month.

So there is continued pressure.

Within that two-month average are a bunch of newly acquired companies that clearly have room for improvement, probably in the area of 200 million or so that we're working on.

In the receivable area, there's probably a little less room at 58 days of a blended rate of our European businesses which probably run closer to 70 days with two-month terms and our North American operations have some room, but our past dues are not big so there's probably less room there. and of course we could string out our suppliers like many companies do.

We don't elect to do that.

We generally take our cash discounts and pay on time, but that serves us well, I believe, with our supplier relationships.

So, we should assume that that level of working capital is sustainable in '03?

I believe so.

You know, you mentioned a rate of 22 percent.

I could see holding that or approximate possibly improving it.

Thank you very much.

Sure.

Next question is from Dean Gray (ph) from Goldman Sachs.

Good afternoon.

Where do you all expect to end up on CAPEX for the year?

And then [inaudible] thinking about CAPEX for '03 at this stage?

I think, you know, we're going to end up in the 260 to 280 range. and for '03, I will have to defer here until we, you know, we're right in the midst of our -- starting our planning activity and we'll know more.

Dean, remember that our budge at the time level for CAPEX for this year was I believe 315.

I couldn't imagine that number being any higher than that going into '03.

Gotcha.

So this is the second year in a row where you've kind of under spent CAPEX.

Are you not approving CAPEX requests, or are the business units just being reluctant to come back with capacity requests?

They are not coming back.

We have a few areas like the residential construction and that's probably the main one that comes in the expansion type projects, but no, you're right, it's the business units that are driving it.

We're not turning things down here.

In any sense of what your maintenance CAPEX level run rate is these days?

You know, -- you know, that's probably kind of where we're at, maintenance and cost improvement is -- we're spending below our depreciation level, so that tells me we're probably there.

And then this might be an unfair question, but do you have a sense of what your utilization rate is broadly across the company?

I mean, is there any way to aggregate that?

It would be -- no, we don't get that measure.

You know, if our overall sales from 2000 levels are down, say in the neighborhood of 9 percent, right, and we tend to operate not much greater than 85 percent.

So we're probably in that 75 percent range.

What would be the peak a trough?

I would think 85, little bit north of 85 would be peak.

We hope we're at the trough.

Got it.

Thank you.

Thanks.

Our next question is from Kevin Silverman (ph) from A B M Amro Asset Management (ph).

Thank you.

You've reported that currency was wind at your back in the quarter on the revenue line.

Yep.

I'm wondering if you can quantify the impact on the operating margin line.

Thank you.

Yeah, we figure it's about 2 cents per share, so it's about $9 to $10 million operating income.

Thank you.

Our next question is from David Bluesian (ph) from UBS Warburg (ph).

Good afternoon.

I know you're not going to give us a capital spending forecast for next year, but can you walk through the discussions you're having internally?

What is the general mood and give us some sense for what customers are telling you about their 2003 capital spending plans?

We've really not -- I haven't been privy to the discussions.

I know that's going on now as our operating units are putting plans together, and we're not going to get a sense of that here for awhile yet.

John, have you -

I think customers, be it director or be it distributor based, I think people are being very cautious about CAPEX and I wouldn't expect any -- I don't think there's any great expectation for a discernible up-tick CAPEX from customers or from distributors.

Are you getting a sense that they feel like they've under-spent and if there's any pick up in demand they'd ramp up quickly or is it more just a general sense there's too much capacity and they're not even close?

That's really what I'm looking for.

I really don't have any sense of that.

I don't have enough data, David.

And then totally different tact, but with the Premark (ph) integration well underway and your debt level is low as it is and cash generation is strong as it is, I guess the question is do you feel the management desire or do you feel you have the management capacity at this point in time to take on another big acquisition?

We probably do.

I know I'm the one that gets to run the numbers on the diversifying larger acquisitions, and that's been an area we continue to look at.

And I think -- I know Jim and Frank both believe that we've clearly got the resources, we've just got to make sure it's the right product and the right price.

Right price being that where we can you know, get the type of returns that we expect from our businesses.

So, there's clearly a willingness, and we do, we do look.

There's a whole group of investment bankers that keep the flow of our coming in here relative to possibilities.

So I think the management team, to answer your question, is very open to a larger acquisition.

Okay, terrific.

Thanks.

The next question is from Robert McCarthy (ph) from Robert W. Baird.

Good afternoon, guys.

Hi Robert.

I need to follow-up on this conversation about acquisitions.

I'm a little confused on numbers here. $200 to $600 million range number you're talking about, Jon, is a targeted total annual revenue of businesses you had acquired this year, right?

Right.

Okay.

I'm showing year to date through the third quarter something like 105 million which would indicate that you expect to step up to at least a roughly $100 million level in the fourth quarter.

Right.

I'm interpreting correctly, okay.

Right.

And you had something that you almost did in the third but backed away from.

That doesn't need to come back for you to get hit your targets?

Right, that's right.

A quarter ago you said your backlog was the strongest it's been since the end of '99.

Yes. the one that dropped out -

Change that?

Yes.

Okay.

A separate question following up on the pension questions, have you done some sensitivity on what a, for example, 50 basis point reduction in your discount rate assumption might mean in terms of recognized expense?

Not yet.

Okay.

That's all I've got.

Thanks.

Okay.

Thanks.

Our next question is from Martin Jacobs (ph)_ from Capital Research.

Good afternoon, gentlemen.

How are you?

Good.

Good.

Just a quick question.

On the North American engineered products segment, revenues were up, margins were down.

Is that mainly because margins on the commercial construction activity are higher than automotive?

And if that's true are automotive margins still higher than the corporate average?

What drove that is primarily restructuring activity and this warranty reserve issue that I mentioned.

So their downside incremental in that commercial area may have been a tad higher than normal because it was a reduction from what they've been experiencing and reducing force and so on and so forth.

Doesn't happen on the turn of a coin, you know.

But the primary reason for the incremental is the restructuring activity in order of priority is probably the warranty accrual under restructuring activity.

Right.

But in addition to that was there any impact at all from this mix?

From mix?

Right.

Martin, the warranty stuff would get aggregated into the construction piece we talked about.

Okay.

Okay.

That makes sense.

Thanks.

Sure.

Our next question is from Jerry McManus (ph) from J.P. Morgan.

Good afternoon.

Hi.

If I take the mid point of your fourth quarter base growth assumption, 2 percent, I mean if I look at it on a sequential basis comparing what's expected for the fourth quarter versus what happened in the third quarter, is that improved, flat or down?

The fourth quarter from a base business standpoint is up 2 percent year over year.

I know.

I'm just wondering -- you were zero in the third. the 2 percent is for improvement.

Is that just because of easier comps or do you expect any ...

I believe it's comps.

So you're not really assuming any change in the overall end market conditions in the fourth quarter versus the third quarter ; is that right?

Fundamentally that's true.

And within the different major end markets is there any kind of areas you see getting better in the fourth quarter and others are getting worse?

Can you break that down a bit by end market?

Jerry, I think we talked about it before auto has operated at a real high level and we expect that to probably moderate a little bit in Q4.

We don't expect construction overall to get much better because of the mix with commercial in Q4.

Our industrial products with engineered products in North America we don't expect to get much better.

And with all the other stuff on the systems side in North America and international which the machinery and capital machinery side is very weak.

So again, it's just gap between what our expectation was in Q4 and what we're actually seeing in terms of the forecast.

We're not seeing a real pick-up in end market demand in Q4.

To Jon's earlier point, growth is going to be associated with easier comps than to pick-up and demand.

To answer your question, we don't see any discernible pick-up in any particular end market.

Okay.

Getting back to Rob's question, you made a worse case of $100,000,000 of acquired revenues in the fourth quarter even though you only had 14 million or so, I'm sorry, not 14 million, but you had a much smaller amount, I think 32 million in the third quarter.

Yes.

Is there acquisitions you've already completed thus far in October that gives you that confidence?

There's some ones that are close, yeah.

Okay. and but if I assumed you don't make a lot of acquisitions, given you have the cash of 720 million, what point do you become uncomfortable with the cash position getting too high?

I mean if it's over a billion, are you happy?

Are you going to continue to let cash just pile up?

What point do you become uncomfortable?

The two things I mentioned I think both the funding of the retiring medical and addressing our shortfall on our pension assets to some degree would gobble up a chunk of that.

Can you quantify how much that would be?

Yeah, at a minimum the retirement medical is in that $300 million range and I know our pension assets are probably 800 million to date versus a liability of a billion to a billion 1.

Now, I don't know if that whole amount can be funded nor do I know if we want to fund it that much, but -- and we do get a tax deduction for that, too.

So if you couldn't find any acquisitions of significance let's say in the near term, it's a greater chance you'll use cash to pay for the pension health care?

Oh, yes.

As opposed to just letting it pile up?

Right.

Okay.

Thank you.

Your next question is from Daniel [inaudible] from Bessemer (ph).

Hey, good afternoon.

Daniel.

I was just looking at your fourth quarter guidance.

If you take the guidance range and base revenues that you gave [inaudible] current levels assume 20 million in incremental restructuring costs and hold margins sort of flattish at third quarter levels, it seems you get a higher fourth quarter EPS than you guys were guiding to.

I guess my question is, does the guidance imply some sort of negative mix shift and secondly does the guidance imply pricing pressure of some sort in any of the businesses?

No, I don't -- we're not forecasting that.

I'm just looking here at our numbers, our margins is one way to get a read on this.

You know, our pretax margins I believe were up one and a half points in the third quarter.

We might not be quite that high in the fourth quarter, but we have a higher restructuring cost which will temper those margins year over year improvement in those margins.

Is it [inaudible] coming from systems North America or divisions where the margins are higher where your outlook is maybe...

Our margins always decrease in the fourth quarter.

Our margins in the third were 15.7, are going to 14.7 in the fourth quarter, but that's a function of seasonality, both of our construction businesses and a lot of the shutdowns that occur, some our European businesses, but construction I think is the primary seasonal driver.

So, I mean, there is seasonality in the fourth quarter.

If you just took third quarter and took margins down and count EPS that way, it would definitely get a higher number.

Secondly I just wanted to know if you could give any detail on whether $20 million might be spent in which segments which businesses you're restructuring?

I do not have that information with me, but I can tell you, as you know, we have 600 business units and I imagine we probably have in the neighborhood of open projects of 130.

So there's lots of different businesses involved What I don't have is a summary of whether it's in packaging.

I know there's a chunk in Premark (ph).

There's some in our packaging area.

There's some in our fastener and component businesses, but I'm, not one is jumping out in my head to give you a read on that.

Okay.

Thank you.

Next question is from John [inaudible] from Merrill Lynch.

Thank you.

Just a follow-up.

I'm curious to know what your exposure, the company is to United Airlines perhaps been leasing or the total company. and then if you could just talk about your exposures as the company to commercial aerospace in general.

The commercial aerospace is virtually zero in terms of sales. and then we've got, as you know, leverage leases with aircraft.

We've got in the neighborhood of $75 million invested.

That's our net investment.

United is dollar 50 or 60 of that.

That's where we stand.

We are actively trying to assess if we have any realization issues associated with these assets.

We've not had an event yet other than, you know, the environmental circumstances that United is facing that might suggest problems, but that's our -- if everything went to hell in a hand basket, Europe would be 70 million, but we don't believe that's the case.

If you were going to file Chapter 11 you're not entitled to write that all down, are you?

No, not with Chapter 11 filing, no.

You're not going to recoup the leasing streams?

That's probably right.

You know, it's the residual value question and that's what we'll have to look at.

Okay.

Thank you.

Uh-huh.

Our last question is from Jeff Sprague (ph) from Salomon Smith Barney.

Well, most of my questions have been answered, but maybe we could just follow-up on that last one.

Could you give us any color on the type of aircraft or the age of aircraft that are in the portfolio at least specifically at United?

777's and a 757 at United.

The triple 7 is a couple years old, Jeff?

It's one triple 7 and one 757?

That's the whole portfolio.

That's the whole portfolio with United.

Okay.

All right.

Thank you very much.

I'm showing no further questions.

I'll turn it back to Mr. Brooklier for any closing remarks.

I just want to thank everybody for joining us on the conference call.

We appreciate your interest, we appreciate the questions and we'll be talking to you.

Thank you.

That concludes today's conference call.

You may disconnect at this time.