Illinois Tool Works Inc (ITW) 2003 Q2 法說會逐字稿

Good afternoon, and welcome to the ITW 2003 second quarter earnings release conference call.

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

The conference is being recorded.

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

I would like to introduce your conference host for today, Mr. Mr. John Brooklier, Vice President of Investor Relations.

Sir, you may begin.

Thank you, Kristine.

Good afternoon, everyone, welcome to ITW’s 2003 second quarter conference call.

As noted I'm John Brooklier, ITW's V.P.of Investor Relations.

With me is Jon Kinney, our CFO.

Thanks for joining us today.

By now you should have received our 2003 earnings release.

To summarize, we're pleased with our second quarter performance.

In continuing operations increased. 7%.

Revenues grew 5% and operating margins 17.7%.

We're 10 basis points better than a year ago period.

While there is no question we were aided in the second quarter by favorable currency translation and additional income from our leasing and investment segment, our performance was nonetheless impressive given the very week north American end markets and declining end market activity internationally.

In just a few moments, Jon Kinney will give you a full Rundown of our second quarter progress.

We hope that today's syncronized slide show, our second such presentation, provides better communication and more transparencies to see in helping investors to better understand the company.

Here is the agenda for today's call.

First, Jon Kinney will give you a financial overview of our 2003 second quarter performance.

I will review our performance for our four manufacturing segments and associated end markets.

Jon will then address our third quarter full year 2003 forecast.

Finally, we'll open the call to your questions, one long-standing request, I'm asking each person to ask one question only and make sure that each question is related to second quarter earnings.

You do get one follow-up question.

We do this so we can accommodate everyone who has a question within a reasonable period of time.

Another long-standing housekeeping item, I would like to mind 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 2003 forecasts.

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 risks, one, a downturn in the construction automotive, general industrial, food service and retail or real estate market, two, deterioration in global and domestic business and economic addition, particularly in North America, the European community and Australia.

Three, the favorable or unfavorable impact of foreign currency fluctuations.

Four, an interruption in or reduction in introducing in products into the company he is product lines and 5, unfavorable environments for making acquisitions or dispose session domestic and international, including adverse accounting or regulatory requirements and market values of candidates.

One last piece of business, a telephone replay for the conference call is good through through -- through midnight of August 5, 2003.

The playback telephone number is 402-220-2269.

Again, that number is 402-220-2269.

No pass code is necessary.

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

Thanks, John, good afternoon, everyone.

I'd like to start with the highlights for the second quarter and they are as follows.

First, our revenues increased over last year by 5% compared to a 5% increase in the last quarter.

Operating margins were slightly higher in spite of a 4% decrease in our base revenue.

Income per share from continuing operations increased 7% over last year.

Free cash flow continued strong at $217 million for the quarter.

And lastly, our return on invested capital was 17.6 or 60 basis points higher than last year.

In short, I believe our second quarter represents solid performance in a continuing soft industrial market.

Now, let me turn to the details.

Our 5% revenue growth was primarily due to four factors, first, the base business revenue declined 4.4%.

This performance was 270 basis points weaker than last quarter.

Second, translation increased revenue by 6.2%.

This increase was 130 basis points stronger than last quarter.

Third, acquisitions increased revenue by 2.1%.

This performance was about the same as last quarter.

And lastly, a market to market adjustment in the leasing and investment segment increased revenues 1%.

Overall, our 5% revenue growth was a result of positive currency translation, acquisitions and a market to market adjustment in leasing and investment segment.

Continuing declines in our base manufacturing revenues reduced these gains.

Our 4.4% year over year based revenue decline was made up of 5.8% decline in North America and a 1% decline internationally internationally.

In North America, the 5.8% decline which is 210 basis points weaker than last quarter.

Internationally, the 1% decline is 390 points -- basis points weaker than last quarter.

In short, North America and international based business revenues were softer than the first quarter.

John Brooklier will provide more details when he begins to discuss this.

Starting to operating margins, we experienced a 10-basis point increase in the second quarter compared to last year.

This was a result of an 08-basis point decline from manufacturing manufacturing, and a 90-basis point improvement from leasing and investment.

Let me talk to the manufacturing side of this improvement.

The major cause for the decline in manufacturing was operating leverage, which reduced margins 120 basis points.

In addition, acquisitions diluted margins 10 basis points.

However, non-volume related improvements, such as cost re reduction, pricing, product mix, increased margins by 40 basis points and lower restructuring costs increased margins 20 basis points.

These improvements were made in spite of higher pension costs of approximately $5 million and higher costs associated with the issuance of restricted shares of 4.5 million.

These higher costs represent approximately 40 basis points of margin.

Had revenues been even with last year, margins would be up approximately 40 basis points, and without acquisitions, margins would have been up 50 basis points.

Again that's on flat revenue crows growth, our margins would have been up 50 basis points.

Before I leave markets let me up update you on the Primark progress.

As you recall Primark margins were 9% when we acquired them at the end of 1999.

We set our targets to improve margins by 18% by the end of 2005.

We ended 2002 with Pre-mark margins of 13%.

Our plans for 2003 call for margins of 15.7% with sales, 7% be low 1999 levels.

That's 7% decline was not in our original thinking.

If we were to operate at 1999 sales levels in 2003, we believe margins would be in the neighborhood of 17%.

Although first half revenues and income were slightly below planned margins are above 15% in the first half and are expected to improve further in the second half.

In our leasing and investment second quarter, income was 28 million higher than last year.

This was mainly the results of a market to market adjustment of approximately $40 million on our mortgage-related assets, resulting from declines in interest rates and our future forecast of reductions in cash flows.

This seems to go counterintuitive, but the contract that we're measuring is a swap agreement, essentially a hedge against reductions in these factors.

So, as these issues, as our interest rates dropped, and as our cash flows dropped, as the cash flows and the properties dropped, the value of our soft agreement increased.

In the non-operating area, interest expense and other operating income were relatively flat.

And our effective tax rate for the quarter was 35%.

Turning to our invested capital, inventory months on hand continued at 1.8 months and our DSO edged up a day to 60 days.

The majority of increases in receivable inventory were due to translation and acquisitions.

In short, we continued our tight control of working capital in the second quarter.

Capital expenditures for the quarter were $66 million and depreciation expense was $71 million.

On the financing side, we slightly reduced our debt and increased our cash position.

Our debt to cap ratio declined to 18% for the total company and excluding leasing and investment segment, the ratio was 11%.

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

Pre-cash for the quarter was $218 million.

During the quarter, we spend $60 million on acquisition, $71 million on dividends, and $12 million on investments and lastly, $7 million on debt reduction.

Pre-cash exceeded these expenditures as a result our cash position increased $109 million for the quarter.

Our second quarter return on invested capital improved approximately 70 basis points to 17.6%.

On a year to date basis, our returns are 15.2% or 70 basis points higher than last year.

Finally, on the acquisition front, we acquired six companies in the second quarter with total revenues of $35 million and an aggregate purchase price of $29 million.

Our current acquisition backlog continues strong and coupled with the first half activity, should allow us at a minimum to achieve the low end of our forecast, which was $200 million.

Before I leave acquisition, a brief update on our difficult divestiture and consumer segment.

The last company on the list here to be divestiture is Florida Tile.

We're in the final stages of completeing this difficult vesture.

We hope to close this deal in 2003.

We are currently estimating no significant gain or loss on the sale of consumer segment and I think you'll notice in our income statement, we increased the loss from discontinued operations and that was mainly due to adjustments on the selling price for that.

Now John Brooklier will have a discussion on our manufacturing segments.

Thank you, Jon, before I give you additional color on the manufacturing segments I wand to focus on key economic data that we regularly focus on as a company and share with you during the conference calls.

We believe these data points serve as a proxy for the health of our very diversified end markets and explain why our base revenues declined from a minus 2% in the 2003 first quarter to minus 4% in the most recent quarter.

First, the institute for supply management continued to be relatively weak through the end of June.

The ISM index of 49.8% in June was actually up from 46.2% in March of this year, but it's under 50 showing is still troubling.

Most of you know that the 50% level is the line of growth, no growth for the index.

Perhaps more positive is that the ISM new orders index actually reached 52.2% in June, up slightly from 51.9% in may.

Hopefully this portends better days ahead for end markets.

U.S. industrial production data, excluding technology continued to be negative in the sect quarter and was actually worse from three months ago.

For June, industrial production was minus 1.7%, that compares to a minus 0.6% performance in March.

This was certainly a contributing factor for our more negative performance in the second quarter.

Internationally, key data points help illustrate why our international numbers slowed a bit in the second quarter.

The purchasing manager's index came in at 46.4% in June, two points lower than the 48.4% index number in March.

And country specific data also shows declines.

Industrial production in the UK was at minus2.6% in may, versus minus 0.7% in January this year.

And France fell to minus 0.5% in may versus a plus 1% in January.

Now, let's take a look at our four manufacturing segments.

For the second quarter, segment revenues declined 3% and operating income decreased 14.2%.

Operating margins of 17.1% declined 220 basis points from a year ago, mainly due to income and associated margin declines in the automotive businesses.

Looking more closely at revenues, the 3% decrease in top line consisted of a minus 6.5% decline in base business revenues, 3.3% growth in acquisitions, and a 0.2% contribution from translation.

Again, that 3% is made up of the following components, minus 6.5% from base, plus 3.3% in acquisitions, and plus 0.2% from translation.

Construction is the largest part of this segment, and its performance was down in the second quarter.

In total, had a 6% decline of base revenues for the second quarter versus a 5% decrease in Q1.

The components for the 6% decrease in the quarter continued the same trends we've seen over the past few quarters, and that is, commercial construction was down 8 to 10%, new housing revenues declineed 3%, and renovation rehabs top line and that's expressed by our sales through the big box stores stores, grew approximately 10%.

Taking a look at the individual pieces of our construction businesses, our commercial construction revenues continue to bounce along the bottom.

The weakest part of our commercial construction business was and continues to be Wilson Art, which had minus 11% in the second quarter, continued to feel the impact of lack of orders for laminate products that are used in applications such as office furniture, commercial flooring and recreational vehicles.

Looking ahead to full-year 2003, we still don't anticipate commercial construction in its entirety to improve in any meaningful way.

The new housing piece of our business performed per our plan and per new housing start activities.

In may, new house housing starts were down about 1% and slight decline in new housing starts has resulted in our top line revenues being down some 3% in the second quarter.

We still believe that new housing starts will be down some 3 to 4% for the full year.

Finally, the strongest piece of our north American construction continues to be renovation rehab, similar to the past number of quarters our IT brands business generated 10% base revenue growth in Q2 thanks to strong sales to box stores such as Home Depot's, Lowe's or the national hardware thanks change.

Moving to automotive, the revenues declined 7% in the quarter versus a 3% gain in the first quarter.

This was directly as a result of second quarter -- of the second quarter drop in north American auto production.

I don't think it'll come as a surprise to anybody that car [bills] declined 11% in Q2.

That, however, did meet our expectations.

We were expecting a decline in the mine minus 10 to minus 11% range.

You can see that we were able to offset four points with the product penetration.

Here are the details of that 11% auto production decline.

GM, which is our largest OEM customer in North America was down 11%.

Ford builds were down 13%.

And Chrysler builds declined 8%.

Looking ahead to the third quarter, we expect builds to be down nearly 10%, and our projections a little more conservative than the 7% decrease currently being forecasted by Ward's automotive tracking service.

However, we remain concerned about the possibility that third quarter plant shutdowns for the new models could be extended out in response to slower auto sales and the need for the big three to bring inventories down to lower levels.

We're still planning a full year build decline of 8%.

So builds down 8% for the full year.

Ward’s, however is calling for a slightly better number of minus 6.

We certainly home hope they are right right.

As to inventories, light vehicles were at a low 70 days on hand at the end of June, better than the 81 days in March and the 97 day inventory level of January of ' '03.

Clearly the cuts in production have helped reduce some of the inventory.

In our industrial products category within engineered products, every business but one had declining base revenues in the second quarter.

Base revenues for the category were down 5% in the second quarter versus 1% decline in Q1.

Our industrial plastics and metals business which serves manufacturers and other industrial suppliers was down 13% in Q2.

We also had base revenue de declines of 8% 8% for engineered polymers business and 3% for our fluid products businesses.

The sole growth business in the category was mini-zip-Pak which saw revenues increase more than 20% in the quarter.

This project sell to the food industry and comes up with exciting packaging application force a growing number of customers.

Let me move now to international engineered products.

For the second quarter segment revenues grew 20.1%, and operating income increased 16.2%.

Even so, operating margins of 14.5% declined 50 basis points from a year earlier period and that was basically due to a write-off we had to take in that particular segment.

Taking a closer look at the top line, the [inaudible] 20.1% increase in revenues consisted of the following components.

Plus 1.5% from base, plus 0.9 from acquisitions, and plus 17.7 from currency.

So that's 1.5 for base, 0.9 from acquisitions, 17.7 from currency.

Similar to North America, the principal business groupings in this segment are construction, automotive and industrial based.

In the second quarter, we generally saw end markets weaken slightly, especially in the industrial-based category.

Let me start with construction first.

Second quarter base revenues were up 1% in the second quarter versus 3% growth in Q1.

By geography the 1% growth broke down in the following way.

Europe was plus 2.

Australia was minus 1.

And Wilson Art International was plus 6.

Growth in Europe emanated from better top line in the U.K. and U.K.

France and Italy.

In Australia base revenues were impacted by a slowing new housing market and slower demand for commercial construction products.

Wilson Art International had another strong quarter as institutional construction activity particularly in China helped grow their top line.

Looking at automotive, our automotive businesses in Europe posted 3% growth in the second quarter versus 4% growth in Q1.

These plastic component and metal fastener center businesses continue to benefit from good product penetration amid a 1% decline in year to date auto production.

Builds are down 1% year to date in Europe.

Looking at that a little bit more specifically, year to date builds were led by GM group.

GM was up 10%.

PUGOT was up 7% and Ford was up 1%.

On the negative side, BMW was down 4% and Daimler Chrysler down 3% and there was a whole host of other companies down to an even greater degree.

For the remainder of the year, we are expecting auto builds to be down 2% to 3%, that’s a slightly more negative build rate than we envisioned last quarter.

The other part of the segment is the industrial based business units.

Similar to North America, base revenue performance for the sub-segment was weaker than the construction and auto pieces.

Base revenues came in at minus 1 1% for the second quarter versus plus 9% in the first quarter.

That substantial swing in base revenues was primarily due to weakening and industrial plastics, which went to -2 in Q2 versus plus 13 in Q1.

Wood products, palmers and electronic packaging saw their top line shrink in the second quarter.

Moving to the system side longer lead times, in North America for the second quarter, segment revenues declined 4.5% and operating income grew 4.1%.

As important, operating margins of 17.1% improved 140 basis points from a year earlier period, thanks in part to easier restructuring comparisons that Jon referenced in his discussion.

Focusing on the top line, the 4. 4.5% decline in revenues consisted of the following.

Base revenues were minus 5.8%.

Acquisitions were plus 0.9% and translation was plus 0.4.

So that's a minus 5.8 offset by a 0.9 from acquisitions and a plus 0.4 from. -- from translation.

It continues to be clear to us that we have not experienced any real rebound for businesses in this segment which rely to a very great extent on cap-ex investments by the companies who our customers.

Our food equipment business continues to be a good example of this.

In Q2, base revenues declined 9%.

And that compares to a 12% decrease in Q1.

Food equipment continued to experience weakness in the two key end markets, the first being food service, which is the restaurant institutional part of the business and the second one being food retail which is the supermarket side of the world.

Food service which accounts to 50% of the North American business. is still being hurt by fewer business and pleasure travelers which impact our sales to hotels, restaurants, cruise ships and the lights.

Food retail, roughly 25% of the business is still feeling the effects of industrial consolidation, and is awaiting a rebound in both capital spending from the larger supermarket chains.

The good news in the second quarter was even with the soft top line, food equipment based income and operating income margins improved significantly compared to a year ago.

Food equipment's base income was up 22% year-over-year and operating margins came in at 17% or more than 400 basis points higher than the year ago period.

This is certainly testimony to the power of past and present 80/20 initiatives.

Moving to the industrial packaging side, we weakened to minus 7% in Q2 versus flat in Q1.

The performance generally mirror mirrored the overall performance of the key markets, general industrial, metals, fibers and corrugated box which continues to be relatively weak.

The trend for [SIG-note] continues to be the same.

Most orders relate to consumable products while orders for machine or systems are practically nil.

Our welding business base revenues were at minus 2 in Q2, slightly better than minus 5 in Q1 and finally our finishing business which is our paint spray operation saw revenues at minus 7 in the second quarter versus a flat performance in Q1.

The impact of fewer auto builds in Q2 coupled with weak demand for industrial applications in such areas as office furniture impact impacted base revenues for finishing.

Moving to the last segment, international specialty systems, for the second quarter, segment revenues increased 17.2%, and operating income grew 8.2%.

Operating margins of 11.6% fell 100 basis points from a year ago and again that's due to a write-down we had in that particular area.

Taking a closer look at the top line, the 17.2% increase in revenues consisted of the following, currency translation was 17.6%.

Acquisitions accounted for 3.1% and base business was a minus 3.5.

So currency plus 17.6, acquisitions plus 3. 1 and base was negative at 3.5.

In our total packaging categories, that includes all of our packaging businesses, base revenues were down 2%.

This was mainly due to SIG-note Europe's performance which saw base revenues decline 3% in Q2 versus a 3% growth in Q1.

The better news is is that SIG-note Asia had another strong revenue quarter this time coming in at 8 plus 12%.

They were plus 10% in Q1.

Similar to North America, any demand we're getting for SIG-note products relates to steal and plastic consumables rather than machinery.

In equipment international, revenues why -- abut as we said for many quarters, the story is operating income and margin improvement based on 80/20 programs.

Food equipment's operating margins of 14% were 120 basis points higher than a year ago period.

And that's on revenues as I noted before of minus 1 for the quarter.

Finally, our finishing businesses produced based business revenues of plus 1% in Q2, versus plus 2 in Q1.

The finishing business is generally served the automotive and general industrial sectors in Europe.

The modest decline in auto builds in Q2 slightly impacted the financial shing top line in the quarter.

This concludes my formal remarks on the manufacturing segment.

Let me return to Jon who will talk about our forecast for the year.

Thank you, John.

At the beginning of this year I started my 2003 forecast discussion with an expression of concern regarding the strength and sustainability of a potential recovery.

In the first quarter our base revenues declined more than we forecasted which reinforced these concerns -- finally, the second quarter base revenues came in at the low end of our forecast range.

In spite of any economists calling for a second half recovery, we remain concerned about the prospect for a meaningful recovery.

Incorporating down size for these concerns into our forecast, we are forecasting third quarter income per share from continuing operations to be within a range of 77 to 87 cents per share.

The low end of this range assumes a minus 5% decline and base revenues and the high end reflects a minus 1 decline in the base.

If we hit the midpoint of this range of 82 cents per share, we will be 4% higher than last year year's third quarter.

For the total year, we have narrowed the forecast range to 312 to 332 per share.

The base revenue growth supporting this forecast is expected to be in a range of minus 4% to minus 2% overall, if we hit the midpoint of this range, full-year income from continuing operations would be 7% higher than last year.

We believe this would be a solid performance with a minus 3% in the base revenues.

If the economy continues its slow improvement as we forecast, income per share could be up 10%.

If the economy declines further to the low end of our range, we believe we can still increase earnings 3%.

Our basic assumptions over and above base business forecasts including in this forecast are as follows, we believe exchange rates will hold at June 30th levels.

Acquired revenues would be in the range of 200 million to 600 million.

Restructuring costs would be in the range of 55 to 60 million, no further good will or intangible impairment costs for the balance of the year, no significant market to market adjustments in our leasing and investment segment, and lastly, holding the tax rate at 35%.

Okay.

John back to you.

This concludes formal remarks remarks.

We'll open the conference call to questions.

Thank you, sir.

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

If you would like to ask a question, please press star 1.

You will be announced prior to asking your question.

To withdraw your question, you may press star 2.

Once again, if you would like to ask a question, please press star 1.

The first question comes from Mr. Deane Dray with Goldman Sachs.

Sir, you may ask your question.

Are you there?

Barbara?

One moment, please.

Mr. Dray, your line is open.

You may ask your question.

Am I on line here?

Yes.

Sorry about that.

A question related to leasing and investments.

Can you remind us again about the lead time that you have in which these gains are recognized and what the forecast is [inaudible]

Well, the principal volatile item is the swap agreement that we have, which is a hedge agreement for us, and it is a function of what interest rates are doing, and also forecasted cash flows on the associated properties covered by the swap.

On the interest rate issue, we were able to read that, you know know, as time goes through the month, we'll see interest rates at any point in time, but the larger driver, although interest rates probably accounted for 10 to 12 of the $40 million, the rest of it was due to forecast reductions and cash flows on the properties, both operating cash flows and disposition proceeds.

These cash flows are forecasted by our counter party to this agreement, and we get those quarterly but a little late in the process.

We -- as a result, I believe in May, as we looked at these numbers, we knew our base business was soft, but we also knew that there was a strong potential for gains in L & I because interest rates had been falling and the commercial property market had been softening a bit.

So we, I believe, put in roughly $20 million gain or 4 cents a share into our May forecast.

So, we at least had our month to get some rough estimate into the numbers, but believe me, it's a fair number crunching exercise at the end of the quarter, and it's something we used to do pretty much on an annual basis, until the fourth quarter of last year where we recorded a market to market gain in -- not that we got caught completely off guard, but, we didn't quite expect that much, and we -- I think we said at that point in time, we're going to monitor this closely, as we did in the first quarter, we booked some small market to market gain, mainly at a function of interest rates, and then in the third quarter, we did a full analysis.

Just two follow-ups.

One is VIN46.

Will that be an impact?

And what happens when interest rates move the other way?

What sort of exposure do you have there.?

On the FIN46, for those of you who are not particularly informed on this, this is a new financial accountings board interpretation of the consolidation policy of companies, and it basically -- the old rule for consolidation was what the legal agreement says relative to ownership, and the new rules say who in the agreement has the majority of gains in and the majority of risk associated with the contracts.

That's the person that's supposed to consolidate these liabilities and assets.

In our case, the legal ownership was ours, so it was clear that we were consolidating it, and -- but when you look to the substance of who bears the most risk and who bears the most rewards, it is our counter party party, so our counterparty is going to consolidate our mortgage-related assets and liabilities and we will show these assets and liabilities as a one-line investment.

Said simpler, we will take our debt of roughly $600 million, our non-recourse debt and we will net that against our $972 million dollars in mortgage as assets.

The -- so that's going to happen for sure.

We are now -- we have been doing the accounting for leasing and investment each piece of the contract that's on our books, the swap agreement the mortgage loans the properties, so on and so forth, we've been accounting for those individually in accordance with the accounting rules for each of those types of assets and liabilities.

We intend to account for this as a single contract, in accordance with the accounting as a one- one-line item.

We -- it's not clear in the accounting literature what is the exact method.

It's not like depreciation policy.

For sure it's more complex than that, but we have talked with our auditors relative to what we believe is the appropriate way.

We're going to the SEC with the preclearance because of the newness the FIN46 and the lack of clear, clear guidance on this this.

If we get approval on this, the volatility of the accounting for LNI will be significantly lower than it is today because all pieces of the transaction would be viewed on their future cash flows and discounted to one number versus today's rather disjointed treating the swap as market to market and treating as assets as cost and market type assets, so on, so forth.

So I wish I could be more clear, but that's the essence of where we're at this point.

Is there any restatement to that?

And when is it effective?

It's -- the deconsolidation is effective this quarter and no no, there is no restatement.

Great, thank you.

The next question comes from Mr. [Blaine Martyr[ with [Seminole] Capital Partners.

On earnings guidance I thought previous guidance assumed base revenues down 3 and $3.02 and now the midpoint is down 3 and 3.20.

Am I missing something?

Have you taken up your margin expectation?

No, what's happened is the base business softened, right?

Softened below what we have forecasted.

We have forecasted starting this year, that the year would be essentially flat, and while -- now we're seeing the business down 3%, but on the positive side, two things have happened.

We've had translation increase, that's added about 11 cents a share, and we've had a market to market adjustment on our LNI and that's added 8 cents a share.

So the two of those, 19 cents a share offset the softer based business which is about negative 19 cents a share.

Okay, fantastic.

Thanks.

The next question comes from Mr. Joel Tiss from Lehman brothers.

Hey guys.

Can you give us a sense of why pile up the cash as opposed to paying off the debt and what kind of return are you getting on it.

We're not getting a high return.

Cash is pretty cheap these days.

We have talked about this before, our preference is to use that cash to acquire companies.

As you see, our first half has not demonstrated a big active program.

I should also say that we have enough companies on our list that could argue for not only a $200 million a year, but in fact a $400 million a year if we could make it come to pass.

So, the acquisitions, this is the second year of slowness in this area.

We don't think that -- we don't this we've lost opportunities here.

If we are disciplined on our pricing and we're still looking to -- and believe that the acquisition program will come back into its own.

If we go another year and that's not the case, in the process we have looked at everything from taking down debt to repurchasing shares.

We're not ready to pull the trigger on that yet.

Okay, and then the weaker free cash flow, is that from the operations being weaker?

And can you give us a sense of your guidance for the full year, if that's changed?

The weaker cash flow relative to last year?

Yes.

Yeah.

We have some modest increases in working capital, receivables being the major item, we picked up one day on receivables, but that's -- the real driver on the receivable issue, as I looked at it, was our April, May, June numbers were very, very flat, all three months being about the same, this year, April, May, June-- June if you will $80 million, all of which went into receivables.

So there is nothing there that concerns me.

I think it's more a sales pattern, difference, and hopefully that increase we had in June, that's a positive sign, although the word around here is one month doesn't make a trend.

So we'll have to see, but that's the main reason.

And for the year, I'm still in the 80 to -- -- depending on what happens to growth here, 80 to 90% of income should drop into pre-cash.

Okay, thank you.

The next question comes from Mr. Andy Casey with Prudential Equity Group.

Sir, you may ask your question.

Good afternoon.

Just to follow-up on Joel's question on that receivable up-tick, was that mainly in the North American businesses?

It was -- it was mainly in the north American business, right.

Okay.

In the described rest [inaudible] decrease of 3% versus a slight drop in housing starts, is that a traditional relationship or do you perceive the contractors were decreasing inventories of whatever they were holding?

I'm sorry, Andy just say that again.

You were talking about --

Yeah, the 3% decrease in your engineered products North American construction related to residential, and that's versus something less than that, about a percent or so, in housing starts.

Is that a traditional relationship that there would be that, you know, almost doubling of a decrease?

No, I don't think so.

These numbers can be skewed quarter to quarter based on different selling programs and, you know, based on, you know, different end market activities, but, typically, we get better penetration as we do in auto.

We get better penetration which would help offset some of that -- some of the new housing builds.

Okay, and then skipping to the international businesses as engineered products and specialty system.

You mentioned in the discussion of the operating margin differential, year over year, a write-off in both cases was that 50 days basis points in Engineered Products International?

And did that account for the specialty systems drop-off as well?

Well, we had -- they contributed to the decline.

The write-offs were in the [inaudible] of 3 to 3-1/2 million dollars in each case.

What were they for, Jon?

One was for Hungarian auto component supplier.

We had transferred some business to Hungary and set up a manufacturing facility there.

And the accounting went a little awry and the inventory walked off the back door a little bit, so we've taken the appropriate steps to stop that.

We caught it, I believe reasonably early.

And then the other margin one was a product liability issue.

Surpriseingly related -- stretch film related to bailing of hay in the U.K.

We're everywhere doing everything.

No kidding.

Just lastly within that North American receivables up, is that related to any specific business or was that just across the board?

I think it was more across the board than it was in any specific segment within our segments.

Thanks a lot.

The next question comes from Mr. Gary McManus with J. J.P. Morgan.

Sir, you may ask your question.

Jon, I want to make sure you got this right.

When you said on June 13th you do 85 to 91, you were including a 4 cent positive impact from LNI?

Yes.

You actually got 6?

We got 8.

For the second quarter? 8 above what you were first expecting?

Right.

We had originally nothing in there, right.

We had no gain in there for leasing and investment in the second quarter.

And it was in May that we really zeroed in on what we thought the impact could be on a market to market and we factored in four cents, but the number came out to be $40 million or 8 cents.

Okay.

The -- the lack of pickup in acquisition activity, previously you were mentioning-- hinting that the pipeline was getting better and just kind of tell us why didn't we see a pickup in the acquisition activity?

Did the potential acquisitions go away?

Are you still in negotiations?

Do you still feel confident that a pickup is possible near term?

Oh, I'm still -- we -- it's timing on closing.

I know we've got a hundred million dollar one in the wings that is close to closing, and we still have, you know, 300 or so million’s worth of businesses on that list that, interests there is no certainty for sure, but we're still feeling good about what we're working on.

Okay.

Just last question is on your third quarter guidance, how much of -- you said you are holding currency constant.

How much of a pick up will there be on earnings per share and LNI, would-- there be a positive or negative third quarter year over year now that you are going to account for it differently?

On the translation question, I believe it'll be 4 to 5 cents a quarter in the next two quarters, holding exchange rates constant.

And on LNI, LNI will be, we think negative to us in the neighborhood of -- I don't know what all is in last year's numbers when gains appeared or not.

Fourth quarter we had a market to market adjustment also, but you can figure leasing and investment in the 13 to $15 million range for quarter.

Negative pretax profit?

No, that's apparent tax profit.

Aren't you going to count -- under the new way of accounting for it under the cash basis?

No, the new way of accounting for it will be a market to market adjustment, but it'll be a much more stable one.

And we still believe it's going to produce a similar type of income number, but you won't have some of the big market to market adjustments as you had this quarter with the swap.

The $13 to $15 million pretax better quarter.

Uh-huh.

Thank you.

Sure.

The next question comes from Mr. [David Rasso] from Smith Barney.

Both Johns, the balance sheet question, the acquisitions are critical to your growth given the core growth of the business is not that terrific?

If you're looking at acquisitions at a period pretty soft in the next six months, six months ago we said, well, at the end of the year, cash keeps piling up, you know, we'll think about something.

The stock at these levels, we can discuss share repurchase, but what's the holdback giving cash back to your shareholders?

The way the balance sheet is structured, you can do deals bigger than you've done -- you can do another Pre-mark probably.

What's the holdup of getting cash back to your shareholders?

There's not a holdback, other than we think that the shareholder is in a better position if we use the money to acquire businesses.

That's --

What is the balance sheet structure you would deem ideal given how low interest rates are right now, and what you are seeing on the acquisition front?

I would not mine seeing a cap in the 30% to 40% range.

Shall we then expect that your looking to make acquisitions equivalent to that gap where you are today and what you think the ideal balance sheet should look like?

We definitely look at larger acquisitions.

We've been through a few this year that are in the billion plus range.

We've just not connected yet with something that we believe makes sense for us, but we continue to look at major acquisitions as well as our bottom-up acquisitions.

Can you give us any insight into the type of businesses you'd be looking at or end market exposure that you'd be willing to take on with an acquisition of that size?

You know, it's -- no.

Not really.

Consumer versus industrial?

No, they tend to be more industrial businesses or business to business sales.

That could be -- that clearly is the sweat spot in this business.

We're not out looking at, you know, things that are too far [inaudible] field from that area, so that's that's -- but -- when I think of the business that is we have looked at, it's been a pretty diverse group in terms of product and customer base.

As a follow-up, the comment you made, again now six months later--again still saying a year from now, if things don't change, your dividend yields are still below 1.4%.

The average is peer group, However, how you want to define that group is up to you, but roughly 2, 2.1%.

Can we at least expect to get back to peer group.

There are no plans at this point to do that.

It's not to say that we're not, but there's nothing in the works.

I mean, we continue to assess our options and discuss with the board what our options are, but but --

And when is the next board meeting?

The next board meeting is august.

August.

David, I would answer the question this way.

I would add to what John is saying.

If you look at the performance of the company over the last so 10, 15, 20 years, the formula has been one where we've been focused on growing the base business and acquiring underperforming companies and turning those into higher performing companies and really driving return on invested capital.

I don't know -- in your mind, what you think an ideal balance sheet is, but that's -- we're not primarily focused on what the ideal balance sheet is.

We're trying to --

You are down 12% relative to the market this year.

You are looking at it in a shorter period of time.

I think we could argue, if you want to look at five years, if you want to look at six months, I can't disagree with you.

Well, John, what is it you've used before, certain percent of your last three years, net income that you would be willing to pay out.

25% of the trailing 3 year.

Roughly 20% payout.

Is that 20%?

Right.

And we have reinvested strongly 80% of our -- and sometimes a lot more than 80% of our free cash on acquisitions and supporting the base revenue growth.

But we're in a very prolonged recession, as you are all aware, and it doesn't make businesses attractive.

It's not attractive for the businesses to sell, and it also makes as a result makes pricing a bit more difficult for everybody.

We think that's easing up a bit, but

The net takeaway, you must feel your acquisitions will pick up very materially in the next 12 months relating to those comments.

We believe that.

I appreciate it.

Thank you.

The next question comes from Mr. David Bleustein with UBS, sir, you may ask your question.

Good afternoon.

Hi David.

Back to acquisitions.

Are we comfortable with the prices of the targets out there or has the recent run in the stock market emboldened some of the sellers?

It's a situation by situation basis.

We've never had sellers willing to just rollover but we've -- we go back a year or so ago, we've had sellers come in with really their head in the clouds in terms of what they think they could get from the business.

We think that's come back down to earth a bit.

David, remember that these sellers tend to be privately held, family owned companies that are less effected, less impacted by capital markets.

There is obviously some relationship, but there is not a direct relationship.

We're not dealing with a lot of publicly held companies, which could drive -- it could drive pricing a little bit higher.

The follow-up, you mentioned a $12 million investment.

What was that in?

[inaudible] 12 million investment.

In your use of cash segment you talked about --

Well, it was an increase in our investment account on the cash flow schedule.

If you look at our investment line, I think it's up 20- 20-something million, and that's the that -- -- that's primarily the step-up on our market to market adjustment on our swap asset.

That's classified in the investment account.

If we did make any investments, the $7 million would probably be excluding what I just mentioned, and I can't think of anything offhand.

We -- you know, we've got lots of things going on in LNI other than this mortgage property.

You know, we've got some housing projects and so on, so forth.

We've made no significant investment.

We might have had to advance more cash into that area, but nothing that I can recall at this point.

Is that an area we should expect to see accelerated levels of cash deployed?

Or not so much?

It's a very opportunistic area for us.

We do not have any set targets to grow that area of the business.

We have opportunities presented to us pretty regularly, but we've got a pretty tight screen.

We want the returns on that, whatever we do in that area, to be minimum risks and returns in line with our returns on our manufacturing side of the business.

And that, I think, when we talk about this area, particularly the mortgage-related investment properties that we've done and the various agreements that we've established to protect ourselves relative to volatility in this area, have really served us well over the last few years.

There's been some little Hick-ups, probably more on the upside than on the downside, but overall, we're north of 20% returns on our investment after tax, and we think that's, you know, it's not something we're going to go out and actively grow.

We don't believe there is all that many opportunities around that cab do that, but to the extent it plays to our tax position, and we can get the types of agreements we want, we'll continue to play in that area.

But to grow it, it's too opportunistic for me to put up. -- you know, put a number to it.

And my last question is, have you looked at any acquisitions that would have stretched your balance sheet even mildly?

Sure.

Terrific, thanks.

The next question comes from Mr. Peter Thompson with [inaudible].

You may ask your question.

John, this is one I think I misunderstanding you had.

I thought I heard you do $60 million in deals and then after that you said you bought six companies for $35 million in revenues and it cost you $29 million.

There is a little bit of disconnect on a year to date basis, the answer is the same, but the disconnect is when we're measuring acquisitions, the disconnect is that our international operations are on a one-month lag.

So the second quarter ends in May.

When we count acquisitions and so on and owe so forth, we count through the end of the quarter, whether they are made international, as of June 30th 30th, whether they are international or not.

I've got you, I'm sorry.

So we have particularly on the cash flow statement where we reference this, there is a little bit of separation there, but I assure you that in total, the cash flow and cash flow statements are what we paid in the aggregate dollars for two quarters is what we've --

So for the first half, then, your year to date cash spending on deals is a little over $100 million?

Is that right?

Right now it's about 75.

So it is this 29 number?

Yeah.

Okay.

Great.

Sorry to bother you.

Thank you.

The next question comes from Mr. Robert McCarthy with Baird.

Sir, you may ask your question.

Hi, guys.

I want to ask you some clarifying questions, including about the one that you just answered.

Okay.

You want clarification on that?

Rob, you still there?

Kristine, I think we lost him.

One moment, sir.

Can you hear me now?

I can hear you now.

Okay, I'm ready for TV.

On your acquisition table, you saw 74 million paid year to date date?

Yes.

It shows $30 million in the second quarter.

Statement of cash flow shows 59. 59.5

Yeah.

Go ahead.

One of these must not be for the second quarter.

That's what I'm not following.

The -- let me, I know the $74 million year to date is the same on both schedules.

It's on our cash flow schedule and on the slide that we showed you, right?

Yeah.

And the quarterly differences is due to the difference I just said.

Whether it was -- if it was an international company it might have been accounted in the -- counted as we count acquisitions and sales purchase, we go on a calendar year, not on a one-month lag basis like our international business.

Okay, all right.

I can follow-up with you if I don't get it.

Let me ask you to clarify a couple other things.

Jon, when you were talking about the 19 cents change in expectations because of disappointing organic growth with the 11 cent offset from currency, was that the change year to date or is that the change in the full year number, year to date?

That is in -- I believe that's a full-year number I gave you.

Okay, so your outlook now for the full year indicates 19 cents less

For base.

I understand.

As opposeed to where you started the year?

Yes, right.

Offset by -- right, translation and LNI.

And when you say that you're using currency translation at the end of June, is that what you mean?

Or do you mean the end of the accounting period, end of May?

Probably end of May, yeah.

And to make sure that I understand the accounting issues issues, surrounding or how you're going to handle the accounting on FIN 46, you are going to -- what you are telling us, I think, is that you are going to have equity of earnings of an unconsolidated affiliate, which --

Yeah.

Which you will then that equity and earnings interest will go through the LNI segment reporting?

Yes, that's right.

Okay.

That's right.

And unless I'm mistaken, and and -- okay, so the 13 to 15 is supposed to be sustainable -- well, never mind.

There will unless I'm mistaken, there will be no affect on shareholders equity by the change in accounting?

There could be.

There would be a change in accounting PNL item and we think it would be an income item.

Or an increase to equity.

So we would have a change in accounting principle.

Let me ask one real question, if I may.

Food equipment, North America, first half -- I'm sorry, first quarter was down 12 or 13%, based unless I'm mistaken, second quarter 9?

That's correct.

I mean, what's really going on in terms of the year to year comparisons?

Because, you know, it looks like it's getting better.

I kind of wonder if it is.

And you know, I talk to the food equipment guys just other day.

Their sense right now is things don't look materially better, they might be a little bit better, but again, we need another month to see what's happening, particularly in North America.

Don't I remember that the second half of last year was particularly weak in that business?

Yes.

Which would then imply that if it's at least going side ways, and -- going sideways.

Comps will be easier.

Thanks.

The next question comes from Mr. [Mark Kosnarnik] with Midwest Research.

Sir you may ask your question.

Good Afternoon.

A question on Pre-mark.

You said it was 15% margin.

Could I ask you what that would have been a year ago.

For the first half a year ago ago, I don't have that -- the first half.

You just have a full-year number?

Yeah.

I know for the full year last year it was 12.9%.

Well I guess, if I could follow up with that detail off line, but the concept is, it seems like overall the manufacturing margins here were down 60 basis points and then you know, adding back your pension and shares and all of that, it's down 20, and it seems like Pre-mark has swung maybe 200 basis points or so positive, meaning your base business is really taking it on the chin from a margin standpoint.

I'm just wondering if you can talk generally about what's going on or, you know, if it is specific to certain businesses.

It seems like a big disconnect between the performance of the two.

Let me just grab my own margin page here.

I think -- I can't answer your question specifically because it would take a little bit of noodleing with pencil and paper, but I know Pre-mark's improvement has been a nice contribution to our margin gain, but our non-volume related margin improvement was in total for the company was 40 basis points, and that's in spite of the pension increase and in spite of the restricted share increase and if you add that on, that's 80 basis points, and then with re restructuring, that's 100 basis points lower.

And I know that's not all Primark.

I know that because I know the restructuring act sift may be a third of -- activity, a third of it has been related to Primark and two-thirds of it is related to other acquisitions that is we've done, as well as base businesses continuing to improve their business.

So, I really can't specifically answer what you are asking.

I guess I'm wondering if there is unusual leverage in some of your base businesses, you know, you called out automotive, for instance in the EP North America, as, you know, being impactful to the margin there.

You know, are there some areas where if you get minor volume changes, it really makes a big difference in margin or is it more than that there is this ongoing restructuring or some other non-volume related things.

No, our variable margins, which really drive the leverage effect are, nothing is uniform around here, but they are not all that different from business to business.

You know, we're in that 35 to 45% range on variable margins, and yeah, you can have a little bit of mix effect, but, no, I don't -- I haven't seen in this quarter any, you know, any one going stronger than another.

Our margins have been year over year variable margins have been pretty -- they've increased a little bit in aggregate.

So, no, I don't I don't think what you said is, you know, do we have one segment that really leverages much stronger than others others.

I don't see it.

Okay, I'll follow-up off line line, one remotely related question, is any signs of that encouragement so far in July?

No, too early.

Nothing that's really tangible, Mark.

Thank you.

The next question comes from Mr. John Inch with Merrill Lynch.

You may ask your question.

Hey thanks, and let me make a suggestion…You guys need to enforce the one question, one answer rule, especially with people and their private discussions here.

I agree.

I have a question just as it pertains, John and Jon to the prospects for rising interest rates, intermediate and longer term rates.

What does that do prospectively to the LNI segment in terms of its future profits?

Is that a potential head wind next year?

Under today's accounting, yes yes, it would be a potential head wind, a bit.

Now, we, you know, I've said the impact on the quarter, and the impact on the year, really, because a market to market adjustment reflects a rate change.

I would imagine -- and we didn't have a full point change, but let me just refresh my memory on just how much that was.

It was -- a full point would probably cost us in the neighborhood of $20 million.

If -- under today's accounting rules.

If we get the type of accounting that we think is appropriate for this transaction and we get the clearance from the SEC, so on and so forth, there would be no effect.

Just a follow-up.

The one business that caught my eye was SIGnote internationally down 7% versus kind of flattish.

Do you think that's an aberration or should that strapping business -- is that telling us something?

I'm wondering how you guys interpreted that number.

Well, John, when I look at the number for North America, I put more credence in it because it's a bigger number, but if you look at it internationally, you're looking at lofts lots of different geographies and end markets.

They are selling in Northern Europe central Europe, Australia, they are selling in India.

So it's really hard to get a fix on what that means as it relates to specific end markets, but I think generally speaking, the majority of their revenues are more European based and it underlies the fact that the economy is -- the economies in Europe have softened.

U.K. and France, some of the numbers I referenced before things have gotten a little bit weaker there there.

And industrial production numbers are down and our SIGnote numbers track industrial production.

Great, thanks, guys.

Next question comes from Mr. Andy Casey with prudential equity groups.

Sir, you may ask your question.

Thanks.

One additional question on FIN96 discussion.

Would that have an impact on the tax rate guidance?

No.

No, it shouldn't.

And then a follow-up on John John's question, SIGnote North America.

Did the trends there on the consumables get better or did that stay pretty flattish?

Stayed pretty flat.

The next question comes from Mr. David Rasso from Smith Barney.

Looking into the improvement we've seen, especially the second quarter in specialty systems in North America, can you give us some help looking out in the next couple of quarters, how much of the improvement in food equipment in essence is sticking on a year over year basis?

And the margin gains we've seen year over year in the second quarter, are those representative of what we should expect for a third and fourth quarter?

I can't give you the exact margin numbers, if you look at it conceptually, the play at food equipment has not been a top line play.

I mean, they've been de-leveraged on the top line, and they've been able to improve operating margins pretty significantly by restructuring their businesses, by taking costs out, by attacking at overhead, we talked about David.

I expect you'll turn to see improvement in margins in food equipment, if things were to stay the same, if they were still down 8 to 10%, I would expect that you would see considerably higher margin improvement, if sales were to get somewhat better, and you would see dramatically higher margins if things got a lot better.

Obviously --

I don't have any numbers to share with you.

No, and the comparisons do get harder as we go into the latter half of the year.

I mean, Primark was making food equipment, particularly was making progress as they went through 2002, and we've so, and we've done some good re restructuring projects so on, so forth and there's more forthcoming, but if you purely went on their forecast, the second half would not be as robust from a margin gain as the first half.

That's helpful.

Thank you.

The next question comes from [Turoon Kana] with Wellington.

You may ask your question.

Hi Jon and John.

Just wanted to clarify one thing that you said early in the conference call.

I think you indicated ought automotive build rates are expected to be down 10% in Q3.

I wondered if that was the correct statement and can you give us some color around that, what's driving that.

Is that an industry or --

That's what we said was that builds, we expect builds to be down 10% for Q3.

That's an ITW estimate.

And the -- I would say if you asked anybody else or a lot of other people in the industry, they would expect something a little less negative, something closer to 7% down.

And what do you think is the driving force behind the 10% decline.

Is that led by the U.S. companies or is that a global phenomena?

I think it's more U.S. based and it’s the OEMs and the fear 1 1s and tier 2s.

OEMs are the particular -- we referenced before with when we get into that third quarter when they start to do plant conversions for new models, that they continue to ramp those out further and close them down longer so they can take production down more if that sales have not been robust.

I guess we always tend to be a little bit more conservative than most, but we've been that the business a long time, and we've seen the good, the bad and the ugly, and we think there's potential for, you know, lower, you know, more reduction in builds.

Than what you are hearing from other people.

Thank you very much.

Uh-huh.

Once again, if you would like to ask a question question, please press star 1.

One moment, please.

At this time, sir, there are no further questions.

Okay, well, we thank you for your joining us on our call today.

We look forward to talking to you again.

Many of you later today.

Take care.