Illinois Tool Works Inc (ITW) 2005 Q2 法說會逐字稿

Good afternoon, and welcome to the ITW 2005 second quarter earnings release conference call.

At this time, all participants are in listen only mode. [Operator instructions] Today's conference is being recorded.

If you have any objections, he may disconnect.

I will now turn the call over to Mr. John Brooklier, Vice President Investor Relations.

Thank you, Julie.

Welcome to ITW is a second quarter 2005 conference call.

I'm John Brooklier, ITW's VP of Investor Relations.

With me is Jon Kinney, our CFO and Ron Kropp, our VP and Controller.

We're pleased that you could join us for today's call.

By now, most of you have seen our financial results with which produced the following year-over-year comparisons.

Revenues increased 10% and diluted net income per share grew 11%.

While our second quarter operating margins declined 150 basis points on a year-over-year basis, a substantial portion of the decrease was tied to the anticipated leasing and investments $42 million or 87% decline in income from the year-ago period.

We'll talk more about this more later.

Here is the agenda for today's call.

Ron Kropp will join us shortly to provide more details about our second quarter results.

I'll then come back and update you on our 4 manufacturing segments and associated end markets.

Jon Kinney will address our 2005 third quarter and full year earnings forecast.

Finally, we will open the call to your questions.

Please note that I will strictly enforce the one question, one follow-up question rule and what we have in place in the past, also if a question has been asked and answered we will move on.

We're targeting a completion time of one hour for this call.

Moving to the next slide, a few normal housekeeping items.

I would like to remind everyone that this conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including without limitation statements regarding end market conditions, acquisitions, base revenue and future tax rates expectations for full year '05 and the Company's related earnings forecast.

These statements are subject to certain risks, uncertainties and other factors which could cause actual results to differ from those anticipated.

The risks are spelled out on this slide and are part our form of our 10-Q for the 2005 first quarter.

Finally, the telephone replay for the conference call is 203-369-1470.

No pass code necessary.

This will be good until 12 midnight on August 4, 2005.

As always, you can also access our webcast PowerPoint presentation on our itw.com website.

The presentation can be found in the Investor Information section.

Just look for the earnings presentation tab.

Before we proceed further, I wanted to take a few moments to remind everyone that Jon Kinney, our CFO, will be retiring in early August.

Today is Jon's last call.

The noise you heard was a big sigh of relief from Jon.

On behalf of everyone, Ron and I wanted to express our gratitude and thanks to Jon for his 32 years of service and contributions to the company.

For those of you know Jon he is one of the talented good guys in the business.

His accomplishments as CFO include implementing significantly more transparency in our financial reporting process and the development of base revenues as a way for you and us to track the progress of the company.

He is also one of the few CFOs that I know who has extensive interests outside of work, including a huge and varied reading appetite, a prodigious green thumb in his garden, and a love of art collecting and travel.

I know that Jon will not want for things to do in retirement, but we will miss him nonetheless.

Again, thanks, Jon, for all you have done at ITW including hiring both Ron and me.

Now, I'll turn the call over to Ron Kropp.

Thanks John.

I echo John's comments regarding Master Kinney here.

He has been a great person to work for for 12 years, a good mentor and a good friend.

The highlights for the second quarter are as follows.

Revenues grew 10% versus the second quarter of last year, but this growth rate was lower than the 13% growth rate in the first quarter.

Operating income was up only 1% versus the prior year due primarily to lower income in the leasing and investment segment. (ph)

Operating margins were down 150 basis points versus last year.

Diluted income per share from continuing operations increased 11% versus last year.

Free cash flow continued strong at $433 million for the quarter.

Return on invested capital was 18.9% for the quarter, which was 110 basis points lower than last year.

Now to the details.

Our 10% revenue growth was primarily due to four factors.

First, base business revenue grew 4%.

This growth rate was 210 basis points lower than the first quarter, primarily due to slowing growth for both our international and North American businesses.

Secondly, currency translation added 2.9% to revenue growth.

Third, acquisitions added 4.4% to revenue growth which was 180 basis points lower than the first quarter.

Fourth, lower revenue from leasing and investments reduced revenues by 1.4%.

Overall, our 10% revenue growth was a result of a solid but moderating base business revenue growth, continued positive currency translations, and the impact of acquisitions, partially offset by less activity in leasing investments.

Our 4% year-over-year base business revenue growth was made up of a 5.6% increase in North America and a 1.4% increase internationally.

In North America, the 5.6% increase was 110 basis points lower than last quarter.

Internationally, the 1.4% increase was 350 basis points lower than last quarter.

John Brooklier will provide more details on the operating results when he discusses the operating segments.

Turning to operating margins, we experienced 150 basis point decrease in the second quarter compared to last year's second quarter.

Two-thirds of this margin decrease is due to the decline in the high margin leasing investment income which reduced margins 150 basis points.

In addition, both acquisitions and high restructuring costs diluted margins 30 basis points each.

Margins for the base business has increased 10 basis points as margin increases of 80 basis points due to operating leverage were mostly offset by margin decreases of 70 basis points due to non volume related items.

This non volume related margin effect primarily relates to the continued impact of raw material cost increases.

The unfavorable margin impact related to material costs of 70 basis points has lessened from the margin reduction of 150 basis points related to this issue in the first quarter of 2005, as a result of our continuing efforts to raise prices to cover our costs increases.

In our leasing investment segment, income was $42 million lower than last year, mainly due to lower income related to the mortgage and venture capital investments in 2005.

In the second quarter of 2004, there were gains on the sales of mortgage properties of $20 million, venture capital income of $10 million, and gains of the sales of properties of $5 million.

In the non-operating area, interest expense increased 8.5 million from last year, primarily as a result of higher U.S. borrowing for acquisitions and share repurchases.

Other income and expense was favorable by 3.4 million primarily due to highest income overseas and lower losses on the disposal of fixed assets.

The effective tax rate for the second quarter declined to 31.6% vs. 34% the prior year.

The year-to-date tax rate of 32% was reduced from the 3.25% rate used in the first quarter.

Turning to our invested capital.

Total invested capital declined 162 million from the first quarter, primarily due to translation effect and lower inventory levels.

Inventory levels improved from last quarter to 1.8 months on hand and accounts receivable days sales outstanding improved to 58.3 days.

Capital expenditures for the quarter were $81 million, and depreciation expense was $75 million.

On the financing side, we decreased our debt 90 million from last quarter, primarily due to strong free operating cash flow and cash repatriated from overseas, partially offset by cash used for share repurchases.

As a result, our debt to total cap ratio decreased from 19% to 18%.

During the second quarter, the U.S government issued detailed guidance regarding the repatriation of foreign dividends under the new tax law.

We still expect to repatriate at least a total of $750 million in foreign dividends for the year.

As of the end of the second quarter, we have repatriated approximately 300 million.

Our cash position decreased 194 million in the second quarter, mainly because our strong free operating cash flow of 430 million was more than offset by cash paid for share repurchases of 383 million, dividends of 81 million, and debt repayment of 87 million.

As you know, our board of directors approved a 31 million share repurchase program in the second quarter of 2004.

During the quarter, we repurchased 4.5 million shares at an average price of $85.19 per share.

For the repurchase program to date we have spent 2.3 billion to acquire 25.5 million shares.

We expect to repurchase up to the full level of authorized shares by the end of 2005.

Our second quarter return on invested capital of 18.9% was 110 basis points lower than last year.

This decrease was a result of higher invested capital, mainly due to acquisitions over the last 12 months and the effect of leasing and investment.

Considering our cost of capital is in the 9 to 10% range, we continued to expand the economic profit that creates shareholder value.

Finally, on the acquisition front, we acquired three companies in the second quarter which have annual revenues of 36 million.

For the first six months, we have acquired 6 companies with annual revenues of 187 million.

We believe our current acquisition backlog is adequate to achieve our planned range for 2005 for acquired revenues of $600 million to $800 million.

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

Thank you, Ron.

Before I talk about our manufacturing segments let me spend a few very brief moments highlighting some North American and international economic data we track on a regular basis.

In North America, the two most salient numbers we focus on are ISM and industrial production data.

The numbers remain a bit mixed but on the whole suggest an environment of moderating but sustainable growth in North America.

While the recent ISM numbers actually moved up to 53.8% in June from 51.4% in May and broke a six months string of ISM declines, industrial production excluding technology for May came in at 2.4%, 2.5%.

That is down from 4.1% for full year 2004.

Internationally, the picture is a bit more bearish.

Euro-zone Purchasing Managers' Index in May was at 48 9.9%, down from the 51.4% number in December 2004.

Euro-zone Industrial Production totaled 1% in the most recent reporting month.

Our spotty European results in the second quarter appeared to support these less than bullish purchasing managers and industrial purchasing numbers.

With that as backdrop, let me move to the next slide.

I will begin by reviewing our four manufacturing segments starting with North America Engineered Products.

Segment revenues increased 12.7% and operating revenue grew 14.5% in the second quarter.

Operating margins of 18.2% were 30 basis points higher than the year-ago period, suggesting to us that we continue to make progress in a variety of businesses, including automotive, on raw material prices price increases from past quarters thanks to ongoing price recovery initiatives.

Looking more closely at second quarter revenues, the 12.7 growth in revenues consisted of the following; 2.9% from base revenues, 9.5% from acquisitions, and 0.3% from translation.

Moving to the next slide, let's take a closer look at the business units in this segment.

Total construction grew base revenues 2% in the second quarter.

Specifically, ITW Construction, those would be our tool and fastening units, grew base revenues 7% in the quarter.

By channel, new housing grew 2%. renovation increased approximately 10%, and commercial construction rose approximately 6% in the quarter.

We continue to watch ourcommercial construction businesses for any meaningful signs of rebound, but to this point, growth has been in the 4% to 6% range in the past three quarters.

Wilsonart base revenues declined 2% in the quarter as commercial demand for their products remained tepid.

Basic laminates were essentially flat in the quarter while laminate flooring saw revenues decline approximately 8% to 10%.

Looking ahead, we believe our construction end markets will remain in reasonable shape.

New housing starts were up 2% in May and renovation demand remains strong.

The wild card, as has been for the last number of months, continues to be if we get any lift from commercial construction end markets in the second half of the year.

Moving to automotive.

Base revenues declined 1% in the quarter, which you may recall was the same base revenue number we produced in the first quarter of this year.

Our performance underscores our ongoing ability to increase our product penetration with North American automotive OEMs and tier one and tier two customers as well as our ability to continue to recapture raw material price.

The weak OEM production data underscores our success in the quarter.

Light vehicle production by the Big 3 declined 6% in the quarter, with GM leading the pack with an 11% decrease.

Ford was down 6%, and Chrysler was actually up 5%.

Not surprisingly, the transplants grew their production 12% in the quarter.

As we have said before, we continue to focus on the transplants as a source of growth and product penetration for our auto businessed in the future.

Another bit of good news is that recent incentives offered by the Big 3 have had a notable impact on inventory levels.

In total, Big 3 inventories were at 62 days in June, at June 30, and specifically GM inventories were at 47 days, that's their lowest level of inventory in more than a year.

Less impressive were Ford's inventory at 81 days and Chrysler at 75 days.

Not surprising, again, the transplants inventories are at a healthy 52 days at the end of June.

Looking ahead, we are forecasting auto builds to be down 3% in Q3 and down 5% for the full year.

In our Industrial Products category of business units, base revenues grew 7% in the second quarter.

The top performers in this category of businesses include Minigrip ZipPak, Fibre Glass Evercoat and Fluid Products.

Our industrial plastic businesses were down 4% in the quarter, largely as a result of weakness with their appliance customers.

Moving to the next slide and International Engineered Products.

For the second quarter, segment revenues grew 8.6% and operating income was essentially flat, thanks to weaker in market conditions for our construction, automotive, industrial products business units.

As a result, operating margins of 14.4% were 120 basis points lower than the year earlier period.

Taking a closer look at topline, the 8.6% growth in revenues consisted of the following. 1.8% decline of base revenues, 4% from acquisitions, and 6.4% were from translation.

Just like our North American segment, business units in EP International consist of construction, automotive, and industrial products.

Looking at total construction, base revenues were flat in the quarter and by geography second quarter base revenues were as follows;

European construction increased 2%, Austral-Asia construction fell 1%, and Wilsonart increased 11%.

In Europe, commercial construction activity slowed in a number of countries in the second quarter including Germany, Belgium, and Spain.

In Austral-Asia, demand for commercial, new housing and renovation products fell in both in Australia and New Zealand in the quarter, much due to the restocking in the retail chains in those particular countries, particularly in Australia.

Wilsonart International continued to benefit from their focus on high pressure laminate applications for commercial use in both China and Germany.

Our automotive business units in Europe saw base revenues decline 4% in the second quarter, largely due to ongoing mix issues with some of our bigger customers.

While second quarter auto builds in Europe declined 4%, production decline by large companies such as Fiat, down almost 21%, and VW down 6.8%, and Daimler/Chrysler down 6.3%, disproportionately impacted our auto business and neutralized -- gave us essentially flat penetration in the quarter.

Looking ahead, we are forecasting builds to be flat for both the third quarter and full year.

The remaining part of the segment is made up our industrial base business units.

These units saw base revenues decline 2% in the quarter with industrial plastics leading the way with an 8% decrease.

Our electronic component packaging business also saw base revenues decline 9% in the quarter.

On the plus side, fluid products was up 4%and polymers grew 3% in the quarter.

We move to the next slide and take a look at our North American Systems businesses for the second quarter.

Segment revenues increased 9.3% and operating income grew a similar 9.3%.

Operating margins of 18.2% were flat with the year- ago period, with fluid equipment and welding posting margin gains in the quarter.

Focusing on the top line, the 9.3% growth in revenues consisted of the following. 8.1% from base revenues, 0.6% from acquisitions, and 0.6 from translation.

Underscoring some of the moderating growth we saw any second quarter, Special Systems of America base revenues grew 8.1%.

This represents the first time since the fourth quarter of 2003 that this segment has not grown base revenue double digits.

Nonetheless, we still had standout performances by some of our units in this segment.

Our North American welding business grew base revenues 17% in the quarter, thanks to our ongoing demand for replacement products and new product introductions and in our food equipment business, base revenues were up 6% largely as a result of the improvement in both the restaurant institutional part of the business as well as our parts and services units.

Our industrial packaging business grew base revenues 4% in the second quarter, representing the second consecutive quarter of 4% growth.

This number underlies our belief that while the North American economy has moderated. it still continues to be in a growth mode.

Finally, our last segment, International Specialty Systems, for the second quarter, segment revenues increased 14.6% and operating income grew 11.4%.

Operating margins of 13.7% were 40 basis points lower than the year earlier period.

Taking a closer look at the top line, the 14.6% increase in segment revenues consisted of the following components. 4.9% from base, 3.3 from acquisitions, and 6.4% from translation.

The nearly 5% growth in the segment's base revenue in the second quarter represented the sixth consecutive quarter of positive growth.

Major contributors to growth included industrial packaging, food equipment, welding, and finishing.

In our industrial packaging, Signode Europe and Signode Asia grew base revenues 7% and 22% respectively.

Demand for both consumables and machinery helped both businesses grow.

Food equipment grew base revenues a modest 2% in the quarter thanks to improved refrigeration sales in Europe and some better activity in Germany.

Finally, our welding and finishing businesses grew base revenues 17% and 8% respectively.

This concludes my formal remarks, so let me introduce our CFO, Jon Kinney who will discuss our earnings forecasts for the 2005 third quarter and full year.

Jon?

Thanks John and good afternoon, everyone.

We are forecasting third quarter diluted income per share to be within a range of $1.33 to $1.39 per share.

The low end of this range assumes a 3.2% growth in base revenues and the high end reflects 5.2% growth in base revenues.

If we hit the midpoint of this range of $1.36 per share, we will be 25% higher than last year.

For the full year, our forecast range is between $5.02 and $5.14 per share.

The base revenue growth supporting this forecast is expected to be in a range of 3.7% to 4.7%.

Overall, if we hit the midpoint of this range, full year income from continuing operations of $5.08 per share would be 16% higher than last year.

The 2005 midpoint forecast was increased 13% per share from our last forecast of $4.95 a share.

Three issues account for this increase.

First, our leasing and Investment segments is forecasting gains on the sale of properties which account for $0.06.

Second, our tax rate reduction to 32% for the full year will add $0.04.

Finally, improvements in the base business added $0.03.

Other assumptions included in this forecast are that exchange rates would hold at current quarter levels, acquired revenues in the 600 million to 800 million range, restructuring costs increased --we increased the range 10 million to a range of 40 million to 60 million for the year.

Leasing and investment increased 20 million, making the range between 65 and 75 million.

And even with this increase, we are still lower than 2004 by 35 million to 45 million.

And finally, a tax rate of 32% for the full year.

Before I turn this back to John, John and Ron both mentioned I will be retiring and August 5 is my last day.

This is my last call.

Ron and John were kind enough to let me participate in this final call for me, but I want to assure you that all of the analysis and forecast work for this meeting was prepared by Ron Kropp, our Vice President and Controller of Finance, Eugene Osterkorn, our Vice President and Controller of Operation and of course, John Brooklier had his hand in the mix also.

I strongly believe that this team will continue ITW's tradition of forthright communication of real financial results to the investment community.

Finally, I would like to thank all of you for taking an interest in ITW.

For those of you who have been shareholders over my last 10 years, your confidence has been well rewarded with a compounded shareholder return of 17% a year, which is nice for you and nice for me also and allows me to retire a tad early.

With that, I will turn it back to you, John.

Thank you.

We will now open the call to your questions.

Once again, we ask for your brevity in asking questions.

[Operator instructions] our first question comes from Dean Dray of Goldman Sachs.

Thank you.

Good afternoon.

I would also like to wish Jon Kinney all the best.

You are a class act and it has been a pleasure.

Best of luck.

A question and a follow-up.

The first question is, when we look at base business growth of 4% in the quarter, how much of that was price and how much of that was volume and then related to that, address specifically where you all are in the continuum of raw material costs and pricing.

It sounds like you're still facing a headwind there.

We have got a few percentage points related to price in there.

2?

Yes, 2.

Regarding the raw material, if you remember, it as about this time last year where we really started to see the increases in costs and it really hit us in the third quarter and we started the initiative to recover that cost.

We have been making good inroads there.

Like I said, in the first quarter we estimated there was about 150 basis point decline in margins related to this cost price issue.

Now it is estimated to be about 70 basis points.

Through the rest of the year, we look like we will be about even as we continue to raise prices.

We have even been able to get price increases out of our friends in Detroit, so that has been helpful as well.

So you will be at parity at some point in the third quarter?

Yes, and remember, the third quarter had the negative impact from last year.

There is a good comparable there for us in the third quarter.

Okay.

My follow-up question relates to some of the changes that you are making in the assumptions here both from leasing and investments, the lower tax rate.

Now, you all just updated your guidance 30 days ago or last month, wouldn't you have had some calibration as to what the tax rate is?

It seems like you lowered guidance and then you raised it here.

Why wouldn't you have done that 30 days ago?

The tax rate is subject to a lot of different tax strategies as well as different jurisdictions.

We are in 45 different countries around the world and really it's a once a quarter view where we add it all up and see where we are at just came out to a lower rate.

Typically, we estimate the rate based on where the rate was in the prior quarter.

It was a large movement.

That rate can move a little bit too, depending upon specific transactions.

There wasn't anything specific in there in the quarter, it was just a function of the ongoing planning as well as the effect of primarily foreign tax rate.

And the L&I gain?

The L&I gain, again those tend to be sporadic.

They come and go.

We do keep a list of those but we typically don't count on those until they are pretty close to a sure thing because they tend to go in and out, so we got some better intelligence today than we did a month ago regarding a couple of gains in the portfolio.

Dean, this actual L&I deal just closed, technically closed earlier this week.

So this is late breaking?

Yes.

Thank you very much.

Thank you for your brief question.

Our next question comes from Joel Tiss, Lehman Brothers.

How are you doing, guys?

I'll glue both of them together to make it even faster.

Can you talk about the average price increases you have put through and also can you help us understand what your acquisition pipeline full why you are still in the $600 to 800 million range for the year and maybe even a hint of what we could look for next year.Thank you.

I will start with the acquisition first.

We have a strong backlog as we mentioned.

In fact, there are quite a few deals that are closing this month.

They were supposed to close earlier, but now they've pushed out a little bit.

We have got a about a 3 month to 4 month view forward in our backlog.

Based on our current backlog, we think we will be in that range.

Regarding the average price increase, it is tough to get that information because it is a lot of different businesses around the world and on average we think it is about 4%.

John Brooklier.

Joel, I would also jump in.

When we talk about our pipeline, know that as we sit here right now we have 400 plus million in the pipeline and Ron referenced the fact that a number of those will close in the month.

I think you asked a question about next year in terms of what forecast we might have for acquisitions.

I think it is a little bit early for that, but to the extent that private equity players get out of the market, at some point in time that certainly would enhance our ability to close more acquisitions as we move forward.

Okay.

Thank you.

Our next question comes from Andrew Casey with Prudential Equity Group.

Good afternoon.

Just a quick question on the material cost pressure.

Where exactly are you encountering that, given we have seen some of the steel commodity stuff come down?

First of all, it primarily has been an issue in North America.

We are seeing a little bit in international over last year, but it is a lot less there.

What we have seen in the resin area, obviously with the price of oil going up, we have seen that tick up slightly.

On the steel side, steel rod has been relatively stable since the beginning of the year.

We're seeing some downticks in things like cold rolled steel as well as phenolic resin which we use in our laminates business

Thanks.

Just a follow-up on Joel's acquisition question, just to clarify their, is it still the valuations that are holding it up or is it just timing?

I think it is a combination of price and timing.

In many cases, we are competing against - on the bigger deals, competing against private equity interests that have priced stuff that we just can't, we're not even in the same league.

That deters you from doing those deals.

On the smaller deals, I think it is a matter of timing where we have a number of deals we're working on right now in the pipeline that are closing or will close shortly.

Andrew Casey Thanks.

Good luck, Jon.

Kinney.

Thank you.

Our next question comes from Ned Armstrong with FBR.

Good afternoon.

Could you talk a little bit about the Wilsonart businesses and the performance there as far as why was it off?

As we look at the Wilsonart business, it has been a little bit of the same story all along, whereas the piece of business that is commercial construction related is about 50% to 60% of their business.

As you know, that business has been experiencing no growth up until the last probably two to three quarters.

So for 3, 4 years, they have been in a very difficult environment.

Over the last 3 to 4 quarters, where we have seen a little bit of growth in the commercial construction side, we have seen our base laminate business improve somewhat.

But I think it is still fundamentally is the equation is commercial construction is a big enough piece of their business where it's going to be a deterrent to any kind a significant base revenue growth for them

You are confident it's purely end market driven as opposed to competitive factors?

We believe that it is much more end market related.

Having said that, we continue to innovate new products and try to continue to get more products into the pipeline, more products in distribution.

We clearly recognize that the value proposition there is product development.

Great.

Thank you.

our next question comes from Brian Langenberg with Foresight Research Solutions.

Thank you very much.

Jon, may your flowers bloom, the sprinkler system always work and your alarm clock never go off before 9 o'clock even during a weekday.

He is laughing, Brian

I kind of thought so.

Best of luck.

My question EP North America, just really impressed with the margins, now I'm going to ask you to explain yourself and maybe just dive a little bit more into how we were able to get so much operating leverage given that most of the core revenue growth would have been price.

Maybe talk about the non-volume related and I apologize if I missed a bit.

I will start with the non volume piece.

Like we talked about earlier, we have been very successful in getting not only cost recovery but some margin recovery in North America, especially in the engineered products.

Okay, so that is the price recovery side buried in there.

Also included in this segment is the - there was a charge last year for a Wilsonart warranty issue of about $10 million that helps the comparable as well.

Okay.

And then on the operating leverage side, pretty straight forward there.

Okay, thank you.

Our next question comes from John Inch with Merrill Lynch.

Thanks.

Congrats, Jon Kinney.

The 4.0 in base to now 4.2, can we just highlight what businesses, without splitting hairs, what businesses do you think are strengthening and what may be perhaps softening a little bit to come up with the 20 basis point delta.

I think you may have said it well, you may be splitting hairs here.

Well then just generally, John.

Clearly, I think we have a little bit more upside from our food equipment business than we thought going into the year, and their performance for the first two quarters has been a little bit better.

So I think that on a go forward basis, that would probably be on the positive side.

Ron, can you think of anything on that?

Welding.

And welding also.

Those would be the two principle contributors.

I think Signode is probably operating at a consistent level.

On the downside, I don't know if I can really identify anything that is really moving materially down enough

Slightly down is international.

All of international.

Okay.

But to come up with the 4.2, is the 4.2 sort of like you look at the quarter and then sort of -- I am just trying to understand, how the 4.2 -- how did you come up with the 4.2 vs. 4.0?

Is it kind of the imputation indirectly of where you think it's going to be or I would have thought you would sort of lined up the businesses and then said here is what kind of the year looks like versus what it looked like a month ago?

The way we do this forecasting, it's really 600 different businesses out there doing their own forecasting in their business.

They are the best ones to know what it looks like.

We're not making those types of top-side adjustments here, so it is really just a function of adding up all the where we are at and up here we look at it and make sure it is reasonable and that is where it came out.

So, t is pretty consistent with the second quarter.

OK, so again, it is food equipment and welding would be the deltas in terms of improvement.

Any of the businesses a little bit less or a little bit worse?

We are getting so micro now would be hard to say, John.

Just as the follow-up, Ron, as the new CFO what basically are your goals going to be in the position and what are you going to be striving for?

First of all, I worked with Jon for all 12 years I've been with ITW and I've learned a lot from him.

One of the things I learned is that the importance of being transparent and having forthright advance reporting, forthright accounting.

Over Jon's tenure, we've definitely improved the transparency of the financial statements and the transparency of this conference call et cetera..

I would just look to continue to build on that going forward.

Also, obviously one of the challenges in the company is the acquisition side and I have had a lot of experience on the accounting side froform acquisitions, so I look to continue to grow that program as well.

Thank you.

Thank you.

Our next question comes from Mark Koznarek of FTN Midwest Securities.

Good afternoon.

Jon Kinney, best of luck.

Question on Wilsonart.

We talked about some of the top line drivers, but can you comment on the profitability?

Is that looking better than what the top line would appear?

Yes.

They have been in a full 80 20 mode for the last number of years there.

They have gotten got much more productive on the manufacturing side and we have seen both income and margin improvement from them in a fairly significant way.

I think, the issue that we look at, and I know they are focused on, is clearly how to move the top line, given all the macro issues they see it within commercial construction.

They're focused on that, but clearly they have been focused on other elements in the business that is attributed to income and margin performance.

So, income..

They are clearly moving in the right direction there, Mark.

Right direction, thanks.

Just to clarify, with the profit in that segment up around 15%, would Wilsonart be up roughly be up the same amount?

I don't know.

We usually don't give out profitability of our individual business units so I'll let you ponder that question.

All right, thanks very much.

our next question is from Eli Lustgarten with Longbow Research.

Good afternoon.

We're going to miss you, Jon.

Question on the automotive outlook that you gave, which was down 5% for the year, if I remember correctly.

That's correct, for North America now.

Yet you're down 1% -- you're down less than that for the first half, you've got 3% in the third quarter and production clearly is going up, because of the lower inventories that we see from the OEM companies as you look out.

Now, I would challenge some of your numbers first.

The production numbers in the first quarter were down 9, down 6 in the second quarter.

I think we're starting with a bigger negative than you think.

I think we clearly think things are going to get a little bit better, but not enough where it will have a material effect on the overall production for the year.

You don't think production is going to ramp up in the fourth quarter?

I don't know.

I think what they have done thus far is they have been able to sell more cars and been able to reduce inventory.

I don't think it's had much of an impact on production.

Well it hasn't yet but they've cleared out the inventory to do it but we'll debate that later.

One clarification.

You gave us the breakdown of why you increased earnings but you didn't talk about lower shares as part of the number?

For the quarter, the effect of the shares?

The 2%, I understand that, for you it's the (inaudible). 2.95 in the first quarter.

But if you are going to complete your share buyback by the end of the year, you didn't include the lower shares outstanding?

We've already factored the lower shares because we expected to complete that by the end of the year.

That has already been factored into the forecast really from the beginning of this year.

Okay, so you're going to be taking down shares by another, what several million by the end of the year?

Yes.

Alright, thank you.

Our next question is from David Lowenstein (ph) with UBS.

Good afternoon.

Can you help me calendarize the leasing and investment numbers?

How big is that Q3 number?

How big is the gain in quarter 3 for total leasing investment you're saying?

It is about 40 million.

Income.

And then my question.

Can you talk about the prices you're paying for acquisitions?

Explain why the private equity folks are not involved in that $400 million in backlog that you mentioned.

And John, you made a comment, I'm just curious to know what gives you the sense that this aggressive private equity phenomenon is going to pass.

I'll address that first.

I think if you look it's cyclical.

If you look at what has happened over the last 10 years.

I think as interest rates increase you'll see that money becomes less cheap and these guys have less leverage and they'll get out of the market like they did the last time we went through this phase of competition from the private equity side.

Now.the question is exactly what does that happen, David ?

We clearly don't know that.

But I think the trend is that as the Fed increases rates there is a better chance that private equity becomes less of a player in the bigger deals.

The other part of the question is for the smaller deals, they just have fundamentally don't have an appetite for anything that small.

They've got a lot of funds they need to deploy and 25, 35, $50 million deals just doesn't cut it for them.

We really haven't bumped into them in those small deals in any meaningful way at all.

Also, on the international side, we see a little bit less competition from private equity.

We have done a fair amount of international deals and there's a fair amount in the pipeline as well.

Terrific.

Thanks.

Our next comes Gary McManus from JP Morgan.

Good afternoon.

Again, let me add my best of luck to you, Jon.

Just a question for the full year.

You expect base revenue growth to be up 4% or so, 4.2% I guess is the midpoint.

Did I hear you expect pricing to be up 3% to 4%?

So you have maybe very little volume growth imbedded in the full year?

If that is true, we are sitting with a 3% economy or so, do you think you're losing share because I know auto is tough, but when I kind of consider all of the other end markets, why don't you think in the 3% type of economy you're not seeing better base revenue growth, ex pricing?

Well, that is a number for the year, Gary, so that is 4% for the year.

That implies a second half growth of certainly less than that...

I don't know if you want to talk about the second half or full year, but most of your base revenue growth is pricing, right, so you're not really assuming a lot of volume growth this year or the second half.

We have a fairly decent economy, 3% or so, whatever you want to call tit...

I think you may be overstating a bit to say that most of the growth is price.

We said, our estimate is about 2% in price of the 4 so....

But is 2% in base volume growth acceptable for ITW in a, let's call it a 3%, fairly decent economic environment?

Do you think you're losing share?

Do you think your ability to increase market share or penetrate these market is becoming more difficult than it's been in the history of the Company?

Well, on thing, the 4% is a worldwide growth rate.

From a North American side, we are seeing higher growth rates than 4, in the or 5%, 6% range or about 5 for the year.

For the International, obviously the end markets we are seeing are some clear slowing over the last three months or four months.

That's really what's dragging down some of the average as well.

Again, if I went back in history, just consider North America, that's where most of your revenues are.

In a 3% economy, I would suspect you were showing much better volume growth then what we are seeing this year.

Would you agree with that?

You are talking about North America?

Just talk North America, because that's two-thirds of the company.

We have better ideas on where the economy is going and so forth.

I think the question has been answered, Gary that YOU have to look at the international piece, too.

What kind of growth did we get out of there.

I think we'll move on.

our next question comes from Chris Kodowitz (ph) from A.G. Edwards.

Good afternoon and congratulations, Jon.

I wanted to ask about EPI, and I guess that was the big margin decline in the quarter.

Can you talk about some of the moving parts and the operating leverage and the non volume related total?

That is a pretty big swing on a 1.8% decline in revenue for the base.

On the non volume side, like we talked about earlier, we haven't made much progress on recovering margin internationally as we have in North America.

We are recovering our costs but not necessarily full margin.

Most of that non-volume related amount of 80 basis points is related to that price cost issue.

There's also some higher overhead costs in there, for instance we started expensing stock options as you remember in the first quarter.

That is an additional cost that goes into all segments as well and there is also some other normal overhead costs that have increased.

Okay.

And then on the sales side or the operating leverage, the construction and automotive and general industrial business are all down.

Construction has been flat, industrial and automotive were down for the quarter, so that what is driving that leverage number.

Okay.

I know you are showing that Fiat and ome of the other guys are down pretty significantly.

Is this an indication that the price cost in that particular business is really going heavily negative and is there a reason to think it will get better in the second half of the year?

The price cost there has been negative, but we do expect it to show some improvement as we go out the rest of the year.

Okay, I'll get back in the queue.

Thanks, guys.

Our next question comes from George Nissan (ph) with Merrill Lynch.

Hello?

Next question, Julie.

Our next question comes from Robert McCarthy with Robert W. Baird.

Good afternoon.

I wanted to follow up the questions about acquisitions.

If I'm reading this right, in the last four quarters, despite an improved M&A environment and 600 plus operating units that are all supposed to be out looking for something to do, you've only been able to close 12 deals.

I recognize the private equity issue and how that affects larger deals, but your bread and butter historically has been the smaller deals that you talk about still being competitive on.

My question is what else explains why activity has been so slow.

Do you have people working on a lot of stuff that you just can't seem to get done or that disappears at the last moment?

Is it multiples?

Could you talk about it a little bit?

I think the two categories would be the bigger and smaller deals.

The bigger deals is a matter of price and we have lost a handful of bigger deals, and I'd say 100 plus million over the last six to nine months.

That is a separate category.

We just can't compete there.

The smaller deals, I really believe it is a matter of the activity level continues to be strong.

We have anywhere from 20, 25 different acquisitions that we are working on in that category as we sit here today.

Many of which, we believe, will be closing not only this month but in the quarter.

We think that it has really been a matter of, it's been more coincidental , it's been a matter of timing.

Is that the way it worked relative to what you were looking at six months ago that most of what you were looking at six months ago has been happening?

You tend to characterize the pipeline as these are deals that really are going to get done unless something unforeseen occurs.

Has that indeed been your experience?

We have closed those deals, it has just been a matter of time.

As you know, these are not straight line and we would like to be able to parcel them out 150 million each quarter and everyone would be happy.

What that adds up to is the next couple of quarters could be 10 companies each.

Could be.

Okay.

The other thing I want ask about is, and I don't mean to quibble with you on your characterization of commercial construction markets, but most of the companies that your audience pays attention to that are selling into those markets are talking about better business conditions.

Commerce is certainly reporting higher spending in the sector on a year-over-year basis.

I can't help but suspect that there is something more at work in the flooring business, John, which has been a persistent sore point.

Is there an element of -- are you guys strategically foregoing business there as part of improving the profitability of the business?

Two things.

One, the answer is no.

Two, the Wilsonart, the flooring business has been disproportionately hurt by the retail channel.

That is the majority of their business.

Sales through the retail center have been weaker.

I haven't said that, but the most recent numbers coming out of Wilsonart for July and what they're forecasting for the quarter is much better performance.

Including the flooring business.

We will see what happens.

Thanks.

Our next question comes from Ann Duignan of Bear Stearns.

Hi there and Jon, congratulations also.

I wish it was me.

Oh, Ann, how could you we do without you?

I wanted to touch on restructuring charges.

You've increase those from last quarter.

They were 30 50 million, now they're 40 60.

Could you give us a little bit of color on where you are increasing our spending on restructuring by division and also could you give us some color on what you've already spent and how you should forecast that for the rest of the year?

As far as the increase in activity, there are no large projects in there.

That is typical of us.

We have a lot of small 80 20 simplification activities that happen.

As a result, restructuring projects come out of that.

There are really no big projects spread over various segments and I don't have the segment numbers here anyway.

For the year, we've spent about $15 million restructuring and the balance of the year will be 25 million.

Should we looked at spreading that pretty proportionally then across the 2 quarters, and across all businesses or more internationally?

More in the third quarter, because typically we have a better view of what is out there and about to happen three months out.

As far as spreading it, there are more in the international side than the North American side.

Okay.

Food service and food equipment up, I am assuming that is driven primarily by spending by restaurants as opposed to institutions.

Is that correct or are you seeing the institutions come in and spend also?

I think that is a combination, Ann.

We've seen contribution from both the restaurant and institutional side.

We talk about parts and services being a contributor.

Okay.

Thank you.

our next question comes from Walt Liptak with KeyBanc.

Good afternoon, John, Jon and Ron Congratulations, Jon.

My question is about the international margins as well, especially on the non volume related.

You may have already answered this question, but I would just like a little more clarity.

The price cost issue, is it because the markets are soft there so you can't push through price or is there a lagged effect on pushing through the price increase, or what is exactly happening?

Remember in international we did not see the increased material costs as soon as we did in North America.

There was a lag there.

So that really started at the end of last year beginning of this year.

Also, International has not seen as big of an impact, so that means it is a little bit harder to get the customer to agree to a price increase.

We are still working at it.

We do see improvement in this non volume related area for the rest of the year.

Of course, it is tough and market where growth is going down as well.

We will see what happens.

Okay.

In international markets, the expectation based in your comments should be for growth to continue slowing in the back half of the year and the negative leverage will continue.

So we would see down margins year-over-year in the back path.

Yes.

We're forecasting that international revenue growth is in that 1.5% range for the rest of the year.

We will continue to see the impact.

It is more on the Engineered Products side than on the Specialty side.

Great, thank you.

our next question comes from Andrew Kopowitz (ph) of Lehman Brothers.

My question was basically answered on food equipment but for the outlook for just the outlook for the rest of the year, Do you think chain restaurant growth will continue?

Will supermarkets come back at all?

Will supermarket's never come back, Andy?

What we're hearing in the market in terms of change is that business is better than we had expected and it continues to be strong.

We're not looking for any discernible change the rest of 2005 and I think supermarkets, believe it or not, have got a little bit better but not significantly better.

I don't think we will see any further decline in the supermarket side, but it still continues to be a struggle.

Thank you.

Our next question comes from Martin Jacobs with Capital Research.

Jon, it has been a pleasure working with you.

Sorry to see you go.

My question is this, I want to make sure that I understand the margin differential between international and North America.

Earlier in the call you said that most of the raw material pressure was in North America, but obviously the adverse variance in margin was international.

Is that mainly because the phenomenon there is taking later and so you are pushing through price later or does that also reflect lower plan absorption rates because that part of the market has been weaker for you guys?

It is just the timing issue.

The cost increase comes first and then you have to go push the price increase.

Because international lags North America, they are behind where North America is.

We have had this cost increase for the year,and the North American segment we have been dealing with it.

The international side is a few quarters behind that.

OK.

Principally in the automotive areas, Martin, that is where we have been most affected.

But it doesn't have anything to do with lower volumes internationally?

No.

Thank you.

our next question comes from Ned Armstrong with FBR..

Good afternoon.

On the international side, you showed that plastics and resins had declined somewhat.

Can you talk about some of the reasons for that?

Our industrial plastics business?

Yes, on the international side.

That business, much like North America, has a set of customers which are appliance related and appliance activity in Europe and even in parts of Asia we have seen a lot of movement in that area.

Sales to that area have been very, very weak.

That has been the principal impact, similar to what we have seen in North America on the industrial plastic side.

And the electronic component packaging, what is driving that down?

That mirrors what the component makers are doing in terms of -- when they are producing chips, we are packaging them; when they're not, we're no packaging them.

We almost see the correlation instantaneously between those

Okay.Thank you.

our next question comes from Mark Koznarek from FTN Midwest.

Just A follow up on the international business.

It seems like as we progress from the first quarter into the second quarter, one of the biggest swings negative was the international construction market or your performance in that.

It went from 8% to flat as you look at it sequentially.

I'm wondering, is all of that JUST the economies in those regions throttling back or is some of it ITW related?

We mentioned both on the European side that we have seen major economies weaken in terms of commercial construction activity.

I mentioned earlier Germany has been an example of that.

There are other countries, Spain was another country where activities throttled back in the end markets.

So it affected our commercial and overall construction activity there.

If you look at Austral-Asia, there was a clear fall-off in demand and fairly broadbased, but particularly on the retail side because restocking going on in a lot of these box stores down there.

On the retail channels.

That impacted us.

We did see a little bit of improvement in the last month in terms of construction on the international side, so we will see if that carries over into period 7 And into the third quarter.

Just another dimension on construction on the tool side.

Is there a change that you guys are observing in the temperature of competition from generic consumables in the marketplace?

No, I don't think anything out of the ordinary.

We are always faced with the issue of generics coming in and people using other kinds of consumables, typically nails in this case.

It is something we deal with all the time.

I don't think it is out of the ordinary.

Thank you, John.

our next question comes from John Inch with Merrill Lynch

Just as a follow-up, did you say why your interest expense was so much higher this quarter?

I apologize if I missed that.

We did.

The reason is our borrowing levels last year in the second quarter on a short-term basis were basically nil and we are in a borrowing position this year because we have made some U.S. acquisitions and we are repurchasing shares in the U.S..

We are in a negative cash position in the U.S..

All of our cash is overseas and as we repatriate those funds the rest of the year, we will be paying down that debt.

John InchL So Ron, what kind of interest expense should we be thinking about for the next couple quarters?

Slightly down, but not a whole lot.

A large component of our interest expense is still the long-term fixed piece that we have got.

I don't have the number handy here.

One more, the free cash was actually up nicely versus last year.

We don't have a full cash flow statement, but were there obvious components that contributed to the improvement in the free cash or cash from operations this quarter?

The biggest piece of it is the reduction in inventory levels.

Also, increases in accruals, normal increases in accruals for rebates and bonuses and things like that also helped out.

Was there an obvious business where inventory was a source of cash?

It is really across the world, really.

Okay, thank you.

At this time, we have no further questions.

Thank you very much.

We appreciate your interest and look forward to talking to everybody in the future.

Thank you.

That does conclude today's conference call.

Thank you for your participation.