Illinois Tool Works Inc (ITW) 2005 Q3 法說會逐字稿

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

All lines will be on a listen-only mode through the duration of the call.

The call is being recorded.

If you do have any objections, please disconnect at this time.

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

Thank you, Kathy.

Good afternoon, everyone, and welcome to ITW's third quarter 2005 conference call.

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

With me today is Ron Kropp, our Vice President and Controller.

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

By now, most of you have seen our third quarter financial results.

Put simply, the third quarter was a bang-up quarter for us.

Revenues grew 10%.

Operating income increased 21%.

Net income rose 24% and diluted net income per share grew a robust 31%.

And even when you exclude the additional income we gained in the quarter from Leasing and Investments and the benefits of expedited share repurchase, our diluted earnings per share increased 28% in the quarter.

Our margins also improved to 19% in the quarter, a 170 basis point improvement versus the prior year.

Ron and I will give you more details on the strong financial performance in just a few moments.

Here is the agenda for today's call.

Ron will join us shortly to provide more details about our third quarter result.

I will then update you on our four manufacturing segments and associated end markets.

Ron will then address our fourth quarter and full year earnings forecast and finally we will open the call to your questions.

Please note that we continue to ask your cooperation as to the one question/one follow-up policy.

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

First a few traditional 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, base revenue growth, higher energy costs and potential acquisitions for full year 2005 and the Company's related earnings forecast.

The various risks I just covered are spelled out on this slide and are also part of our Form 10-Q for the 2005 second quarter.

Finally, one other bit of housekeeping.

The telephone replay for this conference call is 203-369-0666.

No pass code is necessary.

The play back number will be good until 12 midnight on November 2nd, 2005.

As always, you can access our webcast Power Point presentation on ITW.com.

The presentation can be found in the Investor Information section.

Just look for the Earnings Presentation tab.

I'll now turn the call over to Ron Kropp.

Thanks, John.

Good afternoon, everybody.

The highlights for the third quarter are as follows.

Revenues grew 10% over the third quarter of last year.

This growth rate was consistent with the 10% growth rate in the second quarter.

Operating income was up 21% versus the prior year due primarily to improved margins for the base businesses and higher income in the Leasing and Investments segment.

Operating margins were up 170 basis points versus last year.

Diluted income per share was 31% higher than last year and free operating cash flow continued strong at 507 million for the quarter.

Return on invested capital was 20.7% for the quarter which was 280 basis points higher than last year.

Now, to the details.

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

First of all, the base business grew 4.1%.

This growth rate was 10 basis points higher than the second quarter.

Secondly, acquisitions added 3.9% to revenue growth which was 50 basis points lower than the second quarter.

Third, higher revenue from Leasing and Investments increased revenues by 1.1%.

Fourth, currency translation added 0.8% to revenue growth which was 210 basis points lower than the second quarter.

Overall, our 10% revenue growth was the result of solid base revenue growth, the continued impact of acquisitions and higher activity in the Leasing and Investment segment.

Our 4.1% year-over-year base revenue growth was made up of 5.4% increase in North America and 1.8% increase internationally.

In North America, the 5.4 increase was 20 basis points lower than last quarter and internationally the 1.8% increase was 40 basis points higher than the second quarter.

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

Turning to operating margins.

We experienced a margin increase of 170 basis points in the third quarter compared to last year's third quarter.

This margin improvement is primarily due to the base business margin increase of 160 basis points of which 90 basis points related to operating leverage and 70 basis points was due to non-volume related items.

Margin increase related to Leasing and Investments of 80 basis points was offset by margin declines of 50 basis points due to higher restructuring costs and 30 basis points related to acquisitions.

The favorable non-volume margin effect of 70 basis points in the third quarter showed improvement from a non-volume margin unfavorable effect of 70 basis points in the second quarter.

This improvement was the result of our continuing efforts to raise prices for raw material cost increases and some slight cost decreases for certain raw materials.

In addition, lower overhead costs related to restructuring projects earlier in the year contributed to the favorable non-volume margin effect.

In our Leasing and Investments segment, income was $33 million higher than last year, mainly due to higher income related to the mortgage and venture capital investments.

In the third quarter of 2005, there were gains on the sales of mortgage properties of $33 million and venture capital income of 9 million.

In the non-operating area, interest expense was flat versus last year.

Other income and expense was unfavorable by 7.2 million, primarily due to a divestiture loss of $6 million.

Third quarter and year to date effective tax rate was 32% versus 34% in the prior year period.

Turning to our invested capital.

Total invested capital increased 11 million from the second quarter.

Inventory and accounts receivable levels remained under control at 1.8 months on hand and 59.9 days sales outstanding, respectively.

Capital expenditures for the third quarter were 71 million and depreciation expense was 78 million.

On the financing side, we decreased our debt 320 million from last quarter, primarily due to strong free operating cash flow and cash repatriated from overseas, partially offset by cash paid for share repurchases.

As a result, our debt to capital ratio decreased from 18% to 16%.

During the third quarter, we repatriated approximately $700 million of foreign cash back to the U.S.

Year to date, we have repatriated approximately a million dollars.

Our cash position decreased $507 million in the third quarter mainly because our strong free operating cash flow of 507 million was more than offset by cash paid for repurchases of 469 million, acquisitions of 113 million, dividends of 80 million, and debt repayments of 319 million.

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

During the third quarter of 2005, we completed the repurchase program by repurchasing 5.5 million shares at an average price of $84.86 a share.

Our third quarter return on invested capital of 20.7% was 280 basis points higher than last year.

This increase was mainly the result of our strong base business operating performance that after tax operating income increased 25% while average invested capital only increased 8%.

For the year-to-date period, return on invested capital of 18.6% was 30 basis points higher than last year.

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

Finally, on the acquisition front, we acquired 11 companies in the third quarter which have annual revenues of 105 million.

In addition, on October 11, we completed the acquisition of Instron Corporation, a leading worldwide supplier of instrument software and services for the testing of materials and structures which has annual revenues of $240 million.

Year-to-date, we have acquired 18 companies with annual revenues of 532 million.

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

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

Thank you, Ron.

Before I talk about our manufacturing segments, let me spend a moment as I usually do highlighting the North American and international economic data we track on a regular basis.

In both the U.S. and Europe, the two most salient numbers we focus on are ISM and industrial production data.

Both sets of numbers and both geographies have pluses and minuses.

On the one hand, the North American ISM index improved to 59.4% in September from 53.6% in August and the ISM new order index moved to 63.8% in September from 56.4% in August.

However, U.S. industrial production, excluding technology, grew only 1.6% in September versus a 1.9% increase in the prior month.

That data gives us some pause for concern and it is certainly a factor as we look at the fourth quarter forecast.

And internationally, the data points to a mixed and weaker economy.

Euro zone ISM index was essentially flat at 51.7% in September compared to 50.4% in August.

And the Euro zone industrial production index grew a tepid 0.6% in July versus growth of 0.7% in June.

By country, the results also were mixed with industrial production down 1.9% in the UK in August.

Both France, up 1%, and Germany, up 2.1%, trended positively in August.

Moving to the next slide.

Let's review our four manufacturing segments, starting with North American Engineered Products.

Segment revenues increased 10.3% and operating income grew 21.1% in the third quarter.

Operating margins of 18.9% were 70 basis points higher than the year ago period.

Margins were clearly helped by our ability to continue to recapture raw material price increases and the favorable comparisons with the 2004 third quarter when associated price increases were in the early stages of moving up.

Looking more closely at third quarter revenues, the 10.3% growth in revenues consisted of the following: 2.3% from base revenues, 7.6% from acquisitions, and 0.4% from translation.

Looking at the next slide.

We'll take a closer look at the business units in North America Engineered Products.

Total construction based revenues grew 2% in the third quarter amid some modest slowing in end markets.

Specifically, ITW Construction, which encompasses our tool and fastener units, grew base revenues 3% in the quarter.

By end markets, new housing grew 3%, renovation was up 2, and commercial construction increased 4%.

We continue to watch our commercial construction business units for any meaningful signs of improvement but to this point, growth has been essentially in the 4% to 6% range.

We are clearly getting penetration in the commercial sector since Dodge data shows a total commercial building, that is square footage put in place, was down 5% on a year-to-date basis through August.

While new housing starts were down 1% in August on a year-over-year basis, housing permits were up 3% in August and I'm sure many of you saw the data that came out today showing housing starts being up about 3.5% in September.

Wilsonart space revenues showed improvement in the quarter moving to 1% growth from down 2% in the prior quarter.

Both the base laminate and flooring businesses posted modestly positive revenue performance in the quarter.

Moving to automotive.

Base revenues actually grew 3% in the third quarter.

Our solid performance in the automotive arena underscores our ongoing and consistent ability to recapture raw material price increases over the past three quarters as well as continue to penetrate targeted OEM and tier customers.

Our top 5 performance looked especially strong when you look at auto production in the quarter.

Big 3 auto production was down 1% in the quarter with GM down 4%, Ford down 7% and Chrysler up 12%.

Our growing success with the North American new domestics which include Toyota, Honda, Nissan and Hyundai also bolstered our performance.

New domestic builds were up 9% in the quarter.

Inventory levels for the Big 3 climbed from 41 days at the end of July to 69 days at the end of September.

Specifically, GM inventories were at 58 days in September versus 33 days in July.

Ford inventories were at 74 days in September versus 45 days in July.

And Chrysler inventories were at 83 days in September versus 52 days in July.

Supported by stronger sales, new domestic inventories were at 43 days in September versus 40 days in July.

Looking ahead, we continue to believe Big 3 builds will be down 4 to 5% for full year 2005 and that implies Big 3 builds being flat to slightly down in Q4.

We expect new domestic builds to increase 10% for full year 2005.

In our industrial products category of business unit, base revenues grew 3% in the quarter.

Top performers in this category of businesses include Minigrip/Zip-Pak and fluid products with base revenue growth in excess of 10% for both units.

On the down side, our industrial plastic business saw its revenues fall approximately 10% as major customers in the appliance sector felt the pressure of weaker consumer demand and increased global competition.

Moving to the next slide in International Engineered Products.

For the third quarter, segment revenues grew 5.2% and operating income increased 4.5%.

Most of our business units in this segment produced flat to modestly down base revenues in the quarter.

As a result, operating margins of 15.3% were 10 basis points lower than the year earlier period.

We take a closer look at the top line 5.2% growth in revenues consisted of the following: 0.7% decline in base revenues, a 4.5% contribution from acquisition, and a 1.4% increase from translation.

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

Looking at total construction, base revenues were up 1% in the quarter.

And by geography third quarter base revenues were as follows: European construction grew 1%, Australasia construction declined 1%, and Wilsonart International increased 9%.

In Europe, construction was mixed as growth in Spain, France and the Nordic countries was moderated by weakness in the UK and Ireland.

In Australasia, slower demand for commercial and new housing products outweighed gains from the retail renovation driven business units.

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

Moving to the automotive business units, we saw base revenues decline 3% in the quarter.

This was nearly in line with third quarter builds.

It appears that past mix issues with some of our larger OEMs in Europe, VW and Fiat in particular, have improved somewhat.

European auto builds declined 2% in the quarter with Daimler Chrysler down 10.9%, Fiat down 8.5%, BM Group down 7.8%, and Citroen Peugeot down 6.4%.

On the plus side, VW Group was up 8.6% and BMW was up 5.1%.

Looking ahead, we continue to believe the builds will be down 1 to 2% for the full year 2005.

Remaining part of the segment is made up of industrial based business units.

These units saw base revenues decline 2% in the quarter with industrial plastics leading the way with a 12% decrease.

Electronic component packaging also was down 3% in the quarter.

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

Moving to the next slide -- North America Specialty Systems.

For the third quarter, segment revenues increased 9.3% and operating income grew 27.7%.

Operating margins of 20.1% were 290 basis points higher than the year earlier period thanks to pricing and volume gains in a variety of our business units.

Focusing on top line, the 9.3% growth in revenues consisted of the following: 8.2% from base revenues, 0.5% from acquisitions and 0.6% from translation.

This segment continued to produce strong results even as it contended with difficult growth and profitability comparisons from a year ago.

We had standout revenue and operating income performance by a number of our units in this segment including welding, food equipment, marketing and decorating and finishing.

Quality base revenues grew 20 plus % in the quarter thanks to strong volumes and pricing.

We also estimate that the impact of the hurricanes in Louisiana/Texas added more than 10 million of sales in the quarter.

In food equipment, while base revenues grew only 1% in the quarter, base income growth was up double digit.

Marketing and decorating based revenues grew 7% in the quarter and finishing based revenues were up 6%.

Industrial packaging grew a modest 1% in the quarter as they continue to deal with pricing issues related to raw materials such as resins and steel.

Finally, our last segment.

International Specialty Systems for the third quarter, segment revenues increased 8% and operating income declined 10%.

Operating margins of 11.4% were 230 basis points lower than the year earlier period, largely as a result of increased spending for restructuring projects in the quarter.

Taking a closer look at top line.

The 8% increase in revenues consisted of the following: 4.5% from base revenues, 2.8% from acquisitions and 0.7% from translation.

With base revenues growing 4.5% in the third quarter, a number of business units contributed to topline expansion.

Industrial packaging in Europe and Asia posted third quarter base revenue gains of 5% and 6%, respectively.

Demand for consumables ran at a higher rate than machinery for these business units.

Food equipment base revenues grew 2% thanks to contributions from the UK and Germany and welding posted base revenue gains of 13% in the quarter while finishing was up 7% in that same period.

This concludes my formal remarks so let me reintroduce Ron Kropp.

He will discuss our earnings forecast for the fourth quarter and full year.

Thank you, John.

We are forecasting fourth quarter diluted income per share to be within a range of $1.34 to $1.40 per share.

The low end of this range assumes a 2% growth in base business revenues and the high end assumes a 4% growth in base business revenues.

Midpoint of this range of $1.37 per share would be 13% higher than the fourth quarter of last year.

We are currently forecasting base revenue growth of 3% as the mid point for the fourth quarter due to higher than anticipated energy costs and their impact on end markets and raw materials.

For the full year, our forecasted earnings range is $5.12 to $5.18 per share.

The full year base business revenue growth is expected to be in a range of 4.1% to 4.6%.

The midpoint of the earnings range of $5.15 per share would be 17% higher than 2004.

The midpoint of the full year 2005 forecast was increased by $0.07 per share from our last forecast of $5.08 per share for three reasons.

First, improvements in the base business added $0.04 per share, $0.03 in the third quarter and $0.01 in the fourth quarter.

Secondly, the earlier than expected completion of the share repurchase program added $0.01 per share in the third quarter.

Third, higher Leasing and Investments income added $0.02 a share, an additional $0.03 in the third quarter offset by a $0.01 per share reduction in the fourth quarter.

Other assumptions included in this forecast are exchange rates holding at current levels, acquired revenues in the 6 to $800 million range, restructuring costs for the year of 40 to 60 million, no further impairment of goodwill or intangibles, Leasing and Investments income in the range of 95 million to 105 million, which was lower than last year by 25 million, 35 million, and a tax rate of 32% for the fourth quarter.

Okay, John, back to you.

Thank you, Ron.

We'll now open the call to your questions.

At this time, if you do have a question, you can press star one on your touchtone phone.

You will be announced prior to asking your question.

Again, press star one.

Our first question comes from Deane Dray.

Your line is open.

Thank you.

Good afternoon.

Could you give us an update as to where you stood for the third quarter and then year-to-date on the raw material costs offset with pricing?

Well, in the third quarter, our non-volume impact on margins was about 70 basis points.

About half of that relates to the variable margin piece of income so that is about 40 basis points or so.

All in, we are recovering all costs year-to-date and most of our businesses, substantially all of them, are recovering full margins.

So the price increases have been put in place to recover all those cost increases.

And then given where you stand on the latest round of raw material costs increases, you still feel you will be above parity for the fourth quarter?

Yes, we think so.

I mean I think we will be able to react a lot quicker than we did a year ago.

And everybody is aware, all the customers are aware, of the higher input costs so I think passing those on will be something we think we can do.

What are the prospects for an additional buyback program now that the 31 million has been completed?

I think at this point, if you remember, we started the buyback program last year because we had a buildup of cash because we didn't do a lot of acquisitions for a few years so we had 1.7 billion in cash on the balance sheet and we thought, based on even a normal level of acquisition activity, we couldn't spend that given our free operating cash flow.

I think our going forward, I think our strong preference is to use our free operating cash flow for acquisitions.

And I think we have seen some good increase in acquisition activity both in the number of deals we are seeing and also the pricing, although not great, is still okay especially in the under $100 million acquisition range.

So I think our preference at this point is to use our free operating cash flow for acquisition activity and I think if we see a buildup in cash on the balance sheet we may have to revisit that but I think at this point there is no plan for a --

But there would need to be another board reauthorization?

That's correct.

Thank you.

Next question is from Andrew Casey.

Your line is open.

Good afternoon.

Hey, Andy.

Hi.

I guess two part question.

On the Specialty Systems International, can you help me understand what the non-volume related income impact was?

The year earlier comps weren't all that atrocious so if you can explain that I would appreciate it.

And then, well, if you can start there.

Okay.

The non-volume added, the non-volume effect is two pieces.

It's the change in variable margin and overhead costs.

In this case, most of the 170 basis point reduction in margin versus last year relates to overhead costs.

There is no one thing in there.

Stock option expense is part of it.

You had some higher period costed inventory that got released in the P&L because we reduced inventories in certain businesses that were seasonal.

We had some additional pension expenses.

There is no one thing in there.

It's just a variety of overhead costs that the relatively small segment but didn't take much to swing that to a negative 170 basis points.

Okay.

Thanks.

And then was there a charge, if any, related to the cash repatriation in the quarter?

Thanks.

Just to remind everybody.

We booked a $25 million charge in the fourth quarter of 2004 for our expected repatriation.

We bumped up how much we've repatriated.

I think our original estimate was in the neighborhood of 750 million.

We have now done a billion.

So as a result, we did take an additional charge of about 4 million in the current quarter but that really had no effect on the tax rate because there was some other miscellaneous items that were favorable.

Thanks a lot.

All right.

Our next question is from George Nixon.

Your line is open.

Thank you very much, guys.

Congratulations on a solid quarter.

Thank you.

Thank you.

A couple of questions regarding raw material costs.

A lot of your competitors over the past couple of years have been implementing some new strategic initiatives to reach their raw material costs by establishing better lines of communication with their supplier base to overall look at purchasing their entire supply chain costs.

I missed if you brought some color as to what you guys are planning on doing to look at your supply chain as a whole and reduce your raw material costs by opening up better lines of communications with your suppliers?

Well, I think the way we operate our businesses, we are very decentralized and what that results in is our -- each of our business units is very close to customers and very close to their suppliers so we have, I think, a pretty good communication lines with our individual suppliers.

And to some extent, when we have some some common raw material, we will have business units that band together and negotiate together but generally we are dealing specifically with the suppliers and I think we have got a pretty good relationship with them and have been able to establish some nice pricing versus the market in some cases.

Going into '06, what are some of the raw materials that still concern you?

I think the biggest one is resin.

That seems to be the one, given the price of oil and energy, that seems to be going up fairly quickly at this point.

And regarding resin, how are your suppliers helping you to keep those costs as low as possible?

What kind of things are they doing to help you guys?

Well again, I think it's a function somewhat of the input cost.

If energy goes up and oil goes up, that is what you need to make resin.

So it's going to go up and the question is how do we minimize those costs and we are working diligently with our suppliers to try to minimize them.

I guess what I mean by that is you are exactly right, resin costs are what they are.

It's hard to really manipulate those.

How are you working with suppliers to look at logistics, everything, total cost of ownership of your supply chain, to make sure you are working with the right suppliers and getting the right overall cost throughout the supply chain.

I think it goes back to Ron's point initially that in a decentralized structure, you have business units that are very much focused on their end markets and suppliers so they have the ability to target both constituents and in this case the supply base.

So it's a function of working day to day with your suppliers to make sure you have the appropriate amount of raw materials in order to run your business.

And there is not one grand strategy, that is not the way we run things here.

It is really a function of our businesses running their businesses and doing it in a proactive way.

Okay.

Final question.

What is your top initiative that you guys want to accomplish next year?

Probably to make more money than we did this year.

That's all I wanted to hear.

Thanks a lot, guys.

And as evidence of our structure and the way it works, you can see from the results we have been able to recover our cost increases through price increases and actually recover our margins as well.

All right.

Perfect.

Congratulations on a solid quarter.

Thank you.

Our next question from Mark Koznarek.

Your line is open.

Hey, Mark.

Hi, Mark.

Are you there, Mark?

Check your mute button.

Hello?

Go to the next question, sir.

We have Gary McManus.

Your line is open.

Hey, Ron and John.

Can you help me in trying to figure out what happens to Leasing and Investment profits?

I think you said in the July conference call, you expected 40 million in profits in the third quarter.

It ended up being 53.

I know it is tough to predict the asset sales there but if you go back in January, you were predicting income from this business to be 60 to 70 million.

Now it's roughly a hundred million.

So going forward in the next year or two, I remember thinking that this is in kind of a two year, you know, drawdown in profitability in Leasing and Investments as some of these pools of assets wind down.

Can you help me kind of what we should expect in that business going out a year or so?

There is really two investments in there that have contributed to the biggest part of the increase going from a 65 million estimate at the beginning of the year to about a hundred now.

The biggest piece of the portfolio is our commercial mortgage investments, where we have the three different deals, one of which is winding down this year.

In the prior year, we had sold some properties in the various deals and had some gain, but in the current year we weren't expecting any significant gains and we typically don't include those in the forecast.

And so as we have wound down that first portfolio and it is due to be wound down by the end of the year, we have been filling out assets and we have been fortunate enough to get some bigger gains than what was expected.

There was a -- the biggest one was a $25 million gain during the third quarter on a strip mall in Florida that went from listing to closing of the sale pretty quickly given the crazy real estate market down in Florida.

So that was clearly unexpected.

And so I think that has been part of it is winding down this first portfolio.

Also on the venture cap side, we are on a mark to market accounting for that and we had some big mark to market gains last year and we've been fortunate enough to get more gains in the first part of this year so that's helped as well and those are obviously difficult to predict.

So that is why there is has been an increase.

Now, as far as winding down, like I said, 80% of the profit in this segment is commercial mortgage related.

And the first deal will end by the end of the year.

So whatever profits we are getting from that will go away and then we have got the two other transactions and those as we wind down may not be as profitable as the first one was, especially the third one.

So do we think it will be lower next year?

Yes.

We said 65 for this year.

Could be that or below going into next year and it will have better information on that at the end of the fourth quarter obviously after we put together all our plans and everything else.

Okay.

That is pretty helpful.

The -- looking at your earnings guidance for the fourth quarter, even if I strip out , you're going have lower Leasing and Investment profits in the third quarter than what you saw in the third quarter and just looking at the manufacturing side, similar growth, but if I recall fourth quarter '04, you had a big inventory reevaluation, I think it was like 25 million.

So I think you have a pretty easy comp especially in the EP North America where you had, I think, fairly low margins.

So can you comment on that?

I think the 25 million you're referring to, just to refresh everybody's memory, we had a standards revision in the fourth quarter of 2004 which increased inventory and increased income so in fact we have an unfavorable comp for this year versus last year of about 25 million.

So our forecast calls us to basically maintain margins at the same level as last year which really means that we are picking up approximately 25 million or so in additional margin incrementals and that is I think a continuation of what we have seen this quarter, you know, continued recovery of cost increases plus margin, continuing reduction in overhead costs.

Okay.

Great.

Thank you.

You're welcome.

Our next question is from John Inch.

Your line is open.

Thanks.

Good afternoon.

Hey, John.

Hi.

Currency.

What was the -- I apologize if this was somewhere in your presentation, but what was the top line in EPS impact this quarter and considering dollar and comparisons for fourth quarter, what is it for the fourth quarter?

This quarter was 0.8 percent so 80 basis points year-on-year.

Fourth quarter is basically flat versus last year so we're really getting no help from currency any longer.

That is topline, right?

Yes, topline.

What do you think the EPS impact was and will be?

Was is almost nothing.

And will be I think is almost nothing as well.

Okay.

And then overall, I mean I know you referenced I think that one segment with respect to hurricanes.

Is there a way to size up what you thought the net impact was to either revenues and profits for the Company?

Yes.

We have asked that question internally and it is a difficult thing to get your arms around because it is hard to quantify.

The positives we have seen in the quarter are our welding group sells portable power units and they saw some increase in that obviously during the hurricane.

On the downside, there were some businesses that have sales offices or service centers located in the hurricane regions that were shut down and may still be shut down that will obviously hurt earnings and have hurt earnings.

Also, we had a business in Houston where the roof blew off the plant and they had to halt production for awhile.

So there's puts and takes.

As best we can tell, it was pretty much a push in the third quarter and probably will be a push in the fourth quarter.

So this has not in any way affected the way you are thinking about guidance or the outlook?

No.

No.

Okay.

And then just lastly, the impressive 19% return on sales, how much of that may have been a derivative of you guys trying to just put the extra pressure on considering the uncertain outlook in the economy?

I mean is there any of that or how would you like us to think about that number and the sustainability of ROS going even higher potentially?

Well, I think, first of all, the 19 includes Leasing and Investments, right?

Understood.

If you look just at manufacturing, we are at 17.7 which is still obviously good.

It is 100 basis points higher than last year's manufacturing.

And I think that is a function of us recovering costs plus margin as well as reducing overhead costs.

And part of that is, you know, as we saw the downturn in the second half of the year, earlier in the year, we took a close look at overhead costs and were able to reduce some of those.

So that is a typical ITW approach to when we look ahead and when we see a possibility of base business moderating in the second half in this case, the second half of the year, but we use all the various tools to respond.

I think we've been evolutionary in terms of doing this as opposed to being reactionary, doing it all at once.

We're asking our businesses to continue to look at this and to respond in kind.

That is where it helps to have the smaller decentralized business units because the guy who's running the small unit can react a lot quicker because he knows if times are tough where he can cut overhead costs quickly and if you have a big complicated enterprise, the guy at the top doesn't know any of that and he has to do a study and all that to figure it out.

So we think our business model definitely helps that and we have seen increased restructuring activity in the third quarter and we think that will help going forward as well, especially on the international side.

Again, I think what you are saying is the results are attributable for the most part to the merits of the business model versus something that was some sort of incremental initiative beyond kind of what you just talked about about the overhead, et cetera?

Exactly right.

Okay.

Thanks.

Our next question comes from Robert Lacoppa.

Your line is open.

Hi.

Good afternoon, John and Ron.

Hello Mr. Lacoppa.

Just a few questions.

I just wanted to circle back to the acquisition activity and also the share repurchase program.

I wanted to get your thoughts on why you decided to repurchase the remainder of the program in the third quarter and when you look at the acquisition activity and the fact that the pricing looks like it's improved and quality of deals have improved, is there any particular area there and how large is the pipeline?

Are there larger deals in the pipeline or do they remain in that couple hundred million dollar tops range?

Can you maybe just comment on that?

Let me take the acquisition part.

You know, right now, if you size up the pipeline, we are essentially looking at about 20 deals that we are actively working on representing a little bit north of 400 million in annualized revenues.

I don't think that there is any particular area that we are focused on in terms of segments of the marketplace.

We tend to be, you know, relatively opportunistic.

We have in the past and I think we will continue to be in the future.

If you look at the Instron deal, it actually was an opportunistic deal that came up for us that turned out to be something that helped us get something that had a little bit faster and a little bit stronger growth rate than things we typically acquire.

So that fell into a category of both size and growth rates that are advantageous to us.

But that wasn't something that we were necessarily targeting in terms that we wanted to get into instrumentation per se.

Do we like the characteristics of what that business brings to us?

Absolutely.

I wouldn't sit here and tell you that there is any particular areas of the acquisition environment that we are targeting at this point in time.

I will say that I think the acquisition pipeline and the quality and the pricing on deals we are looking at right now looks better than it has in a number of years.

And just in terms of the decision to end the program early in terms of buying back the shares a little bit early.

Was there was any particular thoughts there?

I think that was simply trying to be opportunistic.

We had plenty of free operating cash flow as well as we bought back $700 million during the quarter from the overseas operations.

So we had plenty of cash.

We thought the stock was attractively priced for a repurchase so we went ahead and finished it out.

One follow-up if I might and last question just related to the restructuring costs, and if my math is correct, the restructuring costs through the first nine months of the year, the first three quarters, are something along the lines of about 30 million and your range for the year is 40 to 60 million.

I mean what are you targeting for the fourth quarter?

Is it closer to the 40 million, implying 10 million in additional restructuring, or is it closer to the 60 million which would lead to an additional 30 million in restructuring?

Where exactly are you planning on restructuring?

Is it still going to be in the international businesses, predominantly on the Specialty Systems side, and if so, why?

The numbers for restructuring expense for year-to-date through the third quarter is about 36 million.

So our target, our current forecast is in the midpoint of 40 to 60 so around that $50 million range which would leave 14 for the fourth quarter.

The -- we have some projects identified.

There's other ones that aren't identified and they just come up during the quarter but the ones that are identified are primarily on the international side in Specialty Systems.

Okay.

Remember, that is where we -- when we talked about the results, that is where we saw some higher overhead costs and so appropriately we are doing some restructuring there.

What is contributing to the higher overhead costs?

Is it just a function of lines that are a bit weaker given the sluggishness in Europe?

What is causing the overhead costs to be a bit out of line?

I think it as variety of things.

It is no one thing.

It is no one business.

It is no one set of businesses.

It is a bunch of gnits and gnats.

But it's a few million for the stock option expense which is new this year.

We've had some higher period costs in inventory that got released to the P&L.

Higher pension costs.

So it's no one thing there that goes into the higher overhead.

Okay.

Fair enough.

But inherently international, especially Europe, is going to have a higher overhead cost just because of the way Europe operates with the social costs.

Right.

Thank you very much.

Good quarter.

Thanks.

Our next question is from Ann Duignan.

Your line is open.

Hi, good afternoon guys.

I promise I won't ask a question about the supply chain.

My question is more around your guidance and what appears to be still a quite conservative guidance.

Your organic growth rate this quarter was slightly less than what you had forecast at the beginning of the quarter but your earnings, if you just took a pure operating earnings, are about $0.03 higher than anticipated and now you have taken up your organic growth rate a little bit for fourth quarter but you haven't changed your earnings outlook, and given all the restructuring you have done and the positive impact we have seen on restructuring already, why wouldn't we walk away saying that this earnings outlook still looks conservative?

Well, I think just to be clear first, we did increase the base business revenue growth from 2.6% in our last forecast for the fourth quarter to 3%.

Right.

So that did go up and accordingly, at least from the base side, we have increased the earnings outlook in the fourth quarter by $0.01.

But we have also then taken down earnings by $0.01 for Leasing and Investments because some of the sales that were forecast in the fourth quarter got moved up into the third.

So there is a little bit of a flip there.

Just looking at base, we are up a penny versus the prior forecast.

Okay.

So a penny from improved operations because of the improved outlook on revenues and a penny off of Leasing and Investment.

That is the way I should think about it?

Yes.

Right, and Ann, I think we addressed part of this up front when we said we are still a little concerned about the impact on resin pricing and what that is going do for both the raw material and from an end market stand point and the industrial production number is, I think you would agree, clearly don't look robust right now in North America.

No, but I would argue that offsetting that construction looks a little bit stronger, particularly given the numbers we saw today than we might have thought they would be a month ago or two months ago.

When I always have this discussion with you or whom ever else on forecast and to the extent you think we are conservative, my response usually is we hope you are right.

Two quick follow-ups.

You have options expense showing up on the individual operating segment line items, which makes the reported operating profit of 17.7% even more impressive.

What might that 17.7% have been if you had not distributed the option expenses to the business units?

Well, I'll give you the number.

And you can recalculate it.

But it is about $26 million of additional expense in 2005 versus 2004 for options.

That works out to about $6.5 million a quarter.

And that gets spread across all the segments.

You know, it is a few million bucks.

A million some for each segment really.

Okay.

And so you don't hold any of that option cost at corporate.

No.

Okay.

That -- I guess I could have asked it more simply and then final, a real quick clarification.

This is the first time you talked about industrial plastics declining both in North America.

I think is might have declined in the other businesses prior.

What is going on there?

Can you give us some color on that business and you mentioned increased global competition.

Can you just tell us?

Yes.

I think what is happening is on both the North American and the international side, we are seeing competitors coming out of China, coming out of eastern Europe and coming out of Korea in some cases where they are filling in the markets and taking more market share.

So, you know, the goal and task ahead for us is to make sure that we have better penetration and we are selling more and more products to these new set of competitors.

So we have both of our businesses in North America and on the international side on the appliance targeted area focused on making sure we are dealing with the Hiers of the world and the Samsungs of the world.

What size is that business just for perspective?

What size is it?

Yes.

Roughly.

Well, I mean the business in total is probably, you know, a couple hundred million. 200 or 300 million.

On a global basis.

On a global basis.

Okay.

Thank you.

Thank you.

Our next question is from Mark Koznarek.

Your line is open.

We're going to try this again.

Can you hear me?

Hi, Mark.

That's good, Mark.

Great, thank you.

Hey, just wanted to drill a little bit into the Engineered Products business on, you know, the ITW brand seems to have slowed down a lot relative to the trend rate from the first six months, you know, you talked about 3% and it was 7% growth.

And it looks like the remodel rehab category is the one that slowed the most and we had been picking up from other channels that home center activity in some of the other competing brands actually picked up late in the quarter and there is more promotional activity.

Is there any market share shift story as part of this or how do you explain the slow down?

Well, I think to us it's a fairly simple explanation.

We benefited greatly in Q3 a year ago from a lot of sales into the box stores for the hurricanes down in Florida.

We had some big incremental sales down there.

So the comps on a year-over-year basis have helped to skew the numbers.

I think the comparisons largely explain what we are seeing on the brand side of the business.

Does that then mean there is some pipeline of sales into, you know, overall in the southeast for repair in the fourth quarter that will kind of mirror what we saw third quarter year ago?

Well, the third quarter a huge ago was in preparation for the hurricane.

It was selling our tap con fasteners to board up the houses.

It happened at the same time as the hurricanes.

In the Louisiana/Texas region, there is different kinds of house construction so they don't use our tap con which goes into, with masonry building.

Typically the houses there are stick built.

So there is not a big demand for concrete fasteners prior to the hurricanes there.

Going forward, as far as the rebuilding, we may get a bump in the second half of '06 as they start rebuilding but clearly in the next quarter we don't think there is much of an incremental from rebuilding down in the hurricane zone.

We clearly think there's going to be some positives from the hurricanes both in the gulf coast and in Texas but I think to Ron's point that we are thinking first half of '06 when they start to do some significant rebuilding and we think we're going benefit both from the, clearly from the renovation side and from the new housing side, too.

And probably a little bit from the commercial side.

Okay.

So across the board.

Yes, I would expect so.

But it's really going to be an '06 story rather than soon.

We think so, yes.

Okay.

Then question on Signode, the packaging business.

That slowed down modestly, nearly to flat, and you mentioned something about price and I was unclear what you were saying.

Whether you had to reduce price and that hurt the top line or there's price based competition and you're losing share.

Could you just review that?

It's the former.

We had to reduce price.

We increased raw material pricing a year ago and we have had to basically give some of that pricing back in order to maintain share or not lose as much share so I think it is more of that.

Is that on the consumable part or the actual machines?

Well, it was I think more consumable.

Steel straps in this particular case.

They are also dealing with the issue of rising resin costs, too, for their plastics.

That is more current .

They are dealing with the year ago phenomenon of what they did in order to raise prices and they had to bring prices down so they got cross currents of resin and steel issues they are dealing with.

Okay.

All right, John, thanks.

Next question comes from David Bleustein.

Your line is open.

Most asked and answered but can you just walk us through Instron's geographic revenue mix and give us some sense of margins.

I know you don't want to give extremely specific what you paid but I'm just looking for some sense to help us quantify what the new price of acquisitions is relative to one-time sales.

The geographic mix is fairly simple.

We're about a third North America and the rest of it is international between Europe and Asia with a big concentration in China.

We think big opportunity in China there.

The second part of your question was price paid?

Yes.

Price paid was essentially about one times revenues.

One times sales - okay.

And what was the other part of the question, David?

Margins.

Margins of the business are typical ITW acquisition of 8 to 9% with the goal of trying to double those in a 3 to 5 year period.

Terrific, thank you.

Our next question is from [ INAUDIBLE ].

Your line is open.

I think that was me.

She is cutting out.

Can you give us a little bit more deep dig into the restructuring costs, what are they focused on, and more importantly what kind of impact we might see on the margins in 2006?

Joel, is that you?

Joel?

Yes, that's me.

We didn't hear the introduction.

Okay.

Just like in the third quarter, the fourth quarter restructuring costs are also focused on the international side, primarily in Specialty Systems.

Our industrial packaging businesses, our food equipment businesses, are undergoing some reorganizations which is something we normally do as part of the 80/20 process is look at what's important and reorganize ourselves around the 80 so it is things like, you know, and in particular countries the salesmen maybe have been organized by territory and were being -- and we are going to reorganize them by product and as a result we may need less salesmen.

Thinks like that.

Did that answer your question?

Yes.

And then can you give us any sense of the operating margins are, you know, way below North America at 11.5% or so.

Can you give us a sense of what kind of operating margin improvement we could look for from some of this restructuring in '06?

I think from a dollar standpoint, what we try to do is recapture our dollars spent in restructuring within a year or so.

So to get a gauge of that, I think if you looked at the restructuring expense by segment and look at that over a 12 month period of that coming back over time to improve the margins.

Okay.

And just a quick cleanup.

Can you give us the CapEx number for the year-to-date, please?

Thank you.

Year-to-date or full year?

Year-to-date?

Yes.

I think we can do that.

We said 71 for the quarter. 310 for the year.

I don't have the year-to-date handy but --

Okay.

Thank you.

Joel, I'll give that to you late.

All right, thanks.

Our next question is from Robert McCarthy.

Your line is open.

Hi, guys.

Hi, Rob.

Hi, Rob.

$6 million loss on divesting what?

We can't get into the details too much but it is a construction business on the international side.

And so it will -- I'm just interested in what segment it's going to have an effect on growth.

What segment we will see an effect on growth rate?

It's Engineered Products International, relatively small business.

Great.

Maybe regarding all the discussion about Leasing and Investment, Ron, can you tell us how much of the roughly 100 million of income that you are forecasting for the segment for the year would be accounted for by the commercial pool that winds down this year?

Well, I can tell you that about 65% of this year's income would be related to the commercial mortgages.

And I don't have the exact split of that but I think probably about half is on the first pool because that is where we have been selling all the assets.

Right.

Probably more than half actually because we had a $25 million gain on one asset.

Yes.

Okay.

That helps.

And in the -- admittedly small upward revision to the fourth quarter organic growth forecast, is that something that was concentrated really in one of the segments or was is distributed throughout?

I think it as function of looking at the various businesses.

Probably a little bit more in North America than international.

Across EP North America and across the systems North America.

And if you will -- if you will humor me one more.

Is this a follow-up on a follow-up on a follow-up?

A follow-up on that international construction business question.

You know, you had a decent comp in Australia.

If you had to make a forecast for the coming year in Australasia for construction, would it be up or down?

For -- we're talking about for '06?

That's right.

I would say up.

Clearly up.

Thank you.

The next question is from Wendy Caplan.

Your line is open.

Thanks.

Hi, Wendy.

Hi.

A follow-up on the acquisition pipeline.

In your prepared remarks and in the press release, the written press release, you sound more excited about the acquisition environment than in a awhile.

Question, are you in the pipeline or are there bigger acquisitions that we typically think of in terms of ITW and can you give us some sense whether the multiples being asked for these things are higher or lower?

And finally, is there any change in the hit rate of your -- of the acquisitions?

Well, I think -- I think the pipeline right now in terms of, I told you we have approximately 20 deals.

The ones we are looking at right now I think the largest deal we have is probably in the, you know, 80 to $100 million range.

Maybe even closer to 80.

I don't think there is anything of an Instron size in the pipeline.

Clearly there is nothing of an Instron size in the pipeline.

One of the reasons we are excited is there's a lot of those deals in the $30 million to $50 million range which has typically been our sweet spot as we add complementary businesses to our business units.

And I think we're also encouraged by the fact that the hit rate is becoming a shorter, it's becoming higher in a shorter time period because negotiating prices is a little bit easier now than it was going back a year, year and a half, two years ago, as witnessed by the fact that we were able to close an Instron deal at roughly one times sales.

I think we are still sticking to our pricing discipline but seeing a pipeline that is more active and real signs of encouragement.

Thanks.

And one final question.

As we look at commercial construction as an end market, we have been waiting for some sign of recovery for awhile now.

Can you remind us what historically that's looked like?

I know we have been kind of in the mid single digit uprange.

What should we expect and are there any other businesses or end markets, rather, like that that we are kind of waiting on for you?

Well, I think if we go back to 2000 -- year 2000 levels, commercial construction was probably growing at a rate of 5, 7%, somewhere around there, on a fairly consistent basis.

Right now, I told you the best we've seen is sort of in the 4, midpoint of about 4.

But we have had some months where it's been clearly negative.

So I think if we go back into a consistent environment on commercial construction and we are able to grow commercial construction revenues in that 6-7% range, we would be pretty happy given the mix of our businesses on the North American and the international side.

Thanks.

And any other end markets that appear to be lagging?

Any end markets that appear to be lagging right now?

Yes.

Probably -- well, we talked a little bit about the industrial packaging business.

Some of that due to pricing issues on raw materials.

The auto area, lagging in terms of what our past history has been in 2000 and clearly builds were better.

But probably doing a little bit better than our, a tad better than our original expectations going into the year.

Thank you.

Thanks.

Our next question is from Chris Kodowitz.

Your line is open.

Thank you.

Good afternoon, guys.

Hi, Chris.

I really have a housekeeping type item.

Is there any tale on the charges, the non-volume related charges at the systems international business you guys touched on, going into the fourth quarter?

Is that mostly behind you?

I think again it as bunch of small stuff.

Some of it will continue.

For instance, the option expense, the pension expense, et cetera, but there are a few things that will not continue.

You know, we had a release of overhead costs because inventory levels went down.

That won't happen in the fourth quarter.

So I would expect it to get somewhat better.

Also we had some restructuring costs in that segment that will take effect starting in the fourth quarter and definitely into '06.

Does that 13% headwind go to 5, I mean roughly?

I don't have an exact number for that but it definitely will get better.

Okay.

You touched on the impact of resins pricing and how that is hitting the packaging business.

Are you finding that availability is an issue because we are talking to people in the channel that are saying that basically allocation is a typical thing right now and there is not enough supply and are you finding that your sales forecast for the fourth quarter is somewhat impacted by the fact that you are not necessarily sure you are going to have the material especially on the consumable side that you need to supply demand and that that is going to hurt you on the top line?

I think on the resin side, I think we -- the only place where we have seen an availability issue is the polypropylene.

The bigger issue from availability, I think, is in our polymers and fluids businesses, the ability to get some chemicals.

There were some chemicals plants down in the hurricane area in Texas that were shut down and so we have seen some availability issues there and I think we -- those particular business units have brought down their forecasts for the fourth quarter to reflect that.

I think that is built into the forecast somewhat and one of the reasons I think that you are seeing the base business growth go down to 3%.

Okay.

All right.

That's all I've got for now.

Thanks.

Thank.

Our next question comes from Steve Searle.

Your line is open.

I was just wondering, on the topic of acquisitions, if something larger such as the Textron fastenings unit would make your radar screen or is that out of your scope?

Something specifically like Textron fasteners?

Yes.

The answer is no.

We clearly would not be interested in all those assets.

We possibly could be interested in small pieces of that but I suspect that they are not going to want to disassemble those assets.

I suspect they are going to want to sell them together.

With respect to the pricing you are seeing, is it fair to say that the prices have come down a little bit because there's fewer buyers or sellers have become more realistic or what is the dynamic there?

I don't think prices have come down.

If you look at our historic acquisition price paid going back two, three, four years ago, we were probably paying something close to 0.8, 0.9 on the dollar and now up to perhaps 1.1, in that range.

I think prices have gone up a little bit and that is reflective of the fact that companies are producing better earnings now than they did two or three years ago when they were asking for higher multiples based on lower earnings so at least they have their earnings to support some higher prices paid and by higher prices paid I mean going up by small factors in terms of what we are paying.

Okay.

Thanks.

Our next question comes from David Raso.

Your line is open.

Hi, question first.

Actually clarification.

Instron, if I read the slide right, you give the price as 255 million, correct?

Yes.

Okay.

Regarding the North American based businesses.

If you look at Engineered Products with Specialty Systems together.

If you look at the base business, the incremental margins have gone from first quarter 16% to 34 to this quarter was 69%.

I mean it was a huge incremental margin year-over-year for the North American businesses.

What I'm trying to understand and maybe you can explain it to me is that the non-volume related piece that you consider part of base business, not the restructuring, the non-volume related.

That appears to be the big swing factor looking from first quarter to second to third.

Is the operating leverage that you described hasn't changed dramatically.

Can you help me understand what is in the non-volume related number?

Well, the way we break out the base margin effect and the operating income effect, is operating leverage is simply the sales -- sales dollars holding variable margins.

So we know what the sales dollars are.

We know what variable margins are last year and so we hold that constant and the difference between that incremental income and margin and the actual margin is what we consider non-volume related.

So that's really two things.

That is change in variable margin.

So that gets to the cost issues, you know, higher raw material costs, higher wage costs, anything like that, as well as the ability to increase prices to recover those costs and margins.

And then the second piece is the overhead costs so that is the -- you know, the fixed manufacturing overhead as well as the SG&A.

So those are the two pieces of it.

And the total company basis, the 70 basis points, about half of it is the change of variable margin and about half of it is lower overhead costs.

And just so I'm on the same page when you say variable margin.

If the mix changes, that changes your variable margin as well, correct?

When you say you hold it steady from last year because if I look at the way the years progress in the North American businesses.

Signode growth slowing to me is not a positive mix.

I mean welding has been strong the whole way.

The finishing business has picked up.

And the core fastener business for construction, it's been pretty healthy the whole year.

It is not so much mix I would suspect.

It is more a function of you took the overhead down tremendously as the year's gone on and part of it, of course, based on your comp and also price versus cost.

Some have been dramatic. 16% to 69% incremental margins is tremendous.

Am I capturing right?

It's not mix.

It's more overhead and price versus costs?

Yes.

Okay.

Simple answer.

Thank you.

Our next question is from Ned Armstrong.

Your line is open.

Good afternoon.

It looks as though Wilson has -- Wilsonart has performed better on a year-over-year basis this quarter than last quarter.

And I just would like to know what you attribute that to and whether you think it is sustainable or not?

Well, I mean when we reported the Wilsonart numbers for the quarter, we basically said the base laminate business and the flooring business were both mildly positive.

So clearly flooring got better in the quarter.

And what is causing that from a competitive standpoint or what you're doing or is it something just in the marketplace?

I think it is probably more demand related than anything else.

Okay.

There is no new product introductions that I'm aware of at this point in time.

If you look at the Wilsonart based laminate piece, I think it is -- it is -- it is demand related and probably a little bit of a pickup on the commercial side which helps them because the more than 50% of their sales are commercially based.

So they got a little bit of a pickup.

Any time you get any kind of pickup on the commercial side, Wilsonart you're going to see their numbers improve.

Now are they anywhere near where they think they need to be?

I think they believe they can certainly grow topline at a faster rate but to the extent that both sets of numbers are positive is encouraging.

Okay, great.

Thank you.

At this time we are showing no further questions.

Okay.

We thank everybody for their time and look forward to talking to everybody next quarter.

Thank you.