Illinois Tool Works Inc (ITW) 2006 Q2 法說會逐字稿

Good afternoon and welcome to the Illinois Tool Works ITW second quarter 2006 earnings release conference call.

At this time, all participants are in a listen-only mode. [OPERATOR INSTRUCTIONS] Today's call is also being recorded.

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

I would now like to turn your call over to Mr. Brooklier, Vice President of Investor Relations.

Thank you, sir.

You may begin.

Thank you, Dawn.

Good afternoon, everyone, and welcome to ITW's second quarter 2006 conference call.

As noted, I'm John Brooklier, ITW's VP of IR, and with me today as usual is Ron Kropp, our Vice President and Controller for Financial Reporting.

We're pleased you've joined us for today's call.

Similar to the first quarter of 2006, the second quarter represented another outstanding financial report card for ITW.

Our second quarter results saw revenues grow 9%, operating income increase 18%, and diluted net income per share rise a very strong 27%.

Our operating margins hit 18.4% in the second quarter, a 140 basis point improvement over the year-ago period.

In addition, our pace of acquisitions thus far this year has prompted us to move our target range up to 900 million to 1.1 billion of annualized acquired revenues for the full year.

Ron will give you more details on all these strong financial metrics in just a few moments.

Here's the agenda for today's call: Ron will join us shortly to provide more details about our second quarter results.

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

Ron will then address our 2006 third quarter and full-year earnings forecast and associated assumptions.

Finally we will open the call to your questions.

Please note, as always we ask for your cooperation as to the one question, one follow-up question policy.

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

As always, we have a few housekeeping items.

We would like to remind everyone that this 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, earnings growth, operating income, tax rates, use of free cash, potential acquisitions for full-year 2006, 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.

These risks are spelled out on this slide and are part of our form 10-Q for the 2006 first quarter.

Finally, the telephone replay for the conference call is 402-998-0724, no pass code necessary.

The playback number will be available until midnight on August 3, 2006.

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

Once you find the Investor Information section, just look for the earnings presentation tab.

Now let me turn it over to Ron, who will take you through the financial highlights.

Ron?

Thank you, John.

Good afternoon, everybody.

I'm happy to report we had an excellent second quarter.

The highlights are as follows: Revenues grew 9% versus the second quarter of last year.

This growth rate was 90 basis points higher than the growth rate for the first quarter of 2006.

Operating income was up 18% versus the prior year, due primarily to higher revenues and improved margin for the base businesses.

Operating margins were up 140 basis points.

Diluted net income per share was 27% higher, free operating cash flow was $281 million, and return on invested capital was 20.5%, which was 210 basis points higher than last year.

Now let me give you the details of our operating results.

Our 9% revenue growth was primarily due to three factors: First, base business revenue grew 4.5%.

This growth rate was 160 basis points lower than the first quarter.

North America increased 4.4%, which was lower than the first quarter by 370 basis points.

However, we had one less shipping day for North America in the second quarter versus one more day in the first quarter, which contributed 250 to300 basis points of this decline.

International base revenues increased 4.3%, which was 190 basis points higher than the first quarter.

Second, acquisitions added 6.7% to revenue growth, which was 140 basis points higher than the first quarter acquisition effects.

Third, currency translation reduced revenues by 1.4%, which was favorable by 120 basis points versus the first quarter currency effect.

Overall, our 9% revenue growth was a result of slowing but still reasonably strong base revenue growth in North America, stronger base business growth internationally, and the larger impact of acquisitions, partially offset by the unfavorable effect of currency translation.

Don will provide more details on the operating results when he discusses the individual operating segments.

Operating margins for the second quarter improved to 18.4%, an increase of 140 basis points over last year.

This margin improvement is primarily due to an improvement in base business margins of 150 basis points.

Acquisitions reduced margins by 70 basis points.

Of the 150 basis-point improvement in base business margins, 100 basis points relates to operating leverage and 50 basis points is due to non-volume related items.

The majority of this non-volume effect was due to favorable effect of price increases exceeding raw material cost increases.

In the nonoperating area, interest expense was lower by 10 million due to short-term debt levels in 2006.

Investment income was higher than last year by 18 million, primarily due to a favorable mark to market adjustment in the venture capital fund.

The second quarter effective tax rate was 30.1% versus 31.6% in the prior year.

The estimated tax rate for full-year 2006 was reduced to 30.5% from the 31% rate that was used in the first quarter.

Turning to our invested capital, total invested capital increased $385 million from the first quarter of 2006, primarily due to currency translation,acquisitions, and an increase in prepaid income taxes.

Inventory and accounts receivable also increased during the second quarter, but are still at reasonable levels of 1.8 inventory months on hand and 59.7 receivable day sales outstanding.

Both capital expenditures and depreciation expense were $77 million for the second quarter.

On the financing side, we decreased our debt $139 million from last quarter and our debt to capital ratio decreased from 13% to 11%.

Our cash position increased $5 million in the second quarter as our free operating cash flow of $281 million was utilized for acquisitions of $82 million, dividends of $94 million, and debt repayments of $140 million.

Our free operating cash flow decreased $136 million from the second quarter of last year, primarily due to income tax prepayments in 2006 related to an IRS issue regarding the treatment of our leveraged leases.

Our second quarter return on invested capital of 20.5% was 210 basis points higher than last year.

This increase was mainly the result of our strong base business operating performance as after-tax operating income increased 20% while average invested capital only increased 8%.

We continue to generate economic profit as our ROIC significantly exceeds our estimated cost of capital of 9 to 10%.

Finally on the acquisition front, we acquired ten companies in the second quarter, which have annual revenues of $154 million.

In addition, thus far in July we have closed on two deals with annualized revenues of $188 million.

Based on the year-to-date acquired revenues of $695 million and a strong pipeline of potential deals, we are increasing our forecasted acquisition range for 2006 to $900 million to $1.1 billion of annualized revenues.

Our previous range was $800 million to a billion.

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

Thanks, Ron.

Before I review our manufacturing segments, let me spend a few minutes highlighting North American and international economic data we track and share with you on a regular basis.

The gap between stronger North America economic and end market activity versus slower European trends narrowed in the second quarter.

From an ITW perspective, North American-based revenues came in at 4.4% and international based revenues were 4.3% in Q2.

From a more macro standpoint, the North American ISM index was at 53.8% in June compared to 55.2% in March.

And while that index declined marginally in the quarter, there was better news as to the ISM new order index.

That came in at a reasonably strong 57.9% in June versus 58.4% in March.

Add to that a U.S. industrial production excluding technology number of 4.0% remain, you see we had a reasonably strong growth environment for the quarter.

International activity and data improved in the second quarter.

The Euro zone purchasing managers' index was 57.9% in June versus 56.1% in March and even though the most recent Euro Zone industrial production number was 2.1% versus 2.4% in the prior quarter, more encouraging was German industrial production activity, which was up 6% in the most recent reporting month.

Industrial production was essentially flat in France and U.K. in the most recent reporting period, so hopefully we'll see some improvement from these two key countries in the second half of the year.

Now let's review our four manufacturing segments.

Starting with North American engineered products, segment revenues increased 13.4% and operating income grew 19.8% in the second quarter.

Operating margins of 19.2% were at 100 basis points higher than the year earlier period.

Moving to the next slide and looking more closely at segment results, the 13.4% growth in the top line consisted of the following: 1.9% from base revenues; 11.1% from acquisitions; and 0.4% from translation.

Let's take a closer look at the business units in associated end markets in this segment.

Put simply, construction and automotive based revenues were essentially flat in the quarter and our industrial-based units grew base revenues at a rate of about 6%.

Total construction was down 1% in the quarter with ITW Construction, our tool and fastener businesses, down 2%.

Most of the modest slowing in construction was due to weaker sales of our Paslode products for new housing and industrial applications and slower sales from our ITW brands businesses into the box stores such as Home Depot.

Similar to the first quarter, ITW brands had to deal with inventory issues with Home Depot.

On the plus side, our commercial construction business saw revenues increase approximately 10% in the quarter.

The most recent commercial construction data from McGraw Hill showed that category growing about 7 to 8% in the month.

As to Wilsonart, their base revenues were flat in the quarter as base laminate sales actually grew 4%.

That number, however, was offset by weaker laminate flooring sales, most of which was due to the abundance of products we put into the channel earlier in the year when we rolled out a new flooring product.

Taking a look at automotive, our base revenues grew 1% in the quarter, even as Big Three builds declined 1.0% in the second quarter.

That 2 points of penetration is further testimony to our ability to continue to get more products into the various cars and light truck platforms, even in tougher pricing environments.

The second quarter builds were as follow: GM was flat;

Ford was down 1%; and Chrysler was down 1%.

Even new domestic builds at plus-1% were up modestly in the second quarter.

From an inventory standpoint, Big Three inventories were at 79 days at June 30th, and the breakdown specifically was GM at 73 days, Ford at 79 days, and Chrysler at 91 days.

New domestic inventories were at a healthier 53 days.

Looking ahead, despite better than expected builds by the Big Three for the first half of the year, we are still expecting builds to be down 2 to 4% for full year 2006.

New domestics should be up in the range of 4 to 5% for the full year.

In our Industrial Products category, business units base revenues grew a very healthy 6% in the quarter.

This growth emanated from a variety of business units in the category, including Minigrip Zip-Pak, up about 17%, fluid products up 10%, industrial plastics with base revenues growing at 6%, and polymers,6% base revenue growth.

A number of these businesses serve what we call our longer cycle, more CapEx-oriented end markets and have benefitted from growth opportunities in the manufacturing and industrial sectors.

Moving to the next slide and our next segment in International Engineered Products, for the second quarter segment revenues increased 3.9% and operating income grew 8.2%.

Operating margins of 14.9% were 60 basis points higher than the year-ago period.

Taking a closer look at the topline, the 3.9% increase in revenues consisted of the following: 4.1% from base revenues, 3.7% from acquisitions, and a decline of 3.9% from translation.

Like our North American segment, base units in EP International consist of construction automotive and industrial products.

The good news for us was that two out of the three categories produced base revenue growth in the quarter, resulting in stronger base revenue performance than in the first quarter of 2006.

Looking at total construction, base revenues grew 5% in the quarter compared to a 1% decline in the preceding quarter.

By geography, second quarter base revenues were as follows: European construction increased 6%, Asia Pacific grew 8%, and Wilsonart International was flat.

Europe was driven by increased demand across a wide swath of countries, especially those in the Benelux region.

Asia Pacific benefitted for demand pickup for new housing and commercial products in Australia and New Zealand, and Wilsonart International saw its second quarter strength from its German business essentially neutralized by slower growth in Asia.

Moving to Automotive, our business units in Europe produced base revenue growth of 2% in the quarter.

That growth was essentially in line with vehicle production.

Builds by the OEM there were as follows: Fiat, up 28%;

BMW up 10; and Citroen/Peugeot up 2%.

On the downside, GM group saw builds decline 6%;

Renault was down 4%; and Daimler Chrysler was down 3%.

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

These units in total produced base revenue growth of 5% for the quarter, with electronic component and packaging up 19;

Zip-Pak up 15; polymers up 8; and industrial plastics up 2.

Moving to the next slide, in North American Specialty Systems for the second quarter segment revenues, increased 10.9% and operating income grew a very healthy 22.2%.

Operating margins of 20.0% were 190 basis points higher than the year-ago period.

Again, a closer look at the top line, the 10.9% growth in revenues consisted of the following: 6.8% from base revenues, 3.5% from acquisitions, and 0.6% from translation.

This more CapEx-oriented segment continued to produce strong results yet again.

Welding's base revenues grew an impressive 21% in the quarter as the various business units encompassing machinery, consumables, and components continued to benefit from the continued demand for capital equipment as well as accompanying new product introductions and good pricing metrics.

While total packaging space revenues grew 4% in the quarter, Signode was only up 1%, due largely to price reductions in response to declines in commodity prices on a year-over-year basis.

I should note that volumes for Signode's main product lines were up about 3% in Q2.

The other industrial packaging unit, stretch film and paper products, produced double-digit base revenue growth in the quarter.

Food equipment's base revenues declined 1% in the quarter, as weakness from the supermarket customers offset growth from restaurants, institutions, and our service business.

Finally, our last segment, International Specialty Systems, for the second quarter, segment revenues increased 7.9% and operating income grew 15.9%.

Operating margins of 14.7% were 100 basis points higher than the year earlier period.

Looking at the top line, the 7.9% growth in revenues consisted of the following: 4.6% from base revenues, 7.2% from acquisitions, and a decline of 3.9% from translation.

This segment benefitted from contributions from a number of businesses, most notably welding, finishing, and food equipment.

Welding's base revenue grew 22% in the quarter due to strong equipment and consumables sales in Asia and Europe.

For Total Packaging, base revenues were flat, largely due to Signode in Asia -- Signode-European and Signode-Asian performance.

Signode-Europe declined 1% and Signode Asia was down 10% in the quarter.

A note on Signode-Asia: We believe that the machinery sales added to the decline and it appears that we also have walked away from some low margin business in that region.

Food equipment's base revenues grew 3%, mainly due to sales in Europe, especially in Germany, and Finishing's base revenues increased 8% in the quarter, thanks largely to higher sales of Gema powder products in Europe.

I'll now turn the call back over to Ron, who will talk about the 2006 third quarter and full-year forecast.

Thank you, John.

We are forecasting third quarter diluted income per share to be within a range of $0.78 to $0.82.

The low end of this range assumes a 4% growth in base business revenues and the high end of the range assumes a 6% growth in base revenues.

The midpoint of this range of $0.80 per share would be 11% higher than the prior year.

For the full year, our forecasted earnings range is $3.03 to $3.11 per share.

The full year base business revenue growth is expected to be in a range of 4.7% to 5.7%.

The midpoint of this earnings range of $3.07 would be 18% higher than 2005.

The new midpoint of the full-year earnings range has been increased by $0.08 due to primarily favorable currency translation, a lower tax rate, higher investment income, and lower restructuring costs.

Other assumptions included in this forecast are exchange rates holding at current levels; acquired revenues in the range of 900 million to 1.1 billion; restructuring costs for the year of 25 to $30 million; no further impairment of goodwill and intangibles; non-operating investment income in the range of 60 to 70 million, which is lower than last year by 60 to $70 million; and a tax rate of 30.5% for the third quarter and full year.

I'll now turn it back over to John.

Thank you, Ron.

We will now open the call to your questions.

Please remember, we're going to ask everybody, if you have a question, just one follow-up so as many people can ask a question as they like.

[OPERATOR INSTRUCTIONS] Our first question comes from Robert LaGaipa from CIBC World Markets.

Hi.

Good afternoon.

Just a couple quick questions.

One, in light of the guidance, the sales growth really hasn't changed a whole lot, a little bit lighter on the top end, a little bit more on the bottom end of it, so a lot of this is going to have to come down to margins moving forward.

And I guess with regard to the margins, maybe you could just speak to, one, just the pricing and the pricing that you're getting in the marketplace, is it sustainable?

The raw material impact that you're seeing, especially with the variety of different commodity costs moving up fairly substantially over the last several months.

And, I guess, two, on the restructuring side, you've lowered the anticipated restructuring costs and I was just curious as to what caused you to do that, where have you lowered it, maybe if you could just provide a little bit more color there, that would be helpful.

All right.

Well, let's start with the margins.

The margins for the year are expected to be about 17.7% for the whole company.

Last year it was 16.7, so we're looking at about a 100 basis point increase for the full year.

Currently we're at about 130 basis points for the first half.

And we're continuing to see strong margins in North America, Engineered Products, North America in the 18% range for the year, especially Systems in the 19 to 20% range.

On the international side, 14 to 15%.

So we're continuing to see good margins overall.

On the pricing side, we had a nonvolume effect in the quarter of about 50 basis points and 40 of that is price cost.

So what we've been seeing is we've been able to keep ahead of raw material cost increases by raising prices.

In some cases, we're seeing some costs go down and we've had to reduce prices as well.

The raw materials that we're seeing changes in, steel, year-over-year, is down, so second quarter costs this year versus second quarter costs last year is lower this year.

But we are starting to see some increases towards the end of the quarter in the 10% range.

But we think the rest of the year should be relatively stable.

On the resin side, PET, which is a main part of our Signode strapping product, was up slightly in the second quarter but was down in the first quarter due to over capacity in the market.

And we expect to see it go up a little bit in the third quarter, but maybe down in the fourth.

Polyethylene, which goes into our consumer packaging businesses, year-over-year, was up in the second quarter.

But it was down in both the first quarter and the second quarter.

So we're seeing some costs go up and down.

Overall, we are seeing some positive impact on margins because of that.

Our non-volume effect for the rest of the year is expected to be flat.

If you remember, last year in the third quarter is when we first started to really recover full margins on the raw material cost increases that were really started in 2004.

Right.

On the restructuring side, we reduced the range from 30 to 50 million to 25 to 30.

We have a little bit of the visibility on restructuring projects before they happen and we've just had less activity in the first part of the year than we thought.

We're looking at about 10 to $15 million of restructuring in both the third quarter and the fourth quarter, which is really our normal run rate at a quarterly basis.

We've just have less activity in the first part of the year than we would have expected.

Due largely to increased demand and activity at our business units.

Yes, what we've seen is in the base business units, during the recession we had quite a bit of restructuring.

So the units that have been around for three, four, five years, we've already done a lot of restructuring and we've had expanding markets since then, so it's really more of a -- not increasing staff in accordance with how sales are increasing as opposed to actually going through a restructuring project.

The biggest restructuring we'll see is involving the acquisitions and usually it takes us a little bit of time to sort through what we've got, do our 08/20 work, find simplification opportunities before we'll go forward with restructuring projects.

Typically it's two to three years out and we've had some good acquisition activity over the last couple of years, so I would expect to see that ramp up a bit as we get into 2007.

Terrific, very helpful.

Thank you.

Thank you.

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

Good afternoon, guys.

On the nonoperating investment income, you raised the guidance in '06.

And if I recall, I think your expectations for a long-term run rate in that line item was 10 to $20 million.

Is that still the expectation, let's say, for 2007?

Yes.

If you remember, what's happening in the segment is 80% of the income is coming from our mortgage portfolio.

So we had ten-year deals.

The first one dropped off last year, the second one is scheduled to drop off this year, and the third one is scheduled to drop off in early 2008.

So once those go away, really what we're left with is some leveraged leases which, by the nature of them, have lower income as you get further into them and also some venture capital investments, which mark to market investments tend to go up and down.

So we're not -- we don't even attempt to try to predict what's going to happen in the venture capital area.

So I think around 15 to 20 million is probably a reasonable guesstimate for two or three years out.

Okay.

But not necessarily in 2007, or in 2007 as well?

No, it will be lower in 2007.

I don't have an exact number, but the -- for the year, of the 65 or so million expected in this group of investments, about half of it, a little bit more than half of it is mortgage related.

So you can pick a quarter of it up for that and you're probably looking at 25 to 30 million maybe, next year.

Okay.

And just kind of as a follow-up, just kind of a general question, a lot of concern on the housing market in North America, you've started to see inventories go up and you said that -- and your housing renovation was down slightly in the second quarter.

And so a couple questions here: What's your kind of near term and immediate term, like a couple years out, what's your view on the housing market in general, and if housing does decline meaningfully, is the renovation market going to get hit as well?

Right now, as we look at the housing market, it's starting to trend based on what we thought would happen.

The more recent numbers are telling us that housing is down in about the 3, 4, 5% range, and that's what we had built into our plans for North America.

Now, that's more recently. the first part of the year, housing had been stronger than that.

So year-to-date, housing is probably down just a couple of points.

But we expect longer term that you're going to probably replicate what you see this year down in that 4, 5, maybe 6% range in terms of new housing starts.

We wouldn't expect it to get significantly better next year over this year.

Having said that, and we always try to put this into context so that even at -- down 4 or 5% this year and maybe a similar amount next year, those are still historically very, very strong build levels.

And we could continue to do very well in that kind of environment.

Right now, builds are running at a rate of about 1.8 million.

And the renovation part of the question?

Well, the renovation part of the question is that I think that -- the old thesis was that if new housing goes down, renovation also goes down with it, and I don't think we've seen anything over the years to actually make that stand up.

I think we're -- we believe that our renovation business is probably going to outpace what happens on the new housing side.

And we've seen our ITW brands business, by and large, do much better on the renovation side, and Paslode, which sells into the renovation box store activity markets also doing reasonably well.

The issues we really had on the renovation side, Gary, this year have really been more related to one-off events like what's going on at Home Depot in terms of inventory restocking and bringing inventory levels down to try to manage their inventory levels.

So it's really been more one-off than it has been more macro and more demand-related.

Okay.

Thank you.

Thank you.

Your next question comes from Ann Duignan from Bear Stearns.

Hi.

Good afternoon, guys.

Hi, Ann.

Just to follow up, I think, to Gary's point, first of all, could you just clarify, back into your organic growth expectations for Q4?

It looks like you're expecting about a growth rate of about 5.2, which would imply a little bit of an acceleration from Q3.

It's actually 5.0, Ann.

5.0 for both?

Yes, for Q3 and Q4.

Okay, so you're not anticipating an acceleration, that was going to be my question.

And then on the construction side, could you talk about -- or the consumer side -- could you talk a little bit about your automotive aftermarket business and how that's holding up, and is it seeing any slowdown in light of the high oil prices, etc., etc.?

I think basically our businesses here in North America are performing at reasonably high levels.

Those are the numbers you see in the industrial categories we break out for you.

So a lot of the fluid products that we see are growing at a rate of about 7%, and that would include our Permatex brand and our Wins [sic] brands.

Okay.

So they're not seeing a significant slowdown yet?

No, it's an entirely different channel than anything we see on the automotive OEM side of the equation.

And just different market attributes and different buying patterns and different characteristics.

It really has more to do with the maintenance of cars than acquiring new cars.

So it almost ought to be countercyclical with automotive sales?

I would expect it might be, and I think we're going to take advantage of some of our channels to use some of these new products we brought in from the Wins [sic] and the Permatex platforms to get more products into the channel.

So I think that would help us from a sales standpoint, too.

Okay.

And just on your recent acquisition, I think the most recent one that was announced is a welding-related business.

Could you just give us color on that, and should we expect that to be growing at the same rate as your --

No, I want to clarify: Kester is not a welding-related --

Okay.

It's a soldering type of business that will fit basically into our electronics category.

Okay, so soldering is not the same as welding?

No, it is not.

The end markets for Kester are computers, telecom products, medical equipment, military defense, and it's really involved in really high performance solder and other stuff that go into circuit boards for those types of applications.

What kind of growth rate would you expect out of that business?

Right now it's growing at a rate of 7-plus and we would expect in sort of that 5 to 7-plus range, longer term.

Okay.

And just one other follow-up, on the food equipment side, could you just give us a little bit of color in North America on what is going on there?

We would have expected maybe --

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

It's my turn this quarter.

The food equipment update is essentially -- strength coming from our restaurant institutional side, service side of the business still good, still positive, and we had slower -- we had negative growth on the supermarket side.

Now, I will say that there were some one-off things that actually impacted their numbers.

They had introduced a number of new products second quarter last year on the scale side of the equation, and so the comps from a year ago were much more typical.

But even having said that, the supermarket side is clearly still operating in a different environment than what we're seeing on the restaurant institutional side and the service side of the business.

We still expect the business on a full-year basis to grow in the range of 2 to 4%.

Okay.

I might have expected -- I think there was an anticipation that the restaurant equipment side might have slowed, just given all the negative headline news out of the restaurant.

Something is obviously keeping that business stronger than we might have anticipated.

Yes, yes.

Great.

Thank you.

Thank you.

Thank you.

Our next question is from John Inch of Merrill Lynch.

Thank you.

Good morning.

Hey, John and Ron, your cash flow this quarter was pretty --

Anemic, wasn't it?

Excuse me?

It was anemic, I think.

That's what I read in the note earlier today.

That is a word I might use.

No, I just wanted to understand, Ron, what were you saying about the item?

And then, can you remind us, what is your conversion target for the year and do you expect the cash to kind of get close to 100% in the second half?

Well, there's really two things that are impacting our free operating cash flow this year versus last year.

The first thing is what I mentioned earlier: we had some higher taxes paid, $115 million or so of additional taxes paid in the second quarter of this year versus last year, and most of that is related to prepaying some income taxes related to an issue that the IRS is looking at and the idea is you put in money so you avoid fines and penalties if you happen to lose.

We feel good about the issue but we're just protecting ourselves from fines and penalties and interest.

So that's about 115 of the difference.

Also, contributing to the conversion rate in the quarter, because obviously income is up almost 100 million, is our inventory levels.

If you remember in 2004 into early 2005, we had a big runup in inventory levels, especially related to steel as there was a shortage of steel.

And really, last year, starting in the second quarter all the way through the end of the year, we had some significant reductions in inventory.

So last year, cash generated from inventory reductions was about 50 million.

This year, we've increased inventory of about 45 million.

So the swing between that is about another 100 million.

Regarding the full-year cash flow, we expect to be in the range of about $1.4 billion to $1.6 billion.

So that's an 80 or so percent conversion rate off of net income, and that includes the tax issues I talked about.

And by the way, does the tax issue, do you -- is that polled from other quarters, just so I understand what that is?

Or is that sort of a discrete item?

Well, the way tax payments work, you make actually two estimated payments in the second quarter.

So it has a bigger impact in the second quarter than it will the rest of the year, but it will also have some increase the rest of the year as well.

Okay.

And then, just as a follow up, a lot of your businesses, prospectively, are exposed to consumer, holding up pretty nicely.

What's the game plan, if, indeed, some of these more consumer businesses within your portfolio begin to deteriorate, perhaps at a more advanced pace?

Is there some sort of Plan B, if you will, that comes out that tries to compensate for this?

First of all, John, we have read your note from a couple of weeks ago in terms of the consumer exposure.

I think, first and foremost, we would probably take issue with you in terms of the size of direct consumer exposure here.

I think your number was over 30.

We don't come up with a number -- ours is less than 20.

So I think we would probably dispute that number.

But -- we can quibble about that, but beyond that, I think the short answer is that our businesses respond to end-market conditions.

And they take cost on where appropriate and they manage their business respective or related to what's happening in their particular end market.

So I think the strength of the decentralized approach, everybody's responding to what's happening to their particular markets, their particular products, and their particular customers.

So we would ask them to take a look at their business and to get costs in line and do whatever they can to try to protect margins and income growth.

No, I would agree.

I guess my question, John, is is there something going on in the field that you're aware of or that you've been discussing with in terms of trying to put in place maybe some of these activities now kind of in preparation --

No, we're not.

No, In fact, we're not seeing that to any large degree.

We've talked about new housing coming down, but that's something we talked about in December when we were in New York with you guys.

And we've seen nothing on the new housing side that gives us any sense that things are of a greater order of magnitude than we originally predicted.

Nothing on the automotive North American side that gives us a sense that builds are going to be down to any greater degree, and nothing in our other -- what we would classify as our direct consumer businesses that leads us to believe that there is any sense that things are slowing to any major degree.

So, no, there's nothing we see out there that would lead us to put together a so-called battle plan.

Right.

Okay, thanks.

Appreciate it.

Thank you.

Thank you.

Your next question comes from Mark Koznarek from Cleveland Research.

Hi.

Good afternoon.

Just a couple clarifications here.

One is with regard to your inventory reduction on the Paslode side, is that over with through the big box channel, or is there more of an impact expected in 3Q?

Well, this happened in the first quarter, we don't know, and it happened in the second quarter, so is it a pattern?

I guess you're going to have to ask the big box guys what they're going to do.

This is something that's newer to us over the last two to three quarters, so we're going to have to see what happens in Q3.

But clearly it's something that's affected our businesses in the first two quarters and we're going to have to be mindful of it as we go into the third quarter and beyond.

Okay.

So that's a risk.

Secondly, auto, your revenue outperformed the builds by 2 percentage points in the quarter and last quarter it was only even with the builds, so is that something that we should forecast forward a little bit of out-performance --

Mark, we have talked about this and I think that what we tell you in terms of our ability to get penetration over and above builds is that quarter to quarter that number is going to move up or down.

It's never a consistent number, because you've got different platforms, different products, and so the number will change.

But I think generally speaking, you should look for penetration on a full-year basis to be somewhere in that 3 to 4% range.

So it should pick up then in the second --

I can't guarantee that.

Again, it's a mix issue, you've got new models coming out in the fall and that can change the equation, so there's no way I could accurately predict that number.

Okay, but it's -- only 1% for the first half, so just laying down a 3 to 4% number sounds like it will be --

Generally should, if you run the numbers, yes.

Okay.

Sounds good.

And then finally, did I hear correctly that the delta in the full-year earnings outlook is solely the categories that Ron mentioned -- it didn't appear that any of it was improved operating margin in the core businesses.

Is that --

Yes, that's correct.

We basically kept the base revenue forecast for the second half and the margins where we had them at the end of the last quarter, so just to walk you through the numbers, our midpoint of our full-year range was $2.99 and we lowered restructuring for the year, which helped by a penny.

Translation helped us $0.04.

The higher investment income helped us by a penny, and the lower tax rate for the full year was $0.02.

That gets you to $3.07.

Okay.

Very good.

Thanks, Ron and John.

Your next question comes from Jamie Cook from Credit Suisse.

Hi.

Good afternoon.

My first question, just to talk a little bit about the food equipment side overseas, I guess, are you seeing any change in competitive dynamics, given one of your competitors there is up for sale, any market share gains, or do you consider that an opportunity?

I don't think there's going to be any impact on our markets or market share, per se.

I think there's not a whole lot of overlap with what we do with these folks or our competitors over there.

Fundamentally, the food equipment business on the international side is growing at a rate of -- is growing at a rate of about 1 to 2% right now.

So not great growth dynamics, but a little bit better than what we saw last year.

The other thing to keep in mind is that from a competitive standpoint, 80% of what Anota [sic] sells is North American.

Okay.

There's a very small international piece.

I think it would have more impact on the North American side and I don't think we've seen much impact on the North America side either.

Okay.

And I guess, just given the weakness in your stock lately, when you talk to investors there's a lot of concerns about residential slowdown, consumer slowdown, and your stock is taking a hit despite performance.

But I guess, given that, do you see any change in your use of cash flow, would you consider being more aggressive on share repurchase versus acquisitions for that reason?

We've -- and I think David Speer has been publicly talking about this -- we've looked at -- we've been looking at the whole capital structure issue during this year, so we would expect that by the fourth quarter we'd had some type of decision made on how we'd want to go forward with that.

Okay, great.

Thank you.

Your next question comes from Joel Tiss of Lehman Brothers.

Hi, guys.

This is Henry Kern in for Joel today.

Hey, Henry.

Hey, question for you: You're at $695 million of acquired revenue so far and we're about halfway through the year and the annual guidance is $900 million to $1.1 billion.

If I look at your run rate, you're significantly ahead of that.

Is there some possibility that that number is conservative, or is the pipeline sort of longer term in nature?

Well, the 695 actually includes a few in July.

So if you look at the run rate, you'd be right about at the [inaudible].

The thing to remember is, acquisitions are not a straight line activity so they don't necessarily follow a run rate.

We do have some -- in our pipeline, we do have a good pipeline, but we've been looking at the 100-plus million dollar deals and we don't have as good of a batting average as we do on the smaller deals.

So some of those ones on the pipeline may not happen.

So we do have a good pipeline, we can see four to five months out in the pipeline, so close to the end of the year.

So we think our range is at the current time a good range and if we do better than that, then we'll update you as necessary.

Okay.

In terms of valuations, what type of valuations do you see in the market right now?

Well, I think if you look at our numbers this year, as we've disclosed in the slides, we're actually below 1 to 1 on price to revenues.

Last year we were slightly above 1 to 1.

So we feel pretty good about pricing.

We're able to find some reasonably priced acquisition targets, including some that are over the $100 million range.

So we feel good about it.

I think the other nuance in the acquisition environment right now, Henry, is that we're getting more deals coming from private equity sources.

The companies that they're actually selling out of their portfolio at pretty reasonable prices, too.

So to the extent they are competitors, they are also sellers, too.

That's probably one of the big differentiating factors in this year compared to last year.

Okay, thanks a lot.

That was very helpful.

Thank you.

Your next question is from Ned Armstrong of FBR.

Hello, good afternoon.

With regard to your welding business, you again put up a very, very strong performance.

Can you give a little bit more detail about that performance, vis-a-vis sales growth, as to where you may be taking market share or what new end markets and/or geographic markets that growth is coming from?

Well, I hesitate to talk about market share because the lawyers will run down from the corner and pull me out of here.

So I'll defer that question.

But I think that clearly what's happening is that we've been able to take advantage of opportunities in end markets that have a lot of demand right now.

And we've talked about in the last couple of months introducing new products and having strong product advantages in areas such as oil and pipeline and even the refinery, the platforms through the oil and pipeline, all the way to the refinery stage of oil processing.

So those are -- that's an area that has been very good for us, both on the North American and international side.

The heavy fabricators continue to be a source of strength for us, the Cats, the Deeres, and I think you guys have seen their results over the last year or so or two years.

And our welding products play well on those big products that have a lot of welding applications.

So those are two areas that I would point to.

Clearly, Asia is still an area of high demand for us.

I reference oil and pipeline products that we have now, a lot of oil pipeline being built in the hinterlands of China, as we speak.

And we will have both machinery and we have the consumable, specialized consumable, that helps us there.

Another area that I point to would be ship building.

Most of that ship building taking place in Asia, some of it moving from Korea to China, but still and advantageous end market for us.

So, when you roll everything together, we still have very, very strong demand across a number of end markets, it's the right combination of demand, as I said earlier, new products and our ability to get pricing where appropriate.

So those things all add up to very strong top line.

Okay.

And with respect to the residential construction market in North America, are you able to determine which geographic areas are weakening faster than others?

Do you have any picture on that for us?

Yes.

Typically, northeast and central, those are the two areas we look at, central part of the country.

I'd say that's generally been the case.

But I don't think there's any numbers that are -- in those particular areas that give us any cause for major indigestion.

We look at the numbers as they get rolled up, and as I said earlier, the numbers look in line with what we think is going to happen this year.

There's nothing we've seen that's causing us to back up and say, boy, we really need to recalculate our numbers.

Okay.

So, I guess just to kind of repeat it back to you, it's the northeast and central where you're seeing the weakness, so then I can infer that west, southwest, and southeast are somewhat vibrant?

On a comparative basis, yes.

And you'd also have to look at -- you have to look at your demographics, too, you've got more people, you have more demand for housing in those areas, a lot of retirees moving into those particular areas.

Right.

Great.

Thank you very much.

Thank you.

Your next question comes from Robert McCarthy of Robert W. Baird.

Good afternoon, guys.

Let me follow-up Ned quickly on welding.

The first two quarters of the year in North America, you put up roughly 20% growth comparisons.

Can you talk about what you've got in your assumption for the balance of the year, whether we need to worry about comparisons getting more difficult because of product launches last year, etcetera?

Well, what we have in the rest of the year, the second half is growth above 10%, so in the 10-15% range, and one of the big factors there, if you remember in the third quarter, we had some benefit from the hurricanes last year that we won't repeat this year, unless there's another hurricane.

Hope not, anyway.

Don't forecast hurricanes. [Inaudible] 15%.

Detail: did you guys use any stock in your acquisitions that you completed in the quarter?

No.

And do you -- last one, do you have even a rough estimate, John, for what your construction products North America comparison, the minus two, might have looked like without this unusual inventory issue?

I do not, no.

Do you want to take a stab at it?

Would the business have been up, maybe?

Flat, maybe.

Flattish.

Yes.

Thanks, that's helpful.

Thanks.

Your next question comes from Deane Dray of Goldman Sachs.

Thank you.

Good afternoon.

Follow-up exactly on that point regarding the ITW construction numbers for Engineered Products North America.

If I know -- and if I'm thinking about the relationship correctly, the commercial construction piece being up 10% should offset -- more than offset the new housing and renovation being down slightly.

So absent any inventory adjustments, would that base business number have been positive 2 or so?

I would expect it to be sort of flattish, maybe up a little.

Absent the inventory region adjustments.

Does that answer your question?

Yes.

So -- and if you think about total percentages, not just North America, but total ITW, commercial construction is roughly 15% and housing, both new housing and renovation, 10-ish?

Of total --

Revenues.

You're talking total company now?

Yes, total company.

That sounds -- yes, they're basically a third, a third, a third, within the confines of North American International.

Okay.

And then, separate question on Signode Asia dipping down -- did you say 10%?

What's the --

Down, 10, yes.

That looks like that's the first negative or at least the most sizable negative in quite some time.

No, I don't think so, I think that actually their numbers had been negative for a while.

They were running down -- you're talking about Signode Asia only now, Deane?

Yes.

No, they've been down in that 8 to 9, 10% range for the last couple of months.

Is there anything to read into that?

Is that -- you commented on some price competition?

Well, we clearly think that the machinery piece of what we've seen over there has slowed over the last couple of months.

As I said earlier, they have walked away from some business.

What I can tell you right now is that our period 7 numbers are slightly positive in the Signode Asia area.

So that, I think, gives us a little bit of sense of relief that what we saw the last couple of months, we've seen some improvement.

Okay, thank you.

Thanks.

Your next question comes from Chris Kotowicz from A.J. Edwards.

Good afternoon.

I guess I wanted to circle back on the change in guidance and make sure I heard you correctly when you said that the increase was effectively being driven by entirely non-operating items.

That's correct, yes.

Okay.

And does the -- should we infer, based on your accelerated acquisition pace, that you're not expecting to get much of anything from the M&A efforts so far this year?

I mean, incrementally, it's -- I would have thought maybe you would have had a little bit of a boost there.

Our original forecast includes some amount of acquisition level, but any increase in the level through the rest of the year is not going to have much impact on this year, because by the time you get them folded in and you only have a few months, potentially, in there, and generally acquisitions are 8% margin, so they're not adding a lot.

Although they're adding revenues they may not add that much income.

Okay.

Could you add any light to what's going on with your efforts with the transplants in terms of penetration?

That was something you highlighted at your investor day in December.

And I guess we're halfway through the year and that's obviously the better piece of the market to be trying to play in, at least in North America right now.

Can you share anything about how you've progressed there so far?

Well, we've -- I can tell you qualitatively that we know that we are -- we continue to introduce new products into that category and we're expecting to grow that area of business about 20%, 20-plus percent this year.

And I think last year we grew it at about 25-plus, so we continue -- and obviously come -- 20-plus off of a bigger base number, so I think we continue to be successful in terms of introducing new products.

I could point to specific kinds of projects we're involved in, where we did a tear-down on a Toyota and a minivan and we think there's opportunity there, but clearly Toyota, Nissan, Honda continue to be targets of opportunity for us and I think that based on that 20-plus percent number I gave you, it's testimony to the fact that we continue to be successful there.

It's clearly one of our major focuses on what we're doing in North America auto.

We see which way the market share is going and we continue to make inroads in this area.

Okay.

So the 20 to 25% is really based on -- I won't say business in hand, but that's not just -- we hope we're going to get on stuff, that's stuff you know about.

Actual business, Chris.

Okay.

And then maybe the last thing I'd ask, can you comment at all on nonvolume at EPI?

It was down negative 2.2.

Was that just you had to give up the pricing there, as you mentioned earlier?

Is that basically what this is?

Yes, it was down 30 basis points for the quarter and it's only $2 million so it's an overall higher SG&A type cost.

Okay.

Fair enough.

Thanks.

Thanks.

Your next question comes from Eli Lustgarten from Longbow Securities.

Good afternoon.

Just a quick question, just step back.

Your forecast the second half of the year for base business is effectively midpoint up 5% for both quarters.

With 4.5 in the second quarter, the construction market, residential keeps getting more soft, that's not going to change much, auto production in the third quarter looks like it's down from a year ago.

Can you help us why we should look for some acceleration in the base business the second half of the year?

Is that pricing or can you give us some guidance of where that's coming from?

Well, if you look at it by segment, the second half of the year, where the auto and construction stuff is and Engineered Products North America, we're looking in 3.5 to 4.5% growth rate.

And there -- we're looking at a continued growth from our fluids and polymers businesses, we've had a very strong quarter in the second quarter here.

Also, we're expecting construction to get better --

Non-res, you mean?

Commercial?

Why would some choices get better as it's getting softer?

-- commercial, but also potentially new Home Depot placements.

Also, offsetting that would be lower automotive growth rates and potentially Wilsonart.

On the specialty system side, we're looking at growth rates more like overall of 6 to 7%, welding continuing double-digit growth, continued good growth from finishing.

Our marketing and decorating consumer packaging type businesses are showing good growth rates, offset by lower industrial packaging and food equipment.

So that's kind of how it shakes out.

Okay.

And the international markets should continue to improve?

Yes, and I think that's one of the big swings, Eli, that clearly we think that there's a lot more room for improvement on the international side and we were -- we didn't see our international numbers really get better until sort of later second quarter, and as I said earlier, we already know what we have for period 7 and the number has continued to improve.

So I think it gives us a greater degree of confidence in international margins, or international performance, base revenues will be better, and to Ron's point, what's happening on the North American side, we think that 5 looks fairly reasonable at this point in time.

And do you give a currency benefit as the year goes on in those parts too?

In the base business revenue growth numbers, currency is pulled out of that.

But I'm saying --

We do have a currency benefit now factored in.

That's part of the $0.04 per share increase in our guidance.

It does turn favorable in the second half.

And one other question.

Wilsonart has been problematic and continues to be problematic.

Is there some strategic element that you can do there or is that a candidate for divestiture or what do you do with that?

Well, I think we've answered this question before, that -- I don't think anybody asked the question if we were going to divest Wilsonart last quarter when they were up 11.

And arguably, clearly the number's aren't as strong this quarter, but their base revenues in their base laminate business was up 4%, the flooring business, as we said earlier, they stuffed a lot of product into the pipeline and that's still being absorbed.

So I think what you're seeing this quarter is a little bit of an aberration, but we still expect Wilsonart to be growing in that 3 to 4% range for the full year.

Thank you.

Thank you.

And we have another question from Robert McCarthy from Robert W. Baird.

I'm sorry, guys.

I just wonder if, Ron, could you repeat that impact of the one day less on growth rate that you cited at the very beginning of the call?

And then I want to ask something about it.

What we're talking about is really Easter, where Easter fell.

Right.

And if you remember, it fell in April this year and March the year before, so what that ended up doing was the growth rate in the first quarter was -- included an extra day, year-on-year, and then the growth rate in the second quarter has one day less.

So one day is about 150 basis points, in that range, so we're estimating 250 to 300 basis points between first quarter growth rate and second quarter growth rate related to the days.

Okay, the 250 to 300 is the swing, in other words?

Yes, sequential swing from Q1 to Q2.

Okay.

And wouldn't it be fair to assume that the bigger impact might occur in engineered products, where you have less machinery and the like being sold?

Where I'm going with this is I'm wondering if you have an idea of that what that 1.9% organic growth in EP North America might have looked like, or do I just add 150 bits to it?

It's a shorter cycle, so it would probably have a more immediate impact.

I think that's conceptually right, yes.

All right.

Thanks.

Thank you.

And at this time I'm showing that we have no further questions.

Okay.

Well, we thank everybody for joining us on the conference call and we look forward to talking to everybody either later today or at some future point in time.

Thank you very much.

Thank you.

That does conclude today's conference call.

You may disconnect at this time.