Illinois Tool Works Inc (ITW) 2006 Q3 法說會逐字稿

Hello and welcome to the ITW third quarter 2006 earnings conference call.

[OPERATOR INSTRUCTIONS] Today's conference is being recorded.

If there are any objections, you may disconnect at this time.

I now would like to introduce today's conference host, Mr. John Brooklier, Vice President of Investor Relations.

Sir, you may begin.

Thank you very much.

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

I'm John Brooklier, as noted, and with me today is Ron Kropp, our Vice President and Controller for Financial Reporting.

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

Here are the highlights for the third quarter.

Revenues and operating income both grew 11%, and diluted net income per share increased 8% in the quarter.

At the same time, our operating margins were flat at 17.7%, that's principally the result of the dilutive impact of acquisitions in the quarter.

The quarter was really two different stories for us.

First of all, international end markets showed reasonably strong growth while North American end markets moderated with new housing and big three auto markets declining in the quarter.

We remain encouraged by our growth internationally.

The ongoing diversification of our geographies and end markets and the pace which we continue to make attractive and reasonably priced acquisitions.

Ron Kropp will give you more details on our third quarter financial performance in just a few moments.

Here's the agenda for today's call.

Ron will join us shortly to discuss the quarter.

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

Ron will then address our fourth quarter earnings forecast and associated assumptions and we'll open the call to your questions.

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

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

First, a few housekeeping items.

I would like to remind everyone that this call contains forward-looking statements within the meaning of the Private Securities Litigation Private Securities Litigation Reform Act of 1995, including without limitations, statements regarding end market conditions, base revenue growth, earnings growth, operating income, tax rates, use of free cash, share repurchases, and 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 the slide and are part of our form 10-Q for the 2006 second quarter.

Finally, the telephone replay for this conference call is 402-220-9741, no pass code is necessary.

The playback number will be available until midnight on November 1, 2006.

As always, you can access our webcast power point presentation on our ITW.com website.

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

Now here's Ron, who will take you through the third quarter financial highlights.

Thanks, John.

The highlights for the third quarter are as follows.

Revenue grew 10.6% versus the third quarter of last year.

This growth rate was 170 basis points higher than the growth rate for the second quarter of 2006.

Operating income was up 10.9% versus the prior year, primarily due to acquisitions, higher revenues and improved margins for the base businesses and lower restructuring costs.

Operating margins of 17.7% were even with last year.

Diluted net income per share were 8.3% higher, as the higher operating income was partially offset by lower investment income.

Free operating cash flow was $487 million and return on invested capital was 18.6%, which was even with last year.

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

Our 10.6% revenue growth is primarily due to three factors.

First, base business revenue grew 2.4%.

This growth rate was 200 basis points lower than the second quarter.

North America increased 0.6%, which was lower than the second quarter by 380 basis points.

This low growth was a result of declines in the Company's North American auto and new housing end markets offset by slowing but still reasonable growth in the other North American end markets.

International base revenues increased 5%, which was 70 basis points higher than the second quarter.

Secondly, acquisitions added 7.5% to revenue growth, which was 80 basis points higher than the second quarter acquisition affect.

Third, currency translation increased revenues by 1.6%, which was favorable by 300 basis points versus the negative second quarter currency affect.

Overall, our 11% revenue growth was a result of stronger base business revenue growth internationally and a larger impact of acquisitions.

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

Operating margins for the third quarter of 17.7% were even with last year.

Margins increased 40 basis points due to improvements in the base businesses and 40 basis points due to lower restructuring costs.

Offsetting this, acquisitions reduced margins by 90 basis points.

Of the 40 basis point improvement in base business margins, 50 basis points relates to operating leverage, offset by a 10 basis point reduction due to nonvolume items.

The nonvolume affect was due to a slight unfavorable affect of raw material cost increases versus price increases, partially offset by favorable overhead costs.

In the nonoperating area, investment income was lower than last year by $28 million, primarily due to lower gains from the sales of mortgage assets.

The third quarter and year-to-date effective tax rate was 30.5% in 2006 versus 32% in the prior year.

Turning to our invested capital, total invested capital increased $396 million from the second quarter, primarily due to acquisitions.

Inventory and accounts receivable remained at reasonable levels at 1.9 inventory months on hand and 60.3 receivable day sales outstanding.

For the third quarter, capital expenditures were $78 million and depreciation expense was $81 million.

On the financing side, we increased our debt $437 million from last quarter and our debt to capital ratio increased from 11% to 15%.

Our cash position increased $159 million in the third quarter, as our free operating cash flow of $487 million and proceeds from debt of $432 million were utilized for acquisitions of $447 million, dividends of $94 million, and share repurchases of $248 million.

Our third quarter return on invested capital of 18.6% was consistent with last year.

The year-to-date return on invested capital of 18.8% was 140 basis points higher than last year.

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 13 companies in the third quarter which had annual revenues of $388 million.

Based on the acquired revenues of $895 million through September 30th and a strong pipeline of potential deals, we are increasing our forecasted acquisitions for 2006 to a range of $1.1 billion to $1.4 billion of annualized revenues.

Our previous range was $900 million to $1.1 billion.

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

Thank you, Ron.

Before I review our manufacturing segment, let me just spend a few moments highlighting some data we track on a regular basis.

We essentially saw a reversal of trends from prior quarters when North American activity outpaced international end markets.

As of the 2006 third quarter, international economies and end markets have clearly demonstrated stronger trend data.

For example, the EuroZone purchasing manager's index hit 56.6 in September, a level consistent with the prior month and some five months higher than the year ago period.

As important Eurozone industrial production was 3.3% in the most recent reporting month and German's industrial production number, up 7.3%, led European country growth.

In North America, the numbers were not as robust.

For September, the ISM index came in at 52.9%, that's down 160 basis points from the prior month, and the ISM new order index totalled 54.2% in September, which was consistent with the prior month.

One other note, the recent Fed reports show industrial production declined 60 basis points from August to September.

We believe that collectively all this data supports the thesis of moderating growth in North America.

Now, let's review our four manufacturing segments.

Starting with North American Engineered Products, revenues increased 7.3% and operating income grew modestly in the quarter.

As a result of volume declines in our business units which support assorted construction in big three auto customers and the dilutive impact of acquisitions, operating margins of 17.6% were 130 basis points lower than the year-earlier period.

Looking more closely at segment results, the 7.3% growth in top line consisted of the following.

Negative 1.9% from base revenues, plus 8.9% from acquisitions, and plus 0.3% from translation.

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

Put simply, our construction and automotive-based revenues reflected very difficult conditions due to our new housing-related customers and Big Three automotive OEM and tier customers.

The good news is that our industrial-based business units in this segment continue to perform very well in the quarter.

By category, total construction was down 5% of the quarter with ITW Construction, which consists of our tool and fastener units down 8% and Wilsonart down only 1%.

Most of the slowing in the tool and fastener category came in September, and was due to slower sales of Paslode-related products, which are used for framing and finishing applications for new home building.

These numbers should come as no surprise given the fact that new housing starts were down 19% in Q3.

We also saw an 8% decline in our renovation products as expressed by our ITW sales to box stores.

Part of this decline was due to a falloff in foot traffic at the box stores and tougher comparisons associated with hurricane activity in the 2005 third quarter.

On the plus side, our commercial construction revenues were up approximately 3% in the quarter.

Despite difficult new housing trends, Wilsonart's base revenues were down only 1% in the quarter, and that's in part due to the fact that a large percentage of their revenues were commercially based.

Base laminate sales were up modestly, while flooring was down in the quarter.

As we look ahead to Q4, we're expecting new housing starts to be down in the range of 15 to 20%, renovation to be in a range of zero to minus five percent, and commercial construction to be up in the range of 3 to 5%.

Moving to the next slide, looking at automotive, our base revenues declined 8% in the quarter.

That decline was attributable to a very weak Big Three build, which was down 13% in Q3.

New domestic builds were flat in Q3.

Even so, increased penetration with the big three in new domestics helped us offset the Big Three build by some five points.

The Q3 Big Three builds were as follows, GM was down 8%, Ford was down 12%, and Daimler-Chrysler down 21%.

From an inventory standpoint, the numbers were not all that promising with levels remaining high thanks largely to higher inventories associated with light trucks and SUVs.

At the end of September 30, total Big Three inventories were at 77 days, specifically, GM was at 76 days, Ford was at 74 days, and Daimler-Chrysler was al 83 days.

New domestic inventories were at a much healthier 46 days.

Looking ahead to Q4, we're expecting Big Three builds to be down 13% and new domestics to be up approximately 5%.

If those numbers are correct, Big Three builds will be down 6% for full year and new domestics will be up 4% for the full year.

In our industrial products category, base revenue grew at a very healthy 6% in the quarter.

This growth emanated from our variety of units in the category, including fluid products, which was up 15% on a base revenue standpoint, industrial plastics up 8%, Minigrip Zip-Pak up 7% and polymers up 3%.

A number of these businesses serve Capex-related end markets continue to benefit from growth opportunities in the Manufacturing/Industrial sector.

Moving the to international Engineered Products, for the third quarter segment revenues increased 9.6% and operating income grew 8.6%.

Operating margins of 15.1% were 20 basis points lower than the year-earlier period thanks in part to some price cost issues and an assortment of Asian construction business units.

Taking a closer look at topline, the 9.6% increase in revenues consisted of the following: 4.5% for base revenues, 1.7% from acquisitions, and 3.4% from translation.

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

The good news was that the industrial and construction units produced positive results in the quarter.

Looking at total construction, base revenues were up 6% in the quarter, that's slightly better than our 5% growth in Q2 construction revenues.

By geography, third quarter base revenues were as follows: European construction up 4%, Asia Pacific up 9%, and Wilsonart International up 5%.

Construction in Europe was driven by increased demand across a wide swath of countries.

Asia Pacific benefited from a demand pick up in Australia and New Zealand and a large part of Asia.

Wilsonart International saw its third quarter strength coming from the U.K. and Germany.

Our automotive business units in Europe produced flat base revenues in the quarter and that was in-line with flat auto productions by the OEMs in the quarter.

Sales were as follows: Fiat up 21, VW group up 9, Ford group up 1, GM group down 2, BMW down 9, and Daimler-Chrysler down 17.

Our inability to get better penetration in the quarter was largely a mix issue and a decline in the sale of metal fasteners and components.

Year-to-date, ITW's 2% base revenue growth rate in auto is running some two points above the build rate.

We expect full-year builds to be up approximately 1, perhaps 2%.

The remaining part of this segment is made up of our industrial-based business units.

These units in total produced base revenue growth of 6% in the quarter and continue to benefit from demand from manufacturing industrial customers.

The breakdown by business was as follows: electronic component packaging up 13, industrial plastics up 7, polymers up 6, and fluid products up 4.

Turning to North American Specialty Systems for the third quarter, segment revenues increased 10.4% and operating income grew 7.7%.

Operating margins of 19.5% were 50 basis points lower than the year-ago period, mainly as a result of dilutive impact of acquisitions in the quarter.

Focusing on the top line, the 10.4% growth in revenues consisted of the following: 2.8% from base revenue, 7.3% from acquisitions, and 0.3% from translation.

As noted, this more CapEx manufacturing-oriented segment produced positive base revenue growth in the third quarter, albeit down from Q1 and Q2 revenues.

Welding's base revenues grew 12% in the quarter thanks to contributions from the machinery, consumable, and component units, and while demand welding products fell off from 20% growth levels from past quarters, industries such as energy, heavy fabricators and general industrial continue to buy at very healthy levels.

Similar to North American construction, welding faced difficult comparisons due to hurricane activity in the 2005 third quarter.

Food equipment's base revenues increased 2% in the quarter thanks to demand from end market customers which include casual dining restaurants, as well as institutional users such as airports and hospitals.

Our service business also contributed to growth and while Total Packaging was down 1% of the quarter, Signode was flat in the quarter due mainly to declines in steel revenues.

Moving to our final segment, International Specialty Systems, for the third quarter, segment revenues increased 19.5% and operating income grew 50.1%.

Not surprisingly, operating margins of 14.3% were 290 basis points higher than the year-earlier period.

Looking at top line, the 19.5% growth in revenue consisted of the following: 5.4% for base, 10.8% from acquisitions, and 3.3% from translation.

This segment benefited from contributions from a number of businesses, most notably welding and finishing.

Welding's base revenues grew 27% in the quarter due to strong consumable and equipment sale in Asia and Europe.

Finishing's base revenues were up 12% thanks mainly to higher sales of Gema powder-based systems in Europe and finishing equipment in Asia.

Total packaging base revenues were up 2% with Signode Europe base revenues up 2% and Signode Asia's base revenues down 2%.

And food equipment's base revenues were up a modest 1% in the quarter.

Let me turn this back over to Ron who will address the forecast for the fourth quarter and full year.

Thanks, John.

We are forecasting fourth quarter diluted income per share to be within a range of $0.77 to $0.81.

The low end end of this range assumes a 3.1% growth in base business revenues and the high end of the range assumes a 5.1% growth in base revenues.

The midpoint of this range of $0.79 per share would be 11% higher than the prior year.

For the full-year, our forecast earnings range is $3.01 to $3.05 per share.

The full-year base business revenue growth is expected to be within a range of 4.0% to 4.6%.

The midpoint of this earnings range of $3.03 per share would be 17% higher than 2005.

Lower nonoperating investment income from the wind down of the former L&I segment is expected to reduce full year earnings by $0.06.

Excluding this decline in investment income, full year earnings per share would have been 19% higher than 2005.

The new midpoint of the full-year earnings range has been decreased by $0.02 from the previous forecast due primarily to lower base business income in North America, mostly related to the declines in the automotive and new housing end markets, partially offset by higher investment income.

Other assumptions included in this forecast are, exchange rates hold at current levels, acquired revenues in the range of $1.1 billion to $1.4 billion, share repurchases for the year of $350 million to $450 million, restructuring costs for the year of $25 million to $30 million, no further impairment of good will and intangible, nonoperating investment income in a range of $75 million to $85 million, which is lower than last year by $45 to $55 million, and a tax rate of 30.5% for the fourth quarter.

I will now turn it over back to John.

Thank you, Ron.

We'll now open the call to your questions.

Please remember we're trying to ask everybody to one question and one follow-up.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Ann Duignan of Bear Stearns.

Hi, good afternoon, guys.

Hi, Ann.

Just a question on your base revenue for Q4.

Your midpoint is for 4.1% organic growth.

Your Q3 actual came in at 2.4% total.

Where are you expecting to see acceleration?

Is it international, is it some of the longer cycle businesses, or is it easier comps?

Can you help me understand where some of the upside is coming from there on a sequential basis?

Clearly, international have been growing throughout the year here.

Last year, the second part of the year, international had a fairly weak second half.

So we think on the International side, we definitely see some growth, especially in the Specialty Systems side of things.

Some of the equipment businesses and the welding and finishing areas, Signode, et cetera, internationally.

On the domestic side, in the Specialty Systems area, we're continuing to see some good growth in the welding group, as well as the food equipment group, the finishing group, et cetera.

The drag in North America, as you would expect is in the construction and automotive groups.

The other industrial business, businesses if the Engineered Products segment still showing strong growth.

If we were to look at North America Engineered Products for Q4.

Should we expect a similar organic growth rate in Q4 as you posted in Q3?

I can't see things getting much better in that business?

For Engineered Products, we're looking in the 2% range negative for both the third quarter and the fourth quarter.

So similar growth rates, that's what I was struggling with there.

I know you won't talk directly about 2007, but you highlighted the fact in your presentation that industrial production is slowing.

How do you see that rolling out as we go into 2007?

When you sit back and think of it from a high level, is there another shoe to drop, do you think, or do you think industrial production will remain at current levels as we go through '07?

We haven't done any formal forecast for '07, but I think our internal discussions lead us to believe we'll probably see reasonably good industrial production numbers, but moderating somewhat from where we are right now, maybe in the 2.5 to 3% range.

And automotive production in 2007, do you think it will be flat with '06, or what where are teams telling you for automotive?

For sure the second half is going to be good, Anne.

I know that.

The total year, do you think production will settle down after this quarter's cuts, or do you think more is coming?

It's hard to say, but when you're down 13 in Q3 and another 13 in Q4, they've taken a pretty healthy cut.

Never say never, but I think we're probably more positive than negative going into 2007.

Okay.

Just watch our seasonality as we go through the year.

Thanks, I'll get back in line.

Thank you, and our next question comes from Deane Dray, of Goldman Sachs.

Good afternoon.

First just a clarification, when you talk about 2.4% base business growth for this quarter, have you adjusted that for days because there was one less selling day this quarter?

no, we have not.

And how much higher if you did apples to apples from last year --

For the quarter?

For the quarter.

At least a point.

So more like comparability.

3.4, 3.5, something around there.

And there is no days issue for the fourth quarter, correct?

I think we have one extra day in October and one less day in December, but for the quarter it's same.

A wash in the quarter, okay.

My question is on the housing market and just talk about your visibility.

If I understand the business correctly, the bulk of your customer base is fairly fragmented.

It's a lot of distributors and lumber yards and so forth.

How do you get a read on the demand cycle from a really short-term perspective?

What kind of feedback and how can you make adjustments based upon that?

I think our businesses are the ones that are seeing their relationships with their distributors would be felt almost immediately up or down.

So they can see their numbers and see what's happening.

They would report to us clearly on a monthly basis and if it's more problematic, we would probably hear more than that.

But there's a fairly good -- a fairly narrow response time, Deane, between a business and a distribution area.

Clearly there's destocking that's going on or has gone on in the channel right now.

Distributors don't want to be caught with a lot of inventory.

As you go through rapid deceleration, they don't want to be caught with higher inventory levels.

As the numbers go down, numbers always seem to become a little bit overly negative because of the natural responses we get from our distribution partners.

We would expect that to moderate as the quarter progresses.

How much of that is big box?

I know there's been destocking there?

It doesn't sound like you're including that.

No, this is really more of the the bigger distribution people that are handling the bigger housing tract, the new housing as opposed to the Home Depot and Lowes and Menards of the world.

Good.

And then the big box is more on the renovation side.

And in terms of your forecast, you said flat to positive 5?

Flat to negative 5.

And last question, as we look at that pipeline of acquisitions, give us a sense of how does that mix look in terms of basic traditional brick and mortar type of acquisitions versus some of the more higher technology content businesses?

Well, we do have one public deal pending related to the commerce, which is a software company.

So clearly that's in the high growth potential category and there's a few other ones that are related to some of our recent acquisitions in the higher growth category.

For instance, there's an acquisition related to our material testing business that we just closed at the end of the quarter, there's some other ones related to our Kester soldering business that we acquired this -- in the third quarter as well.

There's definitely some in the mix.

We don't have a number of high growth versus normal.

You would expect us to build out some of these platform opportunities we talked about, on the Kester side.

When we see appropriate acquisition targets, we can add to that platform and get a better mix of technology and hopefully a better mix of growth.

Thank you.

Thank you, our next question comes from David Bleustein, of UBS.

First, what are you guys seeing from a steel,copper, energy input cost perspective?

And the second part of the question is how are your customers now responding in this environment for your attempts to push through pricing?

We had been seeing some increases earlier in the year in the steel area, for instance, but that seems to have leveled off in the third quarter.

And hopefully will drop a little bit in the fourth quarter.

On the steel side, we're in pretty good shape.

We've had some success over the last year and a half of passing through price increases to recover cost and in some cases recovering margins and in some cases not.

On the resin side, this is more related to oil, normal resin-type input costs such as polypropylene or polyethylene were up early in the year, but have been flat in the third quarter.

One of our big resin input costs is recycled PET in our Signode business, and that was been down all year because of an overcapacity in the recycled PET business.

So we expect that to be flat in the fourth quarter.

Also in steel, we used stainless steel and that's been going up a little bit.

Copper is really not significant for us.

Chemicals has been up worldwide throughout the year, but that may be stabilizing.

Energy has been up but we think that's stabilizing as well.

Here's the question, in an environment where just about all your costs are stabilizing in Q3 and the Q4 outlook might be actually for a mild reduction, is it still -- are you now at the point where you can no longer push prices through to customers?

Are they starting to look for price reductions, or are we not that deep yet into the cycle?

I don't think we're that deep into it.

I think some of the businesses are more sensitive to those costs than others.

But generally, we've been able to hold our prices as the costs have leveled off.

Are you still pushing through 1 to 2 to 3% price increases, or are prices now across your mix roughly flat?

Some of our businesses have been able to push through some price increases.

In the welding area, for instance, have had price increases.

Energy, related to the energy end markets, there's been some other ones as well.

Okay.

Okay, terrific.

Thanks a bunch.

Thanks.

Thank you, and our next question comes from Joel Tiss, of Lehman Brothers.

Hi, Joel.

How's it going?

Good.

Can you talk a little bit more about Wilsonart.

There's a lot of buildings being finished and all that sort of stuff and the mix between residential and commercial there.

It's clearly a commercial business.

Their revenues on the commercial side are somewhere between 50 and 60%.

To a lesser degree, it's new housing and renovation.

The remaining 40%, I don't now how you'd split it, maybe 50/50.

Their base business on the laminate side continues to perform at reasonably good levels.

They're up in base laminate in the area of 2 to 4%.

They continue to see more negative performance from their flooring business, which is only 20 -- 15 to 20% of the business, but still impacted their top line a bit.

Their overall business is in decent shape.

I would expect them to participate in a commercial construction revival, let's call it, as we progress into 2007, they should benefit from that.

They also would participate in the store fixtures and office furniture activities on the commercial side.

I think the biggest misconception about Wilsonart is people primarily see it as a residential renovation piece on business.

That's part of what they do, but not primarily what they do.

And a follow-up, you guys were talking kind of fast in the beginning.

I don't know if you gave us the details of what some of these non-volume related in international specialty.

It helped the margins and everywhere else it looked like it hurt.

Can you dig into that a bit?

In total, the affect on margin was ten basis points, which is significantly below where it has been typically.

When you look at the individual segment, there's some ups and downs.

For instance, in Engineered Products International, we're down 160 basis points for nonvolume.

The cost increases versus price increases is 40 basis points of that.

Also, there's some mix issues in that segment as we've had some growth and some lower margin businesses that are reducing margins.

Also some inventory adjustments in Asia Pacific.

In the specialty systems international segment, we're up 1.3% to 130 basis points.

The affect of price versus cost there is flat, but we've just got higher variable margins in some of our businesses in Europe in packaging, finishing, etc.

And the biggest driver there is lower overhead costs,because we had a lot of restructuring costs last year in the third quarter and the fourth quarter related to this segment, and now those restructuring projects are starting to payoff with benefits because we reduced overhead.

Thank you.

Thank you, and our next question comes from Jamie Cook.

Hey, Jamie.

Good afternoon.

My first question just relates to your outlook on commercial construction.

There's two views out there, one that commercial construction will continue to be robust and we're in the beginning stages of a multi-year recovery.

But the other view that is because housing is slowing, that could have an impact on commercial construction or even the moderating growth of the U.S. economy could impact that.

So if you could just talk about your view first on commercial construction as we move forward.

I think our view is basically in 2006, commercial construction never really came back in any significant way.

Our numbers are showing our commercial construction revenues up in a range of 4 to 8%, depending on the quarter.

I don't think we've seen any significant buildout on the commercial construction activity.

It seems to us a lot of commercial construction activities are still being delayed, being rebid, being pushed out as people deal with the raw material costs and other costs associated with the projects.

We've always thought as we got into '06, we always thought that commercial construction had a better chance of improving in '07.

I'm not going to go much beyond that.

I think there's a better chance for a so-called commercial construction revival in '07.

Remember, we went through a period of '01 to '05, Jamie, where commercial construction was just down significantly.

Down 20, 25-30%.

There are a lot of areas that look like there could be some potential upticks in commercial construction, including retail, health care, distribution, manufacturing space, we're probably not so sure of at this point in time.

That's been fairly robust, but I think everything else still has a potential to grow.

And my second question, when we looked at your margins, you mentioned they were hurt a little bit by the acquisitions and that the acquisitions have accelerated, larger than what we thought.

And when you look at the acquisitions that you're digesting, are there any that are underperforming relative to your expectations?

And is that dragging down margins?

They do drag down margins --

I understand that they do not beginning, but below your original expectations of where'd they be.

At this point, I don't think so.

I can't think of any specific ones that are way off the acquisition model.

One thing to realize too is part of the low margins in the first year for acquired companies is we recognize some intangible assets for backlog and inventory step up.

From an accounting standpoint, they get amortized fairly quickly over the first year or.

So the actual operation may be showing decent margins and their income may be getting wiped down by this amortization as well.

I think it's a matter of -- it's pure volume of acquired revenues as opposed to any particular issues in an acquired company.

Thank you very much.

Thank you.

Your next question comes from Andrew Casey, Wachovia.

Hey, Andy.

Hey, John, good afternoon, Ron.

Question on the share repurchase.

In Q3, you did 248.

Your guidance is top end 450.

It kind of implies a little bit slower pace in the fourth quarter.

Is there any reason for that?

No.

I think if you remember, when we talked about the potential for a share repurchase program which we announced in August, we really look at it, instead of the number of shares, but how much can we spend.

We're looking out and saying, what do we think our free operating cash flow is going to be through the end of the year versus what our acquisitions are, our dividends, et cetera, and trying to estimate what we can spend on share repurchases from a cash standpoint.

So we've bumped up our acquisition range, so if we end up on the high end of that range, this will be on the low end of the share repurchase range.

It's kind of a -- we plan on using it as a flexible tool to soak up our excess free cash flow.

So it's inversely related to the number of acquisitions.

So in effect, you're saying no more stretch of the capital structure to do this stuff?

We obviously increased our debt to cap this quarter from 11 to 15%, and there's always some timing issues if acquisitions carry over into next year or one moves forward.

In Specialty Systems North America, you had a lot of acquisitions boosting up the revenue growth and it seemed to have a fairly sizable affect on margins, is that just because of the introduction of mix, or is it something else?

Talking about Specialty Systems in North America, you said, or International?

One of the two, I was going off of memory.

Specialty Systems International acquisitions pulled down margins by 160 basis points.

That had a bigger impact, especially since North America was only 70.

And that's -- some of the acquisitions we've done, whether a multinational companies, the business is based in the U.S. and it tends to be stronger margins in the U.S. versus overseas.

That's part of our normal process of assimilating these acquisitions, trying to understand how we can improve that, but some of it also is amortization of backlog and inventory.

So with the amortization after roughly one year, those should start contributing higher?

Yes.

All right, thank you.

Thank you.

Thank you.

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

Hey, Rob.

Good afternoon, guys.

Let me follow-up Andy's question.

Can you tell me how many shares were repurchased in the quarter and what was outstanding at the end of the quarter?

Okay, during the quarter we spent $248 million in cash on share repurchases.

Yes.

Of that, $48 million was the normal open market type repurchase program, which is about 1.1 million shares. $200 million of the $248 was a payment made in the third quarter where we'll have the shares delivered to us in the fourth quarter.

So it's a future delivery type program.

So that will be about 4.2 million shares, approximately.

So those shares will come into play in the shares outstanding calculation in the fourth quarter depending on when they come in.

So at the end of the third quarter, we had 566.8 million shares outstanding before any dilutive shares and our dilution typically has been running around 4 million.

Okay, and --

So our range is on top of the 250, it's 350 to 450, so that's between 2 million and 4 million additional shares, but whether it affects the weighted average shares for the earnings per share calculation or not will depend on whether we do it in open market fashion or another advanced payment.

Great.

That clears all the fog on that.

That's right.

Okay, thanks, Ron.

The other thing I wanted to ask you about is the comparisons in nonresidential construction, in EP North America.

First of all, it would probably be helpful to everybody if, John, you could give us the -- you had a plus three for commercial, you didn't give us the negative numbers for residential and DIY.

Residential was down about 15, and the -- I think I told you the renovation number was down 8.

I'm sorry, I missed that.

Okay.

When you look at nonres, yes, square footage growth has been relatively slow so far this year.

High single digit number looks about right.

But your comparisons for commercial in EPN&A have been running, what, between slightly down to kind of like this quarter's number, plus three.

For commercial construction?

Yeah.

No, I think the numbers have been strong than that, Rob.

I think they've been more in the 4 to 8 range, depending on the quarter.

For your business?

For our businesses, yes.

Then I'll limit my question to the current quarter only.

Okay.

Why are you so far behind the growth the overall industry is showing?

I don't know.

I would have to attribute it to product mix for the particular quarter.

I don't have a really good explanation.

Okay.

All right, thank you.

Thank you, and our next question is coming from Eli Lustgarten, of Longbow Research

Good afternoon, gentleman.

A couple of follow-up details, in your acquisitions, the implication of your range is that the fourth quarter be very similar to the third quarter in annual revenues acquired.

Mathematically, you've done about 21 North American acquisitions internationally year-to-date.

Do the balance of these look similar and does the revenue break down similar to the number of acquisitions?

Can you give us an idea of how the revenue break down with what's left in North America as International?

A couple of comments.

First of all, the way we count these is North America, International, is really where the company is based, but some of these North American ones have a big international content.

I realize that.

That's I asked the question [multiple speakers] .

Two-thirds of their business is international.

So from that standpoint, it's hard to really put much stock into North America versus International.

But generally we've been seeing strong activity both in North America and International.

I don't know that we have a real break down of what the pipeline is, but we're seeing both acquisition markets be very strong.

Of the 895 million that you've bought so far, how would that revenue split between North America and international?

Roughly 50/50.

It is running close to 50/50?

Yeah.

One question, I've probably asked it a dozen times, maybe you can clarify.

Can you give us the logic behind quick commerce?

As you've probably heard David Speer talk, we are trying to find some higher growth businesses than typically we've had and so as we were looking around, this business, although it's a software business, we've gotten some exposure to software with our acquisitions, our Alpine and Trustwell acquisitions have a heavy software component built into their product line.

So we started to get comfortable with that.

We looked at Quick, and what we liked about it was it's really serving the industrial markets that we're familiar with.

A lot of their companies are industrial companies that are same customers that we have.

It's an area that we have some understanding around the end markets, but clearly this is a new platform.

This is something that we're not going to fold it into something we've got, but this is something that we will start with and try to grow through acquisitions.

To what did degree did you use the analysis that you could be the biggest customer and make use of the technology yourself than to try to grow the platform itself.

That's not really a consideration at all.

Most of our businesses are pretty small and focused and their product is a supply chain product for bigger, more complex type enterprises.

For instance, health care, the fence, that kind of stuff where you have expensive things to keep track of and you've got a big complicated distribution network.

Our businesses tend to be too simple for that.

Eli, this is a stand-alone business, stand-alone platform potential.

Thank you.

The other thing we like about Quick, it has high growth potential, but it also makes money.

It's one of the few software companies that are in that mode that are making some decent money and decent margins.

That was also a consideration.

All right, thank you.

Thank you, our next question is from Robert LaGaipa, CIBC World Markets.

Good afternoon.

I had a few questions.

One, just on the Specialty Systems North America business, can you just talk about what happened specifically in September.

If we look at the overall base business growth, it's probably the slowest it's been in several years.

The last couple of months prior to September were still fairly strong.

What exactly happened in that business in September?

And is it something that concerns you that might be recurring?

You're right, it was one of our slower months.

Although, if I do my adjustment for the one day -- remember, we had one less day in North America, it looks suspiciously like July.

We also are dealing with with the comparisons from a year ago with Katrina which would serve to depress some of the business comparisons, particularly in welding.

That would bring that welding number down a little bit.

We always caution everybody that month to month, things that can happen that can be a bit of an anomaly and that's why we look to look at longer three-month trends.

I would caution you, don't look at September and say, the industrial economy is going to hell in a hand basket.

We don't believe that.

And the follow-up question, on the investment income the quarter.

Obviously you made an adjustment for the full year based on this quarter being much higher.

What specifically drove that?

Was it just the transaction on some of those mortgage-related businesses that landed early?

For the current quarter, the increase was mostly related to the sales of the mortgage properties and if you remember, we had three mortgage deals, one ended last year, one was scheduled to end this year, and one's scheduled to end this year.

They've been in the mode of selling off the properties so they could liquidate the partnership at the end.

So they've been marketing these properties for a couple of years now, so we just had some that closed earlier than expected, so as a matter of the ones that we closed and had a gain on came off the fourth quarter income or even potentially 2007 for the third deal.

So as far as variability, I think most of the properties have now been sold in these portfolios, which is most of the variability.

The other part of the variability in this segment is the venture capital fund, which has been up and down, mostly up over the last couple of years, but depending what happened in the stock market, that could go the other way as well.

But on the mortgage side, there's probably not much variability from what we got in the forecast now, because most of these properties have been sold.

So when you look at 2007, the fact that most of these were sold earlier.

Relative to the midpoint of your range in 2006, the $80 million, what are you expecting for 2007?

Should it be fairly minimal?

Should it be half, how should we think about 2007 as it relates to this portfolio?

It's becoming pretty minimal.

The biggest piece has been commercial mortgage and that's going to end.

So I would say between 15 and $20 million as a run rate starting next year.

Okay, terrific.

Last question, if I could.

Just a clarification.

Obviously there was a number of moving parts given the share repurchases.

What share count are you actually using for your fourth quarter range?

I'm not sure we typically disclose that, but it's not significantly different from where we're at at the end of the quarter.

The end of the quarter, we're at 570.9 million average shares and we're using 2.5 million below that.

Okay.

Terrific, thank you very much.

Your next question comes from Mark Koznarek, Cleveland Research.

Good afternoon.

A question on the North American automotive business where you outperformed the Big Three by five percentage points.

What's the basis of that?

Are you capturing more business with the new domestics or is it penetration in the vehicle platforms you've got currently, all the above?

It's all the above.

You've highlighted two of them already.

The play with the big three is to try to continue to get as many new products on their platforms.

We can't control production, but we can control the number of ITW products we put on the car.

The second thing with new domestics, a as their grows, we'll have better results and better overall penetration rates.

We're working on two fronts, with the big three and as their declines and with the new domestics as their share increases.

What is now the split between traditional and new domestics?

Because it used to be about --

I think 85/15 at the end of this year and this year, it could be closer to 80/20, but we don't have any exact numbers.

Clearly, you're going to see new domestic become a bigger part of our business as we progress through the next 4, 5, 6 years.

And finally, can now discuss the production dynamics during the quarter with the sharp production cuts occurring mid-quarter, were you guys producing at a run rate and then just stopped production for a period of time as the customers burned off their inventories and therefore could we actually be producing at a bit of a higher rate in the fourth quarter as some of these plants come back on, how was the dynamic of this quick adjustment?

You basically laid it out again.

The timing between order and delivery is a matter of days.

Right now, in Q3, when they reduce production, we feel it.

If they increase production, we're going to feel it on the upside.

If you look sequentially, in 3Q '06, they produced about 3.4 million cars in the quarter.

Sequentially, we were expecting them to produce about 3.6 million.

So sequentially, we should see more cars produced even though the year-over-year comparisons are the same.

So there's some potential more activity for us as we look at that comparison.

But you're right.

When their production goes down, our activity goes down.

We feel it almost immediately.

When it goes up, we feel it almost immediately too.

Okay, but there wasn't much inventory to work off, it sounds like.

Initially, there was only a few days of inventory.

Right.

We don't carry lots of inventories and in most cases they don't carry a lot of inventory with us, or from us.

Okay.

All right, John, thanks.

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