Illinois Tool Works Inc (ITW) 2007 Q4 法說會逐字稿

Welcome to the ITW fourth quarter 2007 and year-end earnings release conference call.

All lines will be in a listen-only mode.

Today's conference is being recorded.

(OPERATOR INSTRUCTIONS)

I would like to turn the meeting over to Mr.

John Brooklier, Vice President of Investor Relations.

Sir, you may begin.

Thank you.

Good afternoon, everyone, and welcome to ITWs fourth quarter 2007 conference call.

As noted I'm John Brooklier, ITWs Investor Relations Officer; with me today is David Speer our CEO; and Ron Kropp, our CFO.

Thanks for joining us today.

At this point David will make some general comments about the fourth quarter and full-year.

Thank you, John.

I'm pleased to announce that based on a variety of financial operating and management achievements, the 2007 fourth quarter and full-year results translated into a strong report card for us.

Let me share some highlights.

Our fourth quarter operating revenues of $4.2 billion grew a very healthy 19%, thanks in large part to our ability to find and close valuating acquisitions to our portfolio of businesses.

In the fourth quarter, we acquired 15 companies around the world.

Notably for the full year 2007, we closed 52 transactions and added approximately $1 billion to our top line.

In classic ITW style, we paid less than one-time revenues for these acquisitions, while base revenues increased a total of 2.5% in the fourth quarter, our international units grew base revenues at 4.6%.

This helped offset softness we continued to see in a variety of North American markets.

For the full year our revenues totaled $16.2 billion, representing a 17% growth over 2006.

Operating income grew an impressive 14% in the quarter and increased 10% for the full year.

Diluted income per share from continuing operations was $0.87 a share increased an impressive 19% in the fourth quarter.

For the full year, diluted income per share from continuing operations was $3.28 an 11% increase over 2006.

Free cash totaled a robust $694 million for the quarter and $2.1 billion for the year.

While we used much of this free cash to make numerous acquisitions, we also redeployed cash to help repurchase 32.4 million shares.

That represents 1.8 billion worth of share repurchases for 2007.

By the way, at the end of the year, our debt to cap was approximately 20%.

We also took steps in 2007 to divest businesses that we believe did not fit itws long-term growth and margin profile.

As a result, we have reclassified five businesses which collectively represent $256 million of operating revenues as discontinued operations including gains on sales they $0.08 per share.

Including gains on sales they represent $0.08 per share worth of earnings on a full year basis.

Look for us to continue to review our businesses to ensure they fit long-term growth and margin expectations.

Finally, we have added to the depth of an already strong senior management team in 2007 by adding two new Executive Vice Presidents.

Jane Warner and Juan Valls were named Executive Vice Presidents in the second half of the year and they collectively bring many years of valuable operating experience to their new assignments.

They also represent firsts at ITW.

Jane is our first woman EVP and Juan is our first European based Executive Vice President operating out of Barcelona, Spain.

Together these collective achievements made 2007 a year we can be proud of and also demonstrate the strength of the increased diversified nature of our business.

We believe this diversification will continue to serve us well as we face some challenging end market conditions in 2008.

Now let me turn the call back over to John.

Thank you, David.

Here's the agenda for today's call.

Ron will join us in just a few moments to review our fourth quarter financial performance and other fourth quarter events.

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

Ron will then address our 2008 full year and first quarter earnings forecast and associated comp shift.

Finally, David, Ron, and I will take your questions.

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 today's call.

First, a few compulsory items.

Please note that this call and accompanying presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including without limitation statements regarding end market conditions, earnings growth, operating income, net operating expense, acquisitions, use of free cash, and the Company's related forecasts.

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

Important factors that could cause actual results to differ materially from the Company's expectations are set forth in ITWs Form 10 Q for the 2007 third quarter.

Finally, the telephone replay for this conference call is 203-369-3229, no passcode is necessary.

The playback number will be available through 12:00 midnight on February 13.

You can also access our fourth quarter conference call PowerPoint presentation via the ITW.com website, once you access the investor session, just look for the events tab.

Now let me introduce Ron Kropp who will cover financial information for the quarter.

Thanks, John.

Good afternoon, everybody.

Before I begin discussing the results of the fourth quarter, I want to point out that as David previously mentioned we have reclassified a discontinued operation certain businesses.

Therefore, the income statements for 2006 and the first three quarters of 2007 have been restated to reclassify the results of discontinued operations including the gain on sales in a separate line on the bottom of the income statement.

This restated information was previously released on January 8, on a Form 8-K.

All P&L information on this call reflects continuing operations only unless otherwise noted.

Now the highlights for the fourth quarter.

Revenues grew 19%, and operating income was up 14% versus last year.

Operating margins of 15.7% were lower by 60 basis points mainly due to the lower margins of acquired companies.

Included income from continuing operations per share of $0.87 was 19% higher.

Preoperating cash flow was strong at $694 million and return on invested capital was 18.3%, it was higher than last year by 90 basis points.

Now let's go to the details of the operating results.

Our 18.9% revenue growth is primarily due to three factors.

First, acquisition added 10.8% to revenue growth which was 110 basis points lower than the third quarter acquisition effect.

Secondly, base business grew, revenue grew 2.5%.

This growth rate was 20 basis points higher than the third quarter of 2007.

Internationally-based business revenues increased 4.6%, which was 70 basis points lower than the third quarter.

While international growth slowed a bit from the 8% plus level we saw in the first half, we continue to see solid performance in most of the Company's end markets in Europe and Asia Pacific regions.

North American based revenues increased 0.8% which was favorable by 60 basis points versus the third quarter.

North American businesses continue to see the effect of slowing industrial production and declines in residential construction.

Thirdly, currency translation increased revenues by 6.1% which was 240 basis points higher than the third quarter currency impact.

Similar to the story in the previous quarters of '07 our overall revenue growth was the result of strong based business growth internationally, the impact of acquisitions, and favorable currency translation.

Operating margins for the fourth quarter, 15.7% were lower than last year by 60 basis points primarily due to acquisitions and their typically lower margins which reduced overall margins by 110 basis points.

Base businesses improved margins 30 basis points which partially offset the negative acquisition effect.

When I turn it back over to John he will provide more details on the operating results as he discusses the individual segments.

For the full year, revenues grew 17% and operating income was up 10%.

Operating margins of 16.2% were lower than last year by 110 basis points.

Diluted income from continuing operations per share of $3.28, was 11% higher.

And free operating cash flow of $2.1 billion was 114% of net income.

Our full-year revenue growth of 17.2% was primarily due to the same three factors in the fourth quarter.

Acquisitions contributed 11.3%.

Base business revenue grew 1.8% and translation added 4.1%.

Operating margins for the full year were lower by 110 basis points primarily due to acquisitions which decreased overall margins by 150 basis points.

The base business margins improved by 40 basis points.

In a nonoperating area, other income was lower in the fourth quarter than the prior year by $16 million, primarily due to lower investment income of $10 million.

The fourth quarter effective tax rate of 26.7% was lower than the fourth quarter of '06 rate of 27.3%.

This lower than expected tax rate resulted in a $0.03 per share benefit in fourth quarter versus our previous forecast.

Full-year tax rate was 29.25% versus last year's rate of 29.7%.

Income from discontinued operations was lower than last year by 22 million primarily due to a gain on the sale of a roofing fast turn business in the fourth quarter of 2006.

Turning to the balance sheet, total invested capital increased $364 million from the third quarter primarily due to favorable currency translation and acquisition partially offset by lower working capital for the base businesses.

Accounts receivable increased mainly due to translation in acquisition, however, DSL decreased 62.8 days to 61.8 days.

Inventories were up slightly as on month on hand was flat at 1.8 months, even with inventory increases due to translation and acquisitions.

For the fourth quarter, capital expenditures and depreciation were both [$99] million.

On the financing side, our debt increased $625 million from last quarter, primarily due to the issuance of euro bond of 750 million euros October 1.

Partially offset by lower U.S.

commercial paper balances.

Our debt to capital ratio increased from 15% to 20% during the quarter.

Our cash position increased $225 million in the fourth quarter as our free operating cash flow of $694 million nd net borrowings of $592 million were utilized for acquisitions of $193 million, dividends of $152 million and share repurchases of 799 million.

For the quarter, we repurchased 14.4 million shares under our ongoing open ended program.

For the full year we spent $1.8 billion to repurchase 32 million shares.

Our fourth quarter return on vested capital of 18.3% was higher than last year by 90 basis points.

Lower working capital for the base businesses and a lower tax rate more than offset the negative effect of acquisitions.

For the full year, ROIC was 18%.

Regarding acquisitions, we acquired 15 companies in the fourth quarter which had annual revenues of $165 million.

For the full year we acquired 52 businesses with annualized revenues of approximately $1 billion.

In the fourth quarter we made a change to how our operations were currently reported to top management, our 825 business units have now been grouped into 56 operating segments, these operating segments generally line up with our group presidents who are one level below the EVPs.

Group President's function has gradually evolved over the year to help manage our decentralized operation as the Company has grown.

As a result of this internal reporting change, our external reporting segments have also changed.

The 56 operating segments have been aggregated into 8 reporting segments which I will describe on the next slide.

This change is effective for the fourth quarter of 2007.

The segment operating results for all periods of 2007, 2006, 2005 will be restated for this new segment structure for the 2007 Form 10-K which is expected to be filed near the end of February.

This next slide shows the revenues for the new segment for the last few years.

Note that the results segment will be presented on a world wide basis.

The segments are as follows, industrial packaging includes our strapping, stretch film, protective packaging, and insulation businesses.

Power systems and electronic segment includes our welding, PC board fabrication, ground power, electronic component packaging, and electronic component business.

Transportation segment is made up of our components and faster businesses that serve the automotive, heavy truck, and marine industries, as well as the automotive after-market business units.

The construction product segment include the tool and fastener businesses and the trust products businesses.

The food equipment segment includes businesses that make commercial food equipment for food, institutional, restaurant, and retail operations as well as business that then provide service for that equipment.

The decorative services segment includes the laminate and tiled surface businesses which sell under the [Wolf Hunter] brand and other brand names around the world as well as the laminate flooring business.

Power and fluid segment is made up of business groups which make a variety of adhesives, sealants, lubrication and cutting fluids and janitorial and sanitation materials for a variety of end markets.

The all other segment includes the remaining businesses which are not individually significant enough to be reported separately.

As I had previously mentioned the full operating results for these new segments will be released in late February in the 2007 10-K.

However for informational purposes, John will now provide more details on our fourth quarter operating results under the old segment structure.

Thank you, Rob.

Let me just take a few comments to comment on international U.S.

economic data that underlies slowing end market activity especially in the U.S..

Though the indices have dipped somewhat the news continues to be better internationally, euro zone industrial production grew 2.9% in November versus 4.0% in August and the euro zone purchasing managers index was at 52.6 in December '07 versus 53.2% in September '07.

We have however, continued to see weakening macro data for North America.

U.S.

industrial production ex technology was a tepid 0.2% in December '07 versus 0.7 in September.

As important, the ISM Purchasing Managers index dropped to 47.7% in December '07 from 52% in September '07.

Now, let's review our four manufacturing segments, starting with North American engineered products, revenues increased 2.7% and operating income grew 3.6% in the fourth quarter.

That's the first time segment operating income growth was positive in 2008.

In fact, operating margins of 15.5% were 20 basis points higher than the year ago period thanks to a base margin contribution of 30 basis points.

It represents a base margin improvement of 90 basis points compared to the third quarter.

Looking at segment results the 2.7 increase -- 2.7% increase in top line consisted of the following, minus 1.8% for bates revenues, plus 3.6% from acquisitions, plus 0.8% for translation, plus 0.1% from other.

Moving to the next slide, the fourth quarter represented the best quarterly base revenue performance from our construction businesses in 2007.

Total construction based revenues declined 4% in Q4 having decreased 5% for both Q3 and Q2 and 11% in Q1.

Specifically base revenues for ITW construction consisting of tools, fasteners, and truss products declined 10% in Q4, versus minus 8 in Q3.

By channel, our new housing based revenues decreased 16% in Q4 which improved modestly from the 19% decline in Q3.

Our Q4 housing base revenues performed 8 points better than the housing start decrease of 24% in the quarter.

NAHPs most recent data indicated slightly over 1 million a 38% decrease from a year ago period.

From an ITW perspective we still anticipate housing starts for full year '08 to be approximately in the range of 1 to 1.1 million units.

NAHPs January 24, forecast has 2008 full-year housing starts at 1.066 million.

Our performance and other construction categories was mixed.

For Q4 our renovation businesses declined 8% due to slower activity at box stores such as Home Depot and Lowe's.

Our commercial construction business however grew base revenues 4% in the quarter, mainly as a result of contributions from our truss business units.

In our WIlshire business, base revenues grew 3% marking the fourth quarter as Wilshire's best top line performance of the year.

Improved base laminate sales driven largely by premium high definition products accounted for most of the base revenue increase.

Moving to the next slide, thanks to penetration gains our automotive base revenues were flat in the quarter, even as Detroit fell 3 auto production fell 3% in Q4.

That compares unfavorably to Detroit 3 builds plus 1% in Q3.

Detroit 3 builds for Q4 were as follows.

GM down 7, Ford plus 3, and Chrysler minus 3.

For the full year '07, Detroit 3 builds were GM down 8, Ford down 7 and Chrysler was flat.

As expected, new domestic builds grew 8% in Q4 and increased 6% for the full year.

Inventory showed modest improvement in the quarter.

At December 31, Detroit 3 inventories were at 68 days on hand versus 70 days at September 30.

Specifically GM was at 73 days, Ford was at 70 days, and Chrysler was at 59 days.

New domestic inventories were at a relatively healthy 53 days at December 31, versus 48 days at December 30.

The latest CSM external forecast data now indicates that Detroit's rebuilds will decline 9% and new domestics will increase 3% for full year 2008.

That's a decline of 5% for 2008.

That's more negative than the range of minus 2 to minus 3 we gave you in New York City on November 30.

In our industrial products category of businesses, base revenues were flat in Q4.

That's a slight improvement from our Q3 when base revenues at minus 1%.

E-business unit performance in Q4 included performance polymers growing 3%, Nitty Grip zip pack, increasing 5% and fluid products growing 7%.

On the down side, industrial plastics declined 6% in the quarter mainly due to weaker demand from the appliance and electronic sectors.

Moving to the next sector or I should say the next segment, international engineered products in the fourth quarter segment revenues increased 35.8% and operating income grew 21.4%.

Operating margins of 14.8% were 170 basis points lower than the year ago period due to the dilutive impact of acquisitions.

Taking a closer look at the top line, the 35.8% increase in revenues consisted of the following, plus 6.6%, from base revenues, plus 16.2% and acquisitions minus 0.4% from divestitures, plus 13.3% from translation, and plus 0.1 from other.

Similar to past quarters, this segment in Q4 produced across the board revenue growth in all business categories, total construction based revenues group 7% in Q4 versus 8% growth in Q3.

By geography, Q4 base revenues were as follows, European construction grew 4%.

Asia increased 13% and Wilsonart International grew 3%.

Europe was aided by demand for commercial construction products through a wide variety of countries including France, Germany and a number of Nordic countries.

Asia Pacific benefited from strong performance from retail and trust units in Australia and Wilsonart's growth was largely driven by strong performance from [Resopaul], it's German based business unit.

Automotive based revenues increased a very healthy 8% in Q4 having been up a similar 8% in Q3.

Top line growth was assisted by both penetration and a 6% increase in light vehicle production in Europe.

Key builds in Q4 included the following, Fiat at plus 14, BMW at 13.1%, GM Group at 11.2%, Daimler at 10.1%, Ford Group at 3.2, and PSA Group at 1.5%.

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

These units in aggregate generate a base revenue growth of 5% in Q4.

By base business grew -- Q4 base revenues were as follows, fluid products at plus 11%.

Performance polymers at 7% and Industrial plastics, declined 3%.

Let's move to the North American specialty systems segment.

For the fourth quarter, segment revenues grew 8.2% and operating income increased 6.7%.

Operating margins of 16.8% were 30 basis points lower than a year ago due to the dilutive impact of acquisitions.

In fact, base margins improved 20 basis points in the quarter.

Focusing on the top line, the 8.2% growth in revenues consisted of the following components.

2.9% from base revenues, 4.5% from acquisitions and 0.8% from translation.

The two stand out performers in terms of base revenue performance during the quarter were food equipment and welding.

Food equipment's base revenues grew 6% in Q4 versus an increase of plus 9 in Q3.

For the full year food equipment grew 6%.

In Q4 food equipment benefited from strong institutional casual dining demand for its refrigeration and cooking products and related service businesses.

Welding's base revenues grew 5% in Q4 even with some very difficult comparisons from a year ago and ongoing weakness in a mix of industrial end markets.

That compares to 7% growth in Q3.

For the full year welding's base revenues were up 5%.

The weakness in the segment continues to be the signal and industrial packaging business which saw base revenues decline 2% in Q4 versus a decrease of 6% in Q3.

For the full year, base revenues fell 5%.

Again, weaker demand for end of the line packaging applications in lumber, brick, and block and primary metals continues to impact revenues.

Finally, international specialty systems, for the fourth quarter segment revenues increased 34.9% and operating income grew 32.3%.

Operating margins of 13.8% were 20 basis points lower than a year ago due to acquisitions.

In fact base margins increased 120 points from the year ago period.

Looking at top line, the 34.9% growth in revenues consisted of the following, 2.5% for base, 21.2% from acquisitions, 11.7 from translation, our divestitures were negative 40 basis points and other was negative 10 basis points.

Similar to North America, food equipment and welding were the key contributors to top line growth in the segment.

Food equipments base revenues grew 10% in Q4 with contributions hailing from a variety of countries, especially Germany and France.

Food equipments base revenues increased 10% for the full year.

That compares to growth of 14% Q3.

Weldings base revenues increased 12% in Q4 thanks to strong demand for consumables and equipment in Asia particularly China.

By comparison, weldings base revenues increased 6% in Q3 and for the full year, base revenues grew an impressive 13%.

On the down side Industrial packaging Europe declined 5% Industrial packaging Asia decreased 4% in Q4.

For Q3 both categories were flat, and for the full year, both categories were up 3%.

Now let me turn it back over to Ron who will talk about the '08 forecast.

Thank you.

We are forecasting first quarter 2008 diluted income from continuing operations be with within a range of $0.72 to $0.78 per share.

The low end of this range assumes 8% growth in total revenues and the high end of the range assumes 11% total revenue growth.

The mid point of this EPS range of $0.75 per share, would be 10% higher than the prior year.

For full-year 2008, our forecasted earnings range of $3.47 to $3.61 per share.

The full-year total revenue growth is expected to be in a range of 6 to 10%.

The mid point of this earnings range of $3.54 would be 8% higher than 2007.

Other assumptions included in this forecast are exchange rates holding at current level, barred revenues in the range of 800 million to 1.2 billion, share repurchases for the year of 800 million to 1.0 billion, estimated impairment of goodwill and intangibles is 2 to 6 million in the first quarter, net nonoperating expense which includes interest expense and other nonoperating income in the range of 115 million to 125 million for the year, which is unfavorable versus 2007 by 70 million to 08 million, and a tax rate between 28.75 and 29.25 for the full year.

I will now turn it back over to John for the Q&A.

Thank you, Ron.

We will now open the call to your questions

(OPERATOR INSTRUCTIONS) The first question is from Mr.

LaGaipa, of Oppenheimer.

Good afternoon.

A couple of questions, I guess one you have moved away from giving actual base sales or core growth forecast to total revenue, I guess my first question is just, why did you decide to move away from base sales, and two where do you think base sales are going to be for the first quarter and for the full year?

Let me answer that, Rob.

We, in looking at our new segment reporting have decided that in the data we're going to provide across these eight segments to look at these businesses globally, and as such provide data in terms of total revenue growth.

While we will still reference base revenue growth, really what we are looking at primarily across these segments for is revenue growth including acquisitions.

I think across eight segments you will agree that that data is obviously the most meaningful data as we look at these new groups of businesses.

While base is still a number that we will track it is really not the primary metric in how we look at revenue growth.

Okay.

So, what are you expecting base to be then?

If you are still tracking it, what's that component of your forecast for the first quarter and the full year?

I would expect for the first quarter that we'd be looking at base revenues that are somewhat flat, and for the year, probably base revenue growth somewhere in the 2% range.

Terrific.

And second question, if I could, obviously we have had a couple of years now of acquisitions, it has put pressure on the operating margins of course.

Now that you are a couple of years into the 80/20, of course you are going to continue with the acquisitions especially in this type of environment, but should we expect for 2008, well, first quarter and 2008 are you capable of actually growing the margins year-over-year?

Yes, we are.

We certainly see that if the existing acquisitions.

As you know, the first year of the acquisition, we have the heavy step ups in amortizations that occur that would dilute the margins on a post-amortization basis.

We look at the pretax margins and the growth in those margins on an operating basis and they've performed collectively as a group, the acquisitions in '07 have performed in line with our expectations, and those that we completed in '06 are actually in that same category.

We are seeing the kind of progress we would expect to see.

With the large amount of acquisitions that we did in the fourth quarter of '06, you will start to see the margin improvements as the amortization on those are largely behind us now..

In the first quarter of '08 and forward you will begin to see that reflected.

As was pointed out in I think Ron's comments, we expect the margin impact to be dilutive on acquisitions obviously in the first several years.

It is really not until year three or four where we really start to see the significant change in operating margins.

But I can tell you that for the first year of the acquisitions as we've looked at them this year, we are right in line with what our expectations are.

Terrific.

Thanks very much.

Next question is from Deane Dray of Goldman Sachs.

Thank you.

Good afternoon.

David, I would be interesting in hearing an update on your views on commercial construction for 2008.

You saw the Fed step in this afternoon and give us another 50 basis points in referencing, tightening, credit conditions on some businesses.

What's the expectation with the businesses that ITW touches in the U.S.

and international for commercial construction?

Well, as with we told you in New York in December, our expectation for new awards for 2008 was going to be down, we thought, on a squire footage basis somewhere in the 5% range.

I have seen nothing yet that would indicate that that would change, at least our current outlook.

So I still see it as a market that's going to contract and obviously there are a number of categories in commercial construction.

So the bulk of them we see contracting, there will be a couple that will probably show some positive numbers.

The final numbers from Dodge for 2007 showed a contraction of about 5.5%.

So it actually, the biggest negative part of 2007 was actually in the beginning of the year but they're still tracking at negative numbers overall.

In Europe we saw positive growth in Europe in the markets in 2007 on commercial construction in the 4% range and our view in 2008 is the same as what we shared with you in December which is about a 3% growth in commercial numbers in Europe.

Great.

Just a question on with regard to the emphasis on divestitures and the way you are looking at your businesses today, are you applying any new standards in how you're evaluating the companies, whether there's the right fit, whether there's growth, the synergies, the returns and so forth, sounds like you are giving these businesses, a more critical look than you had in the past?

Well, I think the, from a financial metrics stand poind, the standards are no different.

I think what perhaps is a bit different, Deane is that we have a number of businesses in some of these portfolios that you would have seen we have divested in the last year and a half that were adequate performers but frankly didn't fit the growth profile of what we were looking for going forward and in some cases may have been businesses that individually were interesting businesses, but didn't fit collectively within our group, and certainly not with our long-term growth strategy.

Perhaps that's a bit of a change or a nuance in how we are looking at it but I'd say the financial metrics, again if I look at the businesses we've divested in the last year, and in these five businesses that have been put in discontinued operations, I'd say two of them were divested because of performance related, underperforming what our expectations would be.

The other three would be a variety of end-market sort of issues, businesses that came to us as a result of acquisitions that were a portion of an acquisition that didn't really fit the core strategy and in two cases businesses that end market conditions over the last four or five years changed to the point where we didn't see them being the kinds of businesses going forward that they had been in the past

Great.

Thank you.

Next question is from [Steven Nissan] of Mindflow Capital Investments.

Ys a couple of things.

Congratulations on a solid quarter.

Dave, you always seem to come up with great results.

A couple of things.

Regarding your operational improvement initiatives, what can you elaborate, can you give us some color on what you're doing regarding lean manufacturing TPM, Six Sigma, and how do you expect those benefits to impact the bottom line?

Well, our process is -- as you might know, we refer to it as 80/20.

Our operational programs from a lean standpoint revolve around our institution or our capabilities of implementing 80/20 across our business portfolio.

It is a continuous process so it's not something that stops.

We see the greatest impact in generally new or acquired businesses and clearly that's where we drive the bulk of our improvement in margins.

As a reference point, last year our average acquisition came to us with just over 7% pretax operating margins.

It is our expectation that that group of businesses would be performing somewhere in the 15 to 16% range in the next four to five years.

The bulk of that probably 80% plus of that improvement is going to come from our application of 80/20 inside those businesses and really improving their supply chain, their manufacturing metrics, and the focus on customers and products that are going to drive profitable growth.

.

That would be likewise similar to what goes on inside of our existing operations and certainly as our businesses look at different size market opportunities, as markets expand and contract, they likewise look at their own business base and adjust accordingly as well.

But 80/20 is really what drives our operational

Follow-up to that question is, what metrics are you guys going to be using to manage in your manufacturing process to make sure you are doing the right job in terms of like OEE or RONA and also for the remainer of 2008, what systems and solutions do you plan to put in place as CEO to accelerate your great continuous improvement initiatives, which are definitely one of the best in the industry?

Well, we use a number of different metrics obviously in our operating businesses.

But if you look at it from an investment standpoint, it is a return on investment metric, and obviously, the working capital areas that we pay particular attention to in our operating units which are the short-term assets that they have a great deal of impact on, receivables inventory are generally reflective of how efficient their supply chain operations are and how efficient they are from a service standpoint with their customers.

So those are the metrics that we look at.

We have a lot of businesses, as Ron pointed out, our overall month on hand at 1.8 months gives us about 6.3 turns a year.

We have a lot of businesses that operate with more than 12 turns a year in their inventory.

We look at those as the short-term operating metrics and return on investment obviously is the important metric at the operating units and we use that across our 825 or so business units.

And the second part of that question was what system.

We are going to have to move on.

Thanks, next question.

Your next question is from Mark Koznarek of Cleveland Research Company.

Mark.

Your line is open.

There's a cold snap in Cleveland.

Can we go to the next question?

Certainly.

Jamie Cook of Credit Suisse.

Mr.

Cook.

Jamie.

All right.

Mr.

John Inch of Merrill Lynch.

Thank you.

Good afternoon.

Hi, you made it.

Yes, I did.

Hey, I just wanted to go back just briefly to the base business issue.

David, when you became CEO one of your key initiatives was to move the Company's historical average base business to fiver to six or at least higher than the historical four.

This kind of implies and I don't want to misconstrue it but it implies that you may be moving away from that strategic initiative, could you talk about invariably what sort of prompted this?

No, we are not moving away from that initiative at all, John.

Obviously if you are referring to how we are reporting revenues, as we looked at again, these new eight segments that we're talking about, we wanted to report those on a global basis because that's really the way we are operating those businesses and the way we look at the data.

The most meaningful metric from a revenue standpoint is total revenue growth, but clearly underlying that is the compilation of acquisitions as well as base revenue growth and no, we still are looking at 5 to 6% as our target, long-term for base revenue growth.

Those are the targets that we will be measuring inside of those groups of businesses.

John, keep in mind that we will report base revenues on a quarterly basis.

So we will true-up all the numbers for you.

But I think it is our view that there has been sort of an overly myopic view of base revenues that people want to dissect almost on a daily basis.

I understand.

You are basically saying you just don't want that to be the short-term focus of the Street.

I think that's what you are trying to say?

And frankly, John, it is not the way we develop our plans and report our plans.

We don't develop our plans looking only at base and we don't report them internally looking only at base.

It really is, this is much more reflective of the way we actually operate the businesses.

The original segmentation if I am not mistaken had (inaudible) between equipment versus consumables.

I guess that got blurred over time.

If you were to look at consumables are they equally spread or are some of these segments going to be more equipment versus consumable oriented?

If you look at it, going down the list industrial packaging clearly there's a big consumable element there.

The power systems has the welding consumable and some of the other equipment businesses, for instance food equipment, that's not really consumable but there is an after market service element, so those are the bigger ones that were in specialty systems passed.

We will certainly be in a position when we look at those segments going forward, John, to talk more directly about equipment and consumables inside of each of those segments.

That's one of the benefits I think this segmentation will help us with.

The large equipment groups as you would know are concentrated in those three categories that Ron just mentioned, the Industrial packaging group, the power electronics area which contains the welding, and then certainly food equipment.

Where does click commerce and those businesses go?

That would be in the other category.

Just lastly, your raw material outlook is part of the guidance, steel, I guess debatably could be moving higher.

How are you guys thinking about raw materials and the metals specifically, maybe what's the sensitivity as part of your outlook?

Our plans are structured with a particular point in time look at raw material costs with the idea that any change from that if it is up, we are clearly going to have price recovery plans so we will have to institute price increases.

That's generally the way we approach raw material or input costs going to the plan cycle.

To answer your question about metals, we definitely have seen a rise in metal prices.

Some of our businesses already had seen that telegraphed in the fourth quarter.

Some of that was included in their plans.

Others have had recent announcements of cost increases on steel.

We will be looking to recover cost on some of the steel going forward as well.

But we've definitely seen inflationary pressure on steel particularly in the last 60 to 90 days.

Thank you.

To reiterate David's point, in our margin, as we look at margins for '08, we are forecasting basically a flat impact of price and cost of raw materials in the margin area.

Next question is from Jim Edelman of Highland Capital.

Hello.

Can you comment on discontinued operations in '08, do you expect earnings from those discontinued operations?

If so, can you tell us about how much?

Well, the only earnings we would have in '08 from those would be the businesses that have not yet been sold, the other three have already been sold in either 2007 or 2006.

While they will have some results, it is probably not significant.

The most significant portion of it would probably be when they actually get sold, there may be, a gain.

But we are not at this point trying to forecast what that might be.

Okay.

Thank you.

Your next question is from Joel Tiss of Lehman.

Good afternoon.

Just one clarification, are you going to be giving us operating profits by the new segments?

Yes.

In the -- when we release the 10-K for 2007 in late February, we will be presenting these eight segments basically in the same format as we have done our prior segments, so showing the revenues, operating income, operating margins, and the various components split between ace acquisition, translation, et cetera.

For revenues.

Okay.

And then, in 2008 do you expect to spend more than your free cash flow again in the combination of share prepurchase and acquisitions?

Yes, I think if you look at it, we probably would have estimated free cash flow for '08 in the $2 billion range which is a little higher than one-time net income.

If you look at kind of the three, the three big areas that we spend our free cash flow on, acquisition forecast, the midpoint is 1 billion, share repo is 900 million dividends is probably in the 550 million to 600 million range so we would overspend our free cash flow a bit.

Which we need to do to stay on our target at the cap range of 20 to 25%.

We are on the low end of that range now, if we spend as I have outlined we will be a little more into that 20 to 25% range but shouldn't be above it.

Okay.

And then last one, can you just talk a little bit maybe, David about you seeing any signs of second half economic rebound or what would be the factors that would cause you to re-evaluate your--?

Are you talking about the second half of '07 or '08.

Yes, exactly, we are still waiting for the other one.

Well, I think if you look at the way our plan is structured, Joel, obviously the second half seems a long ways away at the moment but if you look at the way our plan is structured we would expect to see in our businesses a better growth in the second half of the year particularly here in North America.

I will tell you it is primarily based on easier comps not necessarily more robust market activity.

The impact of the change in rate cuts is going to take some time to play through.

We will see what happens but I think what we have seen as John referenced earlier in the ISM data, in the Industrial production data here in North America we are obviously still seeing those markets contracting the ISM data at the end of December was under 50 and the Industrial production number is almost 0 now.

That's clearly in line with what we've been seeing, so I expect the first half of the year to be in North America in particular, flat and then some end markets probably actually down.

I would expect the second half to show improvement.

Thank you.

Your next question is from Mr.

Robert Wertheimer of Morgan Stanley.

My question first on acquisitions, are you looking to be more agressive into the downturn or no?

And can you discuss your pipeline backlog and whether there's any, at least potential for larger chunky acquisitions that could make the number bigger?

Well, as it relates to the acquisition range we have established, it is largely the same range we established going into '07 and in fact it's largely in line with what we actually were able to achieve in '07.

I would say our view of the market in terms of what we see today is not largely different.

Our pipeline is roughly the same, a little over $1 billion in the pipeline.

I think in terms of what I would expect to see, based on what's happened with private equity and leverage I would expect to see some improvement although I have to say that so far we haven't seen any significant change.

That's probably based on the fact that anybody that is selling larger size assets in particular is probably taking a serious look as to whether they want to put anything on the market at the moment.

There has actually been, somewhat of a lull in terms of larger transactions, I would expect though, going forward that we are going to be, have the opportunity to look at perhaps some somewhat larger deals with more favorable valuations of what we see in the past but that's not necessarily represented in our pipeline.

I think there's perhaps only one deal in the pipeline at the moment that approaches 200 million in size.

We haven't seen it yet.

That's helpful.

Thank you.

If I can just ask a quick one.

Was there any change in the internal operating structure along with reporting structure or is it strictly reporting?

Was there any philosophical change there?

There were changes made during 2007 that, in the reporting structure as we added two new Executive Vice Presidents.

And really at that point as we began to look at the businesses and the structures, when we really made the decision that realigning our segments and operating groups under these 56 group Presidents is what we really spent the fourth quarter looking at and making that decision.

I didn't mean to ignore that, I was thinking more though on just a business unit level, if the business unit managers are relating to each other differently now that they're in different silos?

No, no.

Okay.

Thank you.

The next question is from Daniel Dowd of Bernstein.

Your line is open.

Let me follow-up on the internal operating segment change.

Let me just be clear, you have gone to 56 operating segments and you have 825 business units.

Part of your operating model has always been in addition to the acquisitions in addition to 80/20 has been enormous proximity to the end customer.

Are you centralizing the business more today, operationally than you were a year ago?

Should we read that into this change or not?

No, not at all.

No, it is not, the group President level which is the 56 groups that John and Ron referenced earlier, that level has been in existence and it has been growing over the last four or five years.

Really this segment reporting these eight segments we have talked about is really a realignment of the way we are looking at the businesses internally and the way those 56 group Presidents operate.

The 825 business units and the decentralization we use in running those individual businesses is exactly the same as it was in the past.

The focus at the business unit level hasn't changed at all.

In answer to the previous question that was asked as well, we did not realign the group Presidents and the operating units, there really the group President level and the units they have responsibility for are largely intact the way they were throughout 2007.

No change in the focus in terms of decentralization and really no move to centralize anything.

You shouldn't read any of that have into this.

So, am I to understand that, so in this new segment that's reporting Industrial Packaging, there's no one inside ITW who actually has a P&L called Industrial Packaging?

There's no executive who has responsibility for that?

Oh no, there's an executive who has responsibility for that.

Yes.

Okay.

So the EVPs are aligned against the way in which you are reporting that?

In some cases the segment may in totale report to an EVP, but in other cases the segment may be representative of more than one EVPs group of businesses.

Okay.

The way the accounting rules work on this is, it starts with, how does the data get reported up to top management?

So, historically reporting basically at a business unit level to top management, now we have 825 business units and we have this group President layer that we have added over the years.

At the end of the day we have looked at it and said the right place for top management to really look at how the businesses are doing at the group President level and therefore, that's why we have the 56.

You are allowed to aggregate the 56 based on how similar they are.

Some of them fall naturally, like Industrial Packaging together under an EVP, other ones come from different EVPs

That's very helpful.

One last thing, are your acquisitions roughly evenly -- your acquisition pipeline and your thinking about how you're going to acquire roughly evenly distributed across these segments or are there segments that are really going be the focus of acquisition?

Well, as you would look, Dan, not much change going forward, at least in the pipeline.

If you look at what we did in 2007, we did virtually no acquisitions or very small acquisitions in auto and construction as an example.

The bulk of the acquisitions were coming from other areas and as you might remember, about 75% of the acquired dollars in 2007 were in international markets.

That's largely representative of what I see in the pipeline at the moment as well.

It is not that we aren't doing acquisitions in construction and auto.

We just haven't seen the opportunities that are attractive in those two areas.

So polymers and fluids was a very active area for acquisitions as was the powered electronics area and the food equipment area in 2007.

All right.

Thank you very much.

The next question is from Tom Lamb of Weybosset Research.

Yes, good afternoon, gentlemen.

One moment, please.

Hi, it is Fla Lewis.

My question relates to R&D line which is very large relative to revenues and up quite a bit for the quarter and for the year.

What goes into that line?

You are talking about the -- th e line on the income statement is really SG&A, selling, administrative and R&D all together.

It is up year-on-year primarily due to acquisitions, as we acquire companies we bring on their SG&A and as a percentage of revenue it's slightly unfavorable year on year primarily due to acquisitions having higher overhead typically when they start with ITW.

I see.

I thought you sure were doing a lot of research.

Thanks very much.

The next question is from Robert McCarthy of R.

W.

Baird.

Good afternoon, guys.

Hi, Robert.

Can you give us a -- can you give us your forecast for capital spending and appreciation in 2008?

Yes.

For depreciation -- I got it here.

Capital spending will be what, Ron, in excess of 350?

CapEx is about 430 to 440, depreciation about 370.

Depreciation and amortization?

Just depreciation.

Okay.

And I had really two questions about, I guess revenue is what we are talking about.

One is as part of your change in reporting format as we get into next year, are you going to be at a position yet where you can start tor report on the contribution from new product development that you have been working on aggregating?

Not on a global, no.

What does that mean, David?

You are going to start to be able to talk about it maybe in some businesses?

We don't have the same measurement in all the business units, even within some of these groups to be able to aggregate it and have one corporate measure that's the same.

Oh, I see.

My other question goes to the organic or base revenue growth performance in specialty systems international where you saw what, basically flat third quarter in Industrial Packaging go to negative numbers?

It is not so much Europe, I think everybody's pretty satisfied that things will slow down there.

This business is a leading indicator but that gives me some concern about Asia.

Should we read a negative comp in that business as a leading indicator of weakening conditions there or is there something unusual in the comparison that's really ITW specific?

No, you shouldn't read anything into there.

It really is specific to -- the delay in the start up of a business unit, actually two businesses in China and also some restructuring that went on in another.

It was really an anomaly.

It's a relatively modest number at the moment in terms of the Asian content, but it will become much more significant going forward.

No, you shouldn't read anything into that.

Rob, across the Company, Asia growth was about 8% in the quarter.

And for the full year.

I am not sure I know what that is.

Okay.

Well, if you come up with it, tell us later.

The next question is from Ann Duignan of Bear Stearns.

Hi, guys, good afternoon.

I guess my first question would be to David, David, back in November, you had expected organic growth going into '08 to be 2.5 to 3%.

Your outlook now is roughly 2%.

What has changed incrementally, I know some of maybe the discontinued operations that came out, you have partial year and sales of businesses, but you noted that North America automotive has got worse, has anything else deteriorated?

Well, yes, since November, Ann, certainly the housing market, we took our numbers down in actually as we headed into our meetings in December in housing.

We had been at 1.2 to 1.3 million in projected starts for '08 and we moved that down to 1 to 1.1.

The other one would be auto.

Frankly the Industrial production numbers now in North America are clearly much clearer to us.

That is flat and in some end markets the first half of the year probably actually negative.

I think you are seeing that reflected now in the industrial production and ISM numbers.

Those have been the significant changes.

I think where we are in Europe is about where we thought we would be, which is back to more historical growth and GDP ranges in Europe but still positive growth.

Really nothing has changed materially in Asia.

It is really North America.

Okay.

So automotive -- housing you had already talked about it being very weak and then industrial production may be a little bit weaker today than you might have expected a month and a half ago?

Yes.

But actually, the auto build has come down twice since November.

It came down rather significantly in December the numbers we shared with you and it came down again in January as particularly the Detroit 3 cut there bills even further.

So I think when we were with you, in December, we were talking about an auto bill that was for the year, the Detroit 3 were going to be down in the 6% range, now it is down 9.

David, I would also add that the performance out of our industrial plastics area with appliance related products was down fairly significantly from where we thought it would be in November.

Ann we are seeing that mostly on the North American side but starting to see some additional weakness on the international side.

Okay.

That's good color.

Thank you.

Just as a follow-up then, I just want to make sure I understand your '08 guidance, because I think between you and I communicating this morning, John, I might have messed it up, I think what you are saying now is that your earnings from continuing operations is the same as your GAAP earnings for '08?

I am not sure if I understand that.

Your midpoint for your income per share from continuing ops is 3.54.

Correct.

GAAP would be the same is that what you are saying?

Well, we are not really giving guidance on discontinued ops.

That shouldn't be of any significance.

The biggest -- like I mentioned earlier, the biggest item will be -- one or two of these businesses there could be a gain that has some impact, but at this point our guidance is really focused on income from continuing operations which is the GAAP measurement.

Okay.

I was just surprised that it was so far from Consensus giving the positive impact of lower tax rate and lower share count..

I will get back in line and take my questions offline with you.

Okay.

The question is from Mark Koznarek of Cleveland Research.

Are you there, Mark?

You guys can hear me at this point?

I have a conceptual question about the earnings growth for next year having to do with the dilution from acquisition.

If we look at this year, we just came off a year where you had roughly 2% organic growth and posted 11% earnings growth.

Next year the midpoint on about the same organic growth on the top line is 8%.

And we got it looks like about 3 percentage points of growth from the last hurrah of your investments, so you would say that it is a pretty reasonable estimate on the face of it.

One thing that strikes me is that in back in '06, you did this huge slug of acquisitions, 1.7 billion, and we had a big increase in acquisition dilution this year.

Shouldn't that be cresting and going back towards more normal levels, because now you are in the second and even latter part of the year you'll be in the third year of ownership of some of these '06 deals.

So it strikes me that margins should be improving a bit more than your guidance.

I know I have stepped you through a lot of numbers.

I am wondering if you can conceptually help me with that -- those thoughts?

Let's start with the midpoint of 8% on the earnings growth, right?

On the operating margin side we are expecting a little bit lower margins but not as significant as we saw in 2007 and 2006.

We are seeing some more cases of improvement in the base margin, very little effect from price cost as I mentioned earlier So I think we are seeing some of the benefits from year two and three from some of these acquisitions.

The acquisition dilution on margins which was double digits for most of 2007 and 2006, we expect to be a lot less, maybe half of that.

In the 5 to 6 -- 50 to 60 basis points range.

While we are seeing some dilution of margins it is not as big as we have seen.

Now, when you go down the rest of the income statement, the one thing to consider here is that as we have disclosed in our assumptions, we have some negative comparables related to non-operating so we've grouped our other income, which includes the investment income from the past as well as interest expense together, and looked that all in and we're saying that that is going to be down year on year by about 75 million.

50 million of that is interest.

The way we are viewing that interest, that's really interest on leveraging up the balance sheet up to this higher level, primarily to repurchase shares but also to do acquisitions.

We've kind of looked at that increase in interest and the lower share count together and say that together is adding about $0.11 to $0.12 for the year.

So about 3.5% of the 8 is from shares and interest.

What that also means in the nonoperating area, we are losing about $0.04 for the year in other things, primarily investment income will continue to be a drag in that 20 million to $30 million range versus what it was in 2007.

So looking at the total 8%, the midpoint, you have the base in the 2 to 3% range.

Acquisitions in the 1 to 2, a little bit from translation, some negatives in the nonoperating area, and some favorable impact from shares and interest.

Okay.

That's helpful, I'm still not sure it totally adds up.

It seems like there -- is there any kind of mixed dynamic that's going on where you expect certain parts of the business to contribute more of the growth than other more profitable pieces?

Is there any elements like that in there?

Well, similar to '07, international we feel will be stronger than North America.

So there is a bit of a mix issue, because our international margins aren't quite as high as North America.

So there is some of that, but clearly not as much as it was last year.

Okay.

All right.

That's help.

Thank you.

The next question is from Jamie Cook of Credit Suisse.

Hey, can you hear me.

Yes.

Most of my questions have been answered.

Two quick follow-ups.

David, when you think about inventory levels not things that you're selling direct that are going through distribution any areas where you think we-- you might need to -- that they might need to cut back a little or are you pretty comfortable there?

I guess if you could start there first?

No, overall I think our businesses have done a reasonably good job of adjusting inventories, we have seen -- the big changes that we had to deal with, probably here in North America were largely related to what was going on in housing.

Most of those adjustments occurred during the first half of the year.

Even though the market has continued to trend downward, I think our business has run pretty close to those trends lines and adjust accordingly.

The biggest opportunity for us in inventory is with the newer acquisitions.

That's usually the case.

I would expect that in '08 that we are going to see the opportunity as we do with our acquisitions to make significant progress in reducing inventories there, I don't know what the overall MOH number would have been with the acquired businesses in 2007 but it certainly would have been well above our 1.8 average MOH.

So I think most of the opportunity, Jamie, will come from newly acquired businesses.

Then, just second, my last question, the ISM numbers that came out in December, I guess, surprised everyone.

Did you guys see that -- when you think about the month of December, was was it much weaker than October or November?

And as we're at the end o January, any commentary you can give us there yet?

Well, we have been, I think been saying for the last four months or so that we saw the Industrial activity actually weakening and I wasn't using the ISM number when I was looking at that, I was looking at the actual activity levels in our businesses.

So I don't want to say we are a precursor to the ISM but I think we certainly have seen this softening in the Industrial markets here ahead of those indices, that's for sure.

I have not seen any strengthening and I think that in some of the end markets as we would have expected we have seen some continued slowing.

So as I think I pointed out earlier, I think the industrial markets here in North America, I see the first half of the year some of them being flat and probably some of those end segments actually being down.

But I think the ISM data is probably accurately reflecting what we have been seeing going on for the last three or four months.

Jamie, if you look at our North American engineered products in December, it was the weakest month of the quarter for us.

All right.

Thank you, I appreciate the color.

The final question is from Andy Casey of Wachovia.

I got in.

We can even hear you too.

Good, Hey, first question on the nonvolume margin impacts in the two North American businesses in the quarter, is that totally related to the input cost inflation?

Let's talk about them separately.

For engineered products North America, the non volume is favorable by 80 basis points.

The input cost and the pricing is flat, so most of the benefit of that is coming from cost controls and primarily the benefits of some prior restructurings we've done in a bunch of different business units.

Also we had some favorable mix issues, for instance in our (inaudible) business we're selling more high definition laminate that has higher margins.

The specialty systems North American side we're down 50 basis points.

Again price costs is flat, and there we have so inefficiencies and some other miscellaneous issues, nothing of any significance, inventory adjustments in one place and some other issues in another place.

Also, we have some mix issues there where we have some stronger revenue growth and some lower margin-type businesses.

Okay.

And I guess a follow-up on the price costs flat comments in both.

I think earlier in the call, you referred to recapturing pricing.

Was that international or are you going after margin in North America?

Well, I think it is world wide.

I think we have seen this over the past few years and have become much quicker to react to changes in input costs.

Not only are we looking to recover the dollars of cost increases but also trying to establish our margins as well.

We have been able to do that.

Even though it was flat in the quarter we did have some cost increases that we were able to recover.

Then the last one and maybe it gets back to the question Jamie was just asking on the inventory, did you see any disruption in distributor orders related to the new Mexican tax law?

Boy, Andy, I can't tell you that I have heard that come up from any of our executives as an issue.

I would have to say that nothing material, I certainly haven't heard anything, Ron, I don't know whether you heard anything but I certainly did not.

No.

Okay.

Thank you very much.

Okay.

And there are no further questions, sir.

Thank you very much.

Thanks for joining us today.

We look forward to talking to you again