Illinois Tool Works Inc (ITW) 2008 Q2 法說會逐字稿

Welcome to the ITW Second Quarter 2008 Earnings Conference Call.

At this time, all participants are in a listen-only mode.

(OPERATOR INSTRUCTIONS) Today's conference is being recorded.

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

Now, I will turn the call -- the meeting over to Mr.

John Brooklier, Vice President of Investor Relations.

Sir, you may begin.

Thank you very much.

Good afternoon, everyone, and welcome to ITW Second Quarter 2008 Conference Call.

With me today is David Speer, our CEO, and Ron Kropp, our CFO.

As always, thanks for joining us.

At this point, David will make some brief comments about the recently concluded quarter.

David?

Thank you, John, given the current state of the economy in the US, our operating performance in the second quarter was impressive on a number of levels.

Let me site a few examples.

Our diluted income per share from continuing operations grew a strong 17% in the quarter.

Total company revenues increased 10.5% on the quarter.

A second quarter total company operating margins of 16.6% were 20 basis points lower than a year ago period.

But, most notably base margins were 30 basis points higher than a year ago.

We continue to acquire companies that add both revenue size and diversification.

Through June 30, we have completed 26 acquisitions representing $538 million of annualized revenues.

Notably more than two-thirds of these acquired revenue estimates emanate from European and Asian specific locales.

Finally, we continue to repurchase shares in a value adding way.

Through June 30th, the Company has paid $585.6 million to repurchase 11.8 million shares.

All-in-all we believe our operating performance in the second quarter exemplifies our ability to outperform across slowing end-markets thanks in large part to our decentralized operating structure and our aggressive efforts to manage our operating costs.

John, let me turn it back over to you.

Thanks, David.

Here is the agenda for today's call.

Ron will join us shortly to review our Q2 financial performance.

I will then cover operating highlights for our eight reporting segments.

Ron will address our 2008 third quarter forecast and associated assumptions.

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

As always we ask for your cooperation for the one question and one follow-up question policy.

We are targeting a completion time of one hour for today's call.

First, the usual disclaimer.

Please not that this call and accompanying presentation contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including the without limitations statements regarding operating performance, revenue growth, diluted income per share, continuing operations, use of pre-cash, acquisitions, in market conditions, charges and then the Company's related forecast.

These 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 the actual results to differ materially from the Company's expectations are set forth ITW's 10-Q for the2008 first quarter.

Finally, before we get to Ron, the telephone replay for this telephone call is 203-369-1553.

No pass code is necessary.

The play back number will be available through 12:00 midnight on July 31, 2008.

You can also access second quarter conference call PowerPoint presentation via the ITW Web site.

Once you access the Investor information section look for the events tab.

Now, let me turn the call over to Ron.

Ron?

Thanks, John.

Good afternoon, everybody.

The highlights for what we believe to be a very good quarter were as follows.

Revenues grew 11% primarily due to currency transition and acquisitions.

Operating income was up 9%, but margins were lower by 20 basis points.

Diluted income per share for continuing operations of a $1.01 was 17% higher than last year, and free operating cash flow was $354 million.

Note that the second quarter is typically our lowest free cash flow quarter of last year.

Now, let's go to the detail of our operating results.

Our 10.5% revenue growth was primarily due to two factors.

First acquisition added 4.2% to revenue growth which was 200 basis points lower than the first quarter of 2008 Acquisition Act.

Secondly, currency translation increased revenues by 6.4%, which was 160 basis points higher than the first quarter.

In additional, base business point was flat which was unfavorable by 40 basis points versus the first quarter of 2008.

International based revenues increased 2.6%, which was 200 basis points lower than the first quarter.

We have seen some softening in some of our markets in Europe, but Asia remains strong.

North American revenues decreased 1.8% which was favorable by 70 basis points versus the first quarter.

Still, the North American businesses continue to see the affect of slowing industrial productions and declines in residential construction and automotive production.

Operating margins for the second quarter 16.6% were lower than last year by 20 basis points.

The base business improved margins 30 basis points which offset the negative acquisition affect of 30 basis points.

Also higher restructuring expenses reduced by 20 basis points.

When I turn it over to John we will provide more detail on the operating results and discuss the individual segments.

In the non-operating area, interest expense was higher by $11 million as a result of the Euro bond issued in October of 2007.

Other non-operating income and expense in the second quarter was favorable versus the prior year by $2 million.

The second quarter effective tax rate of 29% was lower than the first quarter '07 rate of 30.6%.

Effective tax rate of between 29.75% and 30.25% is expected for the full year.

Income from discontinued operations was lower than last year by $26 million, primarily due to a gain on the sale of an entire Uniformity business in the second quarter of last year.

Turning to the balance sheet, total invested capital increased $691 million from the first quarter primarily due to acquisitions and higher operating working capital.

Due to acquisitions and a higher mix of revenues of international revenues, accounts receivables DSO of 65 days at the end of the second quarter versus 62.7 last year.

Inventory month on hand was 1.9 at the end of the quarter.

The second quarter capital expenditures were $96million, and depreciation was $99 million.

ROIC declined to 18.8% versus 19.1% last year as a result of the dilutive impact of acquisitions.

On the financing side, our debt increased $153 million from last quarter due to our higher US commercial paper.

Our debt-to-capital ratio increased to 24% from 23% last quarter.

Shares outstanding at June 30th were 519.4 million.

Note that the effective option typically add three to four million shares to dilutive share calculations.

Our cash position decreased $287 million in the second quarter as our free operating cash flow of $354 million and net borrowing of $110 million were utilized for acquisitions of $442 million and dividends of $146 million.

In addition, we spent $200 million in the quarter to repurchase 3.9 million shares under our ongoing open-ended program.

Regarding acquisitions we acquired ten companies in the second quarter which have annual revenue of $308 million.

Year-to-date, we have done 26 deals with acquired revenues of $538 million of which two-thirds is outside North America.

Most significant acquisition of the quarter to the stock was the Tape Group, an international recall supplier of die cut adhesive and tapes with annualized revenues of more than $250 million.

I will turn it back over to John, who will provide more details on our second quarter operating results.

Thank you, Ron.

Let's review the second quarter highlights for our eight segment.

Beginning with Industrial Packaging revenues increased 14.6%, and operating income grew 17.3% in the quarter.

Operating margins of 13.2% were 30 basis points higher than the year ago period thanks to a 90 basis point improvement in base margins.

The 14.6% increase in top line consisted of the following 0.7% from base revenues, 5.5% from acquisitions and 8.4% from translation.

The Industrial Packaging segment produced Q2 base revenue growth of approximately 1% of the quarter with North American revenues growing approximately 1% and international revenues contributing about half of a point.

As a result of negative industrial production in North America and slowing activity internationally, and the Strapping Equipment business produced slightly negative revenue growth in the quarter.

The segment was aided by Worldwide Insulation businesses, which grew base revenues more than 30% in the quarter thanks to its focus on energy, related applications such as refineries and natural gas plants.

This business has seen significant demand for products on a global basis, especially India and other developing economies.

Moving to the next segment, Power systems and Electronic in the second quarter segment revenues increased 14.8%, and operating income grew an impressive 22.4%.

Operating margins of 21.9% were 140 basis points higher than the year ago period.

Base margins improved 210 basis points in the quarter.

The 14.8% growth in revenues consisted of the following -- 7.7% from base revenues, 3.7% from acquisitions and 3.4% from translation.

The Power Systems and Electronic segment grew base revenues an impressive 8% in Q2 '08.

As the largest based entity in the segment, Welding Group Worldwide base revenues produced 9% in the quarter.

The Welding Groups international base revenues grew a very strong 25% in the quarter thanks to high level of demands in Asia, especially in China, where speciality consumable products serving energy pipeline and ship building applications.

Despite softness in a variety of industrial-end markets, base revenues for North America Welding increased 3% in the quarter.

Segment growth was also aided by PC Board Fabrication business, which increased base revenues 7% in Q2

Moving to the next segment, Transportation in the second quarter segment revenues increased 8% and operating income decreased 6.9% Operating margins of 15.8% were 240 basis points lower than the year ago period.

Base margins declined 160 basis points in the quarter thanks principally to a significant reduction in auto builds by the Detroit Three.

The 8% growth in top line consisted of the the following -- minus 4.7% for base revenues 5.6% from acquisitions and 7.2% from translation.

As noted the Transportation segment saw base revenues decline by nearly 5% in Q2 with North American based revenues, decreasing 8% and international based revenues were essentially flat.

In North America, our automotive OEM base revenues decreased only 13% even though Detroit Three Auto builds fell 21% in the quarter.

Here are the particulars for the quarter.

GM was down 28%.

Ford was down 15%, and Chrysler was down 19%.

New domestic builds decreased only 1% in the quarter.

On a combined basis, builds were down 14% in Q2.

We now expect Detroit Three rebuilds for the second half of the year to decline 15%.

If this occurs full year 2008 Detroit Three and new domestic builds will be down 10% to 12% on a year-over-year basis.

Internationally our automotive OEM base revenues were flat while builds increased 3% in Q2.

OEM builds in Q2 were as follows Daimyler plus 8%.

VW Group plus 3%.

Ford group was flat.

Renault minus 2.3%, and BMW minus 3.5%.

Finally, our Worldwide Auto After-market business grew base revenues an impressive 6% in Q2.

Future growth trends bode well as consumers are holding onto their vehicles for extended periods of time.

Moving to the fourth segment Construction Products.

In Q2 segment revenues grew 4.6%, and operating income declined 3.5%.

Operating income was impacted by ongoing weakness fundamentals in a variety of North America construction categories.

Operating margins of 13.8% were 120 basis points lower than the year ago period as a result of 150 basis point decline in base margins.

The 4.6% increase in top line consisted of the following -- minus 4.3% from base revenues, 0.6% from acquisitions and 8.2% from translation.

Now, some background on the Construction segment.

We saw total worldwide base revenues decline 4% in Q2 principally due to ongoing weak fundamentals in North America and partially offset by better performance internationally.

North American construction base revenues fell 12% in Q2, a modest improvement from its minus 18% performance in Q1.

Our residential construction based revenues decreased 16% in Q2 while US housing starts were down 30% in the quarter.

In addition, our renovation based revenues decreased 10% of sales at the big box stores continue to be weak.

Finally, Commercial Construction fell 6% in Q2 due to double digit declines in key commercial categories, such as stores and food services, manufacturing and warehouses.

Internationally the story was better.

Base revenues grew 2% on the quarter thanks to an 8% base revenue growth in Asia-Pacific.

European base revenues, however, declined 2% of the quarter as key construction companies such as UK, Spain and Ireland all exhibited weakness compared to Q1.

Moving to Food Equipment, in the second quarter segment revenues grew 13.7% and operating income increased 11.1%.

Operating margins of 13.6% were 30 basis points lower than a year ago.

Base margins declined 40 basis points compared to the year ago period.

The 13.7% increase in revenues consisted of the following -- 2.3% from base revenues, 5.1% from acquisitions and 6.3% from translations Food Equipment segment produced worldwide base revenue growth of2% in the quarter thanks to contributions from both the North America and international operations.

In North America, base revenues increased 2% largely as a result of 2% growth from equipment sold to institutions and restaurants.

The North American Service Business grew its base revenues 3% in the quarter.

Internationally base revenues grew 4% thank to contributions from both Asian and European businesses.

In our Decorative Surfaces category in the second quarter, segment revenues decreased 4.1% and operating income declined 0.5%.

Operating margins were 14.1% were 70 basis points lower than a year ago, and base margins were 40 basis points lower than the prior year period.

The 4.1% increase of revenues consisted of the following -- minus 1.3% from base and 5.4% from translation.

The Decorative Surface segment saw worldwide base revenues decline 1% in the quarter mainly due to North American base revenues falling 2%.

Wilsonart laminate business used for a variety of commercial, residential and renovation applications actually grew base revenues 1% in the quarter due to its larger commercial exposure and new product introductions.

Base revenues declined double digits for Wilsonart flooring business in Q2.

Internationally based revenues were flat on the quarter with Asia-Pacific growing 16% and European based revenues down 2%.

In the Polymer and Fluids segment, in the second quarter, segment revenues increased a very strong 31%, and operating income grew an equally impressive 35.5%.

Operating margins of 18.3% were 60 basis points higher than the year ago period, and base margins improved a very strong 290 basis points in Q2 versus a year ago.

The 31% increase in segment revenues consisted of the following -- 2.3% from base, 20.7% from acquisitions and 8% from translation.

The Polymers and Fluid segment produced worldwide base revenue growth of 2% in the quarter, 6% of total revenue growth coming from North America.

Geographically, the North American Polymers business grew base revenues an impressive 9% in the quarter thanks to specialty adhesive and epoxy products for a wide range of industries , including industrial construction and consumer applications.

North American fluids business saw base revenues decline 1% in Q2.

Internationally based revenues were flat as international polymers grew base revenues 3% and international fluids base revenues declined 6%.

Finally, moving to our final segment, All Other in the first quarter (sic - see slide presentation) segment increased 5.1%, and operating income grew 6.4%.

Operating margins of 19.6% were 20 basis points higher than the year ago period.

Base margins improved 40 basis points compared to a year ago.

The 5.1% increase in segment revenues consisted of the following -- minus 0.9% from base revenues, 1.1% from acquisitions and 4.8% from translation.

As you know, the All Other segment consists of a variety of worldwide ITW businesses.

In the second quarter, worldwide base revenues declined approximately 1% for our reporting purpose here today we will talk about four major subcategories, which include Test Measurement, Consumer Packaging, Finishing and Appliance and Industrial products.

Worldwide base revenues for these subcategories were as follows -- our Test and Measurement area, which is an emerging segment for us, grew base revenues 9% in the second quarter, and that's coming off a strong 8% base revenue growth in Q1.

Consumer Packaging base revenues declined 2% in Q2.

And, our Finishing category base revenue declined 2% in Q2, and our appliance and industrial segment declined 5% in Q2 with the appliance related piece of that accounting for most of the base revenue decline.

I'll put the call back over to Ron, who will address the 2008 forecast and

Thank you, John We are forecasting third quarter 2008 income from continuing operation to be in a range of $0.93 to $0.99 per share.

The low end of this range assumes 10% growth in total revenues, and the high end of the range assumes 14% total revenue growth.

The bid point of this EPS range of $0.96 would be 8% higher than the prior year.

For full year 2008 our forecasted earnings range in $3.40 and $3.52 per share.

Full year total revenue growth is expected to be in the range of 9% to 12%.

The mid-point of this earnings range $3.46 per share to be 5% higher than 2007.

This mid-point of $3.46 is $0.04 higher than our previous range as a result of our actual second quarter results being $0.04 better than the midpoint.

Excluding the two special charges in the the first quarter, the mid-point of the full year EPS range would be 12% higher than 2007.

Other assumptions included in this forecast are exchange rates holding at current levels, acquired revenues in the range of $800 million to $1.2 billion, share repurchases of the year of $800 million to $1 billion, no further impairment of goodwill or intangibles.

That's non-operating expense which includes both interest and other non-operating income in a range of $125 to $135 million for the full year which is unfavorable versus last year of $82 to $92 million, and a tax rate range between 28.75% to 29.25% for the third quarter and 29.75% to 30.25% to the full year.

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

Thanks, Ron.

We will now open the call to your questions.

Again, I remind everyone about the one question and one follow-up question policy.

Thank you.

(OPERATOR INSTRUCTIONS) The first question comes from Eli Lustgarten with Longbow Securities.

I'm sorry the first question comes from Shannon O'Callaghan at Lehman Brothers.

Your line is open.

Good morning, guys.

Hey, Shannon.

Can you talk about the overall I guess base revenue view for the year now, what it is versus what is you last though?

And, some of the puts and takes, you have had some things get worse and some things get better?

I think if you look at what we see happening for the rest of the year, I would describe it perhaps as more of the same.

That is weak growth, weak numbers here in North America, a continuing slowing trajectory in Europe and continuing strong performance in Asia.

So, we would expect the second half base numbers somewhere -- somewhere in all in range to be in the 0% to 2% range.

Okay, and can you flush out the I guess international picture a little bit.

You saw international weakness certainly in Europe.

You are characterizing Asia as a strong.

When did you start to see some of this weakness materialize in Europe, and how bad do you think it is going to be?

I think the weakness we have seen in Europe are characterized probably by some of the larger data segments we talked about earlier.

And, that is in auto, the build rate in Europe is flat probably for the second half of the year be down slightly.

And, in construction, certainly in the residential categories and now in the commercial categories, we have seen market activity there, dip as well.

The residential sectors in Spain, Ireland, the UK have been weak since the end of last year and the commercial sectors in some of those countries have also started to weaken, but still in positive territory in the commercial side.

So, I think Europe -- I would describe Europe, the slowing in Europe is largely in line with what we had projected as we began the year.

So, nothing really outside of what we have expected.

We have seen some of that also in the general industrial markets in Europe as well as the numbers are coming down to 0% to 2% kind of growth in those markets back into a more traditional European range and also coming off fairly strong comparables in the same period last year.

Okay, and then just one last clarification, just so -- obviously auto is one thing we know that has been a little worse than the last projection.

I mean, would you say Power Systems is clearly coming in very strong, is -- that looks like a potentially an off set to some of that incremental weakness there.

Is power systems coming in stronger than you thought, and is that kind of rate that you saw internationally in the quarter sustainable.

Yes, Power Systems has definitely been stronger than what we had in our original projections, and in truth the international side has been very strong.

So, that has been certainly a large upside, and the Test and Measure area is stronger than what we had anticipated.

Those are probably the two most notably strong areas that I would highlight.

Okay.

Thanks a lot.

The next question from Eli Lustgarten with Longbow Securities.

Your line is open.

Hey, Eli.

Good afternoon.

That was a little confusing for a minute.

Let me just start on the trend.

Your guidance for the second half of the year implies a softening economically as we go through.

Your third quarter is softer than the second quarter, and by implication your fourth quarter is actually a little softer than the third quarter.

Is that strictly based on economic forecast, currency anniversaries at the end of the quarter.

It looks like your getting a nickel a currency at this point.

Some current guidances, the trends that you are seeing particularly because it will be more advantage day just for 2009 more than anything else.

Let me answer that first Eli, and I will let Ron comment as well.

I think if you look first of all at our numbers traditionally, the second quarter is our strongest quarter.

The trends you are seeing is normally how our quarters unfold.

I would certainly also suggest as we look at developing our plans originally, our second half is really in line with what we had outlined.

So, nothing really remarkable there.

I think some things may be some what weaker and some things somewhat stronger.

The numbers we are showing for the second half are pretty much in line with the original plan and guidance.

So, I will let Ron add more a little flavor if he would like.

Yes.

To reiterate, I think the base level we are talking about the rest of the year is pretty consistent where we have been for the first half in the 0% to 2% range, and acquisitions have been about the same.

Currency, I think you mentioned currency that we will see a little bit less of a benefit from currency in the second half as we had some very strong currency especially in the fourth quarter last year.

So, that was ticked out a bit.

On the margin side, we expect to be in that similar 15% to 16% range for the rest of the year as well.

So, it is really more of the same.

Thanks.

And can you talk about cost price going on in business?

The -- we have ramped up material and inflation cost everywhere globally.

Can you talk about how much you quotas pricing or give some flavor in pricing, the overall pricing and what assumption you have in the second half as far as price?

You are correct that we have definitely seen raw material price increases this quarter, and I think we will see more in the second half here, especially in the steel area.

Some of our businesses have seen steel increases in the 30% to 40% range in the quarter ,and that's how we keep it significant.

Less so in resin in the second quarter, but we are expecting to see some more increases in resin and given the price of oil, et cetera in the third and fourth quarter.

So, overall, I think we have done a pretty reasonable job at recovering these cost increases.

Most of our businesses have recovered the dollar amount of the cost increase, but we haven't fully been able to recover all businesses the full margin impact.

So that is diluting margins a bit.

In the second quarter, the impact of pricing and cost was about negative 50 basis points for the whole Company versus about negative 20 basis points in the first quarter of this year.

We have seen some multiple increases particularly in the steel category.

I think on a year to date basis the average steel increase for us now for our business is approaching 100%.

We have had multiple increases in the second quarter.

So, as Ron pointed out a 50 basis point detrimental impact in the second quarter so that's really because we haven't been able to get price increases in fast enough to support multiple cost increases.

I expect we will see a similar trend in the third quarter, and, I think as we head towards the end of the year, we will see some catch up occurring.

But, clearly, the steel is most notable.

We have also seen inflation cost pressures on plastic resins and chemicals, but not to the same degree.

Do you have a measure of how much first sales were up by pricing and how much pricing in the quarter?

For the quarter overall, in that 1%, 1% plus range.

Thank you.

I'll get back in the line.

Thank you, Eli.

And, the next question comes from Deane Dray of Goldman Sachs.

Your line is open.

Thank you, good afternoon.

Hey, Deane.

If the -- to the extent that you can, David, I would love for you to recap the notice transaction.

That was unique for ITW that you engaged in a public bidding process for an asset.

It got pricey.

You did not end up with the winner's curse.

But, there's certainly some puts and takes here.

And, what should the take away be for us today?

Well, the take away I would say are a couple things, Deane.

We think the Food Equipment category continues to remain to be an attractive category even without the notice acquisition, we think there is are many good opportunities to continue to acquire in this segment.

We think the fundamentals in the segment over the last seven or eight years remain there.

We have seen strong growth both in our base revenues and in our margins throughout that period.

So, we are encouraged that's a category that continues to be attractive to us, and we have a nice pipeline at the moment of additional opportunities.

So we will continue to be active in that space.

So, I think that's certainly one take away.

The second take away is frankly while the attractive -- the asset was attractive and certainly we think it fit very well strategically, we maintained a discipline in this process.

And, while even our bid by our standards was a pricey bid at 280 positioning the Company there at almost 12 times EBITDA, we think it was at that level a very attractive deal for us, but the number it ultimately went for at 328 well beyond what we thought was a reasonable valuation.

So, in spite of the fact that it was strategically attractive and in spite of the fact that we think we could have done with that, is demonstrated with how well we have done with pre-mark.

There was a limit o what we felt the valuation was and I think the discipline we maintained in that process was evident while we could have bid higher, we didn't.

Sounds good.

It looks the take away is that you never caught deal fever on this.

But, how about the pipeline of transactions?

How does it look today in terms of if you would characterize it, is it still more skewed outside the US?

And how about by segment line.

Is -- are there products that would have higher growth content, more Test and Measurement, just kind of give us some color there if you could.

Yes, sure, the pipeline remains strong.

The pipeline is in the $1.5 billion range in terms of total revenues.

That has got about six months of visibility to it.

So, we are starting to see the end of the year if you will in the pipeline.

Our close rate the last couple of years has been in the 60% range just as a matter of reference.

We have at the moment in the pipeline two larger transactions.

Larger being greater than $200 million in size.

There are several transactions in that size range that we think will close hopefully in the next 30 to 45 days.

So, I would expect that if they close according to schedule, we will be perhaps addressing the range as we look at the year going forward when we release our monthly update in September.

So, I think -- I would characterize the pipeline as strong, good spread in terms of businesses.

There are three nice deals in the pipeline that would fit into our Test and Measurement space and equally some nice deals in a couple other spaces as well.

So, I would characterize it as probably the most robust pipeline since I have been CEO for sure.

Well, that says a lot.

We will stay tuned.

Thank you.

The next question comes from Andy Casey with Wachovia Securities.

Your line is open.

Thanks.

Good afternoon.

Hey, Andy.

On the -- if you could give a little more color on the non-volume negative margin impact on Construction, Food Equipment and Auto, and then the positive impact on Polymers and Fluids, please.

Construction, Food Equipment, Auto, okay.

So, starting with construction, non-volume was negative 30 basis points.

It was actually better than it was in the first quarter, which was negative 50 basis points.

Of that 20 basis points was negative was pricing and costs.

So it is mostly pricing and costs.

In the Food Equipment area, negative 100 basis points.

Most of that is related to a variety of issues including a mix, some additional lost costs for new products and also higher vehicle expenses, primarily related to fuel.

In the Transportation area, negative 60 basis points in the quarter, price costs negative 30.

The rest of it is the variety of mix and other issues, nothing significant.

On the Polymers and Fluids side, favorable 230 basis points, price cost was actually negative 50 in the segment,t but overhead was favorable by 245 basis points -- 245 basis points.

And, they have done a really nice job the head of the group of controlling overhead costs, and we also have seen some benefits of past restructuring programs.

Okay.

Thanks.

The next question comes from Nan with JPMorgan.

Your line is open.

Hi.

Good afternoon.

It is Ann Duignan here.

Hey, Ann.

Hi.

Could you first tell us -- you took down your non-operating expense by $10 million, your guidance for the year.

And, A, why, and, B, how much of that fell into Q2, and how much of that falls into the remainder of the year?

Most of it was in Q2, a little bit in the rest of the year.

But, we picked up about $0.02, $0.015 in the second quarter in the non-operating area versus what we expected.

And was there anything in particular, was it --

No, a few different issues, biggest thing probably be -- being higher gains on our venture capital fund and in our investment portfolio.

That's helpful.

Okay.

Thank you.

My follow-up, David, back to you on the organic growth outlook, if I look at your different businesses, I only see Power Systems and Electronics really accelerating.

All the other businesses are either very weak or decelerating.

How confident are you that that business alone can get you to flat organic growth for the remainder of the year, or are you seeing some other end markets begin to recover?

Well, I think there's -- I think clearly that group alone stands out as being the strongest growth trajectory.

But, there are other pieces of pieces not whole segments that are still growing nicely.

Certainly, in the All Other category, where we have Test and Measurement segments that has grown nicely.

There are probably only three -- three or four businesses I would put in that category that have enough positive trajectory at the moment if you will to be comfortable that those numbers are good.

I think the declines we have seen in particularly Auto and Construction and certainly in North America have been well vetted and really are imbedded in our views going forward as Ron and John highlighted earlier.

We are talking about an use build in the minus -- somewhere in the minus 10% to 12% range.

I might remind you that when the year started the forecast were for the Auto industry to be down in the 6% range.

So, we have clearly recognized that we have greater negative growth in Auto and somewhat greater negative growth in Residential Construction than perhaps we began the year with.

But, all in, from an organic growth standpoint I think the numbers we are seeing are representative of what we expect to see play out in the second half the year with some puts and takes here and there.

But, all in, I think we're comfortable with those numbers.

Okay.

I would also add you would probably want to add Food Equipment and Polymers and Fluids at least as segments that are probably going to hold their own through the second half of the year as opposed to further deceleration.

Okay, that is helpful because as I looked at those businesses and saw the decline.

Also, if you look at the rate of decline in international markets versus the rate of improvement in North America -- if you call it improvement, the rate of decline internationally looks like it is much more aggressive than the rate of improvement.

So, I'm just concerned that places like Europe are going to fall significantly in the back half.

No.

Well, again, we are not coming up with a base revenue number that is a positive number.

We are looking for something in the 0% to up to 2%.

So I think -- we think we are being conservative in our approach here.

So, we had already -- as an example in the second quarter built in some modest improvement in North America and a decline in Europe, and that's in fact what played out.

While Europe was still positive, it was positive at a lower number plus 3% for us, and North America was slightly better in terms of relationship in the first quarter.

But, I think we are pretty much in the categories in terms of growth that we had expected as we laid out this year's plan.

So, I don't see anything remarkably different all in than what we put together.

Okay, and you guys are usually conservative.

So, I will leave it at that.

Thanks.

Thanks.

Is that a compliment.

Yes.

Thank you, Ann.

Coming from me, yes.

Thanks.

The next question comes from Daniel Dowd of Bernstein.

Your line is open.

Good afternoon.

Dan.

Hey, two things really, you noted specifically that the UK, Spain and Ireland were weak in the Construction market.

Did you notice any weakness for alternatively continued strength in the European markets

Dan, what I highlighted in those three markets just to be clear was primarily Residential, and, obviously, those markets are markets that have been under pressure from residential standpoint for probably at least three quarters now.

Eastern Europe, I would say that the construction activity as we have seen it has still been reasonable, but it's still a relatively small number by the west of Europe.

So, while it's got interesting numbers, in all impact is relatively modest.

Okay.

And, I want to make sure I understand what you said earlier in the comments about Q1 Morth American Residential compared to Q2 if I heard you correctly it declined 16% this quarter, but a much greater it declined at a much greater rate than last quarter.

Did I hear that correctly?

That's correct.

Yes.

Do you make anything of that?

Is that a blip, or does it indicate that these decelerating pains?

I think it indicates decelerating pain.

I think part of it is comparisons, and we are not making anything of note of that at this point in time.

The numbers are what they are.

Dan, I think if you look at the annualized sort of start numbers, over the last five or six months, clearly the rate of that decline is narrowing, so we are down in the 925 range now.

Clearly much lower than the $1 .1 million that finished -- $1.2 million that we actually finished the year at last year.

I think we are clearly getting closer to a bottom.

My guess is that the bottom is somewhere in the $800 to $900 range.

So I think the rate of decline is in fact slowing, yes.

And, he bottom is approaching.

But, as I think I have said consistently before I think the bottom is going to be a relatively long bottom.

I don't expect any significant recovery in the US housing numbers until the end of '09 or perhaps into the first half of 2010.

The first half of 2010?

Yes.

Wow.

Okay.

We have significant inventory issues that we have to work through before we get to the point where builds will return to any level in $1 million plus range.

So --

And, one last thing, on the balance sheet, I know this is something we have talked about at length.

Given where your share price is trading, is this not an opportunity to accelerate share repurchases?

Well, I think if you look at our range for the year, we are well -- we are pretty close to the low-end range to begin with.

So, I think we have done a little bit of that versus what we expected at the beginning of the year.

Secondly, as David talked about, we have got a pretty good acquisition year shaping up here.

So, what we always said is we want to use our free cash flow for dividends as a priority and share repurchases is the third priority.

So, something that we are looking at.

Clearly, we have accelerated leverage from where we were a year ago and will continue to look at that and consider that.

And Dan, it is during this August time period that we sit down and reflect on what we have done so far in the year.

And, we look at our plans and outlook for the balance of the year and decide what we will do in terms of any adjustments to the ranges as Ron described.

So, we are in the process of looking at that.

But, as Ron said, we have a strong acquisition pipeline, and we will look at that relative to our you are cash flow projections and make some decisions here in the coming week as to whether we will revise those range upwards.

Alright, thank you.

The next question comes from Ned Armstrong with FBR Capital Markets.

Thank you, good afternoon.

Ned.

I saw in your handout with regard to the acquisition that the price you paid relative to sales is quite higher than it normally is.

Is that reflective more of market that you are seeing, or is that related to one transaction or a couple transactions?

It is related to a couple transactions, but primarily one, the Stokvis acquisition that we did in the second quarter came with a much higher price to sales ratio.

I think it was somewhere in the 1.4 range.

And, had obviously a much stronger growth and earnings profile than our typical acquisition.

That is really -- I would call that an aberration.

If I look at the pipeline the kinds of deal in the pipeline are more reflective of the more traditional numbers.

But, certainly the growth rates in that acquisition along with the fact that it already had a double digit EBITDA earnings rate led it to be a more expensive acquisition.

The market as we have seen it has become much more realistic.

I would say that our numbers are in line with what we have seen in the past.

What it means though is that there are more deals in our range than would have been in the past couple of years.

Okay, and then with the Test and Measurement business was quite strong.

Was there any one or two industries that was driving that or was that across the board in that business?

Well, it has been strong across a number of industries and probably a number of geographic markets.

Probably the industries to highlight in that group would be the Biomedical Healthcare arena.

We have had strong input there.

We have good equipment sales going into the Biomedical devices that end up in knee joints and hips and so forth and testing that goes along with that.

Aerospace has been another very strong end market for us.

The boom that is going on in the moment particularly with aircraft has positioned us well.

The Boeing and Airbus programs require a fair amount of testing and measurement equipment all throughout their supply chain.

So, that has been strong for us, and geographically, it has been very strong growth for us in Asia and Europe as well.

Great.

Thank you.

The next question comes from Jamie Cook of Credit Suisse.

Your line is open

Hi, good afternoon.

Most of my questions have been answered, but just quickly.

One, some of the other companies that have reported so far weakness whether in North America or Europe more towards June or the back end of the quarter.

I am wondering whether you saw the same thing?

And, then it's just my follow-up question.

When we look at the Food Equipment business internationally, it looks like sequentially there was a big acceleration I think in the first quarter you were up 13%, and I think we're now only up 4%.

Was there anything unusual in this quarter, and is that the trend we should we start to think about this going forward?

Well, I think as it relates to the Food Equipment category, I think there are some comparables in the second quarter of '07 and '08 that are somewhat anomalies so I wouldn't put anything significantly in that.

I think the growth trajectory we see internationally is in line with what we discussed earlier, which is a somewhat slowing growth rate in Europe compared to 2007 and continued good growth rates in the Asia region.

So, I would describe what you saw internationally in Q2 as somewhat of a one off.

What was the first part of the question?

I'm sorry.

The first --

Was it international were you asking about for June or July?

Well, no I guess I was just asking about a lot of other companies that have reported -- noticed whether it was in North America or even internationally that things fell off in June or late in the quarter.

I'm just wondering how your quarter sort of play out?

No, I don't think we saw -- not certainly not across the board.

We have some end markets that are decelerating at the moment.

But, the fall off would have been greater towards the end of the quarter, not anything overall.

think the declines that we've seen and the growth we've seen, I wouldn't say there's been any remarkable change in the latter part of the quarter.

June came in basically around 0.

I mean was at 0 for us.

And, that would be the same for Western Europe, too, as I think just generally?

I'm talking about a total Company number now.

The base of 0 for the total Company for June.

Yes.

I'm asking about Western Europe, though.

Yes, no.

Western Europe, I would say no.

I wouldn't say that we say any significant rate of decline in Western Europe.

Again, the decline in Western Europe we have seen a deceleration in western Europe positive base growth in Western Europe.

But, I would certainly say that the growth rates, if that's your question, have certainly declined in Europe.

And, that would certainly be the case in the second half of the quarter.

But, Jamie, the growth rate that David's talking about in June to what we are seeing early signs for July, for period seven, our period international --

Yes.

we not seeing any significant change in growth rates.

Alrighty, that was my question.

Thanks, John.

Thank you.

The next question comes from Robert McCarthy of Robert W.

Baird.

Your line is now open.

Good afternoon, guys.

Good afternoon, Rob.

Good afternoon.

Definitely most questions asked and answered at this point.

Is there any one of your businesses, David, that you could identify where you are seeing a potentially growing impact of tight credit conditions outside of just generally weak macroeconomic growth?

I wouldn't site any business in particular, Rob.

I think the normal markets that we would see that in generally in Residential construction, but that market is as you know very depressed at the moment.

That is normally our kind of bell weather when you see any kind of credit issues.

But, given the weakness of that market, that clearly isn't the case at the moment.

So, no I wouldn't say there is any particular end market.

Certainly, the credit issues have impacted the small-l to medium-sized businesses more so disproportionately so than the larger businesses.

It has probably created somewhat of an error of concern and negativity.

But, in terms of causing problems with being able to transact business, nothing materially.

Okay, good.

Now, the second question, on recent news item, having to do with the termination of supply agreement from the long-time solid supplier to the Decorative Surface business, is this just a technical issue or negotiating situation.

Or, is there something material going on there?

No.

John.

You are talking about Decorative Services businesses, Rob?

Yes.

Yes, no.

It is nothing material, no.

In other words, your ongoing availability of those products aren't being constrained in any way?

No, not at all.

Alright, very good.

Thank you.

The next question comes from Henry Kirn of UBS.

Your line is open.

Good afternoon, guys.

Henry.

The Auto market has been weak for some time now.

When do you think that market could actually start to bottom?

Well, that was an interesting question.

There were a lot of pundants that were smarter than I that were predicting a 5% decline as the bottom.

Clearly weren't close to being right.

The current build rate projections now for the year were under 13.5 million vehicles.

I think we are closer to 13.3 million.

I have to believe that that rate is probably getting close to the bottom, but there still may be some adjustment.

I think what is probably likely to happen is continued displacement, obviously, with the large vehicles and SUVs most notably and a heavier concentration on smaller vehicles.

That trend has accelerated clearly.

The question is do we have the capacity in the smaller vehicles to make up the overall builds, and that is still a factor to be figured out.

Both GM and Ford are spending a fair amount of time, obviously, now to directing resources to the smaller-end of the category.

But, I think the sales rate of vehicles and the build rates probably getting close to the bottom, but I wouldn't want to be so bold to say that we are necessarily there yet.

The same consumer having trouble with their home mortgage are the same ones we are counting on to buy a vehicle.

So.

until the credit crunch issues are resolved, it is going to be hard to predict exactly where the bottom is.

But, I think when you see the decline steadily from 17 million plus vehicles five years ago to where we are today, I have to believe that perhaps we are within 400,00 or 500,000 vehicles of the bottom.

Okay.

That's helpful.

Thanks.

Is it possible to talk about the margin headwinds that you expect from the acquisitions going forward?

Yes, well, as you probably know we tend to acquire companies that have much lower margins than our current businesses.

Typically, the margins before amortization charges are in that 8% to 10% range.

So, we have had a couple of good years of acquisitions, so clearly that has had an impact over the margins in the last couple years although less of an impact in this year than it has over the last couple of years.

So, that's something that we do talk about that every quarter.

For instance in this quarter, we had a negative 30 basis point margin impact.

And, I would expect something similar in that 30 to 50 to 60 impact basis point through the rest of the year.

Okay.

Thanks a lot.

Good quarter, guys.

Thank you.

The next question comes from John Inch of Merrill Lynch.

Your line is open.

Thank you, good afternoon.

John.

Hey, so, can you remind me maybe Ron or David why was the operating cash down again year-over-year?

You would sort of think in a sluggish environment you would be able to harvest some working capital.

Was there something unusual about the seconds quarter?

And, how do you think about cash flow for the rest of the year.

Well, the second quarter is typically our lowest free cash quarter.

It's our highest sales quarter so receivables are at the highest.

So, typically, it is less than 100% of net income which is kind of our annual target.

And, so this quarter it is about two-thirds of net income.

Last year in the second quarter it was more than that.

It was $442 million, about 80% -- 88% of net income.

So, year-on-year it is down, almost $90 million, and that's really due to a couple different things.

The one is receivables.

Receivables have picked up a bit, a day or two on the DSO.

Part of that is acquisitions and part of that is a higher mix of international revenues over the last 12 months, which tend to have longer terms than in North America.

And some of it is just -- some of our customers are taking a day or two longer generally.

So, that's fairly broad based, a day or two.

Other part of it is inventories, cost of free cash about $30 million.

So, that's not terribly significant, and we had a pretty good inventory quarter in the second quarter of last year.

And, then lastly income tax tend to bounce around a little bit and had a negative $50 million impact year-over-year on the quarter on free cash.

But, as we did last year, we expect some strong free cash flow quarters the rest of the year.

And, example, last year in the end of the third quarter, we're at 130% of net income, and, in the fourth quarter, we're almost at 150%.

So, we would expect that to continue as we collect these receivables that we have generated this quarter and move the inventories down which is what we typically do in the last half of the year.

Okay.

And, then, just for my follow-up question, I mean, ITW continues to I think pretty impressively out perform some pretty tough auto markets.

Can you remind us why you are doing better than the actual build numbers?

Is it an issue of platforms or products -- what is it again, and do you expect this out performance to continue?

Well, it is a certainly question of penetration,John, and it is an increased concentration on the vehicle platforms and certainly with the range of new products we have introduced, those have been targeted at newer vehicle platforms and areas where we think we can pick up significant penetration.

So, we expect year-on-year to outperform the build typically in North America.

With the Detroit Three, our penetration gains are usually in the 4% to 5% range.

They have been higher than that with the New Domestics.

Our penetration gains with the New Domestics have been above 10%.

And, do that certainly helps as well.

You may recall that we have focused on the New Domestics significantly in the last three or four years, and it's beginning to show now in our numbers.

And, clearly their build numbers are down less.

Our penetration rates are up greater.

So, it is a combination of penetration gains and new products aimed at the platforms that clearly are the ones that are going to grow in the future, and it is off setting some of the concentration that we have had in the past on the heavy -- the light truck and the large SUV markets.

But, it is really more of the same formula.

Product innovation allows us to drive higher margins, and product innovation allows us to drive more penetration in a declining vehicle market.

You think you can sustain this even though we've got this obvious mix shift away from heavier SUV vehicles to the smaller vehicles.

That's from a content perspective, David --

Yes, we think we can sustain it.

Obviously, the content on a smaller vehicle is not as great as it is on a larger vehicle.

But, that is already factored in, if you will.

But, obviously, we think the ability to penetrate the small platforms or smaller vehicle platforms is clearly there, and we have some strong momentum with the new domestics.

You may recall that we made an acquisition in the latter part of 2006 to position us with the Hyundai Kia Group that allows us to significantly accelerate our penetration into those platforms.

That group is opening two new factories in the US, one that's open and one that is opening.

So, those are considerable upside opportunities for us

We continue to penetrate the Toyota, Nissan and Honda Groups very effectively.

So, yes, I think we expect to seen continued penetration gains.

Certainly, clearly, with the New Domestics, we expect to see higher penetration gains then what we have been achieving even with the Detroit Three.

Thanks, much.

You are welcome.

The next comes from Mark Koznarek with Cleveland Research.

Your line is open.

We are going to make this the last question.

Go ahead, Mark.

Okay, thanks.

Thanks for sneaking me in there.

SG&A as a percent of sales is flat versus the prior year, and my question is whether ITW has in the last 90 days put on any kind of unusual or additional expense control programs, such as hiring freezes or force reductions or limits on T and E or any of a number of things.

But, have you pulled any material levers for cost control in the last 90 days?

Mark, no we haven't pulled any new controls, but I would tell you that as we looked at the economic outlook coming into 2007 or 2008 at the end of last year, most of our businesses developed plans based around what they saw as a weakening environment.

And, so, we've had cost controls in place and adjustments being made as markets have weakened beyond perhaps our original outlooks.

So, nothing that I would call extraordinary and nothing that has been mandated by the Corporate Office.

But, clearly, there have been a number of cost control elements that operating units have been put in place.

And, that is, frankly, a key element in dealing with slowing market conditions.

So, you see that accurately reflected in our SG&A and our overhead numbers.

Ron may add some more flavor to that.

Yes, I think that's -- our decentralized operating model, that's one of our key benefits.

Right?

Is that we are not looking for the big corporate driven cost control program.

We have a lot of small programs that individual business units that are really being put in place as the markets change.

Because they are the first ones to see the end markets change, and they are the first ones to react, and they know their business the best and where they can restructure and get the benefits as well as control cost.

So, I think that has always been a benefit of our operating model that we can react quickly to changes in market condition.

Okay.

And, Ron, I had a follow-up, which is the expectations for currency that in the 9% to 12% revenue outlook of the year.

What is that, and is that different from the quarter ago 9% to 12% outlook?

It is not materially different from where it was.

It is slightly better in the third quarter.

It is in that 5% to 5.5% range percent increase contribution, and, then in the fourth quarter, it is in the 3.5% to 4% range.

Fourth quarter we have much tougher comps than the currency side.

Okay.

Very good, thank you.

Thanks, Mark.

I want to thank everybody for joining us, and we will be talking to you again next quarter.

Thank you for participating in today's conference.

You may now disconnect at this time.