Illinois Tool Works Inc (ITW) 2008 Q3 法說會逐字稿

Welcome to the ITW third 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 over to Mr.

John Brooklier, Vice President of Investor Relations.

Thank you, sir, you may begin.

Thank you, Candy.

Good afternoon, everybody, and welcome to ITW's third quarter 2008 conference call.

I'm John Brooklier, ITW's Investor Relations Officer.

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

Thanks for joining us.

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

Thank you, John.

The third quarter turned out to be a mixed bag of results for us.

First, let me start with the good news.

We grew total company revenue during the quarter 11%, which was within our original forecasted range.

Revenues were clearly helped by our strong acquisition program.

We acquired 14 companies during the quarter, representing $847 million of annualized revenues.

Through the end of September, we've acquired a total of 40 companies now, representing $1.4 billion of annualized revenues.

We are estimating that we will finish the full year with an additional $100 million to $200 million worth of acquisitions.

All in all, it's been a very good acquisition year, especially when you consider that we continue to pay an average price of approximately one-time revenues for the acquisitions completed today.

Our strong free operating cash flow of $599 million in the third quarter was a conversion rate of 132%.

And our $1.4 billion year-to-date total has also permitted to us remain aggressive with our share buyback program.

In the third quarter, we spent $406 million to repurchase approximately 8.5 million shares, and year-to-date, we've paid approximately $1 billion to repurchase 20 million shares.

Now, for the more difficult news, end markets continue to weaken in the third quarter in both North America and internationally.

Many of our end markets reflected underlying negative macro data.

For example, North American industrial production excluding technology was recently reported at minus 3.2%.

The forward-looking ISM index recently came out at 43.5%, the lowest number reported in more than five years.

And on the international side, the underlying data is also trending downward.

The most recent Euro-Zone industrial production number was at minus 0.9%.

And the September Euro-Zone purchasing managers index came in at 45%.

Many of our end markets have responded in kind, and as a result our base revenues for the quarter were minus 0.8%.

Our decreased sales volumes coupled with inherently lower margins associated with raw material cost increases combined to reduce base revenue margins by 130 basis points during the third quarter.

Ron and John will give you more details on these topics in just a few moments.

Looking forward, we continue to assess the local market conditions and implement aggressive cost cutting initiatives where appropriate.

You can be assured that ITW managers around the world are working hard day-to-day to optimize their businesses face of these difficult and volatile end markets.

Let me turn the call now back over to John.

Thank you, David.

Here's the agenda for today's call.

Ron will join us in a few moments to give us a Q3 financial overview.

I will then cover operating highlights for our reporting segments.

Ron will then come back and address our 2008 fourth quarter and full year earnings forecast and associated assumptions.

Finally, we 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 disclaimers.

Please note that this earnings release contains forward-looking statements within the meaning of Private Securities Litigation Reform Act of 1995, including without limitations, statements regarding operating performance, revenue growth, operating income, income from continuing ops, diluted income per share from continuing ops, use of free cash, potential acquisitions, end market conditions, discontinued operations, and 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 actual results to differ are set forth in ITW's Form 10-Q for the 2008 second quarter and our 10-K for 2007.

One other housekeeping item, the telephone replay for this conference call is 402-220-9716.

No passcode is necessary.

The playback number will be available through 12:00 midnight on October 30th, 2008.

You can also access our third quarter conference call PowerPoint presentation via the ITW.com website.

Once you access the Investor Information section, just look for the Events tab.

Now, let me introduce Ron Kropp who will cover the financial highlights for the third quarter.

Thanks, John.

Good afternoon, everybody.

Before I get to the operating results, I would like to remind everyone that last week we released revised income statements for 2007 and the prior quarters of 2008 to reflect the reclassification of the decorative surfaces segment and the Click Commerce business into discontinued operations.

All income statement data presented on this conference call reflect the discontinued operations treatment for all periods presented.

The highlights for the third quarter were as follows.

Revenues grew 11%, primarily due to acquisitions and currency translation.

Operating income was down 2%, and margins were lower by 190 basis points.

Diluted income per share from continuing operations of $0.85 was 1% higher than last year and free operating cash flow was $600 million.

Now, let's go to the details.

Our 10.8% revenue growth was primarily due to two factors.

First, acquisitions added 6.9% to revenue growth, which was 230 basis points higher than the second quarter 2008 acquisition effect.

Secondly, currency translation increased revenues by 4.7%, which was 170 basis points lower than the second quarter effect.

In addition, base revenue was down 0.8%, which was unfavorable by 100 basis points versus the second quarter.

Price increases to recover higher raw material (technical difficulty) was offset by overall volume declines of between 4% and 5%.

International base revenues increased 1.2%, which was 170 basis points lower than the second quarter.

We have seen some softening in our European end markets.

North American base revenues decreased 2.1%, which was unfavorable by 40 basis points versus the second quarter.

The North American businesses continue to see the effect of the overall slowing of the economy, including both the industrial and consumer-related end markets.

Operating margins for the third quarter of 15.4% were lower than last year by 190 basis points.

The base business margins were lower by 130 basis points primarily due to lower sales volume and the effect of higher raw material prices.

While we have recovered the dollar amount of the higher cost of most of our businesses, many of our businesses have not yet been able to recover the full margin.

In addition, the lower margins of acquired companies diluted margins by 70 basis points.

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

In the nonoperating area, interest expense was higher by $12 million as a result of the euro bonds issued in October 2007.

Other nonoperating income expense in the third quarter was unfavorable versus last year by $7 million, mainly due to lower investment income.

Third quarter effective tax rate of 28.2% was essentially flat versus the third quarter 2007 rate.

An effective tax rate of between 28.4% and 28.6% is expected for the full year.

Turning to the balance sheet, total invested capital only increased $36 million from the second quarter, as the increase from acquisitions was partially offset by decreases from currency translation.

Excluding the effect of discontinued operations, accounts receivable DSO was 64.7 at the end of the third quarter versus 63.6 last year.

Inventory months on hand was 2.0 at the end of the quarter.

For the third quarter, capital expenditures were $89 million and depreciation was $95 million.

ROIC declined to 15.6% versus 17.9% last year as a result of the dilutive impact of acquisitions and lower operating income.

On the financing side, our debt increased $667 million from last quarter, primarily due to higher US commercial paper.

Our debt-to-capital ratio increased to 28% from 24% last quarter.

Shares outstanding at September 30th were 511.2 million.

Note that the effect of options typically adds 3 million to 4 million shares to dilutive share calculations.

Our cash position increased $227 million in the third quarter as our free operating cash flow of $600 million and net borrowings of $737 million were utilized for acquisitions of $646 million and dividends of $145 million.

In addition, we spent $406 million in the quarter to repurchase 8.5 million shares under our ongoing open ended share repurchase program.

Regarding acquisitions, we acquired 14 companies in the third quarter, which have annual revenues of $847 million.

Year-to-date, we have done 40 deals with acquired revenues of almost $1.4 billion.

Most significant acquisitions in the quarter were CCI and Avery Weigh-Tronix.

CCI is the North American distributor, remanufacturer, and installer of drive train components for the heavy truck aftermarket.

It has annual revenues of over $400 million and will become part of our transportation segment.

Avery Weigh-Tronix is a multinational manufacturer of high-quality industrial weighing products and systems with annual revenues of approximately $225 million.

It will be included in our test and measurement group in the all other segment.

I will now turn it back over to John, who will provide more details on the third quarter results.

Thank you, Ron.

Let's review the third quarter highlights for our reporting segments.

Beginning with industrial packaging, revenues increased 14.7%, and operating income declined 2.9% in the quarter.

Operating margins of 11.1% were 200 basis points lower than the year ago period, largely as a result of 120 basis point decline in base revenue margins in the quarter.

The 14.7% increase in revenues consisted of the following -- 5.2% for base revenues, 4.2% from acquisitions, and 5.3% from translation.

The industrial packaging segment produced Q3 base revenue growth of 5.2% in the quarter, with industrial packaging North America growing 2.2% and the international businesses increasing 7.5%.

All of that base revenue growth was driven by significant price recovery for raw materials, but at much lower margins.

The standoff business in the segment continue to be insulation worldwide, which grew base revenues more than 40% in the quarter.

This business provides energy-related insulation solutions for worldwide customers, including those in the refinery and natural gas plant sectors.

Moving to the next segment, power system and electronics.

In the quarter segment revenues increased 9.4%, and operating income grew 6.7%.

Operating margins of 19% were 50 basis points lower than the prior year period, mainly due to the dilutive impact of acquisitions.

Notably, base revenue margins improved 40 basis points in the quarter from the year ago period.

The 9.4% growth in revenues consisted of the following -- 3.1% for base revenues, 3.7% from acquisitions, 2.5% from translation, and 0.1% from other.

The power systems and electronics segment increased base revenues approximately 3% in the quarter and the major contributors to base revenue growth were welding and ground support equipment.

Worldwide welding base revenues grew 5.7% in the quarter thanks to 26.4% growth in the international base operations, especially those serving Asian specialty markets such as energy, shipbuilding, and shipping containers.

North America welding base revenues decreased 0.9% in the quarter as underlying industrial production and end market demand continues to slow in the US.

Segment growth was also helped by the ground supported equipment business, which produced base revenue growth of 6.9% in the quarter.

Moving to transportation.

In the third quarter segment revenues increased 8.9% while operating incomes declined 22.4%.

Operating margins of 11.8% were 480 basis points lower than the prior year period due to a decline in sales volumes associated with significant ramp down in North American auto production as well as minimal price recovery on those raw material increases.

Base revenue margins accounted for 430 basis points of dilution in the quarter.

Acquisitions [grew] the margins another 150 basis points in the quarter.

From a top line perspective, the revenues consisted of the following -- minus 9.6% for base revenues, 12.3% from acquisitions, 6.1% from translation, and 0.1% from other.

As noted, transportation base revenues were down approximately 10% in the quarter.

On a worldwide basis, base revenues declined 12.5%, with North America down some 18%, and that's largely due to the historically weak auto production in Q3.

In North America, Detroit Three and new domestic builds declined 16% in the quarter.

By category, Detroit Three builds were down 23% in Q3, with GM down 12%, Ford down 33%, and Chrysler down 31%.

Those are some pretty mindnumbing numbers.

By comparison, new domestic builds were down 6% in Q3.

We believe that North American auto builds will be down in the 18% to 20% range in Q4, and if this occurs, 2008 full year North American builds will be down 15%.

Internationally, automotive base revenues declined 7.3% as European builds decreased 1% in the quarter.

Our negative penetration in Q3 was due to customer mix, and tier suppliers holding up buying products in anticipation of lower builds later in the quarter.

Key international OEM builds in Q3 were as follows -- BMW down 11%, Fiat down 9%, Ford down 8%, PSA down 6%, Renault down 1%, Daimler up 2% and VW Group up 6%.

Finally, our worldwide auto markets after business grew base revenues 2.8% in the quarter.

These businesses, featuring performance enhancing and maintenance extending products, continue to benefit from consumers who are holding on to their vehicles for extended periods of time.

Let's move to the construction products segment.

In Q3, segment revenues increased 1.7% while operating income declined 4.7%.

Operating income was, again, impacted by ongoing weak fundamentals in a variety of North American and international construction categories.

Operating margins of 14% were 90 basis points lower than the year earlier period as a result of the 120 basis points decline in base revenue margins in the quarter.

The 1.7% increase in revenues consisted of the following -- minus 4.4% for base revenues, 0.3% from acquisitions, and 5.8% from translation.

As noted, the segment's base revenues decreased approximately 4.5% in Q3 due to ongoing weak fundamentals in North America and more recent slowing internationally.

Let's look at North America first.

North America construction-based revenues fell 6.2% in Q3.

Despite the weak underlying North American fundamentals, we continue to overperform in all three of our construction categories.

First, our residential construction base revenues declined 12% in the quarter, even as new housing starts were down 31% versus the year ago period.

Secondly, our renovation-based revenues were down a modest 2% in Q3 thanks to an uptick in our business units which supply the big box stores.

Finally, our commercial construction base revenues were down 2% in Q3, versus the Dodge index which currently shows a 19% year-to-date decline in commercial construction activity on a square footage basis.

Moving to international, base revenues declined 3.2% in Q3.

The decrease in base revenues was due to overall weakness in Europe, where base revenues declined 8.3% in the quarter.

And while Asia Pacific's base revenues grew 3.9% in Q3, it was at a lower rate of growth than achieved in the first half of the year.

Moving to food equipment.

In the quarter segment revenues grew 8.4%, while operating income declined 1.6%.

Operating margins of 16.1% were 170 basis points lower than the earlier period due to 100 basis points of base revenue margin dilution and acquisitions contributed an additional 50 basis points of dilution in the quarter.

On the top line perspective, the components consisted of the following -- minus 1.7% from base, 5.8% from acquisitions, 4.4% from translation and minus 0.1% from other.

Food equipment's worldwide base revenues as noted were down approximately 2% in the quarter as a result of end market and customer softness both in North America and international.

Food equipment's base revenues in North America declined 1.2% in the quarter, with institutional businesses declining 3.8%, as customers such as hospitals, universities, and casual dining restaurants delayed purchases.

The North American service business grew base revenues 2.8% in the quarter.

On the international side, base revenues declined 3.2% in the quarter with Europe down 4%, but Asia Pacific base revenues up nearly 9%.

Moving to the polymers and fluids segments.

In Q3, segment revenues increased 46.9% and operating income grew 22%.

Operating margins of 14.4% were 290 basis points lower than the year ago period, thanks mainly to 320 basis points of margin dilution from acquisitions.

Base revenue margins actually improved 20 basis points in the quarter.

The approximately 47% growth in segment revenues consisted of the following -- 3.5% from base revenues, 36.2% from acquisitions, and 7.2% from translation.

The polymers and fluids segment provided worldwide base revenue of 3.5% in Q3 as noted.

Geographically, the North American polymers business grew base revenues at an impressive 15.4% in the quarter, thanks to specialty adhesive and epoxy products for a variety of customer and specialized applications.

International polymers produced essentially flat base revenues in the quarter.

On the fluids side of the business, North America based revenues declined 3.3% as manufacturing demand slackened and the international base revenues were essentially flat in Q3, which is in keeping with some underlying macro data we are seeing in Europe these days.

Finally, our last segment, all other -- in Q3, segment revenues increases 5.9% and operating income declined 0.3%.

Operating margins of 19.4% were 110 basis points lower than a year earlier period.

Base revenue margins declined 130 basis points in the quarter.

The 5.9% increase in revenues consisted of the following -- minus 0.7% for base revenues, 2.9% from acquisitions, and 3.7% in translation.

As noted, base revenues in this all other segment declined 0.7% in the quarter and as we noted before, the segment principally consists of four major categories -- test and measurement, consumer packaging, finishing, and our industrial appliance products.

The worldwide base revenues for these four subcategories were as follows -- test and measurement grew at the most impressive rate, 11.2% in the quarter and that was largely based on strength of their specialty equipment products into Europe, Asia, and Latin America.

Consumer packaging worldwide was down 2.4%, finishing was up 0.8%, and industrial appliance products worldwide was down about 4%.

And that's certainly no surprise given what have you seen underlying appliance numbers to be over the last two or three quarters.

At this point, I will conclude my remarks and turn it back over to Ron, who will address the 2008 forecast and related assumptions.

Thanks, John.

We are forecasting fourth quarter 2008 diluted income from continuing operations to be within a range of $0.74 to $0.82 per share.

The low end of this range assumes 6% growth in total revenues and the high end assumes 9% total revenue growth.

The midpoint of this range of $0.78 would be 5% lower than the prior year.

For full year 2008, our forecasted earnings range is $3.24 and $3.32 per share.

Full year total revenue growth is expected to be in a range of 10% to 11%.

The midpoint of this earnings range of $3.28 would be 6% higher than 2007.

Other assumptions included in this forecast are exchange rates holding at current levels, acquired revenues in the range of $1.5 billion to $1.6 billion, share repurchases for the year of $1 billion to $1.2 billion, no further impairment of goodwill or intangibles, net nonoperating expense which includes interest and other nonoperating income in a range of $110 million to $120 million for the year which is unfavorable versus last year by $65 million to $75 million.

And the tax rate range of between 28.25% and 28.75% for the quarter and 28.4% to 28.6% for the full year.

I will now turn it back to John for the Q&A portion of the call.

We will now open up the call to your questions.

We'll ask one more time that you keep your questions to one question and one follow-up.

At this point, we are ready.

(OPERATOR INSTRUCTIONS) One moment for your first question.

Thank you.

We have Deane Dray, Goldman Sachs.

Your line is open.

Thank you.

Good afternoon.

Hi, Deane.

To start off, David, can you address -- you mentioned that ITW looked to be making more cost-cutting initiatives depending on the severity of the economic slowdown.

Just give us a perspective of what the game plan here is.

How centralized might this effort be?

The size and timing and so forth?

And the reason I ask about centralized is so much of ITW is decentralized.

How do you go about telling each business unit what kind of cost cutting measures that you are looking for and the timing and so forth?

Sure, Deane.

Well, first of all, if you look at what our outlook for the year would consist of, it's roughly $50 million in restructuring, which is about $15 million more than what we spent last year to put it in perspective, with most of that delta occurring in the fourth quarter, as you would expect.

As it relates to the decisions and the process by which we decide what restructurings to do, that also is decentralized in our environment.

So it really does not come from the top.

It's really our business units assessing their local market conditions, and what they are hearing from their customers and getting themselves sized, if you will, to meet what they say is the near term demand -- near term being the next six to 12 months.

Obviously it's a fairly volatile economic environment at the moment.

It's very difficult to get firm reads on some of these end markets as witnessed by the fairly dramatic reduction that the auto industry has just gone through in their outlook for the fourth quarter.

We tried to get as close a read on that as we can, and the business units really look at what they think the demand profile is going to be going forward for the next six to 12 months.

And as a result, try to size their organizations and their efforts accordingly.

So as you would imagine, that's not a precise exercise, but one that we follow obviously quite closely and work with them to come up with the right solutions.

And you would still expect a pay-as-you go type of approach to this restructuring?

Oh, yes.

Absolutely.

The numbers I just cited are all in our current outlook data and I think the total number for the fourth quarter approaches $20 million in restructuring, which is as a mentioned earlier is about $15 million higher than the fourth quarter of last year.

But it's all pay as you go, as we have traditionally done.

And just one other broader question, if I could.

In past cycles, ITW's operating margin appears to have troughed somewhere in the 14% to 15% range.

The mix is obviously changed quite a bit since then, but what, at this point, would you consider to be a trough operating margin for ITW given the current mix and current expectations of the downturn?

Well, I'm not sure I can answer that with a very long-term view, Deane, obviously given the current economic scenario and the lack of certainty around some of that.

But I certainly don't see any reason why our numbers would be significantly different if you measure them looking at the past troughs.

In fact, if you look at the opportunity for us to make -- continue to make some improvements in the margin rates on acquired businesses, I think that provides us some, if you will, delta or cushion versus what we may have seen in the past.

As we entered the last downturn, we didn't have quite as much acquisition activity to improve margins off of.

But I think the 14% to 15% range, without doing a detailed analysis, is probably still a reasonable range.

That's helpful.

Thank you.

Thank you.

Next Jamie Cook, Credit Suisse.

Your line is open.

Hi.

Good morning.

My first question, can you guys just give a little color on what you are seeing in the emerging markets and whether that has started to slow following western Europe?

And if so, where?

And then my second question, can you address where -- if any of your customers are having any types of financing issues and if so, sort of what markets or any color in that respect as well?

Sure, Jamie.

Let me take the question on emerging markets.

I assume you are talking about emerging markets in Asia and east of Europe, potentially Latin America.

If you look at our businesses in emerging markets, I would say we have begun to see at least some early indications some of slowing in the Asian markets.

Although nothing dramatic at this point, certainly early indications that I think the impact of what's happening in Europe and North America, certainly on countries like China, we would expect to see lower growth rates as we move forward, but still in positive territory.

For the third quarter, not really reflected in our current numbers.

Our China businesses, as an example, grew over 25% in the third quarter.

Certainly we are still seeing dramatic growth there.

Our businesses in South America, which are primarily based on Brazil, were up double digits in the third quarter.

So we are still seeing strong growth there, and similarly, in the East of Europe.

So I wouldn't say we have seen any dramatic impact yet, but what we are hearing from our businesses and from our customers is an anticipation of slowdown in some of those markets.

Certainly the East of Europe spends a fair amount of its time and activity servicing the customers in the West of Europe and that slowdown will impact their business as well.

As it relates to the financing and the credit question, I think we have begun to see that clearly emerge particularly in North America, to a lesser extent in Europe.

The impact is probably best described as fairly broad in terms of its impact on small to medium-sized both customers and suppliers, where their terms and availability for credit have changed dramatically in the last 90 days.

We have seen some pushback in terms of how people are looking at building inventories, managing their businesses and that's obviously rippling over into the order books and the activity levels.

And certainly some of their customers in some of these end markets that have been under pressure continue to cut back their production schedules.

You know, that creates other issues as well.

Many of these small to medium-sized manufacturers have traditionally used their lines of credit to help finance their working capital, and certainly as those terms have changed and their cost of credit has changed, it has clearly created some challenges.

In some cases, the ability to access the funds and in other cases access to the funds but at a significantly higher rate.

And David, my last question, I guess what type of visibility do you have today?

How many quarters?

Is it just one quarter out which is what we are hearing from a lot of industrial companies?

How would that compare to if we were sitting here last year?

Our traditional visibility is really not even as long as a quarter.

Most of our order books and businesses will be measured in less than a month, usually in weeks.

So we don't get a great visibility.

Probably the greatest visibility we get is with the auto industry, but that visibility is not very good because they change their schedules regularly.

So while we have a three-month schedule, I would say for the last several years at least here in North America, none of those schedules have proven to be close or accurate.

They typically have been overestimated.

Visibility is, I would say, limited.

What we rely on, less than the order book is really more the feel that our businesses have by working in their markets and around their customers as to what their activity levels are and what their plans look like, some of which may not even be on paper yet.

So we are reflecting what we see in our fourth quarter outlook based on a continuing decline in the US and Europe and we built that into our numbers.

How accurate those are going to be will remain to be seen, but we have counted on things continuing to weaken in the fourth quarter both here and in Europe.

All right, thank you.

I will get back in queue.

Thank you.

Next is Henry Curran with UBS.

Your line is open.

Are you there?

I think we lost him.

Can we go to the next one.

Hello?

Yes, thank you.

Next we have Mark Koznarek with Cleveland Research.

Your line is open.

Yes, thank you.

Just a question here on the power business with regard to welding North America being down 9%.

Could you split that between the consumables business and the electrical power systems business?

Mark, that wasn't down 9% in North America.

I'm sorry, 0.9%.

So the question is what, I'm sorry?

Consumables versus equipment.

Well, the consumables would have been up slightly and the equipment would have been down.

It's about a 70/30 mix here in North America.

So tilted more towards equipment.

I couldn't give you the exact numbers, but equipment probably in the 5% range down.

Okay.

And then the price versus raw materials overall for the quarter, how would you characterize that and how is that expected to change in the fourth quarter?

Clearly for most of the third quarter we saw continued high raw material costs.

It started to drop a bit towards the end of the quarter and we expect to see more of that in the fourth quarter, especially steel and resin -- chemicals will continue to increase.

So it did have an impact clearly on our costs.

We had been able to recover all the dollar amount of the cost, but not all the margins.

So it did have an impact on our variable margins of about 110 basis points during the quarter.

So does that mean since raw materials are dropping in the fourth quarter and presumably you've got some momentum in past positive price actions, would you expect to see that 110 basis points be recouped in 4Q?

I don't know if you could say recouped, but definitely be lessened.

Yes, I would think it would be less than what we saw obviously in the third quarter, but certainly not recouped.

As you might imagine some of these price increases that have been implemented at a time when the costs began to drop, even though our costs hadn't dropped yet, we didn't get full realization on those price increases.

Now of course with the price dropping, the expectation is that we will clearly have to share some and ultimately all of that reduction in the marketplace.

It won't be a perfect process, but certainly shouldn't be near what we saw in the third quarter.

Okay.

So there's some benefit, but eventually that will kind of lapse?

Yes.

Okay.

Thank you.

Thank you.

Next, Henry Curran with UBS.

Your line is open.

Sorry, guys.

Phone glitch on my end.

(Multiple Speakers) Can you hear me?

We can hear you.

You already forfeited one of your questions, however.

That's fine.

Could you describe the progress on the divestitures?

How much longer do you think it will take to get those done and what are you seeing from the M&A market in general?

Well, as you know, we announced the divestiture plan in August, mid-August.

So that was really the start of the process.

So over the last couple of months, we were in the process of pulling together data, et cetera, for the offering memorandums that went out in the marketplace.

So we are still in that process and I think it's going as expected.

I think one question that will -- that we'll have to address is from a timing perspective when is the right time to do this.

And we're working through that.

Clearly the credit markets have an impact on the M&A markets.

We expect to continue to be able to sell these businesses and to be done by the middle of next year.

Okay.

And recognizing that it's early, but how is October trending so far?

Don't have any data at this point to be able to give you any read on October, Henry, but my expectation is that we are going to see -- we saw a significant slowing in September, and my expectation is that we are going to see the same trend when you compare October of '08 to October of '07.

Okay.

Thanks a lot.

Thank you.

Next, Eli Lustgarten, Longbow Securities.

Your line is open.

Good afternoon.

Hi, Eli.

Couple of questions.

One, can you talk about your assumptions for currency in the fourth quarter, and as you look out to 2009 and I'm making a bold assumption that I don't think you are going to have much currency next year.

Your share repurchases so far have been additive.

Do you intend to buy back enough shares to make up for the currency?

What's going to be the additive parts to the earnings?

Or how do you handle that?

So first of all from the fourth quarter currency impact, what we do is we use the end of the quarter currency rates for the forecast.

So that would have been September 30th rates.

And year-on-year, the impact of the currency will be about flat versus the fourth quarter of 2007, based on that end of quarter rate.

Clearly if we see continued weakening that will have some downside.

To answer the question about 2009, Eli, we have not formulated our plans for 2009 yet.

So we couldn't give you any read yet on what we would anticipate with share repurchases and acquisitions, which is really the way we would look at how we will utilize our free cash flow as we look at what the landscape will offer in 2009.

It really won't be a look that is intended to try to offset the difference in the currency translation.

Certainly, the more share repurchases we do, it will have some impact on that, but that's really not the metrics we use in developing that.

And can you give us some insight in transportation, and I guess maybe the food services businesses?

You said you increased your exposure in transportation with the big acquisition you made in the quarter that you outlined.

I guess the $400 million one.

Yet the market conditions continue to deteriorate and they are not likely to do much better next year.

Can you give us some insight as to -- do you expect to be able to improve profitability in these markets under pressure and can you give us some insight on what's going on in food services [with that]?

Well, first of all, Eli, go back to transportation first.

Your question on the acquisition we did on CCI is really a truck aftermarket business.

What they are basically doing, they are basically redoing trucks, drive trains and it's essentially a parts and service business.

So we think it has a whole different set of fundamentals than anything you're looking at on the auto OEM side.

Different growth perspective, different growth trajectory I should say.

So long term, the business has been growing at a rate of 4 to 5 plus.

We think it has enhanced profitability built into the model they currently have in terms of how we'll change it.

So we think there's some great 80/20 initiatives that are very applicable to the business.

So it's clearly encompassed within the transportation segment, but it's very different than what you are seeing in terms of the auto OEM businesses that we are currently supporting both in North America and internationally.

The question on food equipment was what?

Just to the extent that market started to deteriorate after being up (inaudible) pretty much across the board.

Do you expect that deterioration to go through 2009 (inaudible)?

To David's point, we won't get into real 2009 projections.

I think it's clear that the buying cycle of the business has been trending down.

To my commentary earlier, in the third quarter we had a lot of customers who are delaying purchases.

It's essentially a smaller CapEx decision [they've] made in terms of how they are going to purchase products.

Whether it's for an institution or whether it's for a series of restaurants.

I would say that the trajectory is probably going to be flat to slightly down as we move through the next couple of quarters.

Remember also, Eli, that as the equipment sales trend down, the service revenues generally trend up as they customer service the equipment that they keep in place that they are not replacing.

But it certainly is not an equal offset.

I would share John's sentiments that the trajectories there clearly have decelerated and I would suspect that that's probably the environment we will be looking at as we head into 2009.

Thank you.

Thank you.

Next Robert Wertheimer, Morgan Stanley.

Your line is open.

Good afternoon, everybody.

I wanted to ask about the acquisition pipeline and just generally about acquisitions.

It seems as though public company valuations are falling faster than private.

The question I guess is have you seen private company valuations fall?

Have you asked your managers to bid lower just given what's happening in the public market?

And has it changed your appetite for buying back your own stock versus private company assets?

I think if you look at our acquisition pipeline and the way we manage it.

We are clearly are looking at current sort of market pricing, if you will, when we look at these businesses and opportunities.

We certainly have taken a much closer look at valuation in the last 90 days, particularly for deals that we were already working on in the pipeline.

Primarily based on looking at what their business outlooks were going forward and did they need modification.

Clearly there's been a significant change in people's views about the go forward conditions in a number of these end markets and we wanted to make sure those were accurately reflected in our assumptions.

To the extent those assumptions change significantly, they may well have led to a change in valuation.

That's certainly been the case in a number of potential acquisitions.

I would say as it relates to the delta between private and public companies, the vast majority we looked at is private.

We are only occasionally are looking at public.

I don't know that we have a lot of data to describe whether that delta has changed.

My sense is that they have come down together, in terms of both expectations and actual transaction prices.

I will say, however, that what I think we are beginning to see in the acquisition environment is the impact of the latest credit crisis, which is leaving a lot of people that don't already have liquidity in their hands wondering where that liquidity would come from if they are going to close deals.

It's leaving some potential sellers, I think, pushing back and wondering when the right time is to actually move forward aggressively with any sales process.

So, it's a little bit of an interesting time.

It kind of reminds me a bit of what happened when we saw the initial downturn in the private equity funding and leverage more than a year ago.

Okay.

Thanks.

And just for my follow-up, the higher volume of acquired revenues in this quarter was that things coming unstuck because sellers were getting more rational and the pipeline getting bigger, or was that just some of the lumpiness that happens from time to time?

I think in terms of timing, it's not the lumpiness, but certainly in terms of the ability to execute, it was definitely based on what I would suggest are people's expectations having come into a more realistic zone for us.

But those are things that would have occurred six or seven months ago, not in the last 60 days.

It just so happened, in fact, the CCI deal that John spoke about earlier; the $400 million plus deal was actually scheduled to chose in the second quarter.

And due to a variety of reasons it didn't get closed until the third quarter.

Great.

Thanks.

Thank you.

Next is Andy Casey with Wachovia Securities.

Your line is open.

Thanks.

Good afternoon, everybody.

Hello, Andy.

A different take on the acquisition.

The impact on margins this quarter was a little bit more dilutive than the prior quarter and that broke a trend of becoming progressively less dilutive quarter to quarter.

Was that pretty much the concentration of activity in acquisitions during Q3 or was it something else?

Yes, in the current quarter, it was negative 70 basis points on overall company margins; negative impact.

And that's primarily being driven by just a higher volume of acquisitions.

So overall, the acquisitions were almost 7% of revenues.

And those acquisitions have about 5% margins after the impact of amortization.

That 5% margin after amortization is similar to what happened earlier in the year.

We just had lower volumes of acquisitions in the first and second quarter.

So it had less of an impact on the overall margins.

Okay.

And then -- thanks for that, Ron.

On the acquisition impacting polymers and fluid, it was 320 bips.

What was causing that?

We had several major acquisitions or several acquisitions that closed.

The major one, which was the [Stochtus] business, which closed during the quarter.

Actually, I guess it closed at the end of the second quarter.

The impact would have been felt primarily in the third quarter.

Okay.

So more timing issue.

Yes, timing issue and a large acquisition.

It was a $225 million to $230 million acquisition.

So big acquisition for that group in terms of the overall size.

Okay.

And so with the concentration this quarter, the impact of that carrying over into this quarter, do you expect a similar drag in 4Q?

I know you are not making any comment on '09.

Yes, definitely the carryover impact of these bigger ones will also occur in the fourth quarter, so we will have a similar dilutive impact on the overall company margins.

Remember, it usually takes us three to four quarters before we flush through all the amortizations and [step ups] that occur.

What we look at in the interim from an operating standpoint are the preamortization margins.

And those margins were the third quarter were actually 12%.

So very much in line with -- in fact, probably slightly above our original expectations.

I wanted to make sure that we were not going south of 100 basis points again.

We will try to cap it, Andy.

Thank you.

See you.

Next, John Inch, Merrill Lynch.

Your line is open.

Thank you.

Good afternoon.

Hi, John.

Hey.

So I just wanted to know, the increase in the short-term debt, do you guys have plans to term that out?

And if so, what would that cost you incrementally?

How should we be thinking about that?

Well, we have -- we primarily are financing our operations these days through commercial paper.

We've had no issues with placing our commercial paper, given our high credit rating.

So that's been the good news versus what some other companies have had.

Clearly at some point we have to term out that short-term debt, but that time is not any time soon, given the situation in the credit markets.

So something that we are monitoring, and if we get to the right point with the rates in the right place, we will term it out.

At that point we will have a better gauge on what the long-term rate might be.

The overall commercial rate is 2.5% range for the quarter.

How much CP do you have outstanding and I guess where do you see -- what level of short term commercial paper are you comfortable holding based on market conditions, ITW, that sort of thing?

The balance at the end of the quarter was about $1.5 billion.

We have plenty of additional capacity under existing credit facilities to go way above that.

And we would be comfortable with that.

We don't think we would have any issue placing substantially more commercial paper either.

So there's nothing in the short term that would say we would need to term out just based on the capacity.

Okay.

And then just my follow-up here, there's a lot of chatter that General Motors might actually go bankrupt.

If that were to happen, how -- could you guys give us a sense of what you are on the hook for in terms of receivable from them and/or just remind us again how significant GM is specifically to ITW?

Well, I mean, I don't have the specific number to give you on what the exposure would be in bankruptcy.

GM is obviously an important customer overall to ITW in our transportation segment.

They would be, I think, actually the largest single customer in North America, followed closely by Ford.

So we have obviously reasonable exposure there but I couldn't give you an exact number, John.

And should -- we have pretty tight credit terms with them that they pay within.

Our exposure from a DSO standpoint is under 60 days.

I certainly don't have an exact number to share with you, but my belief is that as we move forward we continue to watch and manage that.

We would have some exposure if they were in fact to go bankrupt, but I certainly don't think that's an issue that we are concerned about at least at the moment.

We continue to manage them within the credit terms.

They continue to pay within the credit terms and on that basis, we are comfortable.

Yes.

That's helpful.

Thanks.

All right.

Next Shannon O'Callaghan, Barclays Capital.

Your line is open.

Good afternoon, guys.

Hi, Shannon.

Can you talk about Europe and how it trended more recently?

Obviously it slowed down.

When did you first start to see it?

Did it hit in September?

Do you have any visibility into the first couple of weeks of October?

Well, we don't have any visibility in the first couple of weeks of October.

I can tell you that the most dramatic part of the slowdown in Europe did occur in September.

It's hard to get a read on numbers out of Europe in the August and July timeframes given the holiday periods there.

But definitely have seen a steadying slowing.

We first raised our awareness or at least raised our hands about the slowing in Europe during the second quarter.

We've seen a steady throwing there.

But I'm talking about outside the early markets that we talked about even back in the first quarter, which were some of the residential construction markets in Europe.

So we have definitely seen a consistent slowing there.

Again, I don't have any October data, but our expectation is that we will continue to see slowing in Europe.

We have already seen some revisions in the European auto builds as an example, and European appliance builds.

I expect that we will continue to see a slowing period in Europe for the fourth quarter.

Don't know what will happen in 2009 at this point, but early indications are that the auto build will certainly contract in 2009 overall as well.

So some of the early indicators for some of the larger industries would suggest that the slowing is not temporary.

And I think what we are seeing obviously in the latest data, as reported from the purchasing managers index and the Euro-Zone ISM data would suggest that that slowing is evident in many places as well.

Okay.

How about for 4Q?

What are you assuming now overall base revenues and split North America, international?

We are seeing base revenues somewhere between minus 1% to minus 3% overall.

North America, minus 3% to minus 4%.

And international somewhere between flat to up 1%.

Okay.

And then just one cleanup.

The phone, either your phone or my phone broke up when you were talking about the price and volume in the quarter in the minus 0.8% base.

Can you just give that again?

The overall base revenues were 0.8%, and it's made up of price increases in the 3% to 4% range, and volume decreases in the 4% to 5% range.

Okay.

Great.

All right.

Thanks a lot, guys.

Thank you.

Next, Joel Tiss, Buckingham Research.

Your line is now open.

Thank you.

How's it going?

Oh, it's great.

Just two things I wanted to get into a little bit.

Can you talk about -- I'm not looking for a forecast.

Can you talk about going forward how easy it's going to be to try to better match your raw material contracts with your pricing actions?

To me, it seems like you are a little bit out of whack in the near term.

Yes, we have been out of whack in the near term when you look at what happened during the third quarter.

We still had the hangover of some fairly significant cost increases that occurred during the second quarter that we were trying to recover.

And in the middle some of those price increases, we it actually had some of the input costs begin to go down.

Hard to sell a price increase when somebody's just read about input costs going down.

That's certainly been happening in the steel and to some extent in the plastics market.

So clearly what we saw in the third quarter was not -- the actual result was not in line with what we had projected going into the quarter.

So the 110 basis point delta there on price cost was clearly not what we expected.

We were looking for more like 50 to 60.

In terms of going forward, I would expect normally, as we see the supply lines open up and I think we are beginning to see that.

The end balance between supply and demand, clearly in some markets, the profile has clearly begun to change.

Steel is one of those.

Generally, in those kind of environments, we do much better.

We do much better because our purchasing power then allows us to exercise better contract prices than what we've been able to do in the past.

As an example, in the past two plus years in steel, while we have been able to get supply as a result of our purchasing power, it has not really impacted our ability to get better costs than anybody else.

I expect going forward that while the raw material costs are trending downward, we will be sharing those obviously with the market, but at a rate that should allow us to close some of these gaps that we have seen in the past.

Okay.

And just on a quick follow-up, would it seem reasonable that as we move forward, that the price of acquisitions come more into line with what the public markets are doing and that the attractiveness of share repurchase starts to diminish a little bit?

Well, certainly as you know, Joel, we have always talked about acquisitions ahead of share repurchase.

If we see the opportunity to have a significantly higher volume of acquisitions, it certainly would impact our view of the level of share repurchase activity that we would go through.

Obviously when we set our guidance for next year, we will give you our view on that.

But we obviously adjust that as we go along.

If we see opportunities in the acquisition area open up, we will clearly adjust our sights accordingly.

I would expect -- what we've seen, as you've seen from the data we reported, we are not paying significantly less than what we have traditionally paid but we are able to look at a lot more deals.

Because things in our valuation range are now able to make sense and be closed.

Whereas in the past year it was quite difficult that one times revenue or 7.5 times EBITDA.

There were a whole lot of deals we couldn't get to the final round with.

So I do expect that that's going to change.

Certainly with some of the deals we closed during the third quarter, the valuations were in fact lower.

Okay.

I'm sure you're happy you missed out on some of those deals at this point too.

All right.

Thank you.

Thank you.

Robert McCarthy, Robert W.

Baird.

Your line is open.

Good afternoon, guys.

Hi, Rob.

Just following on Joel's question.

I don't believe I've heard you quantify your acquisition pipeline.

And could you talk about whether your expectations are right now that maybe closing whatever you have in your pipeline might tend to stretch out.

Maybe your hit rate goes down a bit given current conditions?

I think as you look at the pipeline right now, the pipeline is a little over $1 billion in size.

Okay.

If you look at the -- you look at our number to date, $1.4 billion closed in a range of $1.5 billion to $1.6 billion for the year.

That would suggest we don't expect to close any significant number of deals or size deals during the fourth quarter.

That's really based on what we see in the pipeline at the moment.

That doesn't mean that we don't have sizable deals in the pipeline, but none of them are in the fourth quarter.

I would expect going forward as we look at the acquisition environment, we are going to continue to see some impact of what's going on in the credit world.

I think that's going to probably dictate when and how people look at selling assets, and it's unclear at the moment for me to see what that landscape is going to look like.

But I would expect that as 2009 unfolds, maybe by the second or clearly by the third quarter, we will have a much better view of that.

I would expect that valuations in fact would trend downward as a result of that.

Certainly the cost of funds is going to be higher and you could also anticipate that the amount of leverage available on sizable deals is going to be a lot less and that would clearly work in our advantage.

Okay.

Thank you.

And the other thing I wanted to ask about is the North American construction products business.

In residential market, there's been an interesting pattern that's developed in the three quarters so far this year.

In each of the first three quarters, housing starts have been down about 30% compared to the prior year.

But your comparisons have improved from down 20% in the first quarter to 16% in the second, and now it's down only 12% in the third.

So I'm interested in what's driving this improvement.

I suspect a piece of it would be pricing.

But I find myself wanting to make the inference that if the year-to-year decline in housing starts can narrow to something like 10% to 15%, that you all might be reporting flat or even up revenue in that market.

So could you just talk about what you are seeing there?

Clearly, we've positioned ourselves in this kind of difficult market to be able to take advantage in share position and that's really what we have been doing.

We have been doing it on several fronts.

Certainly, from a new products standpoint, we have done a of numbers that have helped there.

But primarily I think it's the position that we have in the marketplace vis-a-vis our competitors, who are importing products into this markets.

There are import advantages from a cost standpoint and a supply standpoint have clearly changed over the last 18 months.

And local availability of product is extremely important because they aren't -- the buying patterns are different.

Nobody is carrying inventory?

Nobody is carrying inventory and the capability for people to buy multi container loads and rely on them arriving on a timely basis are clearly not there.

So you find a lot of people who may have bought a container before, buying a quarter of a container or a quarter of a truck, if you will, of product.

They need local availability of product.

We were able to take advantage of that with the geographic footprint and our supply base here in North America.

That's certainly been helpful.

Okay.

Thanks, David.

Thank you.

Next Daniel Dowd of Bernstein.

This will be the last question we will take, thank you.

Thanks for taking this last one, guys.

I actually want to ask about your acquisitions as well.

As you think about 2009 certainly being very weak in North America end markets and European end markets, are you adjusting your acquisition appetite to focus on much higher percentages of acquisitions on Asia Pacific?

Or is there any geographic strategy or alternatively a strategy to be more focused on certain kinds of business units where the end markets are likely to be less painful in 2009 and 2010?

I think clearly as we develop our acquisition strategies at the group level, we clearly are looking at obviously a number of different dynamics.

But the long-term view in those markets is really what drives our appetite for wanting to acquire.

We want to be comfortable that after we acquired these businesses we've done our 80/20 work and we are on the growth side four or five years down the road that those businesses are going to be solid contributors.

So we certainly don't want to be acquiring into end markets that we think are going to continue to contract, or have fundamentals that don't fit our profitability profile.

Those are natural parts of the way we look at acquisitions.

With that said, clearly the opportunities we have seen from the valuation standpoint have driven our interests or our capabilities to be primarily more international in focus in the last two years.

Certainly if you look at the numbers year-to-date, that will change significantly.

The CCI acquisition that John spoke about earlier is a complete North American acquisition, is a large one.

$400 million.

The concentration of revenues of that is all in North America.

I suspect if you look at our year-to-date numbers, that more than 50% of the acquired revenues are probably in North America as a result of that acquisition.

If you strip that one out, probably closer to 70% of the revenues were international.

So as you look across our business base at the opportunities it will obviously skew what the impacts are.

But the valuations and the capabilities to execute in the space is probably what has driven more of what we've been able to close in the past.

I think the opportunities have been there, but the valuations were out of line.

I expect that going forward, the opportunities will be there and the valuations will be much more in line.

I would expect over time that to mean that some of the larger opportunities we missed out in '06 and '07 were the opportunities we could transact on in '09 and '10 going ahead.

All right.

And then I guess one last thing.

So certainly one of the issues that investors have talked about a lot is that your debt-to-equity ratio is somewhat low.

Clearly that's turned out to be a significant strength in this environment.

Has the tightening of credit made you think you should become even more conservative on your balance sheet or are you going to be more comfortable continuing to increase the debt-to-equity level?

I think as we said we are comfortable in the 20% to 30% range with our current profile of acquisitions, acquiring revenue somewhere in the 5% to 7% of our annualized revenues annually.

Going above that means there's better opportunities, larger opportunities, and we're certainly comfortable going above that range.

So I don't think it's changed our profile.

Certainly we've looked at what's happened in the credit markets and we've followed closely the impact not only on ourselves but on our customers and our markets.

And as Ron highlighted earlier in the comments about the commercial paper and short-term financing, we have done well in this environment -- which makes me comfortable that even in this market of turbulence, we have been able to continue to place our commercial paper at reasonable rates.

Which is a pretty good reflection of, I think, the quality of our balance sheet.

So I don't see any reasons for us to pull our horns in, if you will, but certainly for us to leverage significantly higher than that, it's going to be based on really looking at acquisition opportunities that we think fit the long-term growth profile.

If they come along, we are comfortable with going above the current levels that we are at.

Thank you.

That will end the call for today.

So we thank everybody for joining us and we look forward to hearing from you again.

Thank you.