Illinois Tool Works Inc (ITW) 2009 Q3 法說會逐字稿

Welcome to the Illinois Tool Works third quarter 2009 earnings conference call.

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

(Operator Instructions).

This conference is being recorded.

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

Now I will turn the call over to your first host today, Mr.

John Brooklier, Vice President of Investor Relations.

Sir, you may begin.

Thank you.

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

As noted, I'm John Brooklier, ITW's Investor Relations officer and with me today is our CEO, David Speer, and our CFO, Ron Kropp.

Thanks for joining us.

Let me now turn today's call over to, David, who will make some brief introductory remarks on what turned out to be another strong operating performance for us.

David?

Thank you, John.

You're right, the third quarter did turn out to be better than expected on a number of fronts.

Our total Company base revenues improved sequentially as base revenues declined 17.6% - - excuse me, 17.9% in quarter three, versus a decrease of 22.2% in quarter two.

Some of this improvement in our base revenues was due to a modest pickup of activity in several discreet end markets such as North American auto, and the residential housing markets.

Our very strong quarter three operating margins of 13.5% were 360 basis points higher than our second quarter operating margins and our quarter three margins were 770 basis points higher than our comparative Q1 operating margins.

It's clear that our ongoing restructuring activities have had a positive impact on our numbers.

I'd like to thank and congratulate our operating managers around the world for stepping up to the plate and right-sizing their businesses based on the demands of their local customers and end markets.

Our third quarter free operating cash flow was a very strong $516 million, thanks in large part to our improved operating earnings and working capital reductions.

This represents a free cash flow to net income conversion rate of 171% for the quarter.

And for the year our free operating cash flow totaled nearly $1.5 billion, or an impressive conversion rate of 333%.

Let me now turn the call back over to John.

Thanks, David.

Here's the agenda for today's call.

Ron will join us shortly to cover Q3 financial highlights.

I will then cover operating highlights for our reporting segments and Ron will address our 2009 fourth quarter forecast.

Finally, we will take your questions.

And as always we ask for your cooperation per the one question, one follow-up question policy.

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

Let me cover a couple of the usual items.

Please note that this conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including without limitations, statements regarding operating performance, revenue growth, diluted income per share from continuing operations, restructuring expenses and related benefits, tax rate, end market conditions and the Company's related forecast.

Please consult our 10-K for additional information on this forward-looking statement.

Finally, the telephone playback for this conference call is (203) 369-1074.

No pass code is necessary.

Now let me turn the call over to Ron, who will comment on our Q3 2009 financial highlights.

Good afternoon, everybody.

Here are the highlights for the third quarter.

Revenues decreased 20% due to lower base revenues but showed improvement from the second quarter revenue decline of 26%.

Operating income was down 28%, and margins of 13.5% were lower than last year by 150 basis points, but improved from the second quarter margins by 360 basis points.

Diluted income per share was $0.60 which was lower than last year by $0.29.

Excluding the impact of a $12 million impairment charge, and the higher than expected tax rate of 32.5%, EPS would have been $0.66.

Our previously forecasted range was $0.48 to $0.56 per share.

Free operating cash flow continued to be very strong at $516 million, or 171% of net income.

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

Our 19.8% revenue decrease was primarily due to three factors.

First, base revenues were down 17.9% which was favorable by 430 basis points versus the second quarter.

As David mentioned, we have seen a modest pickup in certain end markets such as North American auto and housing.

North American based revenues decreased 21.6% which 520 basis points better than the second quarter.

International base revenues decreased 13.8% which was an improvement of 350 basis points from the second quarter.

Next, currency translation decreased revenues by 5.6% which was favorable by 320 basis points versus the second quarter negative currency effect.

Lastly, acquisitions added 3.6% to revenue growth, which was 170 basis points lower than the second quarter acquisition impact.

Operating margins for the third quarter of 13.5% were lower than last year by 150 basis points.

The base business margins were actually higher by 20 basis points as the unfavorable impact of the lower sales volume was more than offset by non-volume items.

Non-volume items increased base margins by 580 basis points which was favorable versus the second quarter non-volume effects by 270 basis points.

Included in the non-volume impact for the third quarter were the following items.

We had a favorable price cost effect that improved margins by 260 basis points.

Lower costs as a result of our restructuring programs had a favorable impact of 160 basis points.

And other miscellaneous favorable one time adjustments such as items related to inventory reserves, life insurance investments and benefit accruals improved margins by 90 basis points.

In addition, acquisitions reduced margins by 40 basis points, translation diluted margins by 30 basis points, higher restructuring expense reduced margins by 70 basis points and a goodwill impairment charge had a negative 30 basis point impact.

Starting this quarter, we have changed our annual goodwill testing period from the first quarter to the third quarter, and we had a minimal impairment charge related to one business.

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

In the nonoperating area, interest expense was higher by $7 million as a result of the higher interest rates on the long-term bonds we issued in March.

Other non-operating income expense in the third quarter was unfavorable by $6 million mainly due to higher foreign exchange losses.

The third quarter effective tax rate of 32.5% was higher than the forecasted rate of 28% and reduced earnings by $0.04 per share.

The higher rate was a result of discrete charges including nondeductible goodwill impairment and higher ongoing rate due to higher pretax income.

The ongoing tax rate for the fourth quarter is expected to be in the range of 29.25% to 29.75%.

Turning to the balance sheet, total invested capital decreased $110 million from the second quarter as the continued reductions in operating working capital were partially offset by increases related to currency translation.

Accounts receivable DSO improved to 60.6 days versus 63.5 at the end of the second quarter.

Inventory months on hand was 1.8 at the end of the quarter versus 1.9 at the end of last quarter.

Excluding the effect of translation, inventory levels were reduced by almost $100 million during the third quarter and by more than $500 million year-to-date.

For the third quarter, CapEx was $53 million, and depreciation was $89 million.

ROIC declined to 12.7% versus 16.2% last year, largely related to the result of the lower base business income, but significantly improved from the second quarter ROIC of 8.6%.

On the financing side our debt decreased $99 million from the second quarter as strong free cash flow was used to pay off commercial paper.

As a result, our debt-to-capital ratio decreased to 26% in Q3, from 28% in Q2.

Shares outstanding at September 30 were 500.9 million.

Note that the effect of options typically adds about 2 million shares to dilutive share calculations.

Our cash position increased $327 million in the third quarter as our free operating cash flow of $516 million was utilized for debt repayments of $105 million and dividends of $155 million.

Despite the lower income levels we were able to generate strong free operating cash flow by reducing our working capital, especially inventory.

Regarding acquisitions, we acquired two companies in the third quarter which have annual revenues of $6 million.

Although we have seen a low level of acquisition activity so far this year, our acquisition pipeline for the fourth quarter looks a little better with more than $200 million in acquired revenues.

I will now turn it back over to John who will provide more details on the segment operating results.

Thank you, Ron.

Now let's review our third quarter segment highlights.

We'll start with industrial packaging where segment revenues declined 29.5% and operating income fell 52% in Q3 versus the year-ago period.

Operating margins of 7.6% were 360 basis points lower than the year-ago period.

But sequentially, Q3 operating margins improved 410 basis points compared to Q2.

The 29.5% decline in revenues consisted of the following.

Minus 23.3% from base revenues, 0.9% contribution from acquisitions and minus 7.1% from translation.

Moving to the next slide.

Industrial packaging's base revenues actually showed modest signs of improvement in Q3 versus Q2.

In Q3, base revenues fell 23.3% compared to a Q2 base revenue decline of 26.1%.

Clearly, underlying fundamentals such as industrial production in the US and in Europe have shown some signs of modest improvement as the year has progressed and these trends have helped our industrial packaging businesses somewhat.

For example, our total North American industrial packaging businesses declined 27% in Q3 versus a decrease of nearly 32% in Q2.

And likewise our total international industrial packaging businesses decreased 25% in Q3 versus a decline of 27.3% in Q2.

Small improvements but the numbers appear to be moving in the right direction.

Moving to the Power Systems Electronics segment, in Q3 segment revenues decreased 34.6% and operating income fell 41.2% versus the year-ago period.

The good news is that while strong Q3 operating margins of 17.2% were 200 basis points lower than the year-ago period, they were sequentially higher.

Operating margins in Q3 were 190 basis points higher than Q2.

The 34.6% decrease in revenues consisted of minus 34.2% from base revenues, a contribution of 2.4% from acquisitions, and minus 2.8% from translation.

There appeared to be a bottoming in terms of the segments based revenues performance.

Base revenues declined 34.2% in Q3 versus a base revenue decrease of 36.5% in Q2.

Our worldwide welding businesses produced a base revenue decline of 36.2% in Q3, which was modestly better than their Q2 performance.

North American welding base revenues declined 40% while international welding base revenues fell approximately 27% in Q3.

Remember that the welding businesses are sensitive to both industrial production and CapEx spending as well as activity in the commercial construction sector and as a result, we expect our welding businesses to be among the last of our businesses to recover.

The big improvement in the segment was the PC board fabrication businesses which you saw base revenues decline 42.3% in Q3 versus a base revenue decrease of 59.2% in Q2.

Moving to Transportation, Q3 segment revenues declined 7% and operating income fell 17% versus the year-ago period.

Those numbers represent dramatic improvement from Q2 when segment revenues decreased 20.3% and operating income declined 75.6%.

The even better story was the ongoing margin improvement in the segment.

While margins of 10.5% in Q3 were 130 basis points lower than the year-ago period, those Q3 margins were 570 basis points higher than Q2.

The 7% decline in revenues consisted of minus 7.9% for base revenues, a contribution of 7.5% from acquisitions and minus 6.6% from translation.

Moving to the next slide.

There's a simple reason for better Q3 base revenue performance in the segment and it's simply more auto builds.

Base revenues in the segment moved to minus 7.9% in Q3 from base revenue decline of 23.7% in Q2.

North American automotive base revenue declined 14.3% in Q3 versus a base revenue decrease of nearly 40% in Q2.

And this improvement was directly linked to a dramatic increase in North American auto builds largely associated with the Cash for Clunkers incentive program.

Specifically, North American auto builds moved from 1.8 million units at Q2 to 2.4 million units at Q3.

And Detroit Three accounted for approximately 2/3 of this auto build increase with new domestic auto builds accounting for the remaining part of the growth.

Notably Ford had the best build improvement in the quarter, producing 500,000 vehicles or 15% more cars than the year-ago period.

We are expecting North American builds of roughly 2.5 million total units in Q4.

On the international side, automotive base revenues declined 4.7% in Q3 versus a base revenue decrease of 22.5% in Q2.

While European auto based auto builds slightly declined from 4 million units in Q2 to 3.9 million units in Q3.

And auto build rate of approximately 4 plus million units per quarter looks sustainable in Q4 and into the next year.

Moving to Food Equipment.

The Q3 segment revenues declined 10.2%, and operating income decreased 5.1% versus the year-ago period.

Like most all of our segments, that represents quarter-over-quarter improvement of results as Q2 revenues fell 16.2%, and operating income declined nearly 21%.

Margins also improved.

Q3 margins of 17.2% were not only 90 basis points higher than the year-ago period, but 430 basis points higher than Q2.

The 10.2% decline in revenues consisted of minus 6.3% from base revenues, a contribution of 1.6% from acquisitions and minus 5.5% impact from translation.

Food Equipment's improvement in base revenues from Q2 to Q3 was essentially driven by relatively strong performance from our service business.

This worldwide service business which accounts for 35% of the total segment revenues had flat base revenues in Q3 versus the year-ago period when service numbers were very strong.

And the Q3 2009 service performance was better than Q2 2009 when base revenues declined 1.1%.

Geographically our international businesses also showed modest improvement.

International Food Equipment based revenues declined 4.9% in Q3, versus a base revenue decrease of 10.2% in Q2.

And North American Food Equipment base revenues fell 8% in Q3 versus the base revenue decline of 8.4% in Q2, as customers continued to delay equipment purchases.

Moving to Construction.

Q3 segment revenues declined 23.3%, and operating income fell 41.7% versus the year-ago period.

That's considerably stronger performance than Q2 when revenues were down 34.5%, and operating income declined 72.8%.

Operating margins also improved sequentially as Q3 margins of 10.9% were 500 basis points higher than Q2.

The 23.3% decline in revenues consisted of minus 16.5% from base revenues, contribution of 0.9% from acquisitions and minus 7.8% impact from translation.

Construction segment's base revenues decline of 16.5% in Q3 was an improvement versus Q2 when base revenues fell 22.1%.

The sequential improvement of base revenue in the quarter was largely due to better housing activity in the US and better international construction activity.

In North America, our residential base revenues declined approximately 30% in Q3 versus a decline of approximately 43% in Q2.

And that's largely due to housing starts in Q3, which on a seasonally adjusted basis totaled nearly 600,000 units.

That would represent approximately 100,000 more units than what we saw in Q2.

Internationally, our total Construction base revenues declined 13.2% in Q3 versus a decrease of 20.2% in Q2, with Europe down 22% and Asia-Pacific flat in the quarter.

In the polymers and fluids segment Q3 revenues fell 16.8% and operating income declined 9.7% versus the year-ago period.

More importantly, operating margins improved 130 basis points to 15.8% in Q3, compared to the year-ago period.

As important, Q3 margins were sequentially 540 basis points higher than Q2 operating margins.

The 16.8% decline in revenues consisted of minus 13.9% from base revenues, the contribution of 4.4% from acquisitions, and minus 7.2% impact from translation.

In polymers and fluids base revenues declined 13.9% in Q3 versus a base revenue decrease of 15.1% in Q2.

The modest sequential improvement was largely due to improving trends for our worldwide fluids businesses which produced a base revenue decline of roughly 12% in Q3 versus a base revenue decrease of approximately 16% in Q2.

Some of this pickup was due to increased demand for MRO products in international North American end markets.

Worldwide polymers saw slight or more modest improvement as base revenues moved to minus 16.8% in Q3 versus minus 17.1% in Q2.

While our North America polymers businesses in particular were still grappling with weak industrial end markets in Q3, it a appears that the vast majority of inventory destocking has ceased and modest restocking should take place in both Q4 and beyond.

On to the decorative surfaces segment.

Q3 revenues declined 20.2% while operating income grew 1.9% versus the year-ago period.

Operating margins of 10.9% in Q3 were actually 230 basis points higher than year-ago period and that's mainly due to the benefits of a pension adjustment after the segment moved from Discontinued Operations back into Continuing Operations.

A 20.2% decline in revenues consisted of minus 15.6% for base revenues, and minus 4.5% from translation.

The deck surfaces segments base revenues declined 15.6% in Q3, and that was modestly better than Q2.

Given the segments exposure to North American commercial construction, it's not surprising that North American laminate base revenues declined 20.6% in Q3.

The better news for us is internationally where base revenues fell only 10.7% in the quarter, and we continue to get better performance from our business in the UK.

Finally, our final all other segment, Q3 revenues declined 15.1% and operating income fell 28.4% versus the year-ago period.

That's better than Q2 when revenues decreased 18.2%, and operating income declined 46%.

Notably, operating margins of 16.5% in Q3 were 330 basis points higher than Q2.

The 15.1% decrease in revenues consisted of minus 18.9% from base revenues, contribution of 7.9% from acquisitions, and minus 4.1% impact from translation.

The sequential improvement of base revenues from Q2 to Q3 was largely due to better numbers from our consumer packaging and industrial appliance businesses.

Our consumer packaging businesses base revenues declined 11.7% in Q3, which represents a modest improvement versus Q2.

And our industrial appliance based revenues declined 21.8% in Q3 which represents another sequential improvement versus Q2 which was primarily related to a modest pickup in US housing starts in the quarter.

On the flip side, our test and measuring businesses base revenues went more negative in Q3 versus Q2 as worldwide CapEx spending continues to be soft.

That concludes my remarks on the segments.

Now let me turn it back over to Ron who will address the fourth quarter 2009 forecast.

For the fourth quarter we are forecasting diluted income per share from Continuing Operations to be within a range of $0.54 to $0.66 per share.

The low end of this range assumes a 11% decrease in total revenues versus 2008 and the high end of the range assumes a 5% decrease.

The midpoint of this EPS range of $0.60 would be 2% higher than Q4 2008.

In comparison to the third quarter of 2009, the fourth quarter forecasted revenue change would be in a range of negative 1% to positive 5%.

Even though the midpoint of the range assumes that revenue will increase 2% from the third quarter, the forecasted EPS midpoint of $0.60 is expected to be flat versus the third quarter due to a number of other components.

On the positive side, no fourth quarter impairments is expected and a lower tax rate of 29.5% versus the third quarter rate of 32.5% would each add $0.025 cents to EPS.

In addition, further incremental benefits of our restructuring programs would add between $0.02 and $0.03 to the fourth quarter.

Offsetting these favorable items are several unfavorable items that will impact the fourth quarter as follows.

The favorable third quarter one-time adjustments for inventory reserves and corporate items that I previously mentioned were between $0.04 and $0.05 per share and are not expected to be repeated in the fourth quarter.

Also, fourth quarter - - expected fourth quarter changes in mix and other miscellaneous operating, nonoperating items, would reduce Q4 EPS by $0.04 to $0.05.

And finally, the price cost effect is expected to be less favorable in the fourth quarter resulting in lower income of $0.03 to $0.05 per share.

Other assumptions included in this forecast are exchange rates holding at current levels, restructuring costs of $25 million to $40 million for the fourth quarter which compares to $31 million in the third quarter.

Net nonoperating expense in the range of $35 million to $45 million for the fourth quarter and a tax rate range between 29.25% to 29.75% for the fourth quarter.

I will know turn it back over to John for the q and a.

Thank you, Ron.

We are prepared now to take questions.

I will remind everybody we ask everyone to please honor our one question, one follow-up question.

We will now begin our question-and-answer session.

(Operator Instructions).

One moment, please.

Our first question comes from Deane Dray with FBR Capital Markets.

You may ask your question.

Thank you.

Good afternoon, everyone.

Dave, you knew the day would finally come where you would be on the call saying that North American auto and North American resi would be the brighter spots to call out in the quarter, didn't you?

I did know that that would happen some day.

I wasn't sure when.

But that doesn't count as my question.

Oh, okay.

So, I really like to drill down a bit on auto if we could because I know we had a Cash for Clunkers impact here.

But just give us a sense of what has changed competitively during the downturn.

I mean, you made comments a couple quarters back that some of your competitors because of their liquidity issues, that you were getting increased share and customers were coming to you.

So, after the dust settles here, how has ITW's auto business improved market share, maybe geographic mix, maybe some new products or new platforms.

Just give us a state of the union in auto as you come out of this.

Well, certainly - - the build in North America in the quarter, up over 30%, obviously that's the biggest variable in Q3 versus Q2.

The European auto build was actually relatively flat from Q2 to Q3, so not much impact there.

Clearly, the mix of vehicles and our penetration rates in North America have continued to improve which allowed us to outperform the market.

And we're seeing obviously the leverage that we talked about in earlier calls when we get any volume in these businesses, there's significant leverage on the margin side.

So our penetration as we've talked about for the last several years in North America has been primarily focused on the new domestics.

That's continued to serve us well.

We've got good growth content, both in the current build schedules and in the year ahead as we look at new platforms coming on with new content for us.

So we continue to be optimistic as we see these build rates now begin to improve.

Much of our market penetration gains over the last year have been lost in the dramatic decline in the build numbers themselves so as these builds begin to improve, you'll see the benefit of our increased content per vehicle overall going up.

Again, much of that in North America is skewed to the new domestics.

At the same time our international businesses, particularly those in Asia, are performing well and we're well positioned now in a number of new end markets with new vehicle producers like Cherry, like Tata, like Brillian and others.

They're going to be significant factors in the Asian car build ahead.

Our biggest growth relationship in the last two years has been with Hyuandi and Kia, and that continues to play out strongly.

So I think we're, as we've been saying I think for the last year or so, we're well positioned with the key global auto builders, and now we're starting to see some actual numbers reflect as builds go up and see it in our performance metrics.

Okay.

That's very helpful.

Just as a follow-up.

Want to make sure I heard it correctly.

Was that $6 million in acquired revenues for the quarter and has that ever happened before, that low?

I don't know that it's - - you did hear it right, $6 million was the number.

And I don't know that I would recall certainly any quarter that was lower than that.

So, yes, it was not much happening, two small deals, two small distributorships that really I hardly would count if we weren't scoring all of our acquisitions.

The better news is that the fourth quarter does impact, have about $200 million of activity in it so I think we'll see a much better quarter in the fourth quarter.

And I think as I've said and the number of my comments more recently, I think we're beginning to see some early signs that the environment may in fact start to show some improvement, particularly as sellers begin to adjust to the new realities of their business performance and their earnings.

Great.

That's helpful.

Thank you.

John Inch, Merrill Lynch.

You may ask your question.

Thank you.

Good afternoon, everyone.

Hi, John.

Hi, guys.

Maybe this is a question for Ron.

I just wanted to understand the puts and takes in the fourth quarter.

So, kind of looks like you've got a little bit of a wash between the mix and the price effect and I guess the inventory reserves versus the other tailwinds.

We're calculating possibly up to $0.15 of sequential earnings per share benefit from currency at the dollar Euro rate.

Is there something else we're missing?

Firstly, do you agree with that exchange rate calc and then is there something else that's maybe embedded here as to why you wouldn't be seeing a higher sequential guide forecast for the fourth quarter?

Yes, the currency number we have is definitely not that high, it's $0.15.

May be helpful to take you from the third quarter EPS of 60 to the midpoint of the fourth, with the puts and takes.

So, included in the 60 is an impairment charge in the third quarter of $0.025 so you add that back, also the tax rate of 29.5 versus 32.5 is another $0.025.

That gets you to $0.65, kind of on a normalized basis without some of these other things.

Then you have the higher revenues which will add somewhere between $0.03 and $0.04 around the midpoint.

That's favorable.

And then also favorable would be $0.02 to $0.03 of incremental restructuring benefits, above and beyond what we saw in the third quarter.

Offsetting that, those items, you have the - - kind of the third quarter, one-off adjustments the inventory adjustments and the other corporate adjustments, that's $0.04 or $0.05 negative in the fourth and then other miscellaneous things, mix, some nonoperating stuff, that's also $0.04 to $0.05.

And then reduced price cost impact which is expected to be $0.03 to $0.05.

So all those puts and takes gets you to go from 60 to 60.

But there's obviously a lot of components in there.

But you haven't added in currency, Ron.

I mean currency based on exchange isn't it at least $0.10 plus.

Remember our currency, John, our currency is assumed in this forecast to remain at current levels.

Current levels for us is the end of Q3 internationally.

And you may recall our Q3 international ends in August.

Right.

Okay.

We haven't projected anything forward as we never do with currency.

We peg it at the end of the international quarter so any change from that obviously would be reflected in the 4Q numbers.

But we haven't reflected anything different than that here.

It's neutral in our forecast is the way to look at it.

Right.

But since August, it's helped I think is the way I think about it.

Incrementally helped.

Again, our forecast doesn't include any change in currency since the end of August.

Traditionally we use the end of the quarter and we talk about currency as being a stable in this.

So obviously, if currency remains above that rate, then we'll certainly see a favorable impact of that in our earnings, but it's certainly not reflected in this.

Some companies have been - - they've suspended variable comp or bonuses or other aspects of compensation that may have to just purely for competitive reasons, regardless of the economy, come back next year.

Is that dynamic held at ITW and do you see - - let's assume things don't materially change.

Would you envision any kind of compensation headwinds, again, just to retain key employees or that sort of thing that are material?

No, I do not.

Okay.

Thank you.

Eli Lustgarten with Longbow.

You may ask your question.

Good afternoon, everyone.

Nice quarter.

Just a clarification.

Currency was negative in the quarter, that's negative 7%, 6.9% in operating income?

I'm sorry?

6.9% on income, yes.

It was a negative effect in the quarter, so it will be a big difference between negative and the swing quarter-to-quarter, because it's actually positive in the fourth quarter, wouldn't it.

Yes.

Okay, that would be our biggest point.

Can we talk about you gave a state of the union in automotive.

Can we do it for Construction because that's the other part that doesn't have the same Cash for Clunkers kind of thing, hoping to push market.

You've got residential coming back, but non res is sort of still going down and probably will be.

Can you give us some idea how we should look at Construction not only the fourth quarter but into 2010.

Sure.

Eli, I think as you look at Construction, first let's remember a couple of important elements that 60% of our Construction business is outside of North America.

The components that are here, about 5% of the overall is tied to residential construction.

Residential construction housing starts as John pointed out have approached 600,000.

They've been fairly consistent overall for the last four months.

However, if you look at the single family numbers which I think are a stronger indicator because the multi-family numbers included in there are always fairly choppy.

The single family trend has moved upward consistently for the last nine months from 360,000 to 500,000 and that's from January through September.

So we are in fact beginning to see early signs of a modest recovery in the housing market.

We have not developed a view of 2010 yet for housing but I would expect to see continued modest improvement in these housing numbers going forward.

So, it's clear as I think we've said in the last two calls, we think that the housing market's bottomed but I think the recovery is a long and slow recovery, based on a number of factors in the market, real estate prices still dropping, foreclosures still high, et cetera.

What percent of your sales are related to North American housing that you're talking about.

5%.

5% so it's a very small piece.

Correct.

5% of total Company, right.

Of total Company.

Not just construction side.

That's correct.

Total Company.

Total Company.

Right.

Within the Construction sector, how much would you guys have as residential North America?

Within North America piece, it's about 50%.

Okay.

What you're seeing in non-res construction and what kind of decline can you expect for the next 12 months from where we are now.

Does it stabilize.

I'm sorry, are you talking about housing again now?

Non-

Commercial, I'm sorry.

On the commercial front it's a completely different story.

Obviously, what we track most closely in commercial is the square footage awards, the (inaudible) numbers, and year-to-date those numbers are down 48% on a square footage basis and they continue to show decline.

Although the rate of decline in the last three months has been less than the beginning of the year.

We're still seeing a cumulative number for the year down nearly 50%.

So we're definitely seeing a continued trend downward and I think it's across all of the major building categories in commercial construction, so even in hospital, healthcare, we're seeing declines in the 20% range.

So I expect that we're going to see that continue through the end of the year and probably even into next year which means that most of our businesses are early cycle in commercial construction.

That is, they're involved in building the structure or the frame of the buildings.

So I expect that we will be early indicators when we see things start to turn.

But it will take these construction award values to start rising for that to be a strong signal in the commercial side.

All right.

Thank you.

Henry Kirn with UBS.

You may ask your question.

Good morning, guys.

Hi, Henry.

Hi.

Could you talk a little bit about to what extent and in which segments you're seeing a restocking benefit across your businesses?

Well, - - that's a hard one to measure.

- - across our North American businesses, 90% plus of what we sell in North America is sold through some form of distribution.

Certainly we saw major destocking going on.

I can't say that we've seen significant restocking occur.

However, I believe that as things continue to stabilize and people begin to get a little more comfortable with the trajectory of the end markets and economies, we'll start to see some modest level of restocking begin.

But I would say at this point we haven't been able to put a finite number on that.

I suspect it's probably early for us to be seeing much of that so far, since we really in most of these markets have only begun to see bottom.

Certainly an exception to that would be in the auto business where there's been a dramatic uptick in the production and we've seen that obviously flow through.

But there's not much inventory in that system anyway.

So I wouldn't say that we've seen any dramatic restocking occur at this stage.

That's helpful.

And as we go through the upcycle, could you talk a little bit about how you think about the cost base today and if we were to see an uptick, whether you would need to add costs to be able to support a safe rebound in demand.

Yes, I think from a capacity standpoint, I think we're in good shape to be able to handle reasonable uptick in demand.

Most of our businesses have between 15% to 20% excess capacity today, at today's operating rate so we can handle a fairly good upturn without having to add any significant labor or overhead.

I think the bigger variable for us is probably looking at what happens to input costs, commodity costs.

We have seen some early indications of some modest movement in steel pricing and some on some plastic resins.

So I think probably in the near term it's probably cost pressures are going to be more around input costs than they are around labor or overheads.

Thank you very much.

David Raso with ISI.

You may ask your question.

Thank you.

Regarding core growth, which of the segments that you expect to first see positive year-over-year core growth and when?

Well, I think if you talk about it in terms of the overall portfolio, I mean, certainly what we're seeing in the Transportation segment based on where we've been, we would expect to obviously see that based on the trends that are coming now off some pretty low numbers.

In the general industrial categories it's probably more about what we're going to see in the overall industrial production numbers so as those begin to trend up we'll see that reflected.

I think our Food Equipment business clearly we've seen that already in some markets, particularly internationally, the service volumes have held up well.

I think the equipment sales looked like they have bottomed, but I would expect we would begin to see that from an institutional standpoint probably earlier in the cycle than most.

Certainly, the later cycle businesses like welding and test and measurement I think are a ways away from obviously being able to see where those bottoms might turn for us.

The reason I ask, the businesses that really caused the first quarter 2009 margins to really collapse, unlike ITW, industrial packaging, Transportation and construction.

It looks like Transportation and construction might potentially even go positive core growth this quarter, fourth quarter.

In the margins have already come back pretty aggressively already.

So I'm just trying to think, can I extrapolate the base margins for Transportation already above 15.

Construction is back in double-digit as well.

Is it largely upward and onward from here with those margins getting back to where they were at their previous level.

Or is there anything I should be a little bit more cautious about on those margins.

They've already come back aggressively in just two quarters.

Yes, well they have, David.

I think your sort of direction with your question or with your modeling if you will is accurately.

Certainly the businesses are positioned to return if you will to the kind of traditional earnings power that they've had.

The operating margins as you've pointed out have improved nicely in both those segments.

You may recall that both those segments were the earliest ones down so the first quarters of 2009 were fairly miserable quarters in both auto and housing.

And while we took additional restructuring efforts, much of the restructuring didn't actually occurred before that, the benefits which now are obviously accruing.

Certainly when you look at the auto build numbers, conservative numbers for next year in the 9.5 to 10 million range are up significantly from the 8.2 to 8.3 we'll build this year.

And certainly I would expect the housing numbers to continue to move up modestly, probably somewhere in the 700,000 range.

So if you use those kind of numbers, certainly we're going to continue to see strong incrementals in both of those businesses on the upside, certainly in the 40% plus range.

One issue, do you have any angst about going into 2010.

How quickly does the price versus cost change.

Can you give us a little indication of A; where do you thing 2009 full year price versus costs will be for the Company.

I know obviously across a lot of divisions you're generalizing.

But if you have a number for price versus cost for 2009, and how are you thinking about pricing for 2010.

There's enough indications from commodity prices that you don't want to fall behind.

I recall last time maybe you were a little slow to capture some of the incremental costs years ago.

Are we thinking a little more proactively this time about pushing the needle on pricing for next year, or no.

Yes, David, I think we were slow if you go back to the 2006-2007 timeframe.

We were slow primarily because of the multiple price increases or cost increase that's we got.

In that time frame, steel as an example, we were getting cost increases every month so we were having a hard time getting ahead of of those cost increases.

And as a result on a sequential basis we clearly had some big headwinds.

I can't give you a number for the full year, but obviously we had a significant positive impact this quarter, 260 or 270 basis points.

We were about 170 basis points last quarter.

But frankly, that's been on the back of strong price increases that have occurred since the year-ago period and on the basis that a number of those commodity costs for the first - - at least first two quarters went down.

They've stabilized now and in fact in some cases we're looking at some modest increases or some modest headwinds.

So I think as I think about 2010, I think about it as a more normalized price cost environment where any kind of commodity increases we get we're going to have to stay on top of and find ways to pass those along.

But I'm not expecting significant input cost changes for 2010.

I think we'll see some movement up but I think it will be much more manageable than what we saw heading into this downturn.

I appreciate it.

Thank you.

You bet.

Jamie Cook with credit Credit Suisse.

You may ask your question.

Hi.

Good afternoon.

Sorry.

First, I was just wondering if you could give a little more color specifically on what you're seeing in Europe across the board from some of the other industrial companies.

Sounds like this has been trending better than people's expectations or things have stabilized there.

So your thoughts there and how we come out of it.

And then just on industrial packaging, what you're seeing on equipment versus consumable side.

Yes, Jamie, we have - - we've been saying I think now for probably four or five months that we're seeing the European numbers respond somewhat better than what we originally expected.

Clearly, the European markets did not drop as far as the US markets and in fact, in some cases those markets have begun to show signs of recovery.

In fact, even ahead of some of the US markets.

So, as we pointed out in our base number, our base assumptions, that the international Q3 numbers were down 13.8% versus the North American which was down 21.6.

So, pretty big delta there and recognizing that 75% of our international numbers are coming out of the European region.

You can see that we've seen better performance out of those markets than what we clearly have here.

The auto business there responded much more quickly to the downturn.

In fact, the downturn in auto in Europe was really a very sharp decline that lasted for about two quarters.

They're back onto 4 million pace in the third quarter and a 4.5 plus million base in the fourth quarter.

So, those are examples of some markets that have responded much earlier.

The construction numbers there have not been down as much.

The residential numbers have been challenged in a number of markets there.

But the commercial numbers have not been down anywhere near what we've seen here in North America.

So, I think if there's a question the recovery may be somewhat earlier but probably more importantly the decline was not nearly as great in a number of these end markets than what we've seen in North America.

Any country specifically.

I'm assuming Southern Europe is much weaker, Germany, France, stronger.

Germany and France have certainly been stronger.

The housing market if you look at construction, certainly Spain and Ireland have been in terrible shape, probably will be for a while, they're vastly overbuilt.

If you look at the car production numbers are pretty well spread across all the European automakers so all of them have participated in their version of Cash for Clunkers.

It's been very successful.

So, all the car companies in France, Germany, Italy, have all participated in that.

The overall manufacturing industrial production numbers have improved better in France and Germany than they have in the rest of Europe.

Those are also the strongest industrial markets so I think we've seen clearly a different sort of drum beat over there than what we've seen in North America.

And then sorry, just last on industrial packaging equipment versus consumables.

Yes, well, the consumable volume is obviously on a sequential basis shown some modest improvement.

The mix in that business is still about 70% consumables, 30% equipment.

The equipment side is still down close to 40% on a year-to-date basis and the consumable volumes in the most recent quarter are down in the mid-20's.

So better than what we saw in Q2 but still some fairly significant headwinds in terms of activities.

Thanks.

Congratulations on a nice quarter.

Thank you.

Andy Casey with Wells Fargo Securities.

You may ask your question.

Thanks.

Good afternoon, everybody.

Wanted to look at cash deployment.

On acquisitions, you already touched on improved Q4 pipeline.

Just from a broader standpoint, how are you looking at the current environment as a time to increase your exposure to higher growth regions when developing economies seem to be recovering while North America kind of stabilizes and the US dollar is generally weakening.

Are those valuations already moving away from where you would be comfortable?

Are you talking about from acquisition perspective, Andy?

Yes.

No, I think largely the issue with acquisitions has been really around sellers not wanting to sell at the bottom of the market and in many cases not having adjusted their expectations to the fact that their businesses have been impacted by this downturn as well as others.

And the significant earnings decline along with the fact that they market multiples for businesses has in fact declined.

So, if you've got somebody using math from 2007, 2008, early 2008 valuations, I mean, we're talking about pretty significant reductions in what those businesses would yield today.

Probably to put it in perspective, prices today that would be 40% to 50% of what they would have been in late 2007.

So, I think that's probably the biggest single factor.

On the international front, in terms of looking at acquisitions and opportunities, we're just as active there.

I think the Asian region continues to be a challenging region to do acquisitions going forward.

In many cases, certainly in China, it's based on the complexion of the businesses and how new they are, what market access they bring, et cetera.

But we're working hard in that regard in the international front.

The last couple of years, more than 60% of our acquired revenues have been outside of North America so we continue to focus on those faster growing developing market regions.

But I wouldn't say that there's any different overall issue in the acquisition environment in the international markets.

Perhaps the Chinese market excluded where there's other issues there, but most markets are still adjusting to the fact that sellers' expectations have been - - remained inflated.

Okay.

Thank you very much.

Daniel Dowd with Bernstein.

You may ask your question.

Sure.

One last follow-up on acquisitions.

Part of the the thesis on acquisitions had been that private equity firms would likely be seeking liquidity by selling some of the companies that they might have bought through the past upcycle and obviously we haven't seen that.

What do you think's driving that and is it possible for that thesis to come back or is that kind of just dead?

No, I don't think that thesis is dead.

I think what we've said at least from our perspective, we think that will in fact happen and I think going forward we would expect to see a fair amount of that to show itself in 2010.

When you look at the number of assets in the spaces that we've had an interest in over the last three or four years that private equity was able to transact at significantly higher valuations than us and also the age of those portfolios and the financing arrangement that's were made when those deals were done.

A lot of those factors would indicate that just based on the level of financing and the fact that a lot of that financing was longer term with not a lot of covenants and much of that financing is coming due, coming up for renewal.

Other cases these are assets that have been held for four or five years, they've also been impacted by these downturns.

So I think you're going to begin to see a natural unwinding of some of these assets.

Clearly, on the new front, they're not the same factor.

They don't have the same advantages they had on newer deals that they had over the past three or four years.

But I certainly would expect to see, and we've seen some early indications of that with some inquiries we see in the market that we would expect to see that play out.

I don't think it's going to be a dramatic rise that we're going to see in one quarter, but I think as we look into 2010 that I would imagine by the mid-year of next year we're going to be able to talk about that more discreetly with actual examples.

So many of the companies in the sector have been disproportionately doing their cost cutting in high cost, high tax markets.

Your model has always been very different, right, proximity to the customer and therefore it wasn't really about moving your manufacturing to places where it was less expensive.

Can you confirm that that's still the case, that your cost cutting has been relatively evenly spread across the markets you're in.

Or are you actually seeing a real systematic trend of moving your costs from higher cost locations to lower cost locations.

No, our business model and footprint really remains the same.

Our cost reductions have largely been done inside of the existing business structure.

You're very accurate in pointing out that our preference and approach has long been to put our manufacturing activities where the market is and that remains unchanged.

I will say that that there are some sectors where our customers have moved or are moving more capacity and obviously we will follow them.

Again, putting our factory where their production is going to be but no wholesale changes in terms of a relook.

Remember, direct labor costs represents in most of our products under 7% of the cost of the product.

So that's not the most important factor.

It's much more important that we're close to the customer, logistics costs, freight and duties are much more compelling cost factors than direct labor.

Tax obviously is an issue, variable tax rates.

But frankly, tax rates in the end we have to look at tax rates as it relates to the overall business proposition, not just based on what people are doing in the near term in terms of comparables.

If there's a significant change in tax rate obviously that's a factor that we have to look at but it's not been at least thus far anything that's different any decision process for us.

Okay.

Thank you.

Ann Duignan with JPMorgan.

You may ask your question.

Hi.

Good afternoon, guys.

Can we dig a little bit deeper into the pricing performance this quarter, where exactly are you getting pricing?

Some of the recent PPI data which I know it's industry level but it suggests that pricing compression is upon us and in welding actually it turned negative last month.

So can you just give us a bit of color on where exactly you are seeing pricing power and where you expect to see the most pressure.

Well, remember, Ann, that these comparisons on price costs are compared to the prior quarter a year ago so we have had price increases that were put in place since then and in some cases costs that have decreased which has increased the spread.

So it's a combination of factors.

I would not want to give you the impression that we've had a wholesale group of price increases in the last quarter because that's not the case.

What we're seeing is the overall impact of the change in price cost third quarter this year to third quarter of last year, but most of those price moves were made probably six months ago or so.

On the cost side, we saw some cost declines that occurred earlier in the year and we were, due to our purchasing power, able to get better pricing than most of the indices.

So while we had to give some price back it wasn't as much in most cases as our costs went down.

I would tell you that going forward as Ron pointed out in one of his factors for the fourth quarter, we don't see those same kind of spreads recurring because the fourth quarter last year is a different set of comparables in terms of price costs.

And we're also now beginning to see early signs of some of the cost headwinds that we would expect to see as you've seen announcements around steel, paper board and plastic resins as examples of where we're going to start to see some cost increases.

And cost decreases you've seen to date, I'm assuming that those are mostly oil based related.

Well, we saw some in steel in the first half of the year.

Certainly, some in steel.

But yes, a lot of it has been plastics and chemicals which are oil derived products, yes.

Okay.

And just switching tact a little bit on restructuring, how much of your restructuring spend that you've done is on permanent cost reductions versus headcount reductions or back office headcount reductions that one might consider semi-variable.

Given how decentralized you are, have you taken much structural cost out, i.e, closed factories, shut the lights out?

Yes, we've - - it's a combination obviously, the biggest factor in our restructuring costs, about 85% of it's related to people.

If you look at the headcounts, I mean, the large proportion of those people are going to be in our direct labor force.

The next biggest category would be the period overhead category and then some in the SG&A.

But clearly, we have closed some factories.

We've down sized some factories.

We've retired some equipment.

But largely it's been more about having the right size organization.

So, the difference I think as we look going forward is that in a modest recovery scenario which is what we foresee, we don't see any significant cost additions having put back into the cost base on any near term basis.

So, I don't think this is something where we would expect these were one-time reductions and they'll come back as soon as volumes increase.

They'll come back at some point when volumes increase?

Well, they will, but not the same rate they came out.

Because in many cases we've been able to accelerate productivity improvements and sort of reshape our footprint in a lot of these different factories as well.

So, they will come back, yes.

But they won't come back at the same rate that they came out.

Okay.

Can you quantify the number of facilities you've actually shut down?

It would be, I don't know, probably 10 to 12 facilities.

But the best way to think about it is that we've spent, counting the fourth quarter of last year and what we project to spend the full year this year, somewhere around $200 million, and 85% of that is headcount related.

Okay.

So it's not about facilities in terms of dollar impact as much as it is about the headcount.

We'll take one more question.

Thank you.

One more question, please.

Thank you.

Walt Liptak with Barrington Research.

You may ask your question.

Hi.

Thanks, good afternoon, guys.

Wanted to ask about a quick one on that - - the charge that you took I think in decorating.

The pension charge.

How much was that?

What it was was a charge in the last year in the third quarter related to a pension curtailment charge when decorative services became a discontinued operation.

When we reconsolidated back in the second quarter we restated last year's number.

So it's a comparable issue third quarter of this year versus third quarter of last year, it's about $12 million.

$12 million, okay.

And then on the welding, you talk about being late cycle and that it's going to be one of the last to recover.

But I always think about automotive as being kind of a key welded product and things like pipelines and I think you had a big China business now.

Wouldn't some of those aspects within your welding business be recovering?

Oh, yes.

I mean, certainly some of those end markets are.

Auto is not a huge market for us for our welding businesses.

We don't have a lot of content in the auto industry, per se.

But certainly the oil and gas business have been in Asia in particular continue to grow for us.

But overall if you look at the North American business, remember, this is a business that the welding group is 70% North American centric.

And the mix in our business is 70% equipment, 30% consumables.

So it's a very, very different mix in that regard.

And general industrial manufacturing activities, heavy equipment, steel construction are all down big time in North America.

So, it's really on the strength of that and how people feel about their equipment purchases which drive sort of the capital side of this.

So as expected, we saw much more dramatic decline in equipment than we did in the consumable volume.

Okay.

Has CAT talked to you about their power up program and CAT with - - you mentioned mobile equipment.

Are you seeing increased - - are you ramping up the supply chain for more production next year?

Well, certainly we're familiar with CAT's power up program.

We understand the concept and we're positioned to execute against that program as I think many are.

But we would love to see the upside of their forecast come true and we're ready to participate.

Okay.

Just last one on welding.

Can you talk about market share in North America or Europe?

Has it gotten more competitive?

Ann mentioned pricing, are you still getting pricing in the welding industry.

Well, we haven't had any recent price increases in welding.

Again, most of the price increases that we talked about and the price costs were increases that's occurred the tail end of last year, maybe some in the early part of this year but really nothing significant since then.

The competitive environment remains challenging.

Obviously, in this kind of a market downturn - - it's a very aggressive market environment from a competition standpoint so - - we're out there slugging it out like everybody else is trying to maintain our position and hopefully find ways we can grow it.

It's a challenging market environment when you see your equipment volumes and the activity levels drop in the 50% range.

Thanks, guys.

We'll end it there.

We want to thank everybody for joining us on today's call and we look forward to talking to everybody again.

Thank you.

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