Illinois Tool Works Inc (ITW) 2010 Q3 法說會逐字稿

Welcome to the third quarter's earning release conference call.

All participants are in a listen only until the question-and-answer session of today's conference.

I'd like to inform all parties that the call is being recorded.

Any objections to disconnect at this time.

I'd like to turn the call over to your host today, Mr.

John Brooklier.

You may begin.

Thank you.

Good afternoon, everyone, and welcome to all who have joined us for today's ITW's third quarter 2010 conference call.

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

Despite today's irrational market reaction to our third quarter results and Q4 forecast, we firmly believe we had a very strong set of third quarter financial results.

We'll be talking about those today, especially our organic growth rates and our operating margins.

Let me now turn the call over to David Speer who will talk more about what turned out to be a very, very good quarter for us.

Thank you, John.

The third quarter generated strong total Company operating results, which turned out better that we had expected as we provided our original third quarter guidance.

Worldwide end markets in quarter three appeared to be relatively stable and demand levels were essentially even with our strong 2010 second quarter.

Here's some of the highlights.

Our third quarter organic growth rate of 11.2% was largely driven by strong base revenue growth in our Power Systems and Electronics, Industrial Packaging, and Transportation segments.

Our assorted welding, electronics, industrial packaging and auto OEM businesses also took advantage of solid third quarter end market demand thanks to ITW's strengths, such as our ongoing product innovation and strong customer service.

Our very strong third quarter operating margins of 15.9% were 240 basis points higher than the year-ago period and only 10 basis points lower than the 2010 second quarter, which is generally our top performing operating margin quarter in the year.

It's clear that our past restructuring efforts have helped to improve our operating margins and we thank all of our operating people around the world for a job well done.

Finally, we repurchased 8.1 million shares for $350 million in the quarter.

As we have said a number of times in the past, we consider our share repurchase program to be an ongoing part of our capital allocation process and we remain committed to being opportunistic as to its use as you saw during the quarter.

Now back to you, John.

Thanks, David.

Here's the agenda for today's call.

Ron will join us in a few moments to talk about the Q3 2010 financial highlights.

I will then cover Q3 operating highlights for our reporting segments and then Ron will detail our Q4 and full year earnings forecast.

Finally, we will take your questions.

As always, we ask for your cooperation per our one question and one follow-up question policy.

Next, let's cover our mandatory housekeeping items.

This conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Including without limitation, statements regarding operating performance, revenue growth, diluted income per share from continuing ops, acquisition activity, restructuring expenses and related benefits, tax rates, end market conditions and the Company's 2010 related forecasts.

Finally, one other housekeeping item.

Telephone replay for this conference call is 402-220-9717.

The telephone replay is available through midnight of November 2 and no passcode is necessary.

Now, here's CFO, Ron Kropp, who will comment on our 2010 third quarter financial highlights.

Ron?

Thanks, John.

Good afternoon, everyone.

Here are the highlights for the third quarter.

Revenues increased 12% primarily due to higher base revenues, but this increase was sequentially lower than the second quarter revenue increase of 20% as a result of tougher comparables.

Operating income was $641 million, which was higher than last year by $157 million.

Margins of 15.9% were higher by 240 basis points.

Diluted income per share was $0.83, which was higher than last year by $0.23.

Finally, free operating cash flow was strong, at $412 million or 98% of net income.

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

Our 12.2% revenue increase was primarily due to three factors.

First, base revenues were up 11.2%, which was unfavorable by 390 basis points versus the second quarter base increase of 15.1%.

As David mentioned, we've seen solid revenue gains worldwide led by the Transportation, Industrial Packaging, and Power Systems segments.

North American base revenues increased 11.5% and international base revenues increased 10.8%, which were lower than the second quarter increases of 15.8% and 14.2% respectively.

Next, currency translation decreased revenues by 2.4%, which was unfavorable by 470 basis points versus the second quarter currency benefit.

Lastly, acquisitions net of divestitures added 3.5% to revenue growth, which was 60 basis points higher than the second quarter acquisition impact.

Operating margins for the third quarter of 15.9% were higher than last year by 240 basis points and were essentially the same as second quarter margins.

The base business margins were higher by 160 basis points due to the favorable impact of the higher sales volume, partially offset by the negative impact of non-volume items.

Non-volume items reduced base margins by 130 basis points, which was unfavorable versus the second quarter non-volume impact by 190 basis points.

Including in the non-volume impact for the third quarter were lower costs as a result of past restructuring programs, which improved margins by 40 basis points, offset by the unfavorable impact of price cost, which reduced margins by 90 basis points, and miscellaneous corporate items, which reduced margins by 40 basis points.

In addition, margins were higher by 60 basis points due to higher restructuring expenses last year and acquisitions reduced margins by 30 basis points.

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, other nonoperating income and expense was favorable by $4.9 million, mainly due to a pretax divestiture gain of $20 million related to the sale of the Meyercord tax stamp business.

The third quarter effective tax rate of 31.6% was lower than last year as a result of unfavorable discrete tax adjustments in the prior year.

Excluding the negative impact of taxes related to the Meyercord divestiture, the third quarter effective tax rate would have been 30.5%.

The tax rate for the fourth quarter is forecasted to be in a range of 30% to 31%.

Turning to the balance sheet, total invested capital increased $127 million from the second quarter, primarily due to currency translation.

Accounts receivable DSO was 58.9 days versus 57 days at the end of the second quarter.

Inventory month on hand was 1.8 at the end of the quarter versus 1.7 last quarter.

For the third quarter, capital expenditures were $72 million and depreciation was $81 million.

ROIC for the third quarter increased to a strong 16.6% versus 12.7% last year.

On the financing side, our debt level decreased -- increased approximately $352 million from the second quarter and debt to capital was 28%.

Cash on the balance sheet increased to $1.6 billion from $1.3 billion at the end of the second quarter.

During the third quarter we spent $350 million to repurchase 8.1 million shares.

Our cash position increased $384 million in the third quarter as our free operating cash flow of $412 million was utilized for share repurchases of $350 million and dividends of $156 million.

During the third quarter we acquired five companies who had annual revenues of $120 million.

Our current acquisition forecast for full year 2010 acquired revenues is $500 million to $700 million.

This forecast is supported by an acquisition pipeline of more than $600 million.

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

Thanks, Ron.

Let me quickly review our third quarter segment highlights starting with our Transportation segment.

Q3 2010 total segment revenues increased 16.3% versus the year-ago period.

Our organic revenues, also known as base revenues, grew a very healthy 15.8% in the quarter compared to the year earlier period.

Notably operating margins of 14.9% were 480 basis points higher than the year-ago period.

Base margins accounted for 230 basis points of that improvement.

While year-over-year comparisons continue to get more difficult this quarter based on initial auto production recovery in the third quarter of 2009, our total Transportation segment organic revenues of 15.8% for the quarter was driven by our auto OEM businesses ability to penetrate what today is still a strong auto build environment.

Our worldwide auto OEM businesses grew base revenues 21.3% in the quarter with our North American auto units growing 28.5% and our international auto units increasing 15.5%.

And that's due in large part to their product innovation efforts and form, ongoing platform penetration.

By comparison, North American auto builds grew 26% in Q3 and European auto builds increased 8% in Q3 versus the year-ago period.

So you can see the penetration, our ability to overpenetrate builds continues to be strong within the Company.

On a go forward basis, we continue to forecast that auto builds will remain relatively strong for full year 2010.

North American auto production is forecasted to be in a range of 11.6 million to 11.8 million units, while European auto builds is forecasted to be in a range of 17.8 million to 18.

-- 18 million units for the full year.

In our auto aftermarket group of businesses, Q3 business base revenues declined 2.5% largely as a result of the related downtick in consumer spending in this category.

As new car volume ramped up it appears consumers were aware of spending more dollars on their older vehicles.

Moving to the next segment.

Industrial Packaging's Q3 total segment revenues grew 16.4% versus the year-ago period and Q3 base revenues increased a similar 16.4% year-over-year.

Operating margins of 11.6% were 410 basis points higher than year-ago period, with base margins accounting for 250 basis points of that improvement.

As noted, Industrial Packaging's base revenue growth of 16.4% in Q3 was made up of across the board gains from many of our businesses.

The strong Q3 base revenue growth for the segment underpins our belief that overall end market demand remains at very reasonable and sustainable levels.

Our total North American Industrial Packaging units increased base revenues 19.5% in Q3, while our total international Industrial Packaging units grew base revenues 13% in the quarter.

Coincidental indicator businesses such as our North American plastic and steel strapping businesses and their international counterparts produced base revenue growth of 24% and 13.4% respectively versus the year-ago period.

And our protective packaging units known for their protective corner board and specialty air bag products used for transport purposes grew base revenues a strong 17.3% in the quarter versus a year ago.

Moving to Food Equipment.

Food Equipment's Q3 total segment revenues declined 2.3% as the trend of customers delaying equipment purchases largely stayed in place.

As a result, base revenues grew a very modest 1.4% in the quarter versus a year ago.

The better news in the quarter was that operating margins of 17.6% were 40 basis points higher than the year-ago period.

Most of that operating margin increase was due to improvement in the base margins.

Food Equipment segment's modest uptick in base revenues of 1.4% essentially reflected trends from past quarters and that is customers continue to be weary of buying new equipment, but they continue to invest in our businesses who service their products..

Case in point, our North American equipment business produced a base revenue decline of 3.8% in Q3, but notably our North American service unit generated base revenue growth of 3.6% in the quarter.

So in aggregate, North American Food Equipment base revenues were flat versus the year-ago period.

International Food Equipment results were better, with base revenues growing 2.7% versus the year earlier period.

And this improvement was largely due to better demand for products in Asia and Latin America.

Moving to Power Systems & Electronics, total segment revenues grew a very strong 23.7% versus the year-ago period.

Notably base revenues increased 23.8% on a year-over-year basis thanks to very strong contributions from both the welding and PC board fabrication business units.

Operating margins of 22% were 460 basis points higher than the year-ago period, with 420 basis points of that improvement coming from base margins.

Similar to the 2010 second quarter, the segment's financial performance was driven by our strong operating results from the welding and PC board fabrication businesses.

Our worldwide welding business grew base revenues 14.8% in Q3 versus the year-ago period.

From a geographic standpoint, North America welding base revenues grew 19.4% and that's largely due to better demand from heavy equipment OEMs and assorted manufacturers.

And our international welding Q3 base revenues increased a more modest 5.3%, as European demand was strong while Asia-Pacific was weaker.

For example, China has seen demand for shipbuilding and some infrastructure projects slow over the past few quarters.

Moving to the PC board fabrication side of the business or the segment I should say.

That business produced base revenue growth of 68.6% in Q3 versus the year-ago period.

Ongoing strong consumer demand for products such as cell phones, portable computers and PDAs continue to underpin growth from these segments.

You should note, however, that comparisons from a year ago get much more difficult as we move into fourth quarter and we think we're starting to see a little bit more moderation in order rates in this particular business in Q4.

In Construction Products, Q3 total segment revenues grew 10.9% versus the year-ago period, while base revenues increased 4% in Q3 compared to the year earlier period.

Operating margins of 11.8% were 90 basis points higher than the year-ago period, with 50 basis points of improvement coming from base margins.

It's no surprise that this segment's modest base revenue growth in the third quarter reflected reasonable construction and market demand internationally, contrasted with persistent weakness across North America construction end markets.

Our total international construction base revenues grew 7% in Q3 versus the year-ago period, with our European construction units increasing base revenues 13.3% and our Asia-Pacific construction units growing base revenues 5.1%.

European commercial construction end markets remains relatively strong with German, Germany especially vibrant.

In North America not much of a surprise where our total construction base revenues declined 6.7% in Q3, as weak housing and commercial construction trends persisted.

Our North American residential base revenues decreased 10.7%, while our North American commercial construction base revenues fell 7.8% in Q3 versus the year-ago period.

We move on to the Polymers and Fluids Q3 total segment revenues.

Those revenues grew 5.3% versus the year-ago period.

Base revenues increased 4.3% in Q3 compared to the year earlier period.

Operating margins of 16.4% were 40 basis points higher than the year-ago period.

The segment's base revenue growth of 4.3% in Q3 was largely due to better international activity but slower than expected growth in a few key North American end markets.

Our International Polymers businesses produced base revenue growth of 8.1% in Q3, thanks to better demand in Europe and Asia.

In North America the story was a bit different with our organic growth rates for our Polymers businesses declining 7% in the quarter and this was largely due to issues such as the deep oil drilling disaster in the Gulf of Mexico and its negative impact on oil and gas production.

And also our wind industry demand turned down temporarily as manufacturers slowed production to change to larger blade configurations.

Worldwide Fluids had a more consistent base revenue growth story in Q3, with our international base revenues growing 4% and our North American base revenues increasing 3%.

Moving to Decorative Surfaces, Q3 total segment revenues were flat in the quarter versus the year-ago period, but organic revenue was better with base revenues increasing 3.1% compared to the year-ago period.

Operating margins of 10.7% were 20 basis points lower than the year-ago period as a result of restructuring and other expenses associated with the closing of the flooring business.

Decorative Surfaces base revenue growth of 3.1% in Q3 represented its best quarterly performance of the year.

This improvement was tied to both reasonable demand trends in North America and internationally for high pressure laminate products.

In our North America laminated business, base revenue grew 5% in Q3, largely due to increased buying by office equipment manufacturers for the financial service sector, as well as improved demand for store fixtures for the remodeling of retail stores.

Internationally organic revenues grew 4.9% versus the year-ago period thanks to increased demand in Asia that drove base revenues up 23% on a year-over-year basis.

Finally, as noted before, please note that we are in the process of closing our flooring business due to overall weakening in the high pressure laminate flooring sector.

Base revenue performance by our flooring business was substantially negative in Q3.

And finally moving to our all other segment, Q3 total segment revenues grew 18.6% versus the year-ago period and base revenues increased 13.7% compared with the year earlier period.

Operating margins of 18.4% were 180 basis points higher than the year-ago period, with 100 basis points of that improvement coming from base margins.

The segment's strong base revenue growth of 13.7% in Q3 reflected improvement across our four major businesses in the segment.

In test and measurement our organic revenues grew 8.9% in Q3 and represented the second consecutive quarter where base revenues have grown an 8% to 10% range.

While this business has equipment consumables and service attached to it, recent growth rates may suggest that CapEx spending is perhaps on the rise.

Our consumer packaging business grew base revenues 9.9% in Q3 and was mainly driven by double-digit base revenue contributions from our decorating and graphics businesses.

Our industrial appliance business generated base revenue growth of 18.6% in Q3, with strength coming from both North America and international businesses.

And finally our worldwide finishing businesses produced very strong organic growth rates of 31% in Q3.

Most of that growth came from the international end markets and was led by the specialty Swiss based Gema powder coating business, which has strong product and market positions in both Europe and Asia.

Now, let me turn the call back over to Ron who will cover our 2010 forecast and underlying assumptions.

Ron?

For the fourth quarter of 2010 we are forecasting diluted income per share from continuing operations to be within a range of $0.74 to $0.82.

The low end of this range assumes a 7% increase in total revenues versus 2009 and the high end of the range assumes a 9% increase.

The midpoint of this EPS range of $0.78 would be 28% higher than the fourth quarter of 2009 excluding the impact of last year's favorable discrete tax adjustments in the fourth quarter.

For the full year our forecasted EPS range is now $2.99 to $3.07, based on a total revenue increase of 13% to 14%.

The midpoint of the EPS range of $3.03 would be 57% higher than 2009.

Other assumptions included in this forecast are exchange rates holding at current levels as of the end of the quarter, acquired revenues between $500 million and $700 million, fourth quarter operating margins in a range of 14.2% to 15.2%.

This margin range would be lower than the third quarter margins of 15.9% due mainly to a shift in mix between North America and international businesses and favorable corporate adjustments in the third quarter that are not expected to be repeated in the fourth quarter.

Restructuring costs of $40 million to $50 million for the year, and a tax rate range between 30% and 31% for the fourth quarter.

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

Thank you, Ron.

We will now open the call to questions.

(Operator Instructions) First question comes from Meredith Taylor.

Your line's open.

Hi, good afternoon.

First question is for David.

You've made some comments recently around your expectations for North American construction in 2011.

Could you give some broader comments around some of your other key end markets and how you see some of those trending?

In particular I'm interested in which are the end markets that you see as the strongest and which are the end markets that you see as the weakest looking ahead to 2011?

Well, Meredith, I'll give you some flavor, but obviously we're not providing guidance for 2011, but I certainly from a --

Sure, flavor's great.

Great.

Yes, I have made some comments recently about construction.

I've been asked a lot about particularly what I would expect to see in the residential market and more recently, obviously, the commercial markets and my comments there have largely been that I would expect not to see a significant improvement in residential construction housing starts in 2011.

While I expect we'll see some upward movement, I think we're still obviously dealing with a lot of issues in the housing market due to high unemployment, foreclosures, et cetera.

Commercial market I've also made comments on that the weakness there I think will persist certainly through 2011 and perhaps at the tail end of the year we'll see some improvement in start activity, but I don't expect much out of those markets.

In terms of the markets that have been performing well, I think both John and Ron highlighted some of those in our comments.

We've seen obviously building momentum in our welding businesses, our power Electronics businesses, test and measurement businesses have all been coming on nicely.

I expect that we'll see shortly some improvement in the equipment sales out of the Food Equipment group as I think we're close to seeing those businesses turn as well.

We've seen very strong performance in the Transportation market, but I would expect that the bills in the OEM market, particularly in Europe and ,North America, will be obviously more modest than the significant improvements we saw this year coming off of what was clearly a very, very weak year in 2009.

So I think we're seeing, as we had really suggested, a strong year one of what we saw as a three-year recovery and I think that's largely what I would expect to see as we head into 2011.

Some markets obviously going up against much more difficult comparables so the growth rates will be more modest in 2011.

In some markets that are beginning to see some improvements, the later cycle businesses, I would expect to see better growth rates.

Don't expect to see much contribution at all in 2011 from the North American construction businesses.

Okay, that's helpful.

And just one follow-up.

Can you talk a little bit about your motivation for share repurchase in the quarter?

I mean, was this a reflection on the prospects or timing at least of acquisitions or purely a reflection of your views on valuation.

And maybe to help calibrate that view, could you give us the average share price at which you repurchased in the quarter?

Yes, I think Ron can give you an exact number.

It was $43 and change during the quarter, I think the average share price.

Clearly, as we looked at the quarter and we looked at our strong cash balance and we looked at the acquisition activity over the next quarter or so, it made sense with where we were to buy some shares back, certainly from a valuation standpoint but also from a cash utilization standpoint.

So as you'll note on the balance sheet even after the share repurchases, we have $1.6 billion in cash on the balance sheet.

So we certainly saw it as an opportunity given the current environment and as we've said in the past we would use that share repurchase program on an opportunistic fashion and we did so during the quarter.

Okay.

That's great.

I'll pass it along.

Thank you.

John Inch, your line's open.

Thank you.

Good morning or afternoon, sorry.

Hello.

Yes.

We're here.

Hi.

Okay.

So I want to start with the guidance.

Just as I think about the year, right, so you raised the estimate by $0.08.

You beat this quarter by $0.05.

I think you're lowering restructuring by $0.02 for the year.

Currency, I'm sorry, sales are higher by 1.5 points, could be $0.04 to $0.05.

So then you've got more favorable currency by $0.01 to $0.02.

What is the offset?

Why isn't the fourth quarter midpoint being raised by more and maybe Ron could explain this corporate items issue, you said there was favorable corporate in the third quarter that's less favorable.

What exactly is that and how much is it?

I'll let Ron take that at the end.

Let me answer the beginning of your question, John, by saying first of all the biggest variable between Q3 and Q4, if you're drawing those comparisons, is a significant change in the mix of revenues.

International is a much stronger component of our overall revenue mix during Q4.

As you may recall our international Q4 contains September, October, November, where as the North American is the normal quarter of October, November, December.

So we have a heavier mix and the margins in our international businesses are represented by lower margin profile on the order of about 400 basis points.

So that really explains all-in sort of the change in the margin profile.

As you've noted, there are some other puts and takes that basically net out, but that would be the bulk of the change.

Also remember that the comparable to currency for Q4 for this year versus last year will actually be a negative number as the Q4 currency last year was in the 145, 146 range with the Euro, as an example.

So there's still a headwind on currency built into these numbers.

I'll let Ron comment on the corporate numbers.

One data point on the international North American split.

In the third quarter North America was about 52% of the total revenues and international was 48%.

And that about flips in the fourth quarter.

That's pretty typical given the August month for Europe is in the third quarter and December is in the fourth quarter for North America.

So that's a pretty typical shift in revenues.

The bridge between the margins in the third quarter and the fourth quarter more than half of it is this mix issue.

The other piece of it is base revenues are down slightly and that's due to seasonality, normal seasonality, and then there's corporate items of about $15 million of a benefit that were booked in the third quarter that we're not forecasting for the fourth quarter.

So these are things like we have life insurance investments at the corporate office and the cash surrender value goes up and down based on the market.

That was about $7 million.

Some other reserves for product liability and healthcare, et cetera, was the rest of it.

And Ron, those corporate items, the $15 million benefit, were not part of your original guidance annually, is that correct?

Correct.

Okay.

So I guess I'm just trying to understand, though.

The issues that you've raised, right, so the higher international mix with lower margins, some of the other items and in fact wouldn't those have been known when you gave the annual guidance?

This is sort of what I'm trying to understand.

I think too when you gave your guide at the end of the second quarter, I think currency you had thought was going to be $1.28 dollar to Euro, now it's $1.40.

Just trying to understand.

You raised the year by $0.08.

You beat the quarter by $0.05.

You've got lower restructuring by $0.02.

It just doesn't - it seems like you're actually lowering the core in the fourth quarter, whether it's mix or not, is there something -- I would have anticipated you to have known that.

No?

Or is there something else?

No, we didn't.

I mean, if you look at the changes in guidance for the quarter, first of all, as you know we didn't provide guidance for Q4 before so maybe this is compared to what you had estimated, but I think what Ron has laid out is the typical margin mix.

The growth rate for base revenues for the quarter is about what we had built into our original guidance for Q4, obviously, on much stronger comps.

The corporate items that you're referencing for the quarter, for quarter three they were positive.

We don't forecast those and by and large many of those net out to a pretty zero sum gain by the end of the year, so we don't really predict them quarterly, John.

So it may be that you're doing math here at the end of the year with one quarter left that may suggest that there are other underlying issues.

I think it's the mix of revenues, the lower base growth revenue rate, obviously at 8% as opposed to the 11% we saw in the quarter obviously has somewhat of an impact as well.

But if you look at our traditional seasonality, this is very much in line with the margin profile that we see from Q4 compared to Q3 in a normalized basis.

So I don't think there's anything unusual here that we aren't -- that we haven't explained.

So the base is about where we were at the end of last quarter.

So your $0.08 is really $0.03 of currency, $0.02 of corporate items, $0.02 of restructuring.

Okay.

Did your pipeline for M&A go down?

I thought it was about $800 million and I think you suggested in the call it was just over $600 million.

Maybe just a -- okay, sorry.

We said 600, plus.

Okay.

If we have closed some deals and there are some deals that have fallen out of the pipeline.

But not a significant number.

But that pipeline number -- the pipeline number, John, is going to ebb and flow.

No, I appreciate that.

I was just wondering maybe you could just give us a color in terms of the trend, right, because I think just given your acquisition history and some of the deals you've done historically and the threshold of volumes, one might have expected the activity level to be much higher.

Are we still on that trajectory or the fact that you're repurchasing shares mean maybe we're not.

How should we think about that?

No, no, I wouldn't assume that at all.

That repurchasing shares had nothing to do with how we feel about the pipeline currently.

I would say the activity in the pipeline continues to increase.

As I noted in our last call, the yield in the pipeline does change quarter to quarter, so it's down modestly from what we would have said a quarter ago, but some of that is the result of closed deals and some of that it is a result of deals that are really pushed out into the 2011 timeframe.

So I wouldn't draw any large conclusions out of that modest change in the pipeline nor the repurchase of shares.

Clearly, with the cash balances we had and with the near-term look at the pipeline we had plenty of opportunity to look at this and say it made sense based at those levels to do a share repurchase during the quarter, but certainly not reflective of any change in our view of the acquisition pipeline.

I expect it will continue to firm and I expect as we head into 2011 that we'll begin to see the pipeline continue to grow.

Okay.

Thanks very much.

Thank you.

Terry Darling, your line is open.

Thank you.

Dave or Ron, wonder if we could go back to the price cost gap that you talked about, I think down 90 basis points year-over-year.

And I kind of remember last year there were some unusual benefits, so I'm just trying to get calibrated on really that bridge and then how you're thinking about that, the value gap as you move into 2011 given the recent run-up in some of the metals prices and so forth.

I think partially, I'll let Ron give you some more flavor and detail on it, but partially what you're seeing reflected in that 90 basis point negative headwind is exactly that.

We have seen costs, particularly in the metals category, move up and obviously catching up on that from a price standpoint does take some time.

And that's really what we're seeing in this number in Q3.

I expect that as we head into Q4 we're still seeing some cost increase pressures, but some of the price increases that we have in fact put in place will begin to kick in and I would expect that number to probably come down somewhat modestly during Q4 as a result of that.

So I would describe what's occurring now as probably what typically occurs when you see some commodity cost increases, you have some negative headwinds until you get full cost recovery, which generally takes a quarter or so.

Terry, last year in the third quarter was the low point of most of our raw material costs.

So back last year we had a 270 basis points benefit in margins back to '08 and since then we've seen that come back each quarter.

So it was negative 90 this quarter, was negative 40 last quarter, but given the current situation with prices, we expect it to be relatively stable in the fourth quarter for both steel and resin.

So we're looking at probably 25 to 50 basis points negative in the fourth quarter, so pretty minimal going forward.

And was the 40 to 90 2Q versus 3Q more raw material or more some weakness in pricing or kind of a combination would you say.

I would say it's really driven by primarily cost increases and the speed with which we can recover price.

So we saw some cost increases occur towards the latter part of the second quarter.

We saw lots of it during the third quarter and so some of the price actions we took in Q3 only realized a portion of the cost recovery.

So I'd say it's primarily been driven by cost and the lag effect of price increase.

And as you think ahead to the first half of '11, if you think about how the raw material costs that you're incurring now would kind of ratchet up to spot if we pretended for the sake of the discussion that we held kind of where we are right now, does that gap get more narrow or stay about in that 25 to 50 basis point range you're calling out for the fourth quarter?

I think as costs stabilize, the gap goes to near zero.

Okay.

Just quickly on the Food Equipment margins, should we think of that as a base to build off of or is there something seasonal or mix-wise that made 3Q particularly strong?

No, I think other than the normal seasonal impact, which is volume related, no, I think that's probably a reasonable assumption.

That's a base to build off of.

We have yet to see any significant improvement in the equipment side and obviously when we do we would expect to see strong incrementals in those businesses.

The only growth I've seen of any reason so far, any reasonable growth has been in the service side of the business.

I would expect that the margin profiles you're seeing today is a good foundation for us to build on as we begin to add volume in the coming quarters.

That's terrific there.

And there is no impact in the third quarter on price cost in that segment as well.

So we didn't have the negative we did in some of the other segments.

Okay and then just lastly I'm wondering if you can calibrate the accretion in 2011 from M&A that's already essentially been consummated, give us an update on that.

We really don't have those numbers, Terry.

I think the way to look at the M&A numbers, roughly you take our annual volume and you can figure that about half of that will be spread between 2010 and 2011 in terms of impact, so you can expect that at least half of -- first half of next year will have some impact of that.

The first year all-in of acquisitions we generally get very little earnings accretion as a result of all of the amortization and accounting that takes place in year one.

We really don't get much, generally much net benefit.

So we haven't obviously calculated this for 2011 yet.

Obviously the 2011 guidance we'll have some guidance around what we would plan to acquire next year as well.

But by and large, year one we don't get a lot of accretion, so wouldn't be a huge impact certainly in 2011 in the first half of the year and probably a modest impact from those acquisitions we've done in 2011 in the second half.

Okay, thanks much.

Eli Lustgarten, your line is open.

Good afternoon.

Afternoon.

Very quickly, could you give us some idea of what your business trends are sequentially?

You gave a year-over-year, we know things are slowing with tougher comps.

Can you give us some idea of what's happening sequentially in your businesses.

I mean, it appears that a lot of business -- most industrial markets seem to be relatively flat at this point.

Can you give us some idea of what's going on across the businesses.

I don't have a lot of sequential data here in front of me.

I think Ron provided some flavor on some of the Q2 to Q3 comparables.

I can tell you that overall the revenues in Q3 were pretty much in line with, slightly less than what we saw in Q2, which is somewhat abnormal, given the normal seasonality we would normally have seen a decline between Q2 and Q3 of somewhere in the order of 4% to 5%.

We didn't see that obviously this quarter.

Our revenues in Q2 were about $4.1 billion.

Our revenues in Q3 were $4.04 billion.

So not a significant decline from a seasonal standpoint we would normally have seen.

Obviously that varies across businesses.

The ones that clearly we've seen sequential uplift on are the ones that John highlighted in the earlier discussion.

Certainly the Industrial Packaging businesses, the test and measurement businesses, the welding, electronic segment, those are the ones that sequentially we would have seen growth quarter to quarter but I don't have it by segment.

Perhaps we could come up with that and provide that to you at a later date, but we don't have it at our fingertips at the moment.

Okay.

And are you still expecting -- it doesn't sound like order production is expected to go down very much in the fourth quarter anymore versus what you had both here or in Europe.

Seems like the numbers are a bit higher than you had expected or had been talking about, is that fair?

Yes, the build numbers have clearly gone up throughout the year although I would say that the increases for Q4 are modest by comparison to the last number.

So I think the projected build for Q4 in auto in North America is somewhere in the 3 million range and should end up, as John said, somewhere around 11.6 million to 11.7 million for the year.

Most of the increase in the build occurred in the first two quarters.

It was still a nice increase in Q3 and I think in the European auto builds, likewise, we saw most of the improvement actually occurred during the third quarter and subsequent quarters.

So I'd say that the auto build I would describe it as the normal seasonal flattening in Q4 and I expect that the growth rates based on what we are seeing from the early CSM data for 2011 will be probably in the North America somewhere in the 5% to 6% range and in Europe probably in the 3% to 4% range.

And I think you indicated that welding was softer in Asia at this point.

Is that (inaudible)?

Yes.

It was softer in Asia really driven primarily by our strong concentration in the shipbuilding market there.

The ship building market in China is down nearly 40% this year, so it obviously dampened our overall growth rates in Asia with welding as a result of that.

And the rest of the markets were pretty strong.

Rest of the markets were quite strong.

Our oil and gas business over there is very strong.

The general steel fabrication markets are very strong.

All right, thank you.

You bet.

Deane Dray your line's open.

Thank you.

Good afternoon.

Just a follow-up on Eli's question regarding sequential improvement.

I do have the numbers in front of me on this one but Industrial Packaging, since it is such an important coincidental indicator, looked like it had steady sequential improvement across the quarter and would be interested in hearing what that mix was, equipment versus consumables, but more importantly the read across in terms of what that suggests in terms of longer term growth, industrial production and so forth.

Well, given the strong performance that we've had or the strong mix we have in those businesses in Europe, actually flat quarter to quarter is a strong indication of the continued recovery in those markets.

Normally we would have expected to see somewhere around a 6% decline just based on seasonality and that wasn't the case during the quarter.

So if you look at the overall growth rates that John highlighted and Ron in their comments, if we just take the strapping businesses, Deane, the consumable volume in Q3 was up in the 11% to 12% range.

The equipment volume was up over 50%.

So strong improvement in equipment volume during the quarter.

That's obviously an important indicator that at least we're seeing a significant level of replacement sales taking place and in some cases even some new capacity being added in some markets.

So it's only been two quarters of positive growth on equipment.

Obviously, that's a very strong comparable in Q3 on the equipment side.

All right.

That's very helpful.

And then I know you're not in the 2011 guidance business yet but is it fair just to take a stab at what you believe peak, getting back to peak margins given the pace of the recovery.

You said we were year one of a three year recovery, if you peaked previously at 17% operating margins, is it fair to say that you've got upside to that and we're looking at about 100 basis points from there, but what are you using for internally or just what you can share with us today.

Yes, well I think as we said earlier and you pointed out, we think this is a -- 2010 is year one of a solid recovery.

Our margin profile for this year will finish north of 15% overall for the year if you take the midpoint of our fourth quarter guidance and the three quarters of actual.

Clearly as we look at this as another year of recovery, albeit slower in 2011, I would clearly expect to see margins continue to accelerate.

We said that based on peak to peak, we would expect that we would have somewhere between 50 to perhaps 70 basis points higher peak to peak earnings ratios.

The only impact there would be the level of acquisitions that we did that is dilutive, but if you look at base to base we would expect somewhere between 50 to 70 basis points higher margins.

I don't expect that we get to that next peak in most of these markets until 2012.

That's very helpful.

Thank you.

You bet.

Ann Duignan your line's open.

Hi, good afternoon, guys.

Hi, Ann.

Just building on the last couple of questions, David, maybe you could give us an outlook from your perspective what you're seeing out there.

It looks like if you look at any of your businesses or most of your businesses that are driven by the consumer, those are recovering slower than businesses that are industrial production driven.

And so the notion of restocking comes to mind.

What are you seeing as a kind of from the consumer's perspective.

You noted in a few businesses that consumer spending has actually slowed versus kind of restocking our industrial production driven demand.

What is the net impact maybe looking into 2011?

I know, again, you're not going to give guidance but just what you're seeing out there, David.

You usually have a good finger on the pulse.

Yes, I mean, clearly the consumer businesses, especially in North America, have clearly been plateaued.

They're generally weak, depending on the specific end markets.

Take markets like auto, the auto business has actually performed well on a year on year comparable, but last year was obviously an extremely low year in overall auto production and sales.

So I think any of the consumer-facing businesses have remained challenging in terms of looking at any significant growth.

We don't think there's much restocking going on.

Most of it's been done already in those businesses.

The industrial markets have clearly been the ones that have been stronger and we would expect to see that as we head into 2011, particularly as it relates to North America.

The US consumer, as you accurately point out, consumer spending has gone up and it's gone down.

It's pulled back.

I expect we're going to see that for a while, the consumer markets remain weak.

Unemployment remains persistently high.

The housing market's weak.

So a lot of things tied to the consumer.

Clearly there's not much of a tailwind and in fact in some cases you could say there is perhaps somewhat of a headwind on those markets.

On the industrial side we've seen, I think, good strong recovery in most of the end markets.

As I pointed out earlier, some of those markets are now just beginning to show some signs of recovery.

Those are the later cycle markets that we talked about earlier.

And I would expect that the trends that we're seeing at the moment, I would expect that they would remain intact as we head into 2011.

So albeit somewhat slower growth comparisons, obviously as we head into 2011, you've got a GDP estimate out there now for next year that's somewhere between 2 and 2.25 for the US and that's significantly down from the numbers people expect to see overall this year.

So I don't think that's a surprise we would expect to see slower growth rates.

But I do expect we'll continue to see stronger industrial growth clearly than we will in the consumer markets.

Okay.

Thank you.

And just one follow-up on M&A front.

What kinds of businesses are coming up for offer?

I mean, are you turning down a lot of businesses because they're not in areas that you're interested in or is it kind of everything that's coming on your desk you're taking a good look at?

Just kind of curious what's coming into the pipeline there, whether there's a lot of activity out there and you're just turning down opportunities or whether you're kind of taking whatever is coming up and turning it over.

Right.

Well, first of all, just to remind everyone, pipeline for us are deals that are past the letter of interest stage up to due diligence and closing.

So it's not the idea pipeline.

The front end of the pipeline, if you want to call it that, the idea phase that we don't count, has been very, very active.

There are lots of things out there that have come to us that are not particularly attractive.

They really don't fit strategically with where we want to continue to grow and go.

There are plenty of ideas out there for spaces that we are interested in, valuations have been challenging, particularly anything of size.

Private equity clearly is active in the market for any deals of size, anything $100 million or more in size there's plenty of private equity people out there that with the new math can make significantly higher offers than many strategics.

So it is a more competitive environment, but I would say that in the last 120 days or so the whole market has opened up in terms of ideas and flow of opportunities.

I expect that as we continue to work our pipeline that we're going to see that pipeline improve over the next several quarters.

But a lot of activity, valuations are -- have moved up quickly and I think it's a challenging market from that standpoint.

But we're looking at all the normal spaces and I'm very confident that as we move forward we're going to see that this cycle in acquisition activity for us will move to the next level as we head into 2011.

Okay.

That's helpful.

Thank you.

I'll get back in line.

Mark Koznarek, your line's open.

Hi, good afternoon.

Hi, Mark.

I've got a question about the decorative business with the closing of the flooring.

What kind of impact is that going to have on the revenue line and what kind of margin improvement opportunity is that?

I imagine you're not (inaudible - technical difficulty)-- little bit but just rather -- (inaudible - technical difficulty).

The market is pretty inconsequential all-in.

That business has been in a shrinking mode for the last five years.

So I think the annualized revenues in this year's outlook would be under $25 million.

And it was with the restructure going on a business that would have lost money.

But in or out it's not a huge difference for the segment or for the overall earnings profile.

Dave, did you say 25 or 125?

25.

About $25 million in revenues.

Two and a five.

A two and a five, yes.

Okay.

Not a one, two and a five.

No, no, no, no.

$25 million, right.

Okay.

And so the margin impact is also going to be very modest.

It will be positive because it was losing money.

Okay.

Well, that's sort of what I wanted to focus on a little bit, whether that's material or not, because it seems like moving into 2011 there's a couple positives.

There is that benefit, whether it's material or not I don't know, but we also have lower restructuring probably and also the benefits of the past couple years of significant restructuring.

So it seems like it would be a pretty fair assumption that you would have better than average leverage on the margin line, not a lot of acquisition dilution and then some of these other structural improvements.

Is that a pretty fair assessment or are there some other offsets that you're thinking about?

No, I think the way to think about it, I mean, first of all, the Decorative Surfaces is not consequential, so I would think the best way to respond to your question is to think about our normal incrementals.

Our normal incrementals are in the 30% to 35% range.

They've been running north of 40%, obviously this year, in the first year of a significant recovery.

We are already seeing significant benefits out of those restructuring projects and out of those acquisitions with lower margins.

Some of that's obviously already in our numbers.

I would expect that as we look at the growth rates and business in 2011 that we would expect to see incrementals probably somewhat higher than our norm, maybe in the 35%, maybe as good as 40% range next year.

But certainly not in the same category range they've been in this year, as we've already leveraged significant growth off of some of that.

In terms of restructuring spend next year, I think what you'll see all-in is that our restructuring spend this year is probably going to end up being pretty typical of what it is on a normalized basis, so somewhere in that $40 million to $50 million range is where we'll end up for the year and that's a pretty typical year for us.

So obviously a lot less than what we spent last year when we spent over $160 million, but again, we're not providing guidance for 2011 but a pretty normalized range of restructuring for us is in that $40 million to $50 million range.

Most of it directed towards acquisitions that have been done in the last several years.

Okay.

And then what was that comment about Food Equipment?

I thought you mentioned that it looked like it was about to break out.

It was -- the equipment side was negative in the quarter, but what gives you thoughts that it's likely to turn positive.

I think the activity level from a quoting standpoint, the project level, a lot of our business is institutional ready.

These are larger projects that have a longer planning horizon and we're beginning to see the front end of that activity pick up, which generally is a good indicator that at some point in the next quarter or so we should start to see the equipment revenues begin to rise.

We'll also be going against -- we've got comps now that -- remember, these were the later cycle businesses that actually for the first two quarters of last year had positive growth.

So we're really at a point now where I think we're close to seeing the bottom here and should start to see some improvement in the revenue volumes.

We haven't seen any significant leverage off of the cost base in those businesses yet, obviously, as we haven't seen the volume.

Okay, good.

We'll look forward to that.

Thank you.

Henry Kirn, your line's open.

Hi, guys, it's Henry Kirn.

Hi, Henry.

What do you factor in as the biggest risks to upside to your guidance as we go into the fourth quarter and then into 2011..

What should we be watching?

Well, I mean, you could look at our base revenue growth rates.

I mean, at 8% midpoint for Q4 it's pretty much a what we would describe as a continuation of the recovery that we've seen, so the recovery -- any significant derailing of the recovery would obviously put that growth rate under some pressure.

Most of the significant growth in comparables that are -- the easier comparables, if you will, are behind us.

As Ron pointed out in his earlier comment, our businesses really began to accelerate more significantly in Q3 of last yea, so we're up against a more difficult comparable.

So 8% on a stronger fourth quarter comparable is a pretty good growth rate, but pretty much in line with the trends we've seen recently.

So while it's compared to the fourth quarter of last year, I think on a sequential basis you'll see the number in Q4 certainly in North America shows a modest decline.

So I think the answer to your question would be if the current recovery got derailed in some major fashion I suppose that would be the largest upside risk.

It's hard to cite any particular segment or area because the growth across the segments has been pretty broadly spread across a lot of end markets and geographies.

So don't know if I could add much more flavor than that.

And is there anywhere where you think you might be too conservative, if there was any one area?

Well, I'm not sure I could highlight.

I think the last two quarters the revenue growth rates have really been in line with our original guidance, so I don't want to say we're proud to be right, but I don't know that I'm so bold as to say we've been completely conservative anywhere.

I think we've clearly projected what we saw as continued improvement.

I can't think of any particular area.

Obviously, if something were to change dramatically, if you're looking for a headline, it would have to be a dramatic improvement in residential housing.

I can't think of any other area that we're conservative in and conservative is a measure of what actually happens, right.

Which is very, very unlikely.

Right, exactly.

The housing starts are clearly remaining at historically low levels.

Our forecast there would be perhaps rated conservative if the numbers tick up by 20% next year, but I wouldn't be able to highlight any particular areas being overly conservative.

That's helpful.

Thanks a lot.

Robert Wertheimer your line's open.

Hi, good afternoon, everybody.

Thanks for fitting me in.

My first question would be on share.

We don't talk about it too much, but I wondered as you've gotten through the trough and taken a look at the competitive position, where and how much you think you might gain share.

Specifically we can do auto.

I don't know whether -- the numbers are pretty volatile on the build and the SAR and your numbers, so I don't know whether you have started to see a lot of share gain where that comes in with the '11 models or the '12 models and how much you think that could add any other areas you might call out where share look interesting.

Well, the auto is the easiest one to look at because there's more data, it's more transparent.

If you look at auto builds, content per vehicle, new platform launches, et cetera, we at least have some visibility.

We'll pick up somewhere around 4 to 5 points of penetration gain overall this year and I would expect that as we look at the 2011 year, we'll be expecting something in that range, maybe even slightly better, depending on the timing of a couple of new platform launches where we have significant content.

So I think that in many of our businesses we would suggest we have picked up at least modest amounts of share.

In those where we have more definitive measurements and we can measure it, we can obviously see it more directly, but auto is probably the best example because it's the only solid sort of global database that you can tie sales, production and platform content to.

That's 400 to 500 bps faster than the end market this year that would be sharing in content penetration both together.

That's correct.

Yep, exactly.

And that's measuring the overall global markets; right.

And again, David, as you've gotten through the trough, do you think that any of the lesser acquisitions were due to people being overly focused on operations as opposed to acquisitions and is that reversing or has that just not been a factor?

And are you seeing -- are you spending any more of your time evaluating platform level acquisitions?

I would say that we didn't spend as much time in the first half of 2009 on acquisitions, as we were clearly trying to identify with our base businesses where these markets were going that were in great turmoil.

But by the second half of last year we were really fairly well engaged in the acquisition process again and the really the delay in a lot of this has really been, I think, more around expectations of what happens with potential acquisition targets that were also in a state of decline.

So many of them had, if they were later cycle businesses, they still didn't have good numbers to look at until probably early this year.

In terms of my activity and the activity of our senior executives, we were spending a significant amount of time, certainly even more time than last year, on the acquisition front, particularly as it relates to platform opportunities and perhaps some new segments as we look forward.

So there's a lot of activity in that area for sure and really virtually none of that is included in our pipeline at the moment.

We're going to end -- thank you, Rob.

We're going to end the call now.

We thank everybody for joining us today and we look forward to talking to you later.

Thanks.

That concludes today's conference.

Everyone may disconnect at this time.