Illinois Tool Works Inc.
Q2 2008 Earnings Call Transcript

Published: 18 Jul 2008

[Operator:]

Welcome to the ITW Second Quarter 2008 Earnings Conference Call At this time, all participants are in a listen-only mode. [Operator Instructions]. Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the call... the meeting over to Mr. John Brooklier, Vice President of Investor Relations. Sir, you may begin.

[John L. Brooklier:]

Thank you very much. Good afternoon everyone and welcome to ITW's second quarter 2008 conference call. With me today is David Speer, our CEO, and Ron Kropp, our CFO. As always, thanks for joining us. At this point, David will make some brief comments about the recently concluded quarter. David?

[David B. Speer:]

Thank you, John. Given the current state of the economy in the U.S., our operating performance in the second quarter was impressive on a number of levels. Let me cite a few examples. Our diluted income per share from continuing operations grew a strong 17% in the quarter. Total company revenues increased 10.5% in the quarter, as second quarter total company operating margins of 16.6% were 20 basis points lower than the year-ago period. But most notably, base margins were 30 basis points higher than a year ago. We continue to acquire companies that add both revenue size and diversification. Through June 30th, we have completed 26 acquisitions, representing $538 million of annualized revenues. Notably, more than two-thirds of these acquired revenue estimates emanate from European and Asia Pacific locales. Finally, we continue to repurchase shares in a value-adding way. Through 30th, the company has paid $585.6 million to repurchase 11.8 million shares. All in all, we believe, our operating performance in the second quarter exemplifies our ability to outperform across slowing end markets, thanks in large part to our decentralized operating structure and our aggressive efforts to manage our operating costs. John, let me turn it back over to you.

[John L. Brooklier:]

Thanks David. Here is the agenda for today's call. Ron will join us shortly to review our Q2 financial performance. I will then cover operating highlights for our eight reporting segments. Ron will then address our 2008 full year and third quarter earnings forecast and associated assumptions. Finally, David, Ron, and I will take your questions. As always, we ask for your cooperation for the one question, one follow-up question policy. We are targeting the completion time of one hour for today's call. First, the usual disclaimers. Please note that this call and accompanying presentation contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including without limitations, statements regarding operating performance, revenue growth, operating income, diluted income per share from continuing operations, and use of free cash, acquisitions, end market conditions, charges and the company's related forecasts. These statements are subject to certain risks, uncertainties and other factors, which could cause actual results to differ from those anticipated. Important factors that could cause actual results to differ materially from the company's expectations are set forth in ITW's Form 10-Q for the 2008 first quarter. Finally, before we go to Rob, the telephone replay for this conference call is 203-369-1553. No passcode is necessary. The playback number will be available through 12 midnight on July 31, 2008. You can also access our second quarter conference call PowerPoint Presentation via the itw.com website. Once you access the Investor Information section, just look for the Events tab. Now, let me turn the call over to Ron. Ron?

[Ronald D. Kropp:]

Thanks, John. Good afternoon everybody. The highlights for what we believe to be a very good quarter were as follows

[John L. Brooklier:]

Thank you, Ron. Let's review the second quarter highlights for our eight segments. Beginning with industrial packaging, revenues increased 14.6% and operating income grew 17.3% in the quarter. Operating margins of 13.2% were 30 basis points higher than the year ago period, thanks to a 90 basis-point improvement in base margins. The 14.6% increase in top line consisted of the following

[Ronald D. Kropp:]

Thank you, John. We are forecasting third quarter 2008 diluted income from continuing operations to be within a range of $0.93 to $0.99 per share. The low end of this range assumes 10% growth in total revenues, and the high end of range assumes 14% total revenue growth. The midpoint of this EPS range of $0.96 would be 8% higher than the prior year. For full year 2008, our forecasted earnings range is $3.40 and $3.52 per share. Full year total revenue growth is expected to be in the range of 9% to 12%. The midpoint of this earnings range of $3.46 per share would be 5% higher than 2007. This midpoint of $3.46 is $0.04 higher than our previous range as a result of our actual second quarter results being $0.04 better than the midpoint. Excluding the two special charges in the first quarter, the midpoint of the full year EPS range would be 12% higher than 2007. Other assumptions included in this forecast are

[John L. Brooklier:]

Thanks Ron. We'll now open the call of your questions. Again I remind everybody about the one question, one follow-up question policy. Question And Answer

[Operator:]

Thank you. [Operator Instructions] The first question comes from Eli Lustgarten with Longbow Securities. I'm sorry... the first question comes from Shannon O'callaghan at Lehman Brothers. Your line is open.

[Shannon O'callaghan:]

Good morning guys.

[John L. Brooklier:]

Hi Shannon.

[Shannon O'callaghan:]

Can you talk about the overall, I guess, base revenue view for the year now? What it is versus what you thought and some of the puts and takes. I mean if you had something's get worse, something's get better?

[David B. Speer:]

I think, if you look at what we see happening for the rest of the year, I would describe it perhaps as more of the same. That is weak growth, weak numbers here in North America, a continuing slowing trajectory in Europe, and a continued strong performance in Asia. So I think, we would expect the second half base numbers to be somewhere in the all-in range, somewhere in the 0 to 2% range.

[Shannon O'callaghan:]

Okay. Can you flash out I guess the international picture a little bit? I mean you saw some international weakness certainly in Europe. You're characterizing Asia as sort of just a strong. When did you start to see some of this weakness materialize in Europe and how bad do you think it's going to be?

[David B. Speer:]

Well I think the weakness we have seen in Europe were characterized probably by some of the larger data segments that we talked about earlier. And that is in auto. The build rate in Europe is flat, probably for the second half, it will be down slightly. And in construction, certainly in the residential categories and now in the commercial categories, we have seen market activity there dip as well. The residential sectors in Spain, Ireland, the UK have been weak, since the end of last year. And the commercial sectors in some of those countries have also started to weaken, but still in positive territory in the commercial side. So I think Europe, I would describe Europe, the slowing in Europe is largely in line with what we had projected as we began the year. So nothing really outside of what we had expected. We've seen some of that also in the general industrial markets in Europe as well, as the numbers are coming down to 0 to 2% kind of growth in some of those markets, back into the more traditional sort of European range but also coming off some pretty strong comparables to same period last year.

[Shannon O'callaghan:]

Okay. And then just one last clarification. Just so, obviously auto is one thing we know that's been a little worse than the last projection. I mean, would you say, I mean, I guess Power Systems is clearly coming in very strong. Is that... that looks like a potentially an offset to some of that incremental weakness there, is Power Systems coming in stronger than you thought? Is that kind of a rate you saw internationally in the quarter there sustainable?

[David B. Speer:]

Yes, Power Systems has definitely been stronger than what we had in our original projections. And certainly the international side has been very strong. So that certainly has been a large upside. And the test and measurement area is also stronger than what we had anticipated. Those are probably the two most notable strong areas that I would highlight.

[Shannon O'callaghan:]

Okay, thanks a lot.

[Operator:]

The next question is from Eli Lustgarten with Longbow Securities. Your line is open.

[David B. Speer:]

Hey Eli.

[Eli Lustgarten:]

Good afternoon. I was sort [ph] of confusing for a minute. We just saw on the trends; your guidance for the second half of the year implies a softening economically results slowly [ph]. Your third quarter is a little bit softer than the second quarter. And by implication, your fourth quarter actually is a little softer than the third quarter. Is that just strictly based on economic forecast? currency anniversaries at year end, you're getting a nickel a quarter from currency, looks like at this point. Current guidance, the trends that you are seeing, particularly there's going to be more implications for 2009 than anything else.

[David B. Speer:]

Let me answer that Eli, first, and then I'll let Ron comment as well. I think, first of all, if you look at our numbers traditionally, the second quarters are strongest quarter. So the trends you're seeing in the third and fourth quarter are pretty much in line with how our years normally unfold. I certainly would also suggest that as we look at developing our plans originally, our second half is really in line with what we had outlined. So really nothing remarkable there. As I mentioned earlier, some things may be somewhat weaker and some thing somewhat stronger but all in, the numbers that we're showing for the second half are pretty much in line with our original plan and guidance. So I'll let Ron add a little more flavor if he would like.

[Ronald D. Kropp:]

Yes, I think just to reiterate it, I think the base level we're talking about, rest of the year is pretty consistent with where we've been in the first half at zero to 2% range. Acquisitions have been about the same. Currency, as David mentioned, currency that we will see a little bit less of advances in currency in the second half as we had very some strong currency especially in the fourth quarter last year. So that will tick up a bit. On the margin side, we expect to be, something that's similar 15 to 16% range for the rest of the year as well.

[David B. Speer:]

It's really more of the same.

[Eli Lustgarten:]

Okay. And can you talk about cost price going on in business? We ramp in material inflation cost everywhere, globally. Can you talk about how much of your quarter is pricing or give some flavor what's going on in pricing across your businesses, where the strengths are, the overall pricing and what the assumptions you have in the second half as far as cost price?

[Ronald D. Kropp:]

You are correct that we are definitely seeing some raw material price increases this quarter. And I think we will see some more in the second half here, especially in the steel area. And some of our businesses have seen steel increases in that 30 to 40% range in the quarter and the rest obviously has been significant. Also, less so on the resin in the second quarter but we are expecting to see some more increases in resin given the price of oil in the third and fourth quarters. So, overall, I think we've done a pretty reasonable job of recovering these cost increases. But most of our businesses have recovered the dollar amount of the cost increase. So we haven't fully been able to recover all the full margin impact. So as that is diluting margins a bit in the second quarter, the impact of pricing and cost was a negative 50 basis points for the whole company, versus about negative 20 basis points in the first quarter of this year.

[David B. Speer:]

So we've seen some multiple increases particularly in the steel category. I think on a year-to-date basis, the average steel increase for us now for our businesses is approaching 100%. We've had multiple increases in the second quarter. So as Ron pointed out a 50 basis point detrimental impact in the second quarter and that's really because we haven't been able to get price increases in fast enough to support multiple cost increases. I expect we will see a similar trend in the third quarter. And I think as we head towards the end of the year, we'll see some catch-up occurring. But clearly, the steel is most notable. We've also seen inflation cost pressures on plastic resins and chemicals, but not to the same degree.

[Eli Lustgarten:]

Do you have a make-up, how much first sales were up, by pricing and how much pricing in the quarter?

[John L. Brooklier:]

Yes. For the quarter overall it's in that, 1, 1 plus percent range.

[Eli Lustgarten:]

Okay. Thank you very much. I'll go back in queue.

[David B. Speer:]

Thanks Eli.

[Operator:]

The next question comes from Deane Dray of Goldman Sachs. Your line is open.

[Deane Dray:]

Thank you. Good afternoon.

[John L. Brooklier:]

Hey Deane.

[Deane Dray:]

It sounds like you can't... David, would love to hear you recap the Enodis transaction. This was unique for ITW in that you engaged in a public bidding process for an asset that did get pricy. But the good news is you did not end up with the winners curse, but there are some certainly some puts and takes here and what should the takeaway be for us today?

[David B. Speer:]

Well, I think the takeaway, I would say, are a couple of things. Deane, first of all, we think of food equipment category continues to remain an attractive category, even without the Enodis acquisition, we think there are many good opportunities to continue to acquire in the segment. We think the fundamentals as shown by our performance in the segment over the last seven or eight years remain there. We've seen strong growth both in our base revenues and in our margins throughout that period. So we are encouraged that it's a category that continues to be attractive to us, and we have a nice pipeline at the moment of additional opportunities. So we'll continue to be active in that space. So I think that's certainly one takeaway. The second takeaway is frankly, while the asset was attractive and certainly we think it fit very well strategically, we maintain the valuation discipline on this process. And well even our did by our standers was a pricy bid at 280, positioning the company there at about almost 12 times EBITDA, we think that it was at that level a very attractive deal for us. But the number ultimately went for 328 well beyond what we thought was a reasonable valuation. So I think in spite of the fact that it was strategically attractive and in spite of the fact that we think we could have done very well with it as demonstrated by how well we've done with TRYMER [ph] there was a limit to what we thought the valuation was. And I think discipline we maintained in that process was evident by the fact that, while we could have bid higher, we didn't.

[Deane Dray:]

Sounds good. I mean the takeaway is, it looks like you never caught deal fever on this. But how about pipeline of transactions, as it looks today in terms of, if you would characterize it, is it still more skewed outside the U.S.? And how about by segment line, is there... are there products that would have higher growth content, more test and measurement? Just can you give us some color there, if you could?

[David B. Speer:]

Yes sure. The pipeline remains strong. The pipeline is in the $1.5 billion range in terms of total revenues. That's got about six months visibility to it. So we are starting to see, at the end of the year, if you own in our pipeline, our close rate the last couple of years has been somewhere in the 60% range, just as a matter of reference. We have, at the moment, in the pipeline, two larger transactions, larger being greater than 200 million in size. There are several transactions in that size range that we think will close, hopefully in the next 30 to 45 days. So I would expect that, if they close according to schedule, that will be perhaps addressing the range as we look at the year going forward, when we release our monthly update in September. So I think I would characterize the pipeline as strong, good spread in terms of businesses. There are three nice deals in the pipeline that would feed into our test and measurement space, and equally some nice deals in a couple of other spaces as well. So, I would characterize it as probably the most robust pipeline since I've been CEO for sure.

[Deane Dray:]

Well that says a lot. We'll stay tuned, thank you.

[Operator:]

The next question comes from Andy Casey with Wachovia Securities. Your line is open.

[Andrew Casey:]

Thanks. Good afternoon everybody.

[John L. Brooklier:]

Andy.

[Andrew Casey:]

If you could give a little more color on the non-volume negative margin impact on construction, food equipment and auto and then the positive impact on Polymers and Fluids please.

[Ronald D. Kropp:]

Construction, food equipment, auto, polymers and fluids, okay. So starting with construction, non-volume was negative 33 basis points, was actually better than it was in the first quarter, negative 50 basis points. Of that 20 basis points less negative 20 [ph] pricing and cost. So it's mostly pricing and cost. In the food equipment area, negative 100 basis points, most of that is related to a variety of issues, including mix, additional loss costs on new products, and also higher vehicle expenses primarily related to fuel. In the transportation area, negative 60 basis points, this quarter, price cost, negative 30, the rest of is a variety of mix and other issues, something significant. On the Polymers and Fluids side, favorable 230 basis point. Price cost was actually negative 50 in this segment but overhead was favorable by 245 basis points. And they've done a really nice job in this group of controlling overhead costs, and we've also seen some benefit of past restructuring programs.

[Andrew Casey:]

Okay thanks.

[Operator:]

The next question comes from Ann Duignan with JPMorgan. Your line is open.

[Ann Duignan:]

Hi good afternoon. This is Ann Duignan.

[John L. Brooklier:]

Hi Ann.

[Ann Duignan:]

Hi. Could you just tell us, you took down your non-operating expense by $10 million your guidance for the year, a) why and b) how much of that fell in Q2 and how much of it falls in to the remaining of the year?

[Ronald D. Kropp:]

Most of that was in Q2, a little bit rest of the year. But we picked up about $0.02, $0.015 in the second quarter and non-operating carried out, which is what we expected.

[Ann Duignan:]

Was there anything in particular, was it just --

[Ronald D. Kropp:]

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

[Ann Duignan:]

Okay. That's helpful. Thank you. And then my follow-up, David, back to you on the organic growth. If I look at your different businesses, I only see Power Systems and Electronics really accelerating, all the other businesses are either very weak or decelerating. How confident are you that, that business alone can get you to a flat organic growth for the remainder of the year? Or are you seeing some other end markets beginning to recover?

[David B. Speer:]

Well I think there is... I think clearly that group alone stands out as being the strongest growth trajectory, but there are other pieces of businesses, not necessarily whole segments that are, that are still growing nicely. And certainly in the All Other category where we have test and measurement, that's growing nicely. But there are probably only three or four businesses, I would put in that category, that have enough trajectory, if you will, at the moment for us to be comfortable, those numbers are good. I think the declines that we've seen, particularly in auto and construction, and certainly in North America have been well headed and are really imbedded in our views going forward as Ron and John highlighted earlier. We're talking about auto build in the second half of the year now that is minus... somewhere in the minus 10% to 12% range. I might remind you that when the year started the forecasts were for the auto industry to be down in the 6% range. So we have clearly recognized that we've had greater negative growth in auto and somewhat greater negative growth in residential construction than perhaps we began the year with. But all in, I think from an organic growth standpoint, I think the numbers we're seeing are representative of what we would expect to see play out in the second half of the year, with some puts and takes here and there. But all in I think we're comfortable with those numbers.

[Ronald D. Kropp:]

I would also add, you'd probably want to add food equipment and polymers and fluids at least as a segments, they're going to probably hold their own through the second half of the year as opposed to further deceleration.

[Ann Duignan:]

Okay, that's helpful actually, because as I looked at those businesses, I saw the decline. Also if you look at the rate of decline in international markets versus the rate of improvement, if you call it improvement in North America, I mean the rate of decline internationally looks like it's much more aggressive than the rate of improvements. I am just concerning that, places like Europe are going to fall significantly in the back half.

[John L. Brooklier:]

Well again, we are not coming out with a base revenue number that's a big positive number. We are looking for something in 0 to up to 2. So I think we think we are being conservative in our approach here.

[David B. Speer:]

We had already, as an example, in the second quarter built in some modest improvement in North America and a decline in Europe. And that's in fact what played out. While Europe was still positive, it was positive at lower number plus 3% for us. And North America was slightly better in terms of relationship with the first quarter. But I think we are pretty much in the categories in terms of growth that we had expected as we laid out this year's plans. So I don't see anything remarkably different all in than what we sort of put together in the year end.

[Ann Duignan:]

Okay. And you guys usually are conservative, so I will leave it at that. Thanks.

[John L. Brooklier:]

Nice compliment.

[Ann Duignan:]

Yes.

[David B. Speer:]

Thank you Ann.

[Ann Duignan:]

Coming from me, yes.

[David B. Speer:]

Thanks.

[Operator:]

The next question comes from Daniel Dowd of Bernstein. Your line is open.

[Daniel Dowd:]

Good afternoon.

[John L. Brooklier:]

Hi Dan.

[Daniel Dowd:]

Hey two things really. You noted specifically that the UK, Spain and Ireland were weak in the construction market. Did you notice any specific weakness for alternatively continued strength in Eastern Europe?

[David B. Speer:]

Well Dan, what I highlighted in those three markets, first of all, to be clear was primarily residential and obviously those markets are markets that have been under pressure from residential standpoint for probably at least three quarters now. Eastern Europe, I would say that the construction activity as we see, has still been reasonable but it's a relatively small number by comparison to the West of Europe. So while it's got interesting numbers, all in impact is relatively modest.

[Daniel Dowd:]

Okay. And I want to make sure I understood what you said earlier in the comments about Q1 North American residential compared to Q2. If I heard you correctly, you said, it declined 16% this quarter, but a much greater... it has declined at a much greater rate last quarter. Did I hear that correctly?

[David B. Speer:]

That's correct, yes.

[Daniel Dowd:]

Do you make anything of that? Is that a blip or does that indicate decelerating pain?

[John L. Brooklier:]

I think it indicates decelerating pain. I think a part of it is comparisons, and we're not making anything of notice at this point in time. I mean the numbers are what they are.

[David B. Speer:]

Dan, I think if you look at the annualized, sort of start numbers, over the last five or six months, clearly the rate of that decline is narrowing. So, we're down in the 925 range now, clearly much lower than the 1.1 million that we finished... 1.2 million that we actually finished the year at last year. So I think we are clearly getting closer to a bottom. My guess is that the bottom is probably somewhere in the in the 800 to 900 range. So I think rate of decline is, in fact. slowing, yes. And at the bottom is approaching but as I think I have said consistently before, I think the bottom is going to be a relatively long bottom. I don't expect any significant recovery in the U.S. housing numbers, at least until end of '09 and perhaps not even until the first half of 2010.

[Daniel Dowd:]

The first half of 2010.

[David B. Speer:]

Yes.

[Daniel Dowd:]

Okay.

[David B. Speer:]

We've got significant inventory issue still, to deal with that... we're happy we're through before we get to the point where builds are going to return to any level in the million plus range, so.

[Daniel Dowd:]

Okay. And one last thing on the balance sheet, I know this is something we've talked about at length. But given where your share price is trading, is this not an opportunity to accelerate share repurchases?

[Ronald D. Kropp:]

I think we're going to range for the year, yes, we grew well... yes we're pretty close to the low end of the range to begin with. So I think we have done a little bit of that versus what we expected at the beginning of the year. Secondly, as David talked about, we got a pretty good acquisition year shaping up here. So what we have always said is, we are going to use our free cash flow, first for dividends and acquisition as a priority and really share repurchases as the third priority. So it's something that we are looking at, clearly the accelerated leverage from where we were a year ago. We'll continue to look at that and consider that.

[David B. Speer:]

And Dan, it is during this August time period that we sit down and reflect on what we have done so far in the year. And we look at our plans and outlook for the balance of the year and decide what we will do in terms of any adjustments to the ranges that Ron described. So we are in the process of looking at that, but as Ron said, we have a strong acquisition pipeline and we'll look at that relative to our cash flow projections and make some decisions during the coming weeks as to whether or not we will revise those ranges upward.

[Daniel Dowd:]

All right thank you.

[Operator:]

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

[Ned Armstrong:]

Thank you. Good afternoon.

[John L. Brooklier:]

Ned.

[Ned Armstrong:]

I saw in your hand-out with regard to the acquisitions that the price you paid relative to sale is quite higher than it normally is. Is that reflective more of the market that you are seeing or is that related to one transaction or a couple of transactions?

[David B. Speer:]

It's related to a couple of transactions but primarily one, the Stokvis acquisition that we did in the second quarter, came with a much higher price to sales ratio. I think it was somewhere in the 1.4 range and had obviously much stronger growth and earnings profile than our typical acquisition. So, that's really, I would call that an abrasion. If I look at the pipeline, the kinds of deals in the pipeline are more reflective of the more traditional numbers. But certainly the growth rates in that acquisition along with the fact that it already had a double-digit EBITDA earnings rate, led it to be a more expensive acquisition. I would not say it's reflective of the market on that. I think the market as we've seen has become much more realistic. I would say that our numbers are in line with what we've seen in the past, but it means those, if there is more deals that are in our range that would have been in the past couple of years.

[Ned Armstrong:]

Okay, and then with the test and measurement business was quite strong as... was there any one or two industries that was driving that, or was that across the board within that business?

[David B. Speer:]

Well, it's been strong across a number of industries and probably a number of geographic markets. I mean probably the industries to highlight in that group, first of all, would be the bio-medical healthcare arena. We've had a strong input there. We have a good equipment sales going into a lot of the biomedical devices that end up in knee joints and hips and so forth and the testing that goes with that. Aerospace has been another very strong end market for us. As you know the boom that's going on at the moment, particularly with commercial aircraft has positioned us well. The Boeing and Airbus programs require a fair amount of testing and measurement equipment all throughout their supply chain. So that's been strong for us, and geographically it's been very strong growth for us in Asia and in Europe as well.

[Ned Armstrong:]

Great, thank you.

[Operator:]

The next question comes from Jamie Cook of Credit Suisse. Your line is open.

[Jamie Cook:]

Hi, good afternoon. Most my questions have been answered. Just quickly, one, some of the other companies that have reported so far noted weakness whether it was in North America or Europe more towards June or back end of the quarter. I am wondering whether you saw the same thing. And then it's just my follow-up question. When we look at the food equipment business internationally, looks like sequentially there was a big acceleration, I think in the first quarter you were up 13%, I think now only a 4%. So, was there anything unusual in this quarter, and is that the trend we should start to think about going forward?

[David B. Speer:]

Well, I think as it relates to the food equipment category, I think there are some comparables in the second quarter of '07 and '08 that are somewhat anomalies. So I wouldn't put anything significantly in that. I think the growth trajectory we see internationally is in line with what we discussed earlier, which is somewhat slowing growth rate in Europe compared to 2007 and continued good growth rates in the Asia regions. So, I would describe what you saw internationally in Q2 is somewhat of a one-off. What was the first part of the question? I am sorry.

[Jamie Cook:]

The first part

[David B. Speer:]

Or international, Jamie, you were asking about for July, June to July?

[Jamie Cook:]

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

[David B. Speer:]

No, I don't think we saw... not... certainly not across the board. Again, we have some end markets that are decelerating at the moment. So the fall off naturally would have been greater towards the end of the end of the quarter, but not anything overall. I think the declines that we've seen and the growth we've seen, I wouldn't say there's been any remarkable change in the latter part of the quarter.

[John L. Brooklier:]

And June came in basically around zero. I mean, we had [ph] zero for us.

[Jamie Cook:]

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

[John L. Brooklier:]

I am talking about the total company number down. The base is zero for the total company for June.

[Jamie Cook:]

I am asking about Western Europe, though.

[David B. Speer:]

Yes, no. Western Europe, I would say, no. I wouldn't say that we saw any significant rate of decline in Western Europe. Again, the decline in Western Europe, we have seen a deceleration in Western Europe. We still had positive base growth in Western Europe, however. But I would certainly say that the growth rates, if that's your, have certainly declined in Europe and that would certainly be the case in the second half of the quarter.

[John L. Brooklier:]

But, Jamie, the growth rate that David's talking about from June to what we are seeing early sign for July for period seven.

[Jamie Cook:]

Yes.

[John L. Brooklier:]

Our period [ph] international, we are not seeing any significant change in growth rates.

[Jamie Cook:]

All right. That was my question. Thanks, John. Thank you.

[Operator:]

The next question comes from Robert McCarthy of Robert W. Baird, your line is open.

[Robert McCarthy:]

Good afternoon guys.

[David B. Speer:]

Good afternoon.

[Robert McCarthy:]

Definitely most questions asked and answered at this point, but is there any one of your businesses, David, that you could identify where you are seeing a potentially growing impact of tight credit conditions outside of just generally weak macroeconomic growth?

[David B. Speer:]

No, I wouldn't say any business in particular, Rob. I think the normal markets that we would see that first in are generally in residential construction, but that market is, as you know, very depressive at the moment. So that's normally our kind of bell whether when you see any kind credit issues, but given the weakness in that market, that clearly isn't the case at the moment. So, no, I wouldn't say there is any particular end market. Certainly the credit issues have impacted the small to medium size businesses, more so... disproportionately so than the larger businesses. It's probably created somewhat of an air of concern and negativity, but in term of actually creating problems with being able to transact business, nothing materially.

[Robert McCarthy:]

Okay, good. And second question, recent news item having to do with the termination of supply agreement from the long time solid supplier to the decorative surfaces business. Is it just a technical issue or negotiating situation or is there something material going on there?

[David B. Speer:]

No, you are talking about the decorative surfaces businesses, Rob?

[Robert McCarthy:]

Yes.

[David B. Speer:]

Yes. No, it's nothing, it's nothing material, no.

[Robert McCarthy:]

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

[David B. Speer:]

No, not at all.

[Robert McCarthy:]

All right, very good, thank you.

[Operator:]

The next question comes from Henry Curran [ph] of UBS. Your line is open.

[Unidentified Analyst:]

Good afternoon guys.

[David B. Speer:]

Hi, Henry.

[Unidentified Analyst:]

The auto market has been weak for some time now. When do you think that market could actually start to bottom?

[David B. Speer:]

Well, that's an interesting question. There were a lot of pundits that are much smarter than I. They were in December of last year predicting a 5% decline is the bottom, clearly is more close to being right. At the current build rate projections now for the year, we are under 13.5 million vehicles. I think we are closer to 13.3 million. I have to believe that that rate is probably getting close to the bottom, but there still may be some adjustment. I think what is probably likely to happen is continued displacement, obviously, with the large vehicles and SUVs, most notably, had a heavier concentration on smaller vehicles. That trend has accelerated clearly. The question is do we have the capacities in the small vehicle category to make up the overall builds and that's a still a factor, I think, to be figured out. Both GM and Ford are spending a fair amount of time now obviously directing resources more to the small end of the category. But I think the sales rate of vehicles and the build rates are probably getting close to the bottom, but I wouldn't want to be so boldest to say that we are necessarily there yet. The same consumer who is having problems with his home mortgage is the same one coming on buy a vehicle. So, until the credit crunches issues are resolved, it's going to be hard to predict exactly where the bottom is. But I think when you see the decline steadily from 17 plus million vehicles five years ago to where we are today, I have to believe that we are within perhaps 400,000 or 500,000 vehicles of the bottom.

[Unidentified Analyst:]

Okay, that's helpful. Thanks. Is it possible to talk about the margin headwinds that you expect from acquisitions going forward?

[Ronald D. Kropp:]

Yes. Well, as you probably know, we tend to acquire company this has much lower margins than our content. Typically the margins before amortization charges are in that 8% to 10% range. So we'd had a couple of good years of acquisitions. Clearly that's had an impact on our margins over the last couple of years, although less of an impact in this year than it has over the last couple of year. So, that's something that we do talk about every quarter. For instance, in this quarter, it had a negative 30 basis point margin impact and I would expect something... something similar in that 30 to 50 to 60 basis point impact through the rest of the year.

[Unidentified Analyst:]

Okay, thanks a lot, good quarter guys.

[David B. Speer:]

Thank you.

[Operator:]

The next question comes from John Inch of Merrill Lynch. Your line is open.

[John Inch:]

Thank you. Good afternoon.

[David B. Speer:]

Hi, John.

[John Inch:]

Hey. So jut can you remind me, maybe Ron or David, why was the operating cash down again year-over-year? You were sort of thinking a kind of sluggish environment you'd be able to harvest some working capital. Was there something unusual about the second quarter? And how do you think about cash flow for the rest of the year?

[Ronald D. Kropp:]

John, the second quarter is typically our lowest free cash quarter. That's our highest sales quarter. So, receivables are at the highest. So, typically it is less than 100% of net income, which is kind of our annual target. And so this quarter it's about two-thirds net income. Last year in the second quarter it was more than that, it was $442 million, about 80%, 88% of net income. So year-on-year it is down almost 90 million. And it's really due to a couple of different things

[John Inch:]

Okay. And then just for my follow-up question, I mean, ITW continues to, I think, pretty impressively outperform some pretty tough auto markets. Can you just remind us again why you are doing much better than the actual field numbers? Is it an issue of platforms or products or what is it again and do you expect this outperformance to continue?

[David B. Speer:]

Well, it's certainly a question of penetration, John, and it's an increased concentration on the vehicle platforms. And certainly with the range of new products that we have introduced, those have been targeted at newer vehicle platforms, in areas where we think we can pick up significant penetration. So we expect year-on-year to outperform the build. Typically in North America, with the Detroit 3, our penetration gains are usually somewhere in the 4% to 5% range. They have been higher than that with the new domestics. Penetration gains with the new domestic have been above 10%. And so that certainly helps us well. You may recall that we have focused on the new domestics significantly in the last three or four years and it's beginning to show now in our numbers and clearly their build numbers are down less. Our penetration rates with them are up greater. So it's a combination of penetration gains and new products aimed at the platforms that... they clearly are the ones that are going to grow in the future. And it's offsetting some of the concentration we have had in the past on the heavy... the light truck and the large SUV markets. But it's really more of the same formula. Product innovation allows us to drive higher margins and product innovation allows us to drive more penetration in a declining vehicle market.

[John Inch:]

So you think you can sustain this even though we have got this obvious mix shift away from heavier SUV vehicles to the smaller vehicles, but from a content perspective, David, do you feel comfortable?

[David B. Speer:]

Yes, we think we can sustain. Obviously, the content on a smaller vehicle is not as great as it is on a larger vehicle. But that's already factored in, if you will. But certainly we think the ability to continue to penetrate the small platforms or the smaller vehicle platforms is clearly there, and we have some very strong momentum with the new domestics. You may recall that we made an acquisition in the latter part of 2006 to position us with the Hyundai-Kia Group as an example, that allows us to significantly accelerate our penetration to those platforms. That group is opening two new factories in the U.S.; one that's opened, one that is opening. So those are significant upside opportunities for us and we continue to penetrate the Toyota, Nissan, and Honda groups very effectively. So, yes, I think we expect to see continued penetration gains and certainly with the new domestics, we expect higher penetration gains than what we have been achieving even with the Detroit 3.

[John Inch:]

Thanks much.

[David B. Speer:]

You are welcome.

[Operator:]

The next question comes from Mark Koznarek with Cleveland Research. Your line is open.

[John L. Brooklier:]

We are going to make this the last question. Go ahead, Mark.

[Mark Koznarek:]

Okay, thanks. Thanks for sneaking me in there. SG&A as a percent of sales is flat versus the prior year. And my question is whether ITW has in the last 90 days put on any kind of unusual or additional expense control programs such as hiring freezes or force reductions or limits on T&E or any of the number of things, but have you pulled any material levers for cost control in the last 90 days?

[David B. Speer:]

Mark, no, we haven't pulled any new controls, but I would tell you that as we looked at the economic outlook coming into 2007 or 2008 at the end of last year, most of our businesses developed plans based around what they saw was a weakening environment. And so we've had cost controls in place and adjustments being made as markets weakened even beyond perhaps some of their original outlook. So nothing, what I would call extraordinary and certainly nothing that has been mandated by the corporate office. But clearly there have been a number of cost control elements that our operating units have put in place and that is frankly a key element in being able to deal with slowing market conditions. So you see that accurately reflected in our SG&A and our overhead numbers. Ron may add some more flavor to that.

[Ronald D. Kropp:]

Yes. I think that's... and our decentralized operating model, that's one of the key benefits, right, is that we're not looking for the big corporate-driven cost control program. We have a lot of small programs at individual business units that are... they are really being put in place as the markets change because they are the first ones to see the end markets change, they are the first ones to react and they know their businesses fast [ph] and where they can restructure and get the benefits, as well as control costs. So, I think that's always been a benefit of our operating model, with that we can react quickly to the changes in the market conditions.

[John L. Brooklier:]

Okay. And, Ron, I had a follow-up, which is the expectations for currency that's in the 9% to 12% revenue outlook for the year. What is that and is that different from the quarter ago 9% to 12% outlook?

[Ronald D. Kropp:]

It's not materially different from where it was, it's slightly better. In the third quarter it's in that 5 to 5.5 range percent increase contribution, and then in the fourth quarter it's in the 3.5% to 4% range. In the fourth quarter we have much tougher comps on the currency side.

[John L. Brooklier:]

Okay, very good, thank you.

[David B. Speer:]

Thanks, Mark.

[John L. Brooklier:]

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

[Operator:]

Thank you for participating in today's conference. You may disconnect at this time.