Oct 17, 2007
Executives
John Brooklier - Investor Relations David Speer - Chief Executive Officer Ron Kropp - Chief Financial Officer
Analysts
Steven Boltman - J.P. Morgan Robert Lagava Deane Dray - Goldman Sachs Andy Casey - Wachovia Mark Koznarek - Cleveland Research John Inch - Merrill Lynch Joel Tiss - Lehman Brothers Robert Wertheimer - Morgan Stanley Robert McCarthy - Robert W.
Baird Eli Lustgarten - Longbow Securities Jamie Cook - Credit Suisse Daniel Dowd - Sanford Bernstein Ann Duigan - Bear Stearns David Raso - Citigroup
Operator
Welcome to the ITW third quarter 2007 earnings releaseconference call. (Operator Instructions) I would now like to turn the meetingover to Mr.
John Brooklier. Sir, you may begin.
John Brooklier
Thank you, Michelle. Good afternoon, everyone and welcome toour third quarter 2007 conference call.
I’m John Brooklier, ITW's investorrelations officer, and with me today is David Speer, our CEO, and Ron Kropp,our CFO. Thanks all of you for joining us on today’s call.
At this point, Davidwould like to make some general comments about the recently completed quarter.
David Speer
Thank you, John. I am pleased to report that our thirdquarter operating performance was quite strong.
We grew 14% in the thirdquarter in earnings and that’s the second consecutive quarter in which we’veposted double-digit earnings growth, and we accomplished this in an environmentthat, much like last quarter, where our international end markets were strongand our North American end markets faced difficult headwinds, especially in thenew housing sector. Even so, our third quarter top line increased 16%, operatingincome grew 11%, and net income rose 10%.
I am also encouraged by our operating margin performance of17% in the quarter. While the overall margins were down 70 basis points fromthe year earlier period due to acquisitions, our base margins actually improved60 basis points from the year-ago period.
Speaking of acquisitions, we continue to acquire at a pacewhich we will believe -- believe will be in a range of $1 billion to $1.2billion of annualized revenues for the full year of 2007. As you know, we lookat acquisitions as future earnings growth opportunities for the company.
John, let me turn it back to you.
John Brooklier
Thanks, David. Here’s the agenda for today’s call; Ron willjoin us momentarily to give a review of the financials for the third quarter.
Iwill then update you on our four manufacturing segments and associated endmarkets. Ron will then come back and address our fourth quarter and full yearearnings forecast and associated assumptions, and finally, all of us will takeyour questions.
Please note that as always, we ask for your cooperation asto the one question, one follow-up question policy. We hope to complete thiscall in about an hour today.
Thank you. First, a few items; please note that this call and thecompany presentation contains forward-looking statements within the meaning ofthe Private Securities Litigation Reform Act of 1995, including withoutlimitation statements regarding end market conditions, base revenue growth,earnings growth, operating income, other income, tax rates, use of free cash,acquisitions, and the company’s related forecasts.
These statements are subjectto certain risks, uncertainties, and other factors which could cause actualresults to differ from those anticipated. These risks are spelled out in moredetail on the slide and also in our Form 10-Q for the 2007 second quarter.
Finally, the telephone replay for this conference call is203-369-1278. No passcode is necessary.
The playback number will be availablethrough 12:00 midnight on October 31, 2007, and as always, you can access ourPowerPoint presentation via the itw.com website. At this point, I will turn the call over to Ron Kropp.
Ron.
Ron Kropp
Good afternoon, everybody. The highlights for the thirdquarter are as follows: similar to last quarter, revenues grew approximately16% versus last year.
Operating income was up 11% versus the prior year,primarily due to higher revenues and improved margins for the base businesses,the favorable impact of currency translation, and acquisitions. Operating margins of 17% were lower than last year by 70basis points, mainly due to the lower margins of acquired companies.
Diluted net income per share of $0.89 was 14% higher thanlast year. Free operating cash flow of $656 million was significantly higherthan last year and return on invested capital was 19%, which was higher thanlast year by 40 basis points.
Now let me give you the details of our operating results.Our 15.7% revenue growth was primarily due to three factors. First, basebusiness revenue grew 2.2%.
This growth rate was 20 basis points lower than thesecond quarter of 2007. International base revenues increased 5.1%, which was 290basis points lower than the second quarter.
While international growth had sloweda bit from the 8%-plus levels we saw in the first half of the year, wecontinued to see solid performance in most of the companies end markets inEurope and the Asia-Pacific region. North American based revenues increased 0.2%, which wasfavorable by 160 basis points versus the decline of 1.4% in the second quarter.The North American businesses continued to see the effect of slowing industrialproduction and declines in residential construction, although construction wasnot as negative as the first half of the year.
Secondly, acquisition added 11.7% to revenue growth, whichwas 30 basis points lower than the second quarter acquisition effect. Third, currency translation increased revenues by 3.8%,which was 20 basis points higher than the second quarter currency effect.Overall our 16% revenue growth was primarily the result of strong base businessgrowth internationally and the impact of acquisitions and favorable currencytranslation.
Operating margins for the third quarter of 17.0% were lowerthan last year by 70 basis points, primarily due to the larger amount ofacquired revenues in the last 12 months and our typically lower margin, whichreduced overall margins by 150 basis points. The base businesses improved margins 60 basis points, whichis better than the second quarter by 40 basis points and partially offset thenegative acquisition effect.
John will provide more details of the operatingresults when he discusses the individual operating segments. In the non-operating area, other income was lower in theprior year by $17 million, primarily due to lower investment income of $12.5million versus last year.
The second quarter effective tax rate was 28.8% versus 30.5%in the second quarter of 2006. The year-to-date tax rate is 29.25%, which isslightly lower than last quarter’s year-to-date rate of 29.5%.
Turning to our invested capital, total invested capitalincreased $67 million from the second quarter, primarily due to acquisitions,partially offset by lower operating working capital. Accounts receivable decreased mainly due to seasonality andwere at 62.5 days sales outstanding.
Inventories were essentially flat versus last quarter at 1.8months on hand, even with inventories from acquired companies. For the third quarter, capital expenditures were $80 millionand depreciation expense was $89 million.
On the financing side, our debt increased $190 million fromlast quarter and our debt-to-capital ratio increased to 15.1% from 13.7% lastquarter. As we have previously disclosed, on October 1st, we issuedEUR 750 million of a seven-year bond with a coupon rate of 5.25%.
The proceedsfrom the bonds were distributed back to the U.S. and will be used for generalcorporate purposes.
Going forward, our strong European cash flow will be used toservice this debt. Our cash position increased $121 million in the thirdquarter, as our free operating cash flow of $656 million and borrowings of $183million were utilized for acquisitions of $195 million, dividends of $116million, and share repurchases of $479 million.
For the quarter, we repurchased 8.6 million shares under ourongoing, open-ended program. Year-to-date, we have spent $959 million torepurchase 18 million shares.
Due to our continued strong cash flow andavailable debt capacity, we have increased our full year share repurchaseforecast to a range of $1.5 billion to $1.6 billion, up from our previous rangeof $1.1 billion to $1.4 billion. Our third quarter return on invested capital of 19% washigher than last year by 40 basis points, as lower working capital for the basebusinesses and a lower tax rate more than offset the negative effect ofacquisitions.
Finally, on the acquisition front, we acquired 18 companiesin the third quarter, which have annual revenues of $218 million. Based on acontinued strong pipeline of potential deals, we are forecasting acquisitionsfor ’07 to be in the range of $1.0 billion to $1.2 billion of annualizedrevenues.
Now John will finish our review of the quarter with adiscussion of the manufacturing side.
John Brooklier
Thank you, Ron. Let me take just a very few moments toreference some data that underlies what David referred to earlier in the callregarding strong international activity and weaker North American end markets.
The latest data out of Europe supports a relatively stronggrowth environment there. EuroZone’s industrial production grew 4% in August’07 versus 2.3% in May of ’07 and the EuroZone purchasing managers index was ata reasonably strong 53.2% in September versus 55.6% in June.
On the North American side, the data continues to indicateweaker fundamentals. Industrial production excluding technology continues toperform at less than robust rates.
U.S. industrial production was 0.7% inSeptember of ’07 versus 0.6% in June, and supporting our slower growth in theNorth America piece is the ISM index dropped to 52% in September ’07 versus 56%in June of ’07.
With that as a backdrop, let’s review our four manufacturingsegments. Starting with North America and Engineered Products, revenuesincreased 2.4% and operating income declined 3.2%.
Operating margins of 16.6%were 100 basis points lower than the year-ago period, largely as a result ofour construction related businesses. Looking at segment results, a 2.4% increase on the top lineconsisted of the following: minus 1.7% for base revenues; plus 4.5% fromacquisitions; minus 0.8% from divestitures; and plus 0.4% from translation.
Moving to the next slide, the notable improvement in thissegment was the performance of our automotive units in the quarter. Ourautomotive base revenues grew 2% in the quarter, driven by a Detroit 3 buildenvironment.
Detroit 3 builds were plus one in the quarter, having been atminus 6 in Q2 andminus 12 in Q1.For Q3, the specific Detroit 3 builds were GM, down 3; Ford, plus 2; andChrysler at plus 11. New domestic builds grew 8% in the quarter.
From an inventory standpoint, Detroit 3 inventories alsomodestly improved in the quarter. At September 30, Detroit 3 inventories wereat 70 days on hand versus 76 days at June 30 and specifically, GM was at 66days, Ford at 76 days, Chrysler at 71 days.
New domestic inventories also continued to improve, with 49days on hand at September 30th versus 53 days at June 30th. In our industrial products category businesses, baserevenues declined 1%.
That’s similar to what these businesses produced in thefirst and second quarter of this year. Key business unit performance in Q3included industrial plastics, down 8%, largely due to weaker demand forappliance and electronics sector.
On the plus side, performance polymers grew5% and Minigrip/ZipPak increased 2%. Fluid products base revenues were flat inthe quarter.
Our construction businesses, especially those in the newhousing sector, continue to experience difficult end market conditions in thequarter. Total construction base revenues declined 5% in the quarter versus abase revenue decrease of 5% in Q2 and a decline of 10% in Q1.
Specifically,base revenues for ITW Construction, which is made up of our tool and fastenerand truss units, were down 8% in the quarter versus a decline of 9% in Q2 and adecrease of 12% in Q1. By channel, our Q3 new housing base revenues declined 19%,which was modestly better than the seasonally adjusted housing rate decrease of24% in Q3.
And as you may have read this morning, the near-term housingprospects don’t look promising. Today, NHAP data indicates that throughSeptember, housing starts were at 1.191 million annual units, a 14-year low.
Our performance in other construction categories was betterbut still not robust. For Q3, our renovation businesses were down 3%, largelydue to irregular order patterns from the big box stores, such as Home Depot.Our commercial construction businesses, however, grew base revenues 4% in thequarter, mainly as a result of contributions from our trust businesses.
In our Wilsonart business, base revenues declined only 1% inthe quarter, primarily because revenues associated with base laminate productswere slightly up in the quarter thanks to better pricing or high-end, highdefinition laminate products. Flooring revenues declined modestly in Q3.
On the international side, international products in thethird quarter, segment revenues increased 32.5% and operating income grew28.3%. Operating margins of 14.7% were 50 basis points lower than the year-agoperiod due to the diluted impact of acquisitions.
Taking a closer look at the top line, the 32.5% increase inrevenues consisted of the following components: plus 6.7% from base; plus 16.9%from acquisitions; minus 0.2% from divestitures; and plus 9.2% fromtranslation. What’s going on in the end markets essentially is that this[inaudible] economies are producing across-the-board base revenue growth in allbusiness categories.
Notably, total construction base revenues increased 8% inQ3. By geography, Q3 base revenues were as follows: European construction grew9%; Asia-Pacific increased 6%; and Wilsonart International grew 9%.
Europe was aided by demand for commercial constructionproducts for a variety of countries, including Germany and Sweden. Asia-Pacificbenefited from strong performance from a variety of Australian and New Zealandbusiness units, and Wilsonart International was largely driven by contributionsfrom its German and Chinese business units.
On the automotive side, automotive base revenues increased9% in Q3 on the heels of a 7.5% increase in light vehicle production in Europein the quarter. That’s the second consecutive quarter that automotive baserevenues have improved, moving up from plus 1 in Q1 to plus 5 in Q2.
Key builds in Q3 included thefollowing: BMW, up 16%; VW Group, up 8%; Ford Group, up 7%; PSA Group, up 6%;GM Group, up 2%; and Renault actually was down 4%. The remaining part of this segment is made of our industrialbase units.
These units in aggregate generated base revenues of 3% in thequarter. By business group, key Q3 base revenues were as follows: Polymers,plus 8%; Fluid products, plus 9%; and industrial plastics, minus 1%.
Moving to the next slide and the North American specialtysystems segment for the third quarter, segment revenues increased 10.5% andoperating income increased 7.3%. Operating margins of 19.4% were 60 basispoints lower than the year-ago period due to the dilutive impact of acquisitions.
Focusing on the top line, the 10.5% growth in revenuesconsisted of the following: plus 1.9% from base revenues; plus 9.8% fromacquisitions; minus 1.5% from divestitures; and plus 0.4% from translation. This industrial production driven segment saw our baserevenues grow approximately 2% in Q3, which exceeded U.S.
industrial productiongrowth rate for the quarter by more than a point. The major base revenue contributors included food equipment,which increased 9% in Q3.
Food equipment continues to benefit from a stronginstitutional as well as casual dining demand for its products and follow-upservices. Year-to-date, food equipment base revenues have grown at a rate of[6.2%].
Welding’s base revenues increased 7% in Q3, even with somevery difficult comparisons from a year ago and some sluggishness in industrialend markets. Welding’s year-to-date base revenues have grown at a rate of5%-plus.
Weakness in the segment continues to be centered around theSignode Industrial Packaging business, which declined 6% in Q3. Much of thatdecrease relates to weaker demand for packaging applications and theconstruction related categories, as well as primary metals.
Moving to our final segment, international specialtysystems, for the third quarter, revenues increased 26.3% and operating incomegrew 25.3%. Operating margins of 14.4% were 10 basis points lower than theyear-ago period due to the dilutive impact of acquisitions.
Again, looking at the top line, the 26.3% growth in revenueconsisted of the following components: plus 3.6% for base revenues; plus 18%from acquisitions; minus 3% from divestitures; and 7.6% from translations. Similar to our international product segment, internationalspecialty systems benefited from notable demand across a broad set of endmarkets.
As noted earlier, the segment’s base revenues grew approximately 4% inthe quarter. Food equipment increased its base revenues an impressive 14%in Q3, with big gains coming from Hobart branded products in countries such asGermany, the U.K., and France.
Welding’s base revenues were up 6% in Q3 with growth comingfrom both China and Europe, including Scandinavia. Finishing’s base revenues were up 7% in the quarter, largelydriven by demand for Gema based powder coating products in Europe and Asia.
Signode Europe and Signode Asia’s base revenues were bothflat in Q3. Let me turn the call back over to Ron who will address the2007 forecast and --
Ron Kropp
Thank you, John. We are forecasting fourth quarter 2007diluted income per share to be within the range of $0.86 to $0.90 per share.The low end of this range assumes a 2.1% growth in base business revenues andthe high end of the range assumes a 4.1% growth in base revenues.
The midpointof this earnings per share range of $0.88 would be 14% higher than last year. For full year ’07, our forecasted earnings range of $3.36 to$3.40 per share.
The full year base business revenue growth is expected to bein the range of 1.9% to 2.5%. The midpoint of this earnings range of $3.38would be 12% higher than 2006.
The assumptions included in this forecast are exchange ratesholding at current levels, acquired revenues in the range of $1.0 billion to$1.2 billion, share repurchases of $1.5 billion to $1.6 billion, restructuringcosts of $35 million to $40 million, no further impairment of good will orintangibles, non-operating income, which now includes investment income, in therange of $90 million to $100 million for the year, which is lower than 2006 by$10 million to $20 million. As a reminder, included in non-operating income for 2007 arenon-recurring gains on the sale of businesses of $36 million in the first halfof this year.
And finally, a tax rate of 29.25% for the fourth quarter andfull year. I will now turn itback over to John.
John Brooklier
Thanks, Ron. We will now open the call to your questions.Please remember that we ask for one question and one follow-up.
Operator
(Operator Instructions) Our first call comes from Steven [Boltman].Please state your company name.
Steven Boltman - J.P.Morgan
A question on the base revenue growth. I’ve never been firstbefore.
It’s kind of a shock. But looking at the way the quarter ran, it lookedlike things kind of slowed down for you in September and I guess came in alittle bit lighter than we had thought at the beginning of the quarter.
Can youjust comment on sort of how things went through the quarter? And the implication I guess is that we’ll get somereacceleration into the fourth quarter and your comfort level with that andkind of the build-up to that.
David Speer
Let me answer that question first. I would say that what wesaw clearly in the first two months of the quarter was in line with what ourearlier guidance was.
We saw a noticeable slowing in North America in theSeptember numbers, no question, and it was really I think a couple -- Johnnoted earlier, the auto numbers were actually slightly positive to our originalprojections but the housing numbers were significantly below and the housingnumbers obviously slipped, probably began slipping in actually the Augustnumbers, so clearly a weak market in housing. The general industrial market, as we I think pointed out inour second quarter call, we continue to see slowing there and as you’ve seenthe various indices bounce around, we are at very modest levels of growth nowin industrial production and we clearly have seen that across our businesses.So certainly September was weaker.
I think in regard to your comment or question about the fourthquarter, we certainly have largely easier comparables in a number of keymarkets but with that noted, the housing numbers the way they are, the easiercomparables we had originally thought we had finished in the fourth quarterdon’t look as easy now because actually, the projections for the fourth quarterare probably going to be somewhat below what we actually finished the fourthquarter at last year. I would say the summary for the fourth quarter is, however,largely somewhat easier comparables.
Steven Boltman - J.P.Morgan
So it looks like if we back into September, it was less than1% core growth and yet we’re looking for something around 3 in the fourth quarter, and I shouldattribute that mostly to just easier comps?
John Brooklier
Yes, but also remember that September was essentially flat for-- for the company. The month itself, we had one less day in North America, sothat skews the numbers a little bit more negatively than you would necessarilyon a go-forward basis.
Steven Boltman - J.P.Morgan
And as we look forward then, can you just talk a little bitabout what you are doing to size your businesses, I guess especially thehousing related businesses, appropriately for the new reality here? I’massuming we’ll get some margin expansion next year, just the roll off of someof the acquisitions from last year and so forth, but in the core businesses, Iassume you are doing some things to kind of boost the margin going forward hereas well.
Can you touch on that?
David Speer
I think you’ve probably already seen the impact of some ofthat, as you saw in the quarter, our margins in our base businesses actuallyimproved over the year-ago period. We’ve been right-sizing, if you will, thesebusinesses, particularly in the residential construction oriented businesses,beginning actually at the fourth quarter of last year, so we have been tryingto factor in now our plans for ’08 based on what we think will clearly be alower level of activity than we thought 90 days ago.
But largely, I would say that the sizing of these businesseshas been done already, significantly so I wouldn’t expect much additionalreflection of that, although there is probably some additional incrementalperformance we’ll see as we get the full impact of some of the right-sizingthat occurred during the third quarter.
Steven Boltman - J.P.Morgan
Okay, great. Thanks very much.
Operator
Our next question comes from Robert [Lagava]. Please stateyour company name.
Robert Lagava
Good afternoon. I just want to follow up on the space issue.I mean, if we look at the overall, the total company, not just North America, Imean the base sales comp is similar in the fourth quarter versus the third.
Iunderstand North America but you also have the international growth that isgoing to be facing significantly tougher comps, particularly on the specialtysystem side. How should we think about that end of the business?
I understandNorth America but how should we think about the international business? And I guess to take this one step further, what is yourpreliminary view relative to 2008 versus what you are seeing in the marketright now?
David Speer
Well, 2008 is probably a little bit premature for us tocomment on overall. I mean certainly, some of the markets we are seeing trendsthat we wouldn’t expect to reverse themselves.
Housing is an example. I thinkclearly as we look at housing for next year, we are probably talking about amarket that is going to be in the 1.2 to 1.3 range.
You know, 45 days ago Iwould have probably said 1.3 to 1.4. The auto market here probably modestly up, flat to modestlyup, but frankly in a lot of these end markets, it is probably too early for usto get a read.
We’ll be going through our 2008 planning process here in thenext 30 to 45 days. We’ll have a better read then but those are probably theonly two notables.
In terms of the fourth quarter, Rob, I would say thedifferences that we pretty well highlighted in North America, we’re expectingmodestly better numbers in North America, primarily easier comps, so NorthAmerican growth in the 2% to 2.5% range and international growth in the 4% to4.5% range, so lower than what we’ve seen in the first two quarters --actually, the first three quarters internationally, as we see clearly someslowing. It’s still nice growth rates but slowing from the earlier part of theyear where we had 8%-plus in the first half of the year, particularly inEurope.
Robert Lagava
I guess the follow-on to that is just from a marginperspective, I know earlier in the year, a quarter or two ago, you hadmentioned that pricing in the international businesses, you were trying to passthrough because of -- you were trying to catch up with the cost increases. Imean, where does that stand and how should we think about the margins movinginto the fourth quarter?
You mentioned the acquisition impact this quarterbeing 150 basis points. Is it going to be a similar impact as what you areforecasting for the fourth quarter?
How should we think about the margin?
Ron Kropp
On the margin side, I would expect that the margin would bein that 16% to 17% range that we’ve been at. And we will still see the marginimpact of acquisitions.
However, we have been encouraged by what we’ve seenthis quarter. If you remember last quarter, we had a negative price cost effecton margins of about 60 basis points.
A lot of that was on the internationalside of things where we had cost increases and hadn’t fully recovered those. What we saw this quarter is basically price cost was flat.International, much better than they were last quarter.
We put some priceincreases in place. We’ve also seen some raw material costs going down.
Forinstance, steel, especially stainless steel, has gone down significantly in thelast three months. Overall from a margin standpoint, we don’t see much impacton price cost.
We will however continue to see some impact of acquisition butalso, as the acquisitions become part of base, you know, remember we had a bigchunk of acquisitions in the fourth quarter of last year that will partiallycome into base in the fourth quarter. And as we [improve a little bit], we willsee pick up in margins from recently acquired businesses.
Robert Lagava
If I could just sneak one more in, just on the acquisitionfront; you raised the range, but you raised only the bottom end by about $100million. The top end is the same at $1.2 billion.
What’s the pipeline looklike? Is that just a conservative estimate?
What are you seeing out there justin terms of multiples, especially in light of the credit crunch?
David Speer
It is always difficult to predict the closing dates ofacquisitions. The pipeline remains robust.
We are happy. We haven’t seen anynotable change in the size of the pipeline.
As we’ve said in the past, ourpipeline has about four to five months of visibility. We’ve closed $837 millionduring three quarters.
Clearly the pipeline could yield more than what we havein those numbers but the range I think is based on what we think is likely toclose during the next three months. Things do slip.
Last year we saw a couple of deals slip intothe beginning of this year, so it is very difficult to peg an exact numberthere but I think the range of $1 billion to $1.2 billion suggests that thequarter activity will be somewhere in the $200 million to $350 million range interms of acquired revenues, and I think that is very realistic.
Robert Lagava
And then just the credit turmoil impact from the multiplesthat you are turning out there?
John Brooklier
That’s four questions, Bob.
Robert Lagava
It was all part of one.
David Speer
I think it is too early for us to have seen any significantchange in the pricing of acquisitions as a result of the private equity creditcrunch. But we are certainly seeing at least early indications that that’slikely to play out.
I suspect we are going to see that impact maybe last thisquarter but certainly early in the first quarter of next year, I think we’llhave a better read on that.
Robert Lagava
Terrific. Thanks very much.
Operator
Our next question comes from Deane Dray with Goldman Sachs.Sir, your line is open.
Deane Dray - GoldmanSachs
Thank you. Good afternoon.
I would like to drill down, if wecould, on the North American construction businesses and David, if you couldwalk us through new housing, renovation, commercial. And we’ve got the datapoints as to how it compared versus second quarter, but just qualitatively,what you are seeing in your businesses, maybe even sequentially through thequarter, but buying behavior, sentiment, and so forth.
So start with newhousing, down 19. That’s what we saw in the second quarter but certainly itworsened in September.
David Speer
Correct. I think if you look at the new housing market,probably 60 days ago we thought we were going to see the bottom of that in the1.3 to 1.4 range.
That clearly hasn’t happened. I think it has trended furtherdownward.
At the risk of sounding like I understand where the bottomis, you know, 1.2 would sound close but 1.2 wasn’t in our thoughts 30 days ago. The market clearly as a result of the steps down, we’ve seenit clearly in the marketplace.
I’m not surprised by the numbers that came outbecause we saw it clearly from probably early August on, some prettysignificant push-back. Clearly the sub-prime issues that hit the market fullfold.
We’ve not seen any change, although it’s still early, since the rate dropbut certainly the mood in the market is not very optimistic. If you look at anyof the national home builders that have put out data in the last month, youwould see it reflected in what they are saying as well.
So it is not a very pleasant picture. It’s been a verydramatic slide very quickly.
If you think that at the end of the third quarterlast year the housing market was operating at just under 1.7 million annualizedstarts, and we are now talking about just below 1.2, I mean, that’s a 40% drop.So it’s been pretty dramatic. So that market is clearly pessimistic and it has undoubtedlyaffected buying patterns as well, so hard to qualify how much of thedegradation in the buying patterns is there, but it has rippled over torenovation.
There’s no question the renovation market, if you look at any ofthe major indices now, the HRI index, which we follow, has gone negative now.They are predicting for the year it is going to be negative. That’s not asurprise.
Clearly a lot of the renovation market, particularly residential, isfunded by home equity lines and certainly the credit crunch in the sub-primelending areas have created some big issues there as well. I expect the renovation area is going to be an area that isgoing to be under pressure well into next year as we look at the retrenchmentthere and the costs associated with that category.
And of course, we’ve seen the buying patterns impacted fromthe home centers, which are large outlets that feed that renovation and newhousing category, so you’ve got a lot of moving parts going on there and thegeneral drift is clearly downward in those markets.
Deane Dray - GoldmanSachs
Can I interrupt just for a second? That was exactly thatlast point you made regarding renovation.
Last quarter, it was up 6% but youwere clear to say that you felt there was some restocking going on.
David Speer
Correct.
Deane Dray - GoldmanSachs
Is that just from a sequential standpoint, you’re not seeingthe benefit of restocking? Actually, in a 3% down is actually pretty favorablecompared to the severity on new housing.
David Speer
Our same-store sales numbers in the categories that we payattention to are still reasonable but the category is clearly under pressureand I would say what we saw was more buying behavior in our negative numbersthan we did in actual same-store growth, so some shrink in inventory. Thatwould suggest that some of that will get replenished at some point in time butthere is a general mood, a very cautious approach in purchasing habits so it ishard to get a read on that.
I expect it is going to continue to be bouncingaround in the slightly negative to flat kind of category for us.
Deane Dray - GoldmanSachs
That’s helpful. And then on commercial?
David Speer
Commercial construction year-to-date, the numbers on asquare footage basis on starts, or awards, if you will, are down 6%. There areonly a couple of categories that are positive.
Most of the categories arenegative. The numbers that we are seeing that have been somewhat better thanthat are really related primarily to finishing buildings that were begun in2006.
The early indicators of the construction, commercialsegments, at least, are beginning to show clearly a negative drift and thatwill clearly head towards 2008. If you look across the major categories thatare fairly significant, the warehousing category, which is a significantcategory in terms of awards this year, down 4.5% year-to-date; themanufacturing category is down 14.5%; education is down 6%; hospitals are down17%; so you are seeing the impact I think now in the awards or the contractcategories of what I think will bode to be a relatively difficult year next yearin non-residential construction in North America.
Deane Dray - GoldmanSachs
But probably too premature to say how your commercialbusiness would fare in an ’08 environment with awards down?
David Speer
Yes, it’s -- we’ll have to get a better look at thesenumbers in the next 30 to 45 days. We’ll be able to tell you more when we seeyou in New York in December, but it is going to -- it will have a negativeimpact but it is hard to read at this point how much.
Deane Dray - GoldmanSachs
And just to clarify, for the quarter, your commercialbusiness was up 4%?
David Speer
That’s correct.
John Brooklier
Steve, that’s primarily because of our truss businesses. Idon’t think that’s necessarily predictive of what we might see in Q4.
Theyactually had a very strong September.
Deane Dray - GoldmanSachs
Thank you.
Operator
Andy Casey with Wachovia, you may ask your question.
Andy Casey - Wachovia
Good afternoon, everybody. Just back quickly on one of thequestions Deane had on renovation.
If I recall, David, in the fourth quarterand part of the first quarter last -- earlier this year and last year, therewas a significantly destocking from the channel. Are you saying the bouncearound flat to maybe negative is a year to year comp or is that a sequentialstatement?
David Speer
You’re talking about for the fourth quarter this year?
Andy Casey - Wachovia
Yes, fourth quarter this year versus fourth quarter lastyear.
David Speer
It’s a sequential statement and it’s really based on -- I’mnot predicting what they are going to do with destocking. What I am saying isthat the activity levels that we see in the categories that they serve, whichare primarily renovation, number one, and then new housing, number two, is thatwe should be flat to maybe down slightly.
If there is a significant destockingthat occurs on top of that, it would be obviously a larger negative number. What we saw last year was a very significant destocking thatoccurred in the fourth quarter and into the first quarter.
We saw somesignificant restocking that occurred during the second quarter of this year. Sowe knew that the activity levels we were seeing in the first quarter last yearweren’t reflective of the purchases but at the end of the day, it caught up inthe second quarter as the stores began to get more fully stocked.
Andy Casey - Wachovia
And the last question; the industrial packaging performancein North America took a step down I think sequentially, negative 3 last quarterto negative 6 this quarter. Can you comment on the sub-segments in there?
Wasit again lumber and brick and block that was causing the down-tick?
David Speer
It was two categories. It’s the primary metals category,which is steel and aluminum, and as you’d expect with the continued downturnleveling in the auto business, they are a huge consumer of steel, as is theappliances right goods area.
So the steel market collectively here in NorthAmerica is down. And the second category is clearly the building materialrelated categories -- lumber, brick, block, et cetera.
Those are the twolargest categories in our Signode businesses. Collectively, those twocategories represent about 45% of the business.
We’ve also seen that decline occur in the equipmentbusinesses where we are not seeing any significant capacity expansions, and sowhat we are seeing now is really only replacement sales and that’s had animpact on the equipment side as well. And that would impact in our generalindustrial markets even more so than the commercial or construction relatedmarkets.
Andy Casey - Wachovia
Thank you.
Operator
Mark Koznarek with Cleveland Research, you may ask yourquestion.
Mark Koznarek -Cleveland Research
Good afternoon. A question on the international specialtysystems business with the base revenue growth having contracted by about halfof where it was in the second quarter and industrial packaging went to flat.And you guys have said in the past, at least with domestic industrialpackaging, that that’s -- you often use that as a leading indicator for trendsin the region.
I wonder if that dynamic is true internationally, if this ispointing to some kind of slower activity in the international markets in theforeseeable future.
David Speer
I would say in Europe, it certainly would be at least some noteof caution in terms of what we saw. Some of it was related to price actions.
AsRon noted in his comments earlier, we saw some decrease in some steel pricingthat did impact pricing, so the unit volume activity wasn’t impacted asnegatively as the dollar volume or Euro volume, if you will. However, we have seen some slowing in some of those Europeanmarkets as is reflected in some of the other numbers.
I think in Asia it wasmore a question of timing -- timing as it related to a couple of major units inour welding business that deal with people that use a lot of stainless steelwho in fact were anticipating and waiting for the major drop or decrease insteel prices before they increased their activity levels. I think if you factor that out, Asia I still think is areasonably good growth story in those categories.
I think in the Signode orindustrial packaging categories, it really is reflective I think more of theEuropean slowing in demand and some price adjustments.
Mark Koznarek -Cleveland Research
Given that there’s price adjustment in this quarter and Asiahas some one-time dynamics, it sounds like it would be reasonable to forecastthat that core sales of specialty systems international ought to be better inthe fourth than we are seeing here in the third? Is that a pretty reasonableassumption?
John Brooklier
Are you talking about for the entire segment, Mark?
Mark Koznarek -Cleveland Research
Yes, that’s right, John.
David Speer
Yes, I think that for the entire segment, that’s reasonable.
Mark Koznarek -Cleveland Research
Very good. Thanks.
Operator
Our next question comes from John Inch with Merrill Lynch.
John Inch - MerrillLynch
Thank you. First I wanted to just ask about thenon-operating other income.
It obviously benefited you by a couple of penniesversus what you thought last quarter. Was there something obvious that was inthere?
Was there some sort of gain or real estate transaction or something? Whydid it not move around next quarter?
Ron Kropp
The difference between what we originally forecast there andwhat we ended up with was about $0.015 in the quarter. And the biggest piece ofthat was some mark-to-market adjustments on some of our venture capitalinvestments.
Also, we sold some idle properties for a little bit of a gain aswell. So nothing that was of a recurring nature that we can expect to changewhat our forecast is for the fourth quarter.
John Inch - MerrillLynch
Just to be clear, Ron, when you say mark-to-market, that’ssomething that you weren’t aware of heading into the quarter or that you wererequired to do as a function of some other external event? Just what’s thedynamic there again and why couldn’t that happen in the fourth quarter?
Ron Kropp
It could, I guess, but we don’t forecast mark-to-marketadjustments in our venture capital fund because those go up and down with themarket, obviously. So that is our one investment in this portfolio that is tiedto the market and typically we haven’t forecasted any gains in that segment.
For the year overall, non-operating income is up a littlebit because we’ve been fortunate enough to have some mark-to-market gains onthat fund, but sometimes that can turn around on you.
John Inch - MerrillLynch
No, I understand. There’s a lot of moving parts with all ofthese sub-segments and so forth.
I mean, it’s pretty clear that manufacturingin North America has begun, not unexpectedly, to soften. Can you just puteverything together in terms of Europe?
I know you have touched on all thesedifferent businesses but has Europe in the quarter,David, has it begun to get worse? And as you look at your outlook and the guidance, are youexpecting that trend to continue or -- because it seems a little bit moremixed, if you will, versus North America.
North America is clearly deceleratingbut what is going on in Europe? Because I know you’ve got some pockets ofstrength and weakness, but if you could give us an overall view, that would behelpful.
David Speer
I think my overall view in Europe, John, is the numbers youare seeing now are really more reflective of slower growth based on toughercomparables. I mean, we had very strong growth in Europe the second half oflast year and the first half of this year.
The growth levels, or the rates, ifyou will, of activity remain good. But clearly we saw 8% growth in ourbusinesses the second half of last year.
We saw the same growth rates in thefirst half of this year, so I think these are in line with what we wereexpecting as we prepared our plans. So not wildly out of sync.
Some areas, the general industrial areas in Europe clearlyhave trended to slower levels. Again, not so unexpectedly.
I don’t think Iwould say at this moment that there’s been any big surprises in terms of whatwe’ve seen in Europe. I think it’s pretty much been inline with what we’d expected but certainly the growth scenario in Europe is a slower growth scenario than whatwe’ve seen for the last four quarters and that’s exactly what I would expect aswe head into 2008, that we are going to see albeit positive growth and byEuropean standards, strong growth, but compared to the kind of growth rateswe’ve seen the last four to five quarters, it will be more modest.
John Inch - MerrillLynch
One more question; if you were to -- as we sort of think of thetouch points of what’s changed this quarter, clearly housing has gotten a lotworse, there’s some manufacturing deceleration, you just talked about Europe --I mean, as you are thinking about managing ITW and the prospects of what couldturn out to be a significant U.S. recession, are you in the process of planningfor that sort of a risk?
And what does the company do? Do you have plans inplace to begin to right-size businesses quickly or do you think 80-20 takescare of it?
Or maybe just a little bit of your own thought process, as clearlythings have gotten worse here versus where your expectations were fairlyrecently.
David Speer
I think first of all, I don’t think we’re headed towards asignificant recession. I think we clearly are at a level in the economy herethat is a broader pause than what many were predicting, certainly in theindustrial cycle.
We are still seeing modest positive numbers but certainly notanything that is significant measurable, so I think we are -- it is likely whatwe are in is a pause now. The question is for how long and how it impactscertain end markets and segments remain to be seen.
In terms of right-sizing the businesses, in ourdecentralized environment, that is a constant process for us and we areconstantly paying attention to that. And as I mentioned in my earlier comments,we’ve been right-sizing in particular our construction and automotivebusinesses for the last four to five quarters.
So our response as we see things slow is a measured responsethat says what do we think the activity levels are going to look like over thenext several quarters, not over the next several months. And we are pretty goodat moving as we sense those activity levels.
On the other hand, there is clearly a point of view thatsays that we want to keep these things sized properly but also properly to thepoint where if in fact this is a pause, that we are not cutting ourselves tothe point where we are not able to respond in any reasonable up-turn. I think we are in a flat spot in the U.S.
industrial economyand my guess is we are going to be in that flat spot for a number of quartersto come. But I certainly don’t view it as a recession.
John Inch - MerrillLynch
Thanks much.
Operator
Our next question comes from Joel Tiss with Lehman Brothers.
Joel Tiss - LehmanBrothers
Thank you. I just wonder if we can dig a little bit moreinto what’s behind on the welding markets and the food equipment markets.
Canyou talk a little -- new products, pricing, volumes and which particular endmarkets are really strong?
David Speer
If you look at our food equipment businesses here in North America, we’ve done well in the casual dining segment, we’ve donewell in the institutional segments. Those are our two primary focuses.
We havehad a number of new product introductions in several of our key businesses,which have clearly helped. In general, I would say that we are beginning now toidentify what we could call a trend, which is we are creating some reasonablegrowth opportunities in these markets.
This is the second year in a row thatwe’ve been able to do that, after four or five years of sizing and focusing onwhere we really thought we could grow with these businesses, so I think it isencouraging to us in that regard. And we’ve seen solid margin improvements in those businessesalong the way, so I think we are clearly now in a position where we have Ithink targeted where we think we can grow and our innovation initiatives arebeginning to pay off in that regard as well.
I think the service business continues to be a major area ofgrowth for us in our food equipment area. We’ve done well and continue toexpand that organization and focus on the after sale of service of therestaurant equipment, so that’s been a growing area for us.
We’ve done very well internationally. We’re up in thequarter 14% and very strong in both Europe and more recently in the Asianregion.
I think it’s more of the same there as well. We’ve had a number ofyears of getting these businesses refocused, re-segmented and in many casesreorganized, and now we are beginning to see the benefit of that and somereasonable growth prospects in front of us as a result.
Joel Tiss - LehmanBrothers
Okay, and the same on welding?
David Speer
On the welding side, clearly here in North America, thegeneral industrial markets have slowed but the markets that are impacted bysome higher end growth opportunities, like the energy infrastructure marketsstill go quite well. Our large equipment category has done very well.
Internationally, the Asian growth story is largely focusedaround what we are doing in China and our China business is focused largely onthe energy infrastructure and ship building. We’ve done well in our European businesses as well.
We’veparticipated well and gained some penetration there, and a nice blend of newproducts and some new segment focus has helped us in those businesses as well.
Joel Tiss - LehmanBrothers
And just quick, for Ron, is the lower tax rate, is that justthe mix in the quarter?
Ron Kropp
Yes, as we’ve had higher revenues overseas, we’ve seen somelower tax rate overseas and more of a shift in places like China, which havenaturally lower tax rates.
Joel Tiss - LehmanBrothers
Thank you.
Operator
Our next question comes from Robert Wertheimer with MorganStanley.
Robert Wertheimer -Morgan Stanley
Good morning, guys. Just a quick follow-up -- I hope I’m notbeating a dead horse here but on the renovation side, should I understand thatthe sell-through at the Home Depots is still pretty solid and it seems likethat’s been the case and it’s surprisingly been the case.
And then on the commercial construction side, I understandsome of the macro indicators have been weak, or the macro forecasting, but areyou hearing the same things from the field in terms of seeing some of themanufacturing down, the healthcare, the education down? Or is it more just themacro you are going on?
David Speer
Let me comment on the renovation category first. There has,for a long period of time, been a disconnect between the purchasing patternsfrom the big boxes and the actual sell-through activity, so that’s not new.
Itgets I think fairly dramatic in these period of uncertainty in some cases ofcontraction where the buying patterns and inventory levels are altered butaren’t necessarily reflective of individual category sales. We have generally seen, on the same-store sale growth,numbers that are still reasonably positive for our categories overall, or forour products overall.
They get exacerbated when they get caught up in inventoryreduction or destocking programs. So it’s hard to create a directionconnection.
With all that said, there is no question that the marketthat they serve, the markets that they serve, primarily renovation andresidential construction, are down and so you can expect to see overallactivity levels out of those outlets down as well. But the dramatic swings upand down are exacerbated by what they do at their inventories and theirpurchasing decisions along the way.
Robert Wertheimer -Morgan Stanley
Thanks. I guess I understand that it should turn down.
Fromwhat I understand, it has not yet turned down on a sell-through basis.
David Speer
That’s correct. It’s still been reasonably good.
Robert Wertheimer -Morgan Stanley
Okay, and then on commercial construction, are you hearingfrom the field the same thing that you are seeing in the construction starts?
David Speer
Oh, yeah, we are definitely seeing that in the bid activity,clearly. You know, it is also geographically dependent.
I mean, you are stillseeing strong growth in some markets, but you are seeing the growth largelybased on build-out. The bid activity is clearly down and it’s down, depending onthe categories, fairly significantly and these are contracts awarded, so giventhat these projects are generally 18 to 24 months duration, if the contractsaren’t awarded you can kind of see thevoid, if you will, coming in the coming months.
I think these numbers are real. I mean, the [dodge] numbersyear-to-date are down 6% in terms of square footage that have been awarded thisyear, so it’s clearly having an impact going forward, no question.
Robert Wertheimer -Morgan Stanley
Okay, thanks.
Operator
Our next question comes from Robert McCarthy with Robert W.Baird.
Robert McCarthy -Robert W. Baird
Hi, guys. Mostly asked and answered -- restructuringexpenses forecast for the year, $35 million to $40 million.
It has been 35 to50 all year long. It’s not unusual for you guys to true-up the estimate at the endof the year but my question goes to organic growth prospects having beendisappointing really so far and prospectively for the fourth quarter.
You got alot of questions earlier about right-sizing construction businesses, et cetera.Why don’t we see that translate into the restructuring expense numbers? Or doesit mean that we are likely to see that number increase next year?
David Speer
Let me answer it from my perspective, Rob, and Ron maybe canadd some flavor to it. First of all, I think the right-sizing that we’ve beendoing, we’ve been doing all along with those units that have been impacted thegreatest by the significant declines -- what we’ve seen clearly in theresidential markets here would be the most notable.
As a result of that activity, I wouldn’t expect to see anysignificant change in the fourth quarter activity. So as you correctly pointout, we try to true those numbers up as we head towards the end of the year.
As we look at next year and we look at the budget process,we’ll come up with a range for restructuring next year. I expect the range forrestructuring next year to be somewhat larger but not necessarily based onright-sizing base businesses.
It is really more a reflection of what we do withthese businesses that we acquire. So it is probably more reflective of the majorrestructurings that will occur in recently acquired businesses than necessarilythose that have been with us for a while.
They usually come at a more measuredrate.
Robert McCarthy -Robert W. Baird
Okay, thank you and I would just like to follow-up -- Ithink it was Mark’s question earlier, I’m not sure, but regarding industrialpackaging internationally, more specifically Asia. You talked about Europe andhow we might understand what is happening there but in Asia specifically, givenwhat is going on in terms of GEP growth or industrial production growth orwhatever you like, why no growth for you?
Is it a heavy Australian exposure orwhat?
David Speer
Well, I would say it’s a couple of things. One is yes, we dohave a heavy Australian exposure but more importantly, we are just in theprocess of opening two new facilities in China in our industrial packaginggroup, one around plastic and one around steel strapping.
So we are not fullyparticipating yet in the growth there, so that is really going to be a 2008story for us. We have seen some adjustments in pricing there, like we didin Europe as well, which has impacted the revenue comparables.
But I think froma positioning standpoint, I think we are in the right spot. It’s just aquestion of timing now.
Robert McCarthy -Robert W. Baird
So there’s been some volume growth and there’s been strongervolume growth yet outside of Australia and New Zealand?
David Speer
Yes.
Robert McCarthy -Robert W. Baird
Okay. All right, thanks.
Operator
Our next question comes from Eli Lustgarten with LongbowSecurities.
Eli Lustgarten -Longbow Securities
Good afternoon. A couple of quick follow-up questions, if Imay; what is your [inaudible] in the fourth quarter, both domestically andoverseas?
When you are looking at ’08 being [relatively flat to up], would yousay is that back-end loaded for improvement?
John Brooklier
Well, we know Detroit 3 in Q4 is down about, prospectively down about 4%, 4% to5% in Q4. We don’t have any estimates for ’08 at this point in time.
On theinternational side --
David Speer
New domestic is up about 5% in the fourth quarter, sooverall the market will be down I think about 2%. That’s what we’re predictingfor the fourth quarter.
John Brooklier
And on the international side, we would expect sales in thefourth quarter to be 2% up, up 2 to 3, kind of come off a very robust Q2 andQ3.
Eli Lustgarten -Longbow Securities
Can you talk a little bit -- the other income number, $9 millionis what the fourth quarter is suggesting, that’s what the guidance was. You hadgains from divestitures in the first half of the year.
Is there anythingplanned the second half of the year or ’08 and is the run-rate still in the $35million range for that other income number?
Ron Kropp
The fourth quarter is about where we would thought it wouldbe at the beginning of the year. There are no unusual items planned for that,whether it’s in our investment portfolio or any potential significant divestitures.Also, we don’t see any for ’08 as well.
From a run-rate perspective, there’s different parts ofthis. The biggest part has been the investment income from our [inaudible]investment segment.
That will be in the neighborhood of $40 million to $50 millionthis year and the run-rate on that is probably more like a 25 to 30 goingforward.
Eli Lustgarten -Longbow Securities
So 25 to 30 is the kind of number we should be thinking forthat group next year and there will probably be some -- there is alwayssomething that will happen, I realize that.
Ron Kropp
And the rest of non-operating income is a lot of -- thingslike interest income and translation and those kinds of things. Those are hardto predict, which way they go year on year.
Eli Lustgarten -Longbow Securities
And the tax rate stays flat for next year with this year?
Ron Kropp
We’re not in a position now to talk about next year’s taxrate.
Eli Lustgarten -Longbow Securities
Thank you.
Operator
Our next question comes from Jamie Cook with Credit Suisse.
Jamie Cook - CreditSuisse
Good morning. Most of my questions have been asked.
Just Iguess one bigger picture question; as you guys look at your longer term goals,you had given organic 5% to 6% growth rate. I mean, in the face of a slowingNorth America, moderating Europe, do you guys feel like you need to do anythingdramatically to change your mix of business in order to achieve those goals?Focus more on energy infrastructure and if so, how do you get there?
David Speer
Well, I’d say Jamie, first of all, the 5% to 6% obviously isa long range growth goal, so it is not next year. The good news that comes outof these terrible comparables this year is that there will be easiercomparables next year.
But frankly, no, we focus as you know, through a lot ofwhat we are doing at our base businesses is already directing them towardstheir finding their way towards some of the higher growth end markets that theyalready participate in. And certainly our acquisitions have been focused more,but I wouldn’t say that we are looking exclusively at any one particular endmarket segment.
Certainly the energy market segment that you highlight isone that we’ve done quite well in with our welding businesses and there maywell be other businesses in the future that will be focused or centered aroundthat. But we clearly are looking at organic growth at higherlevels and we’ve got a number of measures we put in place to help us get there.But clearly with a year like 2007 inauto and residential housing here in the U.S., those are the kind of yearswhere you have to take a step back and recognize that we are looking at thisfor the long term and fundamentally, the kinds of markets that we think willyield that growth long-term is going to be a blend of not only new end markets,but new geographic markets as we continue to diversify our portfolio.
Jamie Cook - CreditSuisse
All right, thanks. I’ll get back in queue.
Operator
Daniel Dowd with Bernstein, you may ask your question.
Daniel Dowd - SanfordBernstein
Good afternoon, guys. Can I actually return to theacquisition strategy for just a minute?
You know, with the decline in privateequity activity, does that change -- you know, we had talked about themultiples you might be paying, but does that change the pool of companies youmight be interested in bidding on in terms of size or anything?
David Speer
Dan, what I think what it changes potentially going forwardis that I think there will be more things that are in the private equityportfolios that will probably come out, so I think in that regard, there islikely to be more potential assets that will be available than there mightnormally have been. I think some of these portfolios, if they were to getunwound prematurely as a result of what’s happened to the credit and the costof credit in these markets for deals that they’ve already done.
I think as it relates to the larger deals that we look at,which are sort of that $300 million to $700 million range, that’s clearly beenan area where the primary buyers in that category for the last several yearshas been the private equity folks. So I think we are going to see an increasein activity where they actually begin to sell some assets probably earlier thanwhat their original plans were in the portfolio.
So instead of holding some of these assets perhaps four orfive years, we may see them coming out in two years. But it is really early tosay.
We’ve heard a lot of things, there’s a lot of speculation, but I can’t saythat we have any hard data yet that would suggest that there is going to be adramatic -- there’s been a dramatic change downward in valuation, but all theindications would lead to that with the decrease in their leverage and theincrease in their cost of capital. It would certainly lead to valuations thatare going to be more realistic than what we’ve seen.
Daniel Dowd - SanfordBernstein
Does this have any implications for the rate at which yourpercentage of revenues that come from emerging markets is likely to change? If youassume that potentially some of these bigger acquisitions are more likely to bein developed markets, could that slow the rate of your total percentage ofrevenues that come from emerging markets?
David Speer
Actually, we have been focused, as you know, on ouracquisition program, looking now at beginning to build out in some of thesenewer markets. If you look at our acquisition activity year-to-date, 75% of theacquired revenues year-to-date have been in our international markets, sothere’s been a significant increase, if you will.
It was 50%, slightly over 50%last year. I don’t know that private equity is going to have much of animpact, the change in private equity is going to have much of an impact in theAsian markets.
It will likely have an impact in Europe as it has here. Wehaven’t seen that much activity in our acquisition programs in Asia fromprivate equity in the past but we clearly have in Europe, so I expect we’d seemore of it in Europe than we would necessarily in Asia.
Although the presenceof private equity in any market in the past several years has had an inflationin valuation, there’s no question.
Daniel Dowd - SanfordBernstein
Thank you.
Operator
Our next question comes from Andy Casey with Wachovia.
Andy Casey - Wachovia
Hello, again. Just a quick question; are you seeing anyupward bias on resin prices because of what is going on in the petroleummarkets?
Ron Kropp
During the quarter, we saw resin come down a bit but we areexpecting that it may tick up a bit, given the oil prices recently.
David Speer
It really depends on the grades of material too, Andy. Wehave some that, as Ron points out, have gone down.
We’ve had some that havegone up. In aggregate, they’ve probably been slightly up but frankly, there’sno way that $85 a barrel oil has been factored into a lot of this pricing, so Iexpect that we are going to begin to see some more pressure on resin prices inthe fourth quarter.
We are already seeing early indications of that and Isuspect that’s going to play out in the fourth quarter.
Andy Casey - Wachovia
Thank you.
Operator
Robert Wertheimer with Morgan Stanley, you may ask yourquestion.
Robert Wertheimer -Morgan Stanley
Very quickly, do you have the diluted share count period endfor the quarter?
Ron Kropp
The diluted share count period end -- without dilution, it’sabout 544. Dilution has tended to be 4.5 million to 5 million on top of that,so about 550.
Robert Wertheimer -Morgan Stanley
Thank you.
Operator
Ann Duigan with Bear Stearns, your line is open.
Ann Duigan - BearStearns
I guess my only question remaining is just morephilosophically, David, could you tell us why you wouldn’t consider doing amore formal accelerated share repurchase program? If I look at -- you expect tospend 7 on share repurchases and that has drifted up through the course of theyear.
I’ve got to wonder why it wouldn’t have been better for shareholders ifyou had spent that $1.3 billion right up front at the beginning of the year andtaken the share count down immediately.
David Speer
Well, as we said from the outset, Ann, we provide theseranges based on what we see the growth prospects are and then we adjust as wego along. As you would know, we changed our capital structure allocation duringthe year and as we changed that and began to look at more acceleratedrepurchase of shares, we put those in place, but we’ve traditionally looked atour capital structure and our acquisition programs on a quarterly basis, andwe’ve consistently for the last two years moved those ranges upward as it madesense.
None of that to us looked like an accelerated repurchaseprogram as you’ve outlined was particularly necessary. We’ve been comfortablewith the way we approached it, so by the end of the year, we’ll have repurchasedabout 1.5 billion shares.
We’ve done that in basically four quarterly programsand we think its achieved our objectives. If we had done it one accelerated share repurchase programin the first quarter, it would have been a much smaller program than what wecompleted because we would not have committed to 1.5 billion at that point intime with the data that we had.
Ann Duigan - BearStearns
What changed during the course of the year then? I mean, youknew you were going to significant cash and you knew you were underleveraged,so I don’t understand fully why you would not have considered 1.5 billion atthe beginning of the year.
Ron Kropp
Well, remember the key part of our capital structure in useof cash is acquisition, and that’s our preferred use of free cash. So goinginto the year, after a very strong 2006 year with $1.7 billion of acquiredrevenues, and we had an estimate of $1 billion or so, it could have been higherand it still could be higher but -- so that’s the key measurement.
As we get into the year, we see how the acquisition pipelineshakes out, we see how our free cash flow works, and then we adjust as we go. I will point out as we have become more active in sharerepurchases starting about a year ago and we have met with all the differentinvestment banks that do this for a living and talked about a lot of thedifferent structure that are out there, including the accelerated repurchaseprograms.
And one thing that struck us with the accelerate repurchase programsis for the most part, even when you enter into a big program up front, you arekind of exposed to the change it the stock price anyway. So it doesn’t get youtoo much at the end of the day from what you paid for the stock versus doing itas you go, versus committing to it up front and then buying it over a six- ornine-month period.
Ann Duigan - BearStearns
But by our back-of-the-envelope calculation, it would havereduced your -- it would have increased your EPS by about $0.20 and theincremental cost of doing it that way would not have shown up in the P&L. So I would disagree with you that it is not of value to yourshareholders, plus --
Ron Kropp
-- that’s an accounting metric, right? I mean, theaccounting rules allow you to reduce your share count even though you don’t ownthe shares.
Ann Duigan - BearStearns
Yes, so --
Ron Kropp
Economically, there’s really no difference.
Ann Duigan - BearStearns
There’s no difference to your cash but there is an impact toyour EPS. Anyway, we can talk about it offline, but --
David Speer
There is for the quarter of the year you do it in, Ann, butover the long haul, the points meet. So it’s just a question of -- you know,our approach in looking at this is measured.
We look at this quarterly and wehave made some significant changes in the capital structure and I think that’sreally reflective of what you see going on. We would not have been in aposition to predict or to be able to offer an accelerated share repurchaseprogram of this magnitude at the beginning of the year.
Ann Duigan - BearStearns
Your debt to capital is still only 15%, so --
Ron Kropp
Let’s move on.
Ann Duigan - BearStearns
Okay, we’ll talk about it offline. Take care, guys.
Operator
(Operator Instructions) David Raso with Citigroup, your line is open.
David Raso -Citigroup
Thank you. A quick question on the acquired revenues, themargins; we’ve seen them drop from 9% in ’05 to 5%, a little below 5% in ’06and now we’re in the low single.
There’s a couple of ways to look at it. Yourmultiples you are paying don’t seem high but obviously it appears you aregetting businesses that either A, you are buying at particularly low marginsrelative to history or you are buying businesses and maybe they’ve been alittle more of a struggle to run the first say two, three, four quarters.
Can you help me understand why the margins are so low on theacquired sales? And then if you want to take the glass-half-full view of it,you could say if we could still think of these businesses as eventual ITWbusinesses, can they get to 10% over the next couple of years.
I understand international businesses might be inherentlylower margin, but not low single digit.
Ron Kropp
The typical metric we use before any amortization charges,our typical acquisition is maybe between 8% to 10% margin. And afteramortization, depending on the earlier quarters of the acquisition, sometimesthey have a bigger hit.
And we’ve seen some of that, especially in the firstpart of this year because we did so many acquisitions in the fourth quarter,that the first quarters after the acquisition have a bigger chunk ofamortization on things like inventory step-ups and backlog. Now that we’ve gotten to this quarter, we have seen someimprovement in that.
For instance, before the effect of amortization, themargins on our businesses are around 8% to 10%. So it’s about where we expected.
It’s fairly close tohistorical. There are some international businesses that are lower, lower thantypical but we see a lot of room for improvement there, and our metric ofdoubling those margins of 8% to 10% over a five-year period is still themetric.
David Raso -Citigroup
I apologize if I missed it; why is this different than twoyears ago when the acquired revenue margins were a lot higher? Can you help meunderstand?
Ron Kropp
I think part of it is timing. We didn’t have such bigquarter’s worth of acquisitions all at once like we did in the fourth quarterof last year.
I think what you are seeing now is a little bit more normalizedrevenue. But also the international does play a part as well.
[Multiple Speakers]
David Speer
-- acquisitions for ’06 were done in the fourth quarter oflast year, so in terms of pace, it was completely different than we probablywould have seen in say ’05, or even the impact in ’06 in acquisitions and in’05.
David Raso -Citigroup
Okay, we can talk offline. I just want to make surestructurally, we’re not looking at -- I mean, obviously the margins in thecompany are coming down as you get more international and the acquisitions havepicked up.
I’m just trying to understand the pace of the margin degradation.Are we looking inherently at businesses out there that -- and you would thinkthe last couple of years had a decent economy globally. I’m not sure whatbusinesses we’re looking at where we find a low margin, but you’re saying it’snot the case -- it’s some accounting issue with the amortizations and inventorychanges on the valuation of it, but the margins themselves are literally stillkind of a traditional ITW model, 8% to 10%, five years later, get them up tomid-teens.
David Speer
That’s exactly what they are and in fact, the profile mighteven be slightly better than that with the portfolio of what we’ve done in thelast 18 months.
David Raso -Citigroup
I appreciate it. Thank you.
Operator
I’m showing no further questions.
John Brooklier
Thanks, everybody who joined us for the call and we willtalk to you next quarter. Thank you.
Operator
That concludes today’s call. Thank you all for joining.
Youmay disconnect your lines at this time.