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Illinois Tool Works Inc. (ITW)

Q3 2010 Earnings Call

October 19, 2010 11:30 am ET

Executives

John Brooklier - IR

David Speer - CEO

Ron Kropp - CFO

Analyst

Meredith Taylor - Barclays Capital

John Inch- BofA Merrill Lynch

Terry Darling - Goldman Sachs

Mark Koznarek - Cleveland Research Company

Deane Dray - Citi

Ann Duignan - JPMorgan

Henry Kirn - UBS

Robert Wertheimer - Morgan Stanley

Operator

Welcome to the Third Quarters Earnings Release Conference Call. All participants are in a listen-only until the question-and-answer session of today’s conference. (Operator Instructions). I would like to turn the call up here, host today Mr. John Brooklier, you may begin

John Brooklier

Welcome to all of who joined us for today’s ITW’s third quarter 2010 conference call. With me today is our CEO, David Speer, and our CFO, Ron Kropp. Despite today’s irrational market reaction to your third quarter results and Q4 forecast, we firmly believe we had a very strong set of third quarter financial results, while we talk about those today especially our organic growth rates on our operating margins.

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

David Speer

The third quarter generated strong total company operating results, which turned out better than we had expected as we provided our original third quarter guidance. Worldwide end markets in quarter three appeared to be relatively stable and demand levels were essentially even with our strong 2010 second quarter. Here are some of the highlights.

Our third quarter organic growth rate of 11.2% was largely driven by strong base revenue growth in our Power Systems and Electronics, Industrial Packaging, and Transportation segments. Our sorted welding electronics, industrial packaging and auto OEM businesses also took advantage in solid third quarter end-market demand, thanks to ITW strengths such as our ongoing product innovation and strong customer service.

Our very strong in third quarter operating margins of 15.9% were 240 basis points higher than the year ago period and only 10 basis points lower than the 2010 second quarter, which is generally our top performing operating margin quarter in the quarter. It’s clear that our past restructuring efforts have helped to improve our operating margins, and we thank all of our operating people around the world for job well done.

Finally, we have repurchased 8.1 million shares for $350 million in the quarter, as we said a number of times in the past we consider our share repurchase program to be an ongoing part of our capital allocation process and we remain committed to being opportunistic as to choose as you saw during the quarter.

Now back to you, John.

John Brooklier

Here is the agenda for today’s call. Ron will join us in a few moments to talk about the Q3 ‘10 financial highlights. I will then cover Q3 operating highlights for our reporting segments and then Ron will detail our Q4 and full year earnings forecast. Finally, we will take your questions as always we asked your cooperation for a first question and first follow-up question policy.

Next, let’s cover our mandatory housekeeping items. This conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including without limitation statements regarding operating performance, revenue growth, diluted net income per share from continuing ops, acquisition activity, restructuring expenses and related benefits, tax rates, end-market conditions, and the company’s 2010 related forecast.

Finally, one of the housekeeping items, telephone replay for this conference call is 402-220-9717. The telephone replay is available through midnight of November 2 and no pass code is necessary.

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

Ron Kropp

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

Operating income was $641 million, which was higher than last year by $157 million. Margins of 15.9% were higher by 240 basis points. Diluted income per share was $0.83, which was higher than last year by $0.23. Finally free operating cash flow was strong at $412 million or 98% of net income.

Now let’s go to the components of our operating results. At 12.2% revenue increase was primarily due to three factors. First, base revenues were up 11.2%, which was unfavorable by 390 basis points versus the second quarter base increase of 15.1%. As David mentioned, we have seen solid revenues gains worldwide led by the Transportation, Industrial Packaging and Power Systems segments.

North American base revenues increased 11.5% and international base revenues increased 10.8%, which were lower than the second quarter increases of 15.8% and 14.2% respectively. Next currency translation decrease revenues by 2.4%, which was unfavorable by 470 basis points versus the second quarter currency benefit.

Lastly, acquisitions and divestitures added 3.5% revenue growth which was 60 basis points higher than the second quarter acquisition impact. Operating margins for the third quarter 15.9%, where higher than last year by 240 basis points and where essentially the same as second quarter margins.

The base business margins were higher by 160 basis points due to the favorable impact of the higher sales volume, partially offset, but the negative impact of non-volume items. Non-volume items reduced base margins by 130 basis points, which was unfavorable first and the second quarter non-volume impact by 190 basis points.

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

In addition, margins were higher by 60 basis points did higher restructure expenses last year and acquisition reduced margins by 30 basis points, when I turn it back over to John, who will provide more details on the operating results, as he discuss of the individual segments.

In a non-operating area, other non-operating income and expense was favorable by $4.9 million, mainly due to pre-tax divestiture gain of $20 million related to the sale of the (inaudible) business.

The third quarter effective tax rate of 31.6% was lower than last year as a result of unfavorable discreet tax adjustments in the prior year. Excluding the negative impact of taxes related to the (inaudible) divestiture, the third quarter effective tax rate would have been 30.5%. The tax rate for the fourth quarter is forecasted to be in a range from 30% to 31%.

Turning to the balance sheet, total invested capital increased $127 million from the second quarter primarily due to currency translation. The accounts receivable DSO was 58.9 days versus 57 days at the end of the second quarter. Inventory month on hand was 1.8 at the end of the quarter versus 1.7 last quarter.

For the third quarter capital expenditures were $72 million, the depreciation was $81 million; ROIC for the third quarter increased to a strong 16.6% versus 12.7% last year.

On the financing side, our debt level increased approximately $352 million from the second quarter and debt to capital was 28%. Cash on the balance sheet increased to $1.6 billion from $1.3 billion at the end of the second quarter. During the third quarter we spent $350 million to repurchase 8.8 million shares.

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

During the third quarter we acquired seven companies, which had annual revenues of $120 million; our current acquisition forecast for full year 2010 acquired revenues is $500 million to $700 million. This forecast is supported by an acquisition pipeline of more than $600 million.

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

John Brooklier

Let me quickly review our third quarter segment highlights starting with our Transportation segment Q3 2010 total segment revenues increased 16.3% versus the year ago period.

Our organic revenues also known as base revenues grew very healthy 15.8% in the quarter compared to the year earlier period. Notably, operating margins of 14.9% were 480 basis points higher than the year ago period. Base margins accounted for 230 basis points net improvement.

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

Our worldwide auto OEM businesses group base revenue is 21.3% in the quarter with our North American auto units growing 28.5% and our international auto units increasing 15.5% and that’s due in large part to their product innovation efforts and ongoing platform penetration.

By comparison North American auto builds grew 26% in Q3, and European auto builds increased 8% in Q3 versus the year ago. So, you could see the penetration ability over penetrate builds continues to be strong within the company.

On a go forward basis, we continue to forecast that auto builds will remain relatively strong portfolio year 2010; North American auto production, which is forecasted to be in a range of $11.6 million to a $11.8 million units, while European auto builds is forecasted to be in a range of $17.8 million to $18 million units for the full year.

In our auto after-market group of businesses, Q3 business base revenues declined 2.5% largely as a results of the related down taking consumer spending in this category, as new turbine wrapped up it appears consumers, who were spending more dollars on the older vehicles.

Moving to the next segment, Industrial Packaging’s Q3 total segment revenues grew 16.4% versus the year ago period and Q3 base revenues increased to somewhere 16.4% year-over-year. Operating margins 11.6% were 410 basis points higher than a year ago period with base margins accounting for 250 basis points for that improvement.

As noted Industrial Packaging base revenues growth is 16.4% in Q3 was made up of across the board gains for many of our businesses. This strong Q3 base revenue growth for the segment underpins our belief that overall end-market demand will remains at very reasonable and sustainable levels.

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

Coincidental indicator businesses such as our North American plastic and steel strapping businesses and their international counterpart to produce base revenue growth of 24% and 13.4% respectively versus the year ago period, and our protective packaging units known for their protective corner board and specialty airbag products used for transport purposes, grew base revenues strong 17.3% in the quarter versus year ago.

Moving to Food Equipment, the Food Equipment’s Q3 total segment revenues declined 2.3% as the trend of customer delaying equipment purchases largely stayed in place. As a result, base revenues grew a very modest 1.4% in the quarter versus the year ago. The better news in the quarter was that operating margins of 17.6% were 40 basis points higher than the year ago period. Most of that operating margin increase was due to improvement in the base margin.

Food Equipment segments modest uptick in base revenues of 1.4% essentially reflected trends from past quarters, that is customers continue to be weary of buying new equipment, but they continue to invest in our businesses, who serve us in our products.

Catch in points, our North American equipment business produced a base revenue decline of 3.8% in Q3, but notably our North American service unit generated base revenue growth of 3.6% in the quarter. When aggregate, North American Food Equipment base revenues were flat versus year ago.

International Food Equipment results were better with base revenues growing 2.7% versus the year earlier period and this improvement was largely due to better demand for products in Asia and Latin America.

Moving to Power System and Electronics, total segment revenues grew a very strong 23.7% versus a year ago period. Notably base revenues increased 23.8% on a year-over-year basis, thanks to very strong contributions from both the welding and PC board fabrication business units.

Operating margins up 22% were 460 basis points higher than a year ago with 420 basis points so that improvement coming from base margins. Similar to the 2010 second quarter of the segments financial performance was driven by our strong operating results from the welding and PC board fabrication businesses.

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

From a geographic standpoint, North America welding base revenues grew 19.4% that’s largely due to better demand from heavy equipment OEMs and assorted manufactures, and our international welding Q3 base revenues increased the more modest 5.3%, as European demand was strong, while an Asia-Pacific was weaker. For example, China has in demand for ship building and some infrastructure projects slow over the past few quarters.

Moving to the PC board fabrication side of the business for the segment I should say, that business produced base revenue growth of 68.6% in Q3 versus the year ago period. Ongoing strong customer demand for products such as cell phones, portable computers and PDAs continue to underpin growth from these segments.

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

In Construction Products, Q3 total segment revenues grew 10.9% versus the year ago period, while base revenues increased 4% in Q3 compared to the year earlier period. Operating margins of 11.8% were 90 basis points higher than a year ago period with 50 basis points of improvement coming from base margins.

There is no surprise of the segments modest base revenue growth in the third quarter reflected reasonable construction and market demand internationally, contrasted with persistent weakness across North American construction end-markets.

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

European commercial construction end markets remains relatively strong with Germany especially vibrant. In North America, not much of a surprise, where our total construction base revenues declined 6.7% in Q3 as weak housing in commercial construction trends persisted.

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

We move on to the Polymers and Fluids Q3 total segment revenues. Those revenues grew 5.3% versus the year ago period. Base revenues increased 4.3% in Q3 compared to the year earlier period. Operating margins of 16.4% were 40 basis points higher than year ago period.

The segments base revenue growth of 4.3% Q3 was largely due to better international activity, but slower than expected growth in a few key North American end markets. Our international Polymers businesses produced base revenue growth of 8.1% in Q3, thanks to better demand in Europe and Asia.

In North America, the story was a bit different with our organic growth rates, while our Polymers businesses declining 7% in the quarter. This is largely due to issues such as the deep oil drilling disaster in the Gulf of Mexico and its negative impact on oil and gas production and also our wind industry demand turned down temporarily as manufactures slowed production to change to larger blade configurations.

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

Moving to Decorative Surfaces, Q3 total segment revenues were flat in the quarter versus the year ago period, but organic revenue was better with base revenues increasing 3.1% compared to the year ago period. Operating margins of 10.7% were 20 basis points lower than the year ago period as a result of restructuring and other expenses associated with the closing of the flooring business.

Decorative surfaces base revenue growth of 3.1% in Q3 represented its best quarterly performance of the year. This improvement was tied to both reasonable demand trends in North America and internationally for high pressure laminate products.

In our North America laminate business base revenue grew 5% in Q3 largely due to the increased buying by office equipment manufactures for the financial service sector as well as improved demand for store fixtures for the remodeling. Internationally, organic revenues grew 4.9% versus the year ago period, thanks to increased demand in Asia that drove base revenues up 23% on a year-over-year basis.

Finally, as noted before please note that we are in the process of closing our flooring business due to overall weakening in the high pressure laminate flooring sector, base revenue performance by our flooring business was substantially negative in Q3.

Finally moving to all other segment, Q3 total segment revenues grew 18.6% versus a year ago period and base revenues increased 13.7% compared with a year earlier period. Operating margins of 18.4% were 183 basis points higher than a year ago period, with a 100 basis points of an improvement coming from base margins. The segment's strong base revenue growth of 13.7% in Q3 reflected and proven across our four major businesses in this segment.

In test and measurement, our organic grew 8.9% in Q3 and represented a second consecutive quarter where base revenues have grown in 8% to 10% range. While the business of equipment, consumables and service attached to it, recent growth rates may suggest the CapEx spending is perhaps on the rise. Our consumer packaging business grew base revenues 9.9% in Q3 and was mainly driven by double digit base revenue contributions from our decorating and graphics businesses. Our industrial appliance business generated a base revenue growth of 18.6% in Q3 with strength coming from both North America and international businesses.

Finally, our worldwide finishing businesses produced very strong organic growth rates of 31% in Q3. Most of that growth came from international end markets and was led by the specialty Swiss based Gema powder coating business, which has strong products and market positions in both Europe and Asia.

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

Ron Kropp

For the fourth quarter of 2010, we are forecasting diluted income per share for continuing operations to be within a range of $0.74 to $0.82. The low end of this range assumes a 7% increase in total revenues versus 2009 and the high end of the range assumes a 9% increase. The midpoint of this EPS range of $0.78 will be 28% higher than the fourth quarter of 2009 excluding the impact of last year's favorable discrete tax adjustments in the fourth quarter.

For the full year our forecast of the EPS range is now $2.99 to $3.07 based on a total revenue increase of 13% to 14%. The midpoint of the EPS range of $3.03 would be 57% higher than 2009.

Other assumptions included in this forecast are exchange rates holding at current levels as of the end of the quarter. The quarter revenue is between $500 million to $700 million. Fourth quarter operating margins in a range of 14.2% to 15.2%. This margin range would be lower than the third quarter margins of 15.9 due mainly to a shift in mix between North America and international businesses and favorable corporate adjustments in the third quarter that are not expected to be repeated in the fourth quarter. Restructuring cost of $40 million to $50 million for the year and a tax rate range between 30% and 31% for the fourth quarter.

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

John Brooklier

Thank you, Ron. We will now open the call to questions.

Operator

(Operator Instructions). First question comes from Meredith Taylor. Your line is open.

Meredith Taylor - Barclays Capital

The first question is for David. You made some comments recently round your expectations for North American construction in 2011. Could you give some broader comments around some of your other key end markets and how you see some of those trending? In particular, I am interested in which are the end markets that you see as the strongest and which of the end markets that you see as the weakest, looking ahead at 2011?

David Speer

Well Meredith, I will give you some flavor, but obviously we are not providing guidance for 2011 but certainly from a……….

Meredith Taylor - Barclays Capital

Flavor is great.

David Speer

Yes I have made some comments recently about construction, I have been asked a lot about particularly what I would expect to see in the residential market and more recently obviously the commercial markets and my comments there have largely been that I would expect not to see a significant improvement in residential construction housing starts in 2011. While I expect we will see some upward movement, I think we are still obviously dealing with a lot of issues in the housing market due to higher employment, foreclosures, etc.

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

In terms of the markets that have been performing well, I think both John and Ron highlighted some of those in our comments. We have seen obviously building momentum in our welding business, our power electronics businesses, test and measurement businesses have all been coming on nicely. I expect that we will see shortly some improvement in the equipment sales of the food equipment group is I think we are close to seeing those businesses turned as well.

We have seen very strong performances in the transportation market but I would expect that the bills in the OEM market particularly up in North America would be obviously more modest than the significant improvement we saw this year coming off of what was clearly a very, very weak year in 2009.

So I think we are seeing as we had really suggested a strong year one of what we saw as a three-year recovery and I think that is largely what I would except to see as we had this 2011. Some markets obviously are going up against much more difficult comparable so the growth rate would be more modest in 2011. In some markets that are beginning to see some improvement in later cycle businesses I would expect to see better growth rates, do not expect to see much contribution law in 2011 from the North American construction businesses.

Meredith Taylor - Barclays Capital

Can you talk a little bit about your motivation for share repurchase in the quarter? I mean with this the reflection on the prospects or timing at least of acquisition or purely a reflection or your views on valuations? May be help calibrate that view, could you give us that average share price which you would repurchased in the quarter?

David Speer

Yeah. I think Ron can give the exact numbers $43 and change during the quarter of the average share price. Clearly as we looked at the quarter we looked at our strong cash balance and we looked at that acquisition activities over the next quarter so it made sense with where we were to buy some shares back certainly from evaluation standpoint but also from a cash utilization standpoint. So, as you will note on the balance sheet even after the cherry purchases we have $1.6 billion in cash on the balance sheet. So, we certainly saw this an opportunity given the current environment as we said in the past we would use that share repurchase program on an opportunistic fashion and we did so during the quarter.

Operator

John Inch, your line is open.

John Inch - BofA Merrill Lynch

I want to start with the guidance. Just as I think about the year right so you raised the estimate by $0.08. You beat this quarter by 5 and I think you are lowering restructuring by $0.02 for the year, sales are higher by one and half point so the $0.04 to $0.05and then you got more favorable currency by $0.01 to $0.02. What is the offset? Why it is not the fourth quarter midpoint being raised by more? May be, may be Ron could explain this corporate item issues but he said that it was favorable corporate in the third quarter that is less favorable, what exactly is that and how much is that?

David Speer

While at Ron dig that at the end let me answer the beginning your question, John, by saying first of all the biggest variable between the Q3 and Q4 if you are drawing those comparison is a significant change and the mixed revenues. International is a much stronger component of overall revenue mix during Q4. As you may recall international Q4 contains September, October, and November whereas the North American is the normal quarter of October, November, and December. So we have a heavier mix and the margins in our international businesses represented by lower margin profile on the order of about 400 basis points. So that really explains all in sort of changes in the margin profile. As you have noted that there are some other puts and takes that basically not out but that would be the bulk of the change.

Also remember that the comparable to currency per Q4 for this year versus last year will actually be a negative number as the Q4 currency last year was in the 145-146 range with Euro as an example. So there is still a headwind on currency built in to these numbers. I'll let Ron comment on the corporate numbers.

Ron Kropp

One data point on the international North American split in the third quarter, North America was about 52% of the total revenues and international with 48. That about flipped in the fourth quarter. That is pretty typical given the August month for Europe is in the third quarter and December is in the fourth quarter for North America. So it’s a pretty typical shift in revenues.

The bridge between the margins in the third quarter and fourth quarter more than half of it is this mix issue. The other piece of it is base revenues are down slightly and that is you know due to seasonality and normal seasonality and there is corporate items of about $15 million of benefit that were booked in the third quarter that were not forecasting for the forth quarter. So, these are things like we have life insurance an investment at the corporate office and the cash surrender value goes up and down based on the market. That was about $7 million. Some other reserves for product liability and healthcare etcetera were the rest of it.

John Inch- BofA Merrill Lynch

Ron, those corporate items of 15 million benefit, we’re not part of your original guidance annually, is that correct?

Ron Kropp

Correct.

John Inch- BofA Merrill Lynch

Okay. So, I guess I’m just trying to understand though. The issues that you brace right so would be higher international mix with lower margins some of the other items and in the fact wouldn’t note have been known when you gave the annual guide. This is sort of we’re trying to understand. I think to when you gave your current, when you gave your guide at the end of the second quarter, I think currency you would thought was going to be a $1.28, dollar to euro now is at $1.40. So, I just trying to understand like you raised the year by $0.08 should be reported by five that low restructuring by two it just doesn’t, it things like we’re actually lowering the core in the fourth quarter whether it’s mix or not, is there something I would anticipate you to known that, know or is there something else.

David Speer

No, we didn’t I mean, if you look at the changes in guidance for the quarter first of all, as you know we didn’t provide guidance for Q4 before so, may be this is compared to what you that estimated, but I think that Ron is laid out is the typical margin mix the growth rate for base revenues for the quarter is about what we had built into our original guidance for Q4 obviously on much stronger comps.

The corporate item that you’re referencing for the quarter for quarter three they were positive. We don’t forget those, and by large many of those net out to pretty zero sum game by the end of the year so, we don’t really predict them a quarterly John. So, may be that you’re doing math here at the end of the year is one quarter left that may suggest that they are other underlying issues. I think it’s the mix of revenues; the lower base growth revenue rate obviously at 8% as opposed to the 11% we saw in the quarter obviously has somewhat of an impact as well. If you look at our traditional seasonality, this is very much in line with the margin profile that we see from Q4 compared to Q3 in the normalized basis. So, I don’t think there is anything unusual here that we haven’t explained.

David Speer

So the basis about where we were at the end of last quarter. So, your $0.08 is really $0.03 of currency, $0.02 of corporate items, $0.02 of restructuring.

John Inch- BofA Merrill Lynch

Did you pipeline for M&A go down? I thought it was about 800 million, I think you suggest in the call was just over six. And may be this is…

Ron Kropp

600 plus, if we are close some deals, I know some deals are up fall under pipeline, it’s not not a significant number, but the pipeline number, John, we’re going to have in as well.

John Inch- BofA Merrill Lynch

I appreciated that. I just wondering may be you could just give us a color in terms of the trend right because I think just given your acquisition history and some of the deals you’ve done historically and the threshold volumes, one might have expected the activity level to be much higher. So, are we still on that trajectory or (inaudible) may be we’re not? How should we think about that?

Ron Kropp

No, no, I wouldn’t assume that at all that repurchasing share is nothing to do with how we feel about the pipeline currently. I would say the activity in the pipeline continues to increase. As I noted in our last call, the yield in the pipeline just changed quarter-to-quarter so, it’s down modestly from what we would said quarter ago, but some of that is a result of closed deals and some of that is a result of deals that are really pushed out into the 2011 timeframe. So, I wouldn’t draw any large conclusions out of how that modest change in the pipeline nor the repurchase of shares.

Clearly with the cash balances we had and with the near term look at the pipeline, we had plenty of opportunity to look at this and say it made sense based of those levels to do share repurchase during the quarter, but certainly not reflective of any change in our view the acquisition pipeline. I expect it will continue to firm and I expect as we had into 2011 that will begin to see the pipeline continue to grow.

Operator

Terry Darling, your line is open.

Terry Darling - Goldman Sachs

Speer and Ron, if we go back to the price cost gap that you talked about I think down 90 basis points year over year and I remember last year there were some unusual benefits so, just trying to calibrated on early that bridge, and then how you are thinking about that the value gap as you move into your 2011 given the recent run up in some of the metals prices and so forth?

David Speer

I will let Ron give you some flavor in detail but partially what you are seeing reflected that 90 basis point negative headwind is exactly that. We have seen costs particularly in the metals category move up and obviously catching up on that from a price standpoint it does take some time and that’s really what we're seeing in this number in Q3. I expect that as we head into Q4 we're still seeing some cost increase pressures but some of the price increases that we have in fact put in place will begin to kick in and I would expect that number to probably come down somewhat modestly during Q4 as a result of that. So, I would describe what's occurring now as probably what typically occurs when you see some commodity cost increases you have some negative headwinds until you get full cost recovery which generally takes a quarter or so.

Ron Kropp

Yeah, Terry, last year in the third quarter was the low point in most of our raw material cost. So back last year we had a 270 basis points margin year back to '08 and since then we've seen that come back each quarter. So, the negative 90 this quarter was negative 40 last quarter. Given the current situation with prices we expect it to be relatively stable in the fourth quarter for both steel and resin. So, we are looking at probably 25 to 50 basis points negative in the fourth quarter so, pretty minimal going forward.

Terry Darling - Goldman Sachs

Was the 40 did 90 2Q versus 3Q more raw material or more some weakness in pricing or kind of a combination would you say?

David Speer

I would say it's really driven by primarily cost increases and the speed with which we can recover price. So, we saw some cost increases occur towards the latter part of the second quarter. We saw lots of it during the third quarter and so some of the price actions we took in Q3 only realized a portion of the cost recovery. So, I'd say it's primarily been driven by cost and the lag effect of a price increase.

Terry Darling - Goldman Sachs

As you head to the first half of '11, if you think about how the raw material cost that you are incurring now would kind of rachet up the spot if we pretended for the sake of the discussion that we held where we are right now, does that gap more narrow or stay about in that 25 to 50 basis points you are calling out for the fourth quarter?

David Speer

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

Terry Darling - Goldman Sachs

Just quickly on the food equipment margin, should we think of that as a base to build off of or was there something seasonal or mix-wise that made 3Q particularly strong?

David Speer

I think other than the normal seasonal impact which is volume related, no. I think that’s probably reasonable assumption that’s a base to build off of. We've yet to see any significant improvement in the equipment side and obviously when we do we would expect to see strong incrementals in those businesses. The only reasonable growth we have seen so far has been in the service side of the business. So, I would expect that the margin profile you are seeing today is a good foundation for us to build on as we begin to add volume in the coming quarters.

Unidentified Company Speaker

The seasonal impact in the third quarter on price cost in that segment as well. So we didn’t have the negative we did in some of the segments.

Terry Darling - Goldman Sachs

Lastly, I wonder if you can calibrate the accretion in 2011 from M&A that’s already essentially (inaudible) being consummated, give us an update on that.

David Speer

We really don’t have those numbers, Terry. I think the way to look at the M&A number is roughly you can take our annual volume and you can figure that about half of that will be spread between 2010 and 2011 impact. So, you can expect that at least first half of next year will have some impact of that. The first year all in of acquisitions we generally get very little earnings accretion as a result of all of the amortization on accounting that takes place in year one, we really don’t get much net benefit. So, we haven’t obviously calculated this for 2011 yet. Obviously the 2011 guidance we will have some guidance around what we would plan to acquire next year as well. By and large, year one we don’t get a lot of accretion. So, it wouldn’t be a huge certainly in 2011 in the first half of the year and probably a modest impact from those acquisitions we've done 2011 in the second half.

Operator

Mark Koznarek, your line is open.

Mark Koznarek - Cleveland Research Company

Can you give us some idea of what business trends are sequentially in year-over-year, we know things are slowing with tougher comps? Can you give us some idea what's happening sequentially in your businesses? It appear most investor markets will be relative flat at this point can you give me some idea what’s going on across the business/

David Speer

Well, I don’t have a lot of sequential data here in front of me I think, Ron provided some flavor on some of the Q2 to Q3 either comparables I can tell you that overall the revenues in Q3 were pretty much in line with slightly less than what we saw in Q2, which is somewhat abnormal given the normal seasonality we would normally seen a decline between Q2 and Q3 or some more in the order 4 to 5%, we didn’t see that obviously this quarter, our revenues in Q2 were about 4.1 billion revenues in Q3 where 4.04 billion so, not a significant decline from a sequence standpoint we would normally seen. Obviously that varies on the cost businesses, the once that clearly we’ve seen sequential uplift ones that John highlighted in the earlier discussion certainly the industrial packaging businesses, the test and measurement businesses, the welding electronic segment. Those are the ones that sequentially we’d have seen growth quarter-by-quarter, but I don’t have it by segment perhaps we could come up with that and provide that here later date, but we don’t have at with our fingertips at the moment.

Mark Koznarek - Cleveland Research Company

Great, and you’re still expecting is in channel like what projection expected that very much in the fourth quarter anymore (inaudible) but here or in here I mentioned that the numbers are bit higher than you would expected that will be talking about this.

Ron Kropp

Yeah, the build numbers have clearly gone up throughout the year although, I would say that the increases for Q4 are modest by comparison to the last numbers. So, I think the projected bill for Q4 auto in North America somewhere in the 3 million range and should end up as John said somewhat around 116 to 117 for the year. Most of the increase in the bill occurred in the first two quarters that were still a nice increase in Q3 and I think in the European auto bills are likewise we saw most of the improvement actually occurred during the third quarter and subsequent quarter. So, I’d say that auto build I would describe as the normal seasonal flattening in Q4 and I expect that the growth rates based on what we’re seeing from the early CSM data for 2011 will be probably in the North America somewhere in the 5 to 6% range in New York probably in the 3 to 4% range.

Mark Koznarek - Cleveland Research Company

I think indicated that welding was softer in Asia at this point is during the time.

Ron Kropp

It was softer in Asia really driven primarily by our strong concentration to shipbuilding, market there the shipbuilding market in China is down nearly 40%, this year so it obviously damped our overall growth rates in Asia with welding as a result of that.

Mark Koznarek - Cleveland Research Company

An aftermarket was pretty sure on (inaudible).

David Speer

After markets were quite strong. Our oil and gas business over there is very strong. The general steel fabrication markets are very strong.

Operator

Deane Dray, your line is open.

Deane Dray - Citi

Thank you, good afternoon. Just a follow-up on (inaudible) question regarding sequential improvement I do have the numbers in front of me on this one, but industrial packaging since that is such an improvement coincidental indicator look like it had steady sequential improvement across the quarter and would be interested to hearing that what that mix was equipment versus consumables, but more importantly the read class in terms of what that suggest in terms of our longer term growth, industrial production, and so forth.

Unidentified Speaker

Well, given the strong performance that we’ve had or the strong mix we have in those businesses in Europe had actually flat quarter-to-quarter a strong indication of the continued recovery in those markets normally we would expecting to see some more around 6% decline just based on seasonality that wasn’t the case during the quarter. So, if you look at the overall growth rates that John highlighted and Ron in their comments if we just take the strapping business is being. The consumable volume in Q3 was up in the 11 to 12% range. The equipment volume was up over 50%. So, strong improvement in equipment volume during the quarter that’s the obviously an important indicator that at least we are seeing a significant level of replacement sales taking place and in some cases even some new capacity being added in some markets. So, it’s only been two quarters of positive quarter on equipment obviously that’s a very strong comparable in Q3 on the equipment side.

Deane Dray - Citi

That’s very helpful. And then I know you not in the 2011 guidance business yet, but is it fair just to take a step at what you believe peak getting back to peak margins given the phase of the recovery said it year one of the three year recovery. If you peaked previously at 17% operating margin is it a fair to say that you’ve got upside to that and we’re looking at about 100 basis points from their, but what you’re using for internally or just what you can share with us today.

Unidentified Speaker

Yeah, while I think as we said earlier and you pointed out we think this is 2010 is one of the solid recovery, our margin profile for this year will finish more than 15% overall for the year just you take the midpoint of our fourth quarter guidance in the three quarters of actual. Clearly as we look at this is the another year of recovery albeit slower in 2011, I would clearly expect to see margins continue to accelerate. We said that based on peak-to-peak, we would expect that we would have some more 50 to perhaps 70 basis points higher peak-to-peak earnings ratios, the only impact there would be those level of acquisitions that we did that is diluted, but it look at base-to-base we’d expect some more between 50 to 70 basis points higher margins. I don’t expect that we get to that next peak in most of these markets until 2012.

Operator

Ann Duignan, your line is open.

Ann Duignan - JPMorgan

I had just building on the last couple of questions and David may be you could give us an outlook from your prospective what you’re seeing as they’d looks like if you look at any of your businesses, our most of your businesses that are driven by the consumer. Those are recovering slower than businesses that are industrial production driven and so the notion of restocking comes to mind. What you’re seeing as kind from the consumer’s prospective we noted in the few businesses that the consumer spending is actually slowed versus kind of restocking our industry production driven demand and what is the net impact may be looking into 2010 and again we’re not going to give guidance, but we just producing at their (inaudible) usually have a good thing on the [pulse].

David Speer

Yeah, I mean, clearly the consumer businesses are especially in North America have clearly been plateau, they are generally week depending on the specific end markets, I mean, we take markets like auto, the auto businesses actually performed well on a year-on-year comparable, but last year was obviously extremely low year and an overall auto production and sale. I think any of the consumer phasing businesses has remained challenging in terms of looking any significant growth. We don’t think there is much restocking going on; most of it’s been already in those businesses. The industrial markets have clearly been the one that have been stronger and we would expect to see that as we had into 2011 particularly as it relates to North America.

The US consumer as accurately point out consumer spending is gone up, but it’s gone down, it’s pull back. I expect we’re going to see that for a while the consumer markets remain weak, unemployment range persistently hide the housing markets weak so, a lot of things try to the consumer clearly there is not much of a tailwind and fact in some cases you could there is perhaps somewhat in the headwind on those markets. On the industrial side, we’re seeing, I think good strong recovery in most of the end markets. As I pointed out earlier, some of those markets are not just beginning to show some signs or recovery. Those are the later cycle markets that we talked about earlier.

Then I would expect that the trends that we’re seeing at the moment I would expect that they would remain intact as we had into 2011 so, albeit somewhat slower growth comparisons obviously as we had into 2011, you’ve got a GDP estimate out there now for next year that’s some more between 2 and 2 in a quarter for the US and that’s significantly down from the number of people expect to see overall this year. So, I don’t think that’s a surprise we’d expect to see slower growth rates, but I do expect we’ll continue to see stronger industrial growth early then we will in the consumer markets.

Ann Duignan - JPMorgan

Okay, thank you and just one follow-up on the M&A front and what kinds of businesses are coming up for offer, you’re turning down a lot of businesses because they’re not in areas that you’re interested in or is a kind of everything that’s coming on your debt here you’re taking a good look at. Just kind of curious what’s coming into pipeline there was – there is a lot of activity out there and you’re just turning down opportunities are whether you’re kind of taken whatever is coming up and turning over.

David Speer

Right, well, first of all, just to remind everyone, pipeline for us are deals that are passed letter of interest stage up to due diligence in closing. So, it’s not the ideal pipeline, the front end of the pipeline if you want to call about the idea phase that we don’t count has been very, very active. There are lots of things out there that have come to us that are not particularly attractive. They really don’t fit strategically with where we want to continue to grow and grow.

There are plenty of ideas out there for spaces that are interested in, evaluations have been challenging particularly anything of size, private equity clearly is active in the market for any deals of size, anything 100 million or more in size is plenty private equity people out there that with the new math convert significantly higher offers and the many strategic so, it is more competitive environment, but I would say that in the last 120 days or so the whole market is opened up in terms of ideas in flow of opportunities. I expect that we continue to work our pipeline that we’re going to see that pipeline improved over the next several quarters, but lot of activity evaluations are have moved up quickly and I think it's a challenging market from that standpoint, but we are looking at the normal spaces and I'm very confident that as we move forward we're going see that this cycle in acquisition for us we'll move to the next level as we head in to 2011.

Operator

(Inaudible) your line is open.

Unidentified Analyst

I've got a question about the decorative business with the closing of the flooring. What kind of impact does that have on the new line and what kind of margin improvement opportunities that I mentioned (inaudible)?

David Speer

Market is pretty inconsequential all in. That business has been in a shrinking mode for the last five years. So, I think the annualized revenues in this year's outlook would be under $25 million and it was with the restructuring going on the business would have lost money. In or out it's not a huge difference for the segment or for the overall earnings profile.

Unidentified Analyst

David, you say 25 or a 125?

David Speer

25. About $25 million in revenues.

Unidentified Analyst

2 on a 5?

David Speer

2 on a 5, yes. 25 million right.

Unidentified Analyst

So the margin impact is also going to be very modest.

David Speer

It will be positive because it was losing money.

Unidentified Analyst

That’s sort of what I wanted to focus on a little bit, whether that’s material or not, because it seems like moving into 2011, there's a couple of positives. There is that benefit whether its material or not, I don’t know, but we also have lower restructuring probably and also the benefits of the past couple of years of significant restructuring. So, it seems like it'd be a pretty fair assumption that you would have better than average leverage on the margin line, not a lot of acquisition to lose in and then some of these other structural improvements. Is that a pretty fair assessment or are there some other offsets that you are thinking about?

David Speer

No, the way to think about, I mean, first of all, the decorative services is not consequent. So, I would think the best way to respond to your question is to think about our normal incrementals. Our normal incrementals are in the 30% to 35% range. They have been running north of 40% obviously this year in the first year of a significant recovery. We are already seeing significant benefits out of those restructuring projects and out of those acquisitions with lower margins. Some of that is obviously already in our numbers. I would expect that as we look at the growth and the business in 2011 that we would expect to see incremental probably somewhat higher than our norm, maybe in the 35, maybe as good as 40% next year but certainly not in same category or range they've been in this year as we've already leveraged significant off of some of that.

In terms of restructuring spend next year, what you'll see all in is that our restructuring spend this year is probably going to end up being pretty typical of what it is on a normalized basis. So, somewhere in that $40 million to $50 million range is where we will end up for the year and that’s a pretty typical year for us. So, obviously a lot less on what we spent last year when we spent over $160 million. Again, we are not providing guidance for 2011 but a pretty normalized range of restructuring price is in that $40 million to $50 million range, most of it directed to acquisitions as it has been done in the last several years.

Unidentified Analyst

What was that comment about food equipment? Thought you mentioned it looked like it was about to break out, the equipment side was negative in the quarter but what gives you a thought that it is likely to turn positive?

David Speer

I think the activity level from a coding standpoint at the project a lot of our business is institutional. These are larger projects that have a longer planning horizon. We are beginning to see the front end of that activity pick up which generally is a good indicator that at some point in the next quarter so we should start to see the equipment revenues begin to rise.

We'll also be going to against, I mean, we got comps now that -- remember these are the later cycle businesses that actually for the first two quarters of last year had positive growth. So, we are really at a point now where I think we're close to seeing the bottom here and should start to see some improvement in the revenue volumes. We haven't seen any significant leverage off of the cost base in those business because obviously we haven’t seen the volume.

Operator

Henry Kirn, your line is open.

Henry Kirn - UBS

What do you factor in as the biggest risk to upset your guidance as we go into the fourth quarter in 2011? What should be watching?

David Speer

Well, I mean you can look at our base revenue growth rates, I mean the 8% midpoint for Q4, it’s pretty much what we would describe as a continuation of the recovery that we’re seeing all the recovery any significant derailing of the recovery would obviously put back the growth rates under some pressure. Most of the significant growth in comparables that are the easier comparables of over behind us as Ron pointed out his earlier comment, our businesses really began to accelerate more significant in Q3 last year.

So, it up against a more difficult comparable, so 8% on a strong fourth quarter comparables are pretty good growth rate, but pretty much in line with the trends we’re seeing recently. So, was compared to the fourth quarter last year, I think at a sequential basis you’ll see the number in Q4 certainly in North America shows a modest decline. So, I think the answer to your question would be if the current recovery got derailed in some major fashion as suppose that would be the largest upside risk, it’s hard in the site any particular segment or earlier because the growth across the segments has been pretty broadly spread across a lot of end markets in geography. So, I could add much more flavor than that.

Henry Kirn - UBS

Is there anyway where you think you might be too conservative if there was anyone here?

David Speer

I’m sure, I could highlight, (inaudible), I think the last two quarters, the revenue growth rates have really been in line with our original guidance, so, I don’t want to say we’re proud to be right, but I don’t know what I’m so bold as to say we’ve been completely conservative anywhere. I think we’ve clearly projective what we saw as continued improvement. I can’t think of any particular area, I mean obviously if something would have changed dramatically if you’re looking for a headline it would have be a periodic improvement residential housing. I can’t think of any other area that were conservative and in conservative in a measure of on actually happens right, such as very, very unlikely.

Henry Kirn - UBS

Right.

David Speer

Exactly, I mean the housing starts are a clearly remaining historically low level that’s our forecast there would be perhaps very conservative at the numbers tick up by 20% next year, but I wouldn’t be able to highlight any particular areas being overly conservative.

Operator

Robert Wertheimer, your line is open.

Robert Wertheimer - Morgan Stanley

My first question would be on share. We don’t talk about too much, but I wondered as you’ve gotten through the trials and taking look at the competitive position where and how much you think you might gain shares specifically we can do auto, I don’t know whether that the numbers are pretty volatile in the (inaudible) and your numbers. So, I don’t know whether you’ve started to see a lot of share gain where that comes in with a 11 models of the 12 models and how much you think that could add any other areas in my call out per share looks interesting.

David Speer

Well, let the auto was the easiest one to look at because there is more data, it’s more transparent. If you look at auto bills, content for vehicle, new platform launches etcetera, we’ve [reached] some visibility. We’ll pickup some more around four to five points of penetration gain overall this year and I would expected as we look at the 2011, here will be expecting something in that range may be even slightly better depending on the timing of a couple of new platform launches where we have significant content. So, I think that in many of our businesses, we would suggest we had picked up at least modest amounts of share in those where we have more definitive measurements and we can measure it. We can obviously see it more directly, but auto is probably the best example because it’s the only solid sort of global database that you can tie sales production and platform content too.

Robert Wertheimer - Morgan Stanley

That’s 400 to 500 bits faster than the end market this year that will be sharing in content penetration.

David Speer

That’s correct. Yep, exactly. That’s measuring the overall global markets, right.

Robert Wertheimer - Morgan Stanley

And again, David as you gotten to the [trust], do you think that any of the lesser acquisitions will due to people being overly focused on new operations as post acquisitions is that reversing or is that just not been a factor. You’re seeing – are you spending anymore of your time of evaluating platform level acquisitions.

David Speer

I would say that we didn’t spend as much time in the first half of 2009 when acquisitions as we were clearly trying to identify with our base businesses where these markets were going that we’re in great turmoil. By the second half of last year, we were really fairly well engaged in the acquisition process again and they’re really the delay and lot of this has really been I think more around expectations of what happens with potential acquisition targets that were also in the state of decline. So, many of them had -- that they were later cycle businesses they still didn’t have good numbers to look until probably early this year.

In terms of my activity and the activity of our senior executives we are spending a significant amount of time, certainly even more time than last year on the acquisition front particularly as it relates to platform opportunities and perhaps some new segments as we look forward. So, there's a lot of activity in that area for sure and really virtually none of that is included in our pipeline at the moment.

John Brooklier

Thank you, Ron. We're going to end the call now. We thank everybody for joining us today, and we look forward to talk to you later. Thanks.

Operator

Thank you. That concludes today's conference. Everyone may disconnect at this time.

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