Illinois Tool Works (ITW) 10-K 2005 FY Annual report

Exhibit 13

MANAGEMENT’S DISCUSSION AND ANALYSIS     30

Management’s Discussion and Analysis

INTRODUCTION

Illinois Tool Works Inc. (the “Company” or “ITW”) is a worldwide manufacturer of highly engineered products and specialty systems. The Company has approximately 700 operations in 48 countries which are aggregated and organized for internal reporting purposes in 2005 into the following five segments: Engineered Products—North America; Engineered Products—International; Specialty Systems—North America; Specialty Systems—International; and Leasing and Investments. These segments are described below.

Due to the large number of diverse businesses and the Company’s highly decentralized operating style, the Company does not require its business units to provide detailed information on operating results. Instead, the Company’s corporate management collects data on a few key measurements: operating revenues, operating income, operating margins, overhead costs, number of months on hand in inventory, days sales outstanding in accounts receivable, past due receivables, return on invested capital and cash flow. These key measures are monitored by management and significant changes in operating results versus current trends in end markets and variances from forecasts are discussed with operating unit management.

The results of each segment are analyzed by identifying the effects of changes in the results of the base businesses, newly acquired companies, currency translation, restructuring costs, and goodwill and intangible impairment charges on the operating revenues and operating income of each segment. Base businesses are those businesses that have been included in the Company’s results of operations for more than a year. The changes to base business operating income include the estimated effects of both operating leverage and changes in variable margins and overhead costs. Operating leverage is the estimated effect of the base business revenue changes on operating income, assuming variable margins remain the same as the prior period. As manufacturing and administrative overhead costs usually do not significantly change as a result of revenues increasing or decreasing, the percentage change in operating income due to operating leverage is usually more than the percentage change in the base business revenues.

A key element of the Company’s business strategy is its continuous 80/20 business process for both existing businesses and new acquisitions. The basic concept of this 80/20 business process is to focus on what is most important (the 20% of the items which account for 80% of the value) and to spend less time and resources on the less important (the 80% of the items which account for 20% of the value). The Company’s operations use this 80/20 business process to simplify and focus on the key parts of their business, and as a result, reduce complexity that often disguises what is truly important. The Company’s 700 operations utilize the 80/20 process in various aspects of their business. Common applications of the 80/20 business process include:

• Simplifying manufactured product lines by reducing the number of products offered by combining the features of similar products, outsourcing products or, as a last resort, eliminating products.

• Simplifying the customer base by focusing on the 80/20 customers and finding different ways to serve the 20/80 customers.

• Simplifying the supplier base by partnering with key 80/20 suppliers and reducing the number of 20/80 suppliers.

• Designing business processes and systems around the key 80/20 activities.

The result of the application of this 80/20 business process is that the Company improves its operating and financial performance. These 80/20 efforts often result in restructuring projects that reduce costs and improve margins. Corporate management works closely with those business units that have operating results below expectations to help those units apply this 80/20 business process and improve their results.

CONSOLIDATED RESULTS OF OPERATIONS

The Company’s consolidated results of operations for 2005, 2004 and 2003 are summarized as follows:

DOLLARS IN THOUSANDS	2005			2004			2003
Operating revenues	$	12,921,792		$	11,731,425		$	10,035,623
Operating income		2,259,204			2,056,613			1,633,458
Margin %		17.5	%		17.5	%		16.3	%

31     2005 ANNUAL REPORT

In 2005 and 2004, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

	2005 COMPARED TO 2004									2004 COMPARED TO 2003
							% POINT INCREASE									% POINT INCREASE
	% INCREASE (DECREASE)						(DECREASE)			% INCREASE (DECREASE)						(DECREASE)
	OPERATING			OPERATING			OPERATING			OPERATING			OPERATING			OPERATING
	REVENUES			INCOME			MARGINS			REVENUES			INCOME			MARGINS
Base manufacturing business:
Revenue change/Operating leverage		4.4	%		10.2	%		1.0	%		8.1	%		20.3	%		1.8	%
Changes in variable margins and overhead costs		—			(2.9	)		(0.5	)		—			(3.2	)		(0.5	)
Total		4.4			7.3			0.5			8.1			17.1			1.3
Acquisitions and divestitures		5.0			2.6			(0.4	)		5.0			2.4			(0.4	)
Translation		1.3			1.5			—			4.4			4.3			(0.1	)
Restructuring costs		—			(1.0	)		(0.2	)		—			2.3			0.4
Impairment of goodwill and intangibles		—			0.3			0.1			—			(1.1	)		(0.2	)
Leasing and Investments		(0.1	)		(0.8	)		(0.1	)		—			0.9			0.1
Other		(0.5	)		—			0.1			(0.6	)		—			0.1
		10.1	%		9.9	%		0.0	%		16.9	%		25.9	%		1.2	%

Operating Revenues

The total Company base business revenue increase in 2005 versus 2004 was primarily related to a 5.8% revenue increase in North American base business revenue. The growth in North American revenues was primarily due to price increases implemented to offset raw material cost increases, modest growth in industrial production and increased demand in certain capital equipment markets. Internationally, base business revenues increased 2.2% in 2005 over 2004 as slow European economic growth continued to hamper international revenue growth.

The total Company base business revenue increase in 2004 versus 2003 was primarily related to an 8.9% revenue increase in North American base business revenue. Industrial production levels in North America improved over the prior year’s sluggish levels. This improvement was evident in the higher revenues for both the North American Specialty Systems and Engineered Products segments. Internationally, base business revenues increased 5.7% in 2004 over 2003 as a result of increased penetration in European industrial markets despite an only slightly improved European economic environment.

Operating Income

Operating income in 2005 improved over 2004 primarily due to leverage from the growth in base business revenue, income from acquired companies and favorable currency translation. These increases were partially offset by higher raw material costs, higher restructuring expenses, higher expenses related to stock incentive compensation and lower Leasing and Investments income.

Operating income in 2004 improved over 2003 primarily due to leverage from the growth in base business revenue, the favorable effect of foreign currency translation, income from acquired companies and lower restructuring costs. These improvements were partially offset by higher raw material costs, increased overhead costs and higher impairment charges.

ENGINEERED PRODUCTS—NORTH AMERICA SEGMENT

Businesses in this segment are located in North America and manufacture a variety of short lead-time plastic and metal components and fasteners, as well as specialty products for a diverse customer base. These commercially oriented, value-added products become part of the customers’ products and typically are manufactured and delivered in a time period less than 30 days.

In the plastic and metal components and fasteners category, products include:

• metal fasteners and fastening tools for the commercial and residential construction industries;

• metal plate connecting components and software for the commercial and residential construction industries;

• laminate products for the commercial and residential construction industries and furniture markets;

• specialty laminate film used in the construction market;

• metal fasteners for automotive, appliance and general industrial applications;

• metal components for automotive, appliance and general industrial applications;

MANAGEMENT’S DISCUSSION AND ANALYSIS     32

• plastic components for automotive, appliance, furniture and electronics applications; and

• plastic fasteners for automotive, appliance and electronics applications.

In the specialty products category, products include:

• reclosable packaging for consumer food applications;

• swabs, wipes and mats for clean room usage in the electronics and pharmaceutical industries;

• hand wipes and cleaners for use in industrial manufacturing locations;

• chemical fluids which clean or add lubrication to machines and automobiles;

• adhesives for industrial, construction and consumer purposes;

• epoxy and resin-based coating products for industrial applications;

• components for industrial machines;

• manual and power operated chucking equipment for industrial applications; and

• automotive aftermarket maintenance and appearance products.

In 2005, this segment primarily served the construction (45%), automotive (28%) and general industrial (9%) markets.

The results of operations for the Engineered Products—North America segment for 2005, 2004 and 2003 were as follows:

DOLLARS IN THOUSANDS	2005			2004			2003
Operating revenues	$	3,766,417		$	3,377,373		$	3,118,404
Operating income		659,222			573,175			504,071
Margin %		17.5	%		17.0	%		16.2	%

In 2005 and 2004, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

	2005 COMPARED TO 2004									2004 COMPARED TO 2003
							% POINT INCREASE									% POINT INCREASE
	% INCREASE (DECREASE)						(DECREASE)			% INCREASE (DECREASE)						(DECREASE)
	OPERATING			OPERATING			OPERATING			OPERATING			OPERATING			OPERATING
	REVENUES			INCOME			MARGINS			REVENUES			INCOME			MARGINS
Base manufacturing business:
Revenue change/Operating leverage		2.8	%		6.8	%		0.6	%		6.9	%		17.7	%		1.6	%
Changes in variable margins and overhead costs		—			3.0			0.5			—			(5.6	)		(0.8	)
Total		2.8			9.8			1.1			6.9			12.1			0.8
Acquisitions and divestitures		8.4			5.1			(0.6	)		1.2			0.8			(0.1	)
Translation		0.3			0.2			—			0.2			0.2			—
Restructuring costs		—			(0.4	)		(0.1	)		—			1.8			0.3
Impairment of goodwill and intangibles		—			0.3			0.1			—			(1.2	)		(0.2	)
		11.5	%		15.0	%		0.5	%		8.3	%		13.7	%		0.8	%

Operating Revenues

Revenues increased in 2005 over 2004 primarily due to revenues from acquisitions and higher base business revenues. The incremental acquisition revenue was primarily related to the acquisitions of two engineered polymers businesses, a construction business and an automotive business. Construction base business revenues increased 1.4% in 2005 due to a slowing residential construction market as well as declines in revenue at the Wilsonart businesses. Automotive base revenues increased 1.5% despite a 4% decline in automotive production at the North American Big 3 automotive manufacturers. This was due to increased product penetration which helped to offset lower production levels. Base revenues from the other industrial-based businesses in this segment grew 5.7% due to strong demand throughout most of the businesses in this segment, particularly the reclosable packaging group.

Revenues increased in 2004 over 2003 primarily due to higher base business revenues and revenues from acquisitions. The base revenue increase was a result of stronger end market demand and price increases that partially offset raw material cost increases. Construction base business revenues increased 8.5% in 2004 as a result of growth in the residential, remodeling and commercial construction markets. As a result of increased penetration, automotive base revenues were flat in 2004 despite a 4% decline in automotive production at the North American Big 3 automotive manufacturers. Revenues from the other industrial base businesses in this segment grew 11.2% in 2004 as they benefited from increased demand in a broad array of end markets.

33     2005 ANNUAL REPORT

Operating Income

Operating income increased in 2005 over 2004 primarily due to leverage from the growth in base business revenues, lower overhead expenses and income from acquisitions. These increases were partially offset by base business variable margin declines of 60 basis points due to sales declines in high margin businesses. In addition, income was higher due to lower goodwill and intangible asset impairment charges over the prior year. In the first quarter of 2005, an intangible asset impairment charge of $5.0 million was recorded related to the intangibles of a U.S. manufacturer of clean room mats. Additionally, income increased in 2005 due to a $9.0 million charge in 2004 associated with a warranty issue related to a discontinued product at the Wilsonart laminate business.

Operating income increased in 2004 over 2003 primarily due to leverage from the growth in base business revenues described above, lower restructuring costs and income from acquisitions. These increases were partially offset by base business variable margin declines of 20 basis points, primarily due to steel cost increases. In addition, income in 2004 was negatively impacted by a $9.0 million charge associated with a warranty issue related to a discontinued product at the Wilsonart laminate business. Also partially offsetting the base business increases were first quarter 2004 goodwill and impairment charges of $7.0 million, primarily related to the goodwill of a U.S. electrical components business and the trademarks and brands of a U.S. manufacturer of clean room mats.

ENGINEERED PRODUCTS—INTERNATIONAL SEGMENT

Businesses in this segment are located outside North America and manufacture a variety of short lead-time plastic and metal components and fasteners, as well as specialty products for a diverse customer base. These commercially oriented, value-added products become part of the customers’ products and typically are manufactured and delivered in a time period less than 30 days.

In the plastic and metal components and fastener category, products include:

• metal fasteners and fastening tools for the commercial and residential construction industries;

• laminate products for the commercial and residential construction industries and furniture markets;

• specialty laminate film used in the construction market;

• metal plate connecting components and software for the commercial and residential construction markets;

• metal fasteners for automotive, appliance and general industrial applications;

• metal components for automotive, appliance and general industrial applications;

• plastic components for automotive, appliance and electronics applications; and

• plastic fasteners for automotive, appliance and electronics applications.

In the specialty products category, products include:

• electronic component packaging trays used for the storage, shipment and manufacturing insertion of electronic components and microchips;

• swabs, wipes and mats for clean room usage in the electronics and pharmaceutical industries;

• adhesives for industrial, construction and consumer purposes;

• chemical fluids which clean or add lubrication to machines and automobiles;

• epoxy and resin-based coating products for industrial applications; and

• manual and power operated chucking equipment for industrial applications.

In 2005, this segment primarily served the construction (39%), automotive (28%) and general industrial (13%) markets.

The results of operations for the Engineered Products—International segment for 2005, 2004 and 2003 were as follows:

DOLLARS IN THOUSANDS	2005			2004			2003
Operating revenues	$	2,727,922		$	2,491,908		$	1,897,951
Operating income		403,507			372,368			263,464
Margin %		14.8	%		14.9	%		13.9	%

MANAGEMENT’S DISCUSSION AND ANALYSIS     34

In 2005 and 2004, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

	2005 COMPARED TO 2004									2004 COMPARED TO 2003
							% POINT INCREASE									% POINT INCREASE
	% INCREASE (DECREASE)						(DECREASE)			% INCREASE (DECREASE)						(DECREASE)
	OPERATING			OPERATING			OPERATING			OPERATING			OPERATING			OPERATING
	REVENUES			INCOME			MARGINS			REVENUES			INCOME			MARGINS
Base manufacturing business:
Revenue change/Operating leverage		0.1	%		0.3	%		—	%		7.3	%		21.1	%		1.8	%
Changes in variable margins and overhead costs		—			(1.9	)		(0.3	)		—			(0.6	)		(0.1	)
Total		0.1			(1.6	)		(0.3	)		7.3			20.5			1.7
Acquisitions and divestitures		6.6			4.5			(0.3	)		12.4			8.8			(0.6	)
Translation		2.8			3.9			0.2			11.6			13.8			0.1
Restructuring costs		—			(0.7	)		—			—			1.4			0.2
Impairment of goodwill and intangibles		—			2.3			0.3			—			(3.2	)		(0.4	)
		9.5	%		8.4	%		(0.1	)%		31.3	%		41.3	%		1.0	%

Operating Revenues

Revenues increased in 2005 over 2004 primarily due to contributions from acquisitions and the favorable effect of currency translation. The incremental acquisition revenue was primarily related to the acquisitions of two European polymers businesses, two European fluid product businesses and a European construction business. Base business construction revenues increased 2.2% as increased demand at the Wilsonart laminate businesses was partially offset by weak European and Australian construction markets. Automotive base revenues declined 2.9% primarily due to declines in automotive production at certain European automotive manufacturers. Base business revenues for the other businesses in this segment that serve a broad array of industrial and commercial end markets were flat in 2005.

Revenues increased in 2004 over 2003 due to contributions from acquisitions, increased base business revenues and the favorable effect of currency translation, primarily as a result of the euro strengthening versus the U.S. dollar. The acquisition revenue is primarily related to the acquisitions of an Australian construction business and a European polymer business in the first quarter of 2004 and two European fluid product businesses in the second quarter of 2004. Base business construction revenues increased 7.8% in 2004 due to a rise in commercial construction activity in Europe, as well as increased commercial and residential demand in the Australasia region. Automotive base revenues grew 6.8% primarily due to increased product penetration at the European automotive manufacturers. Base business revenue for the other businesses in this segment increased 5.8% in 2004 due to strong demand through the end markets that this segment serves.

Operating Income

Operating income increased in 2005 over 2004 primarily due to acquisitions, the favorable effect of currency translation, and lower impairment charges offset by higher restructuring expenses. In addition, variable margins decreased 30 basis points primarily due to increases in raw material costs.

Operating income increased in 2004 over 2003 primarily due to leverage from the increase in base business revenues described above, the favorable effect of currency translation, income from acquisitions and lower restructuring expenses. Partially offsetting the above income increases was a goodwill impairment charge of $8.5 million incurred in the first quarter of 2004, primarily related to the diminished cash flow expectations of a European automotive components business.

SPECIALTY SYSTEMS—NORTH AMERICA SEGMENT

Businesses in this segment are located in North America and design and manufacture longer lead-time machinery and related consumables, as well as specialty equipment for a diverse customer base. These commercially oriented, value-added products become part of the customers’ processes and typically are manufactured and delivered in a time period of more than 30 days.

In the machinery and related consumables category, products include:

• industrial packaging equipment and plastic and steel strapping for the bundling and shipment of a variety of products for customers in numerous end markets;

• welding equipment and metal consumables for a variety of end market users;

35     2005 ANNUAL REPORT

• equipment and plastic consumables that multi-pack cans and bottles for the food and beverage industry;

• plastic stretch film and related packaging equipment for various industrial purposes;

• paper and plastic products used to protect shipments of goods in transit;

• marking tools and inks for various end users; and

• foil and film and related equipment used to decorate a variety of consumer products.

In the specialty equipment category, products include:

• commercial food equipment such as dishwashers, refrigerators, mixers, ovens, food slicers and specialty scales for use by restaurants, institutions and supermarkets;

• paint spray equipment for a variety of general industrial applications;

• materials and structural testing machinery and software;

• static control equipment for electronics and industrial applications;

• wheel balancing and tire uniformity equipment used in the automotive industry; and

• airport ground power generators for commercial and military applications.

In 2005, this segment primarily served the food institutional and retail (25%), general industrial (25%), construction (11%) and food and beverage (8%) markets.

The results of operations for the Specialty Systems — North America segment for 2005, 2004 and 2003 were as follows:

DOLLARS IN THOUSANDS	2005				2004				2003
Operating revenues		$	4,168,305			$	3,776,100			$	3,300,776
Operating income			776,094				668,114				534,384
Margin %			18.6	%			17.7	%			16.2	%

In 2005 and 2004, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

	2005 COMPARED TO 2004									2004 COMPARED TO 2003
							% POINT INCREASE									% POINT INCREASE
	% INCREASE (DECREASE)						(DECREASE)			% INCREASE (DECREASE)						(DECREASE)
	OPERATING			OPERATING			OPERATING			OPERATING			OPERATING			OPERATING
	REVENUES			INCOME			MARGINS			REVENUES			INCOME			MARGINS
Base manufacturing business:
Revenue change/Operating leverage		8.4	%		19.5	%		1.8	%		10.9	%		28.2	%		2.5	%
Changes in variable margins and overhead costs		—			(4.5	)		(0.7	)		—			(4.8	)		(0.7	)
Total		8.4			15.0			1.1			10.9			23.4			1.8
Acquisitions and divestitures		1.5			1.1			(0.1	)		3.1			1.4			(0.3	)
Translation		0.5			0.6			—			0.4			0.4			—
Restructuring costs		—			—			—			—			0.2			0.1
Impairment of goodwill and intangibles		—			(0.5	)		(0.1	)		—			(0.4	)		(0.1	)
		10.4	%		16.2	%		0.9	%		14.4	%		25.0	%		1.5	%

Operating Revenues

Revenues increased in 2005 over 2004 primarily due to higher base business revenues as a result of increased demand for machinery and consumables in most of the end markets this segment serves. Welding base revenues increased 18.7% mainly due to increases in volume in the oil, pipeline and construction markets. Food equipment and industrial packaging base revenues increased 5.0% and 3.3%, respectively, in 2005. Base revenues in the other businesses in this segment, including the marking, decorating and finishing businesses, increased 9.5%. The acquisition revenue is primarily related to the acquisitions of a materials and structural testing business and a specialty packaging business.

Revenues increased in 2004 over 2003 due to increased base business revenues and revenues from acquisitions. The acquisition revenue increase is primarily due to a third quarter 2003 acquisition of a North American steel strapping business. The base revenue increase was a result of stronger end market demand and price increases that partially offset raw material cost increases. Base business revenue growth in 2004 is primarily due to an increase in demand in most of the end markets that this segment serves. Welding base revenues

MANAGEMENT’S DISCUSSION AND ANALYSIS     36

increased 26.6% due to an increase in equipment orders due to the economic recovery in industrial markets. Industrial packaging base revenues grew 10.8%, food equipment base revenues increased 2.1% and base revenues in the other businesses in this segment increased 8.5%.

Operating Income

Operating income increased in 2005 over 2004 primarily due to leverage from the base business revenue increases and income from acquisitions. These increases were partially offset by a 70 basis point decrease in operating margins. Margins decreased due to raw material cost increases and revenue gains in lower margin businesses. In addition, overhead costs increased partially due to higher expenses related to stock incentive compensation. In addition, income was adversely affected by 2005 goodwill impairment charges of $9.6 million mainly related to the reduced cash flow expectations at a welding business and a specialty packaging business.

Operating income increased in 2004 over 2003 primarily due to leverage from the base business revenue increases described above. Additionally, income from acquisitions increased income in 2004. However, variable margins declined 50 basis points in 2004 primarily due to steel raw material cost increases. Additionally, income was adversely impacted in 2004 due to goodwill and intangible asset impairment charges of $5.9 million incurred in the first quarter of 2004, primarily related to the diminished cash flow expectations at two welding businesses and an industrial packaging unit.

SPECIALTY SYSTEMS—INTERNATIONAL SEGMENT

Businesses in this segment are located outside North America and design and manufacture longer lead-time machinery and related consumables, as well as specialty equipment for a diverse customer base. These commercially oriented, value-added products become part of the customers’ processes and typically are manufactured and delivered in a time period of more than 30 days.

In the machinery and related consumables category, products include:

• industrial packaging equipment and plastic and steel strapping for the bundling and shipment of a variety of products for customers in numerous end markets;

• welding equipment and metal consumables for a variety of end market users;

• equipment and plastic consumables that multi-pack cans and bottles for the food and beverage industry;

• plastic bottle sleeves and related equipment for the food and beverage industry;

• plastic stretch film and related packaging equipment for various industrial purposes;

• paper and plastic products used to protect shipments of goods in transit; and

• foil and film and related equipment used to decorate a variety of consumer products.

In the specialty equipment category, products include:

• commercial food equipment such as dishwashers, refrigerators, mixers, ovens, food slicers and specialty scales for use by restaurants, institutions and supermarkets;

• materials and structural testing machinery and software;

• paint spray equipment for a variety of general industrial applications;

• static control equipment for electronics and industrial applications; and

• airport ground power generators for commercial applications.

In 2005, this segment primarily served the general industrial (29%) food institutional and retail (19%) and food and beverage (14%) markets.

The results of operations for the Specialty Systems—International segment for 2005, 2004 and 2003 were as follows:

DOLLARS IN THOUSANDS	2005			2004			2003
Operating revenues	$	2,582,346		$	2,349,238		$	1,943,447
Operating income		304,288			311,354			214,602
Margin %		11.8	%		13.3	%		11.0	%

37     2005 ANNUAL REPORT

In 2005 and 2004, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

	2005 COMPARED TO 2004									2004 COMPARED TO 2003
							% POINT INCREASE									% POINT INCREASE
	% INCREASE (DECREASE)						(DECREASE)			% INCREASE (DECREASE)						(DECREASE)
	OPERATING			OPERATING			OPERATING			OPERATING			OPERATING			OPERATING
	REVENUES			INCOME			MARGINS			REVENUES			INCOME			MARGINS
Base manufacturing business:
Revenue change/Operating leverage		4.3	%		12.8	%		1.1	%		4.1	%		14.1	%		1.1	%
Changes in variable margins and overhead costs		—			(13.1	)		(1.7	)		—			4.0			0.4
Total		4.3			(0.3	)		(0.6	)		4.1			18.1			1.5
Acquisitions and divestitures		3.3			(0.2	)		(0.4	)		6.2			2.5			(0.5	)
Translation		2.3			3.1			0.1			10.6			13.3			0.1
Restructuring costs		—			(5.0	)		(0.6	)		—			11.3			1.2
Impairment of goodwill and intangibles		—			0.1			—			—			(0.1	)		—
		9.9	%		(2.3	)%		(1.5	)%		20.9	%		45.1	%		2.3	%

Operating Revenues

Revenues increased in 2005 over 2004 mainly due to base business revenue growth, revenues from acquired companies and the effect of favorable currency translation. Industrial packaging base revenues grew 5.8% due to stronger demand in Asia and price increases in Europe. Food equipment base revenues increased 3.3% due to an increase in European refrigeration and cooking orders. Other base business revenues, including welding and finishing businesses, increased 2.4% due to improved end markets. Acquisition revenues primarily increased due to the acquisitions of an industrial packaging business, two decorating businesses and a material and structural testing business.

Revenues increased in 2004 over 2003 mainly due to favorable currency translation, primarily as a result of the euro strengthening versus the U.S. dollar. Revenues also grew due to acquisitions, including a second quarter 2003 acquisition of an Asian manufacturer of welding consumables. Base business revenues increased as demand increased in most end markets that this segment serves. Industrial packaging base revenues grew 5.2%, food equipment base business revenues grew 2.3%, and other base business revenues, including welding and finishing, increased 3.3% due to improved end markets.

Operating Income

Operating income decreased in 2005 versus 2004 primarily due to increased operating costs. Income was also adversely affected by increased restructuring expenses primarily related to several industrial packaging, food equipment and decorating businesses. A first quarter 2005 adjustment of $8.7 million to resolve accounting issues at a European food equipment business also reduced income. These decreases were partially offset by an increase in income due to higher revenues and the favorable effect of currency translation. Variable margins decreased 50 basis points and overhead costs increased partially due to the above mentioned food equipment charge and higher expenses related to stock incentive compensation.

Operating income increased in 2004 versus 2003 primarily as a result of leverage from higher base business revenues, the favorable effect of currency translation, lower restructuring expenses and income from acquisitions. In addition, variable margins improved 70 basis points reflecting the benefits of past restructuring efforts.

LEASING AND INVESTMENTS SEGMENT

Businesses in this segment make investments in mortgage entities; leases of telecommunications, aircraft, air traffic control and other equipment; properties; affordable housing and a venture capital fund. See the Investments note for a detailed discussion of the accounting policies for the various investments in this segment.

The results of operations for the Leasing and Investments segment for 2005, 2004 and 2003 were as follows:

IN THOUSANDS	2005		2004		2003
Operating revenues	$	132,080	$	148,791	$	152,585
Operating income		116,093		131,602		116,937

MANAGEMENT’S DISCUSSION AND ANALYSIS     38

Operating income (loss) by investment for the years ended December 31, 2005, 2004 and 2003 was as follows:

IN THOUSANDS	2005			2004		2003
Mortgage investments	$	76,715		$	72,270	$	72,570
Leases of equipment		13,681			23,294		23,744
Property developments		7,146			7,440		10,398
Properties held for sale		(1,845	)		4,177		(3,044	)
Venture capital limited partnership		9,000			18,211		(924	)
Other		11,396			6,210		14,193
	$	116,093		$	131,602	$	116,937

The net assets attributed to the Leasing and Investments segment at December 31, 2005 and 2004 are summarized by investment type as follows:

IN THOUSANDS	2005		2004
Mortgage investments	$	269,852	$	376,194
Leases of equipment		5,003		(14,821	)
Property developments		29,327		24,831
Properties held for sale		27,443		21,602
Affordable housing limited partnerships		14,107		7,110
Other, net		58,809		49,344
	$	404,541	$	464,260

The net assets attributed to the Leasing and Investments segment as of December 31, 2005 and 2004 were as follows:

IN THOUSANDS	2005			2004
Investments	$	896,487		$	912,483
Deferred tax assets		109,356			114,517
Allocated general corporate debt		(25,545	)		(78,991	)
Deferred tax liabilities		(301,276	)		(247,954	)
Affordable housing capital obligations		(72,145	)		(94,657	)
Preferred stock of subsidiaries		(40,000	)		(60,000	)
Accrued dividends on preferred stock of subsidiaries		(24,820	)		(32,700	)
4.88% Preferred debt securities		(53,735	)		—
Other, net		(83,781	)		(48,438	)
	$	404,541		$	464,260

A portion of the Company’s general corporate debt has been attributed to the various investments of the Leasing and Investments segment based on the net cumulative after-tax cash investments in the applicable projects.

Mortgage Investments

In 1995, 1996 and 1997, the Company, through its investments in separate mortgage entities, acquired three distinct pools of mortgage-related assets in exchange for aggregate nonrecourse notes payable of $739.7 million, preferred stock of subsidiaries of $60.0 million and cash of $240.0 million. The mortgage-related assets acquired in these transactions related to office buildings, apartment buildings and shopping malls located throughout the United States and included one variable-rate balloon loan and 12 properties at December 31, 2005. In conjunction with these transactions, the mortgage entities simultaneously entered into ten-year swap agreements and other related agreements whereby a third party receives the portion of the interest and net operating cash flow from the mortgage-related assets in excess of specified semi-annual amounts and a portion of the proceeds from the disposition of the mortgage-related assets and principal repayments, in exchange for the third party making the contractual principal and interest payments on the nonrecourse notes payable. In addition, in the event that the pools of mortgage-related assets do not generate interest and net operating cash flow greater than the specified amounts, the Company has the right to receive the shortfall from the cash flow generated by separate pools of mortgage-related assets (owned by third parties in which the Company has minimal interests), which the swap counter party has estimated to have a total fair value of approximately $600.0 million at December 31, 2005.

39     2005 ANNUAL REPORT

The mortgage entities entered into the swaps and other related agreements in order to reduce the Company’s real estate, credit and interest rate risks relative to its net mortgage investments. The swap counter party has assumed the majority of the real estate and credit risk related to the commercial mortgage loans and real estate, and has assumed all of the interest rate risk related to the nonrecourse notes payable.

In December 2005, in accordance with the 10-year term of the transaction, all remaining mortgage-related assets related to the 1995 mortgage investment transaction (the “First Mortgage Transaction”) were sold. The Company received $150.8 million for its share of the disposition proceeds and paid $32.0 million for the redemption of preferred stock of a subsidiary and related accrued dividends. As of December 31, 2005, there are no remaining assets or liabilities related to the First Mortgage Transaction.

On July 1, 2003, the Company adopted FASB Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”) relative to its investments in mortgage entities. See the Investments note for further discussion of the change in accounting for these investments.

Income (loss) from mortgage investments consisted of the following components for the years ended December 31, 2005, 2004 and 2003:

IN THOUSANDS	2005			2004			2003
Equity income from mortgage investments	$	84,193		$	81,030		$	23,298
Commercial mortgage loans		—			—			623
Commercial real estate		—			—			(11,852	)
Net swap receivables		—			—			69,547
Deferred mortgage investment income		—			—			15,362
Interest expense on nonrecourse debt		—			—			(18,696	)
Interest expense on allocated debt		(1,908	)		(3,582	)		(1,027	)
Preferred stock dividend expense		(4,120	)		(4,120	)		(4,120	)
Other		(1,450	)		(1,058	)		(565	)
	$	76,715		$	72,270		$	72,570

In 2005, mortgage equity income increased over 2004 primarily as a result of gains on the sales of properties in 2005 of $51.3 million versus gains of $45.3 million in 2004, higher interest income and lower depreciation expense, partially offset by higher property impairments in 2005 of $11.4 million versus $1.3 million in 2004.

In 2004, mortgage investment income was flat versus 2003 as gains on sales of properties in 2004 of $45.3 million were essentially offset by the net income recorded in the first half of 2003 before the adoption of FIN 46, primarily related to a $39 million favorable swap mark-to-market adjustment in the second quarter of 2003.

The Company’s net assets related to mortgage investments as of December 31, 2005 and 2004 were as follows:

IN THOUSANDS	2005			2004
Net equity investments in mortgage entities	$	292,370		$	380,465
Deferred tax assets		63,990			106,722
Allocated general corporate debt		(21,751	)		(18,422	)
Preferred stock of subsidiaries		(40,000	)		(60,000	)
Accrued dividends on preferred stock of subsidiaries		(24,820	)		(32,700	)
Other, net		63			129
	$	269,852		$	376,194

The decline in mortgage investments as of December 31, 2005 is due to the disposition of the assets and related cash distribution from the First Mortgage Transaction.

MANAGEMENT’S DISCUSSION AND ANALYSIS     40

As shown below, the amount of future cash flows which is greater than the Company’s net equity investments in mortgage entities at December 31, 2005 will be recorded as income during the remaining terms of the transactions:

	MORTGAGE		MORTGAGE
	TRANSACTION		TRANSACTION
	ENDING		ENDING
	DECEMBER 31,		FEBRUARY 28,
IN THOUSANDS	2006		2008		TOTAL
ITW’s estimated share of future cash flows:
Annual operating cash flows	$	—	$	12,000	$	12,000
Disposition proceeds		150,925		165,900		316,825
		150,925		177,900		328,825
Net equity investments in mortgage entities at December 31, 2005		129,331		163,039		292,370
Future income expected to be recorded	$	21,594	$	14,861	$	36,455

The Company believes that because the swaps’ counter party is AAA-rated, there is minimal risk that the nonrecourse notes payable of the mortgage entities will not be repaid by the swap counter party. In addition, because significant assets back the total annual cash flow, the Company believes its risk of not receiving the $12.0 million of annual cumulative operating cash flows is also minimal.

Under the terms of the servicing agreements, the swap counter party, upon sale of the mortgage loans and real estate by the mortgage entities, is entitled to receive most of the disposition proceeds in excess of specified levels. Currently, the projected disposition proceeds exceed the levels specified. Furthermore, the disposition value of certain properties has been guaranteed by the swap counter party to be at least equal to their original cost. As such, fluctuations in the market values of the mortgage loans and real estate held by the mortgage entities would have a greater impact on the swap counter party than ITW.

To illustrate the extent to which the Company’s risk related to its share of the disposition proceeds has been mitigated, the effects of decreases in the estimated disposition proceeds at December 31, 2005 are shown below:

	DISPOSITION PROCEEDS
			SWAP				FUTURE POTENTIAL
			COUNTER				ITW
	ITW’S		PARTY’S				INCOME (LOSS) TO BE
IN THOUSANDS	SHARE		SHARE		TOTAL		RECOGNIZED
Current estimate	$	316,825	$	273,326	$	590,151	$	36,455
10% reduction in disposition proceeds		312,142		218,993		531,135		31,772
20% reduction in disposition proceeds		290,403		181,717		472,120		10,033
30% reduction in disposition proceeds		266,100		147,006		413,106		(14,270	)

If the swap counter party is unable to sell all of the commercial loans and real estate by the end of the tenth year for each transaction, the Company will begin receiving all of the annual operating cash flow from the remaining assets. Accordingly, the Company believes that it is unlikely that the assets will not be sold within the ten-year term of each transaction.

Leases of Equipment

Income from leases of equipment consisted of the following components for the years ended December 31, 2005, 2004 and 2003:

IN THOUSANDS	2005		2004		2003
Air traffic control equipment	$	5,115	$	9,211	$	2,419
Aircraft		4,589		2,129		3,488
Telecommunications equipment		3,599		11,214		17,393
Other		378		740		444
	$	13,681	$	23,294	$	23,744

In 2005, lease income was lower than 2004 due to the normal decline in leveraged lease income, partially offset by a $2.9 million gain on the sale of a United Airlines bankruptcy claim. In 2004, lease income was essentially flat compared to 2003 as higher income from the new air traffic control lease was offset by lower income from the telecommunications leases.

41     2005 ANNUAL REPORT

The Company’s net assets related to investments in leases of equipment at December 31, 2005 and 2004 were as follows:

IN THOUSANDS	2005			2004
Investments in leases:
Telecommunications equipment	$	196,348		$	193,306
Air traffic control equipment		68,268			61,757
Aircraft		43,480			44,020
Manufacturing equipment		1,341			3,404
Deferred tax liabilities		(295,064	)		(245,723	)
Allocated general corporate debt		(9,363	)		(69,578	)
Other, net		(7	)		(2,007	)
	$	5,003		$	(14,821	)

In the third quarter of 2003, the Company entered into a leveraged lease transaction related to air traffic control equipment in Australia with a cash investment of $48.8 million. In the first half of 2002, the Company entered into leveraged leasing transactions related to mobile telecommunications equipment with two major European telecommunications companies with cash investments of $144.7 million. Under the terms of the telecommunications and air traffic control lease transactions, the lessees have made upfront payments to creditworthy third party financial institutions that are acting as payment undertakers. These payment undertakers are obligated to make the required scheduled payments directly to the nonrecourse debt holders and to the lessors, including the Company. In the event of default by the lessees, the Company can recover its net investment from the payment undertakers. In addition, the lessees are required to purchase residual value insurance from a creditworthy third party at a date near the end of the lease term. As a result of the payment undertaker arrangements and the residual value insurance, the Company believes that any credit and residual value risks related to the telecommunications and air traffic control leases have been significantly mitigated.

Other Investments

Although 36 more properties were sold in 2005 than in 2004, income from property developments decreased to $7.1 million in 2005 from $7.4 million in 2004, due to lower average sales prices. Income from property developments declined to $7.4 million in 2004 from $10.4 million in 2003 as a result of more residential home sales in 2003 than 2004.

Income from properties held for sale was lower in 2005 as net gains of $2.0 million on the 2005 sales of six former manufacturing facilities were lower than net gains of $8.2 million on the sales of eight former manufacturing facilities in 2004. Income from properties held for sale was higher in 2004 due to net gains of $8.2 million versus net gains of $1.2 million on the sale of four properties in 2003 and a 2003 asset writedown of $1.2 million.

Operating income from the venture capital limited partnership was $9.0 million in 2005 versus $18.2 million in 2004 and losses of $0.9 million in 2003 due to higher mark-to-market gains in 2004.

Segment Reporting Change

In January 2006, the Company announced that given the planned run-off of assets in the Leasing and Investments portfolio and its desire to utilize free cash flow for core manufacturing investments and acquisitions, rather than to make additional financial investments, management has decided to no longer report this activity as a segment on a prospective basis. In 2006, income from these activities will be reported as non-operating investment income.

AMORTIZATION AND IMPAIRMENT OF GOODWILL AND INTANGIBLE ASSETS

The Company does not amortize goodwill and intangible assets that have indefinite lives. In the first quarter of each year, the Company performs an annual impairment assessment of goodwill and intangible assets with indefinite lives based on the fair value of the related reporting unit or intangible asset.

As of January 1, 2005, the Company had assigned its recorded goodwill and intangible assets to approximately 340 of its then 650 reporting units. When performing its annual impairment assessment, the Company compares the fair value of each reporting unit to its carrying value. Fair values are determined by discounting estimated future cash flows at the Company’s estimated cost of capital of 10%. Estimated future cash flows are based either on current operating cash flows or on a detailed cash flow forecast prepared by the relevant operating unit. If the fair value of an operating unit is less than its carrying value, an impairment loss is recorded for the difference between the implied fair value of the unit’s goodwill and the carrying value of the goodwill.

MANAGEMENT’S DISCUSSION AND ANALYSIS     42

Amortization and impairment of goodwill and other intangible assets for the years ended December 31, 2005, 2004 and 2003 were as follows:

IN THOUSANDS	2005		2004		2003
Goodwill:
Impairment	$	9,650	$	11,492	$	702
Intangible Assets:
Amortization		69,143		37,409		19,813
Impairment		5,049		10,220		3,761
	$	83,842	$	59,121	$	24,276

Total goodwill and intangible asset impairment charges by segment for the years ended December 31, 2005, 2004 and 2003 were as follows:

IN THOUSANDS	2005		2004		2003
Engineered Products—North America	$	5,049	$	7,007	$	762
Engineered Products—International		80		8,492		—
Specialty Systems—North America		9,559		5,937		3,701
Specialty Systems—International		11		276		—
	$	14,699	$	21,712	$	4,463

See the Goodwill and Intangible Assets note for details of the impairment charges.

INTEREST EXPENSE

Interest expense increased to $87.0 million in 2005 versus $69.2 million in 2004 primarily as a result of a higher interest expense on short-term commercial paper, interest expense on the $53.7 million senior note securities issued in March 2005, and expense resulting from an interest rate swap on the 5.75% notes. The higher interest expense in 2005 was partially offset by lower interest expense at international operations. Interest expense of $69.2 million in 2004 was essentially flat as compared to the interest expense of $70.7 million in 2003.

OTHER INCOME

Other income was $9.4 million in 2005 versus $12.0 million in 2004. The decline was primarily due to an estimated divestiture loss in 2005 and a nonrecurring gain in 2004 on forgiveness of debt. This is partially offset by lower losses on currency translation and higher interest income. Other income was $12.0 million in 2004 versus $13.3 million in 2003. The decline was primarily due to lower gains on the sale of operating affiliates and higher losses on currency translation, partially offset by a gain on forgiveness of debt and lower losses on sale of fixed assets.

INCOME TAXES

The effective tax rate was 31.5% in 2005, 33.0% in 2004, and 34.0% in 2003. See the Income Taxes note for a reconciliation of the U.S. federal statutory rate to the effective tax rate.

In October 2004, the American Jobs Creation Act of 2004 (“AJCA”) was enacted in the United States. The provisions of the AJCA that are expected to have the most impact on the U.S. federal taxes paid by the Company are as follows:

• A special one-time dividends-received deduction of 85% for the repatriation of foreign earnings during 2005 only.In 2005, the Company repatriated foreign dividends of $1.4 billion and incurred a tax cost of $42.4 million related to these dividends. See the Income Taxes note for further information regarding the 2005 effect of this provision.

• A deduction related to U.S. manufacturing income of 3% of eligible income in 2005 and 2006, 6% in 2007 through 2009 and 9% in 2010 and thereafter.The Company believes that substantially all of the U.S. pretax income from its manufacturing segments would qualify as eligible income under this provision. In 2005, the estimated benefit of the U.S. manufacturing income deduction was approximately $9.3 million.

43     2005 ANNUAL REPORT

• A gradual repeal of the exclusion of certain extraterritorial income (“ETI”) related to export sales from the U.S.This provision provides that the ETI benefit is reduced to 80% in 2005, 60% in 2006 and 0% in 2007 and thereafter. Because the Company generally manufactures locally in the major foreign countries in which it sells products, the repeal of the ETI benefit will not have a significant impact on the Company’s future U.S. tax payments. The benefit of the ETI exclusion was approximately $5.7 million in 2005 and $7.4 million in 2004.

INCOME FROM CONTINUING OPERATIONS

Income from continuing operations in 2005 of $1,494.9 million ($5.20 per diluted share) was 11.6% higher than 2004 income of $1,339.6 million ($4.39 per diluted share). Income from continuing operations in 2004 was 28.8% higher than 2003 income of $1,040.2 million ($3.37 per diluted share).

FOREIGN CURRENCY

The weakening of the U.S. dollar against foreign currencies increased operating revenues by approximately $150 million in 2005, $430 million in 2004, and $520 million in 2003, and increased income from continuing operations by approximately 6 cents per diluted share in 2005, 15 cents per diluted share in 2004 and 16 cents per diluted share in 2003.

NEW ACCOUNTING PRONOUNCEMENT

Effective January 1, 2005, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which requires the Company to measure the cost of employee services received in exchange for equity awards based on the grant date fair value. Starting in 2005, the Company recorded compensation cost related to the amortization of the unamortized grant date fair value of stock awards unvested as of December 31, 2004 over the remaining service periods of those awards. See the Stock-Based Compensation footnote for further details of the effect of the adoption of this pronouncement.

2006 FORECAST

The Company believes that while its end markets will remain relatively stable in 2006, the contribution from Leasing and Investments will diminish substantially in the upcoming year. As a result, the Company is forecasting full-year 2006 income from continuing operations to be in a range of $5.60 to $5.78 per diluted share. The following key assumptions were used for this forecast:

• base business revenue growth in a range of 3.2% to 5.2%;

• foreign exchange rates holding at year-end 2005 levels;

• annualized revenues from acquired companies in a range of $800 million to $1.0 billion;

• restructuring costs of $30 million to $50 million;

• nonoperating investment income of $45 to $55 million, which is lower than 2005 by $75 to $85 million;

• estimated impairment of goodwill/intangibles of $15 to $25 million;

• operating income (excluding Leasing and Investments) to increase between 9.4% and 13.0% for full-year 2006;

• an effective tax rate of 31.5%.

The Company updates its forecast and assumptions throughout the year via monthly press releases.

DISCONTINUED OPERATIONS

Discontinued Operations represents the Company’s former Consumer Products segment which was comprised of the following businesses: Precor specialty exercise equipment, West Bend small appliances and premium cookware, and Florida Tile ceramic tile. The Company’s net loss on disposal of the segment was $0.9 million in 2004 and $16.5 million in 2003.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow

The Company’s primary source of liquidity is free operating cash flow. Management continues to believe that such internally generated cash flow will be adequate to service existing debt and to continue to pay dividends that meet its dividend payout objective of 25% to 30% of the last three years’ average net income. In addition, free operating cash flow is expected to be adequate to finance internal growth and small-to medium-sized acquisitions.

The Company uses free operating cash flow to measure normal cash flow generated by its operations that is available for dividends, acquisitions and debt repayment. Free operating cash flow is a measurement that is not the same as net cash flow from operating activities per the statement of cash flows and may not be consistent with similarly titled measures used by other companies.

MANAGEMENT’S DISCUSSION AND ANALYSIS     44

On April 19, 2004 the Company’s Board of Directors authorized a stock repurchase program, which provided for the buyback of up to 31.0 million shares. Under this program, the Company repurchased 31.0 million shares of its common stock for $2.8 billion at an average price of $89.41 per share. The Company completed the stock repurchase program in September 2005.

Summarized cash flow information for the three years ended December 31, 2005, 2004 and 2003 was as follows:

IN THOUSANDS	2005			2004			2003
Net cash provided by operating activities	$	1,846,536		$	1,532,031		$	1,368,741
Additions to plant and equipment		(293,102	)		(282,560	)		(258,312	)
Free operating cash flow	$	1,553,434		$	1,249,471		$	1,110,429
Acquisitions	$	(626,922	)	$	(587,783	)	$	(203,726	)
Purchases of investments		(120,240	)		(64,442	)		(133,236	)
Proceeds from investments		220,082			85,412			59,509
Cash dividends paid		(335,092	)		(304,581	)		(285,399	)
Repurchases of common stock		(1,041,798	)		(1,729,806	)		—
Net proceeds (repayments) of debt		93,126			127,487			(95,766	)
Other		(39,563	)		207,149			174,985
Net increase (decrease) in cash and equivalents	$	(296,973	)	$	(1,017,093	)	$	626,796

Return on Invested Capital

The Company uses return on average invested capital (“ROIC”) to measure the effectiveness of the operations’ use of invested capital to generate profits. ROIC for the three years ended December 31, 2005, 2004 and 2003 was as follows:

DOLLARS IN THOUSANDS	2005			2004			2003
Operating income after taxes of 31.5%, 33.0%, and 34.0%, respectively	$	1,547,555		$	1,377,931		$	1,078,082
Total debt	$	1,211,220		$	1,124,621		$	976,454
Less: Cash and equivalents		(370,417	)		(667,390	)		(1,684,483	)
Adjusted net debt		840,803			457,231			(708,029	)
Total stockholders’ equity		7,546,895			7,627,610			7,874,286
Invested capital	$	8,387,698		$	8,084,841		$	7,166,257
Average invested capital	$	8,277,715		$	7,603,773		$	7,169,813
Return on average invested capital		18.7	%		18.1	%		15.0	%

The 60 basis point increase in ROIC in 2005 versus 2004 was due primarily to a 12.3% increase in after-tax operating income, mainly as a result of increased base business operating income and a decrease in the effective tax rate to 31.5% in 2005 from 33.0% in 2004. The positive impact was partially offset by an increase of 8.9% in average invested capital, primarily from acquisitions.

The 310 basis point increase in ROIC in 2004 versus 2003 was due primarily to a 27.8% increase in after-tax operating income, mainly as a result of increased base business operating income and a decrease in the effective tax rate to 33.0% in 2004 from 34.0% in 2003.

45     2005 ANNUAL REPORT

Working Capital

Net working capital at December 31, 2005 and 2004 is summarized as follows:

					INCREASE
DOLLARS IN THOUSANDS	2005		2004		(DECREASE)
Current Assets:
Cash and equivalents	$	370,417	$	667,390	$	(296,973	)
Trade receivables		2,098,276		2,054,624		43,652
Inventories		1,203,063		1,281,156		(78,093	)
Other		439,849		319,028		120,821
		4,111,605		4,322,198		(210,593	)
Current Liabilities:
Short-term debt		252,899		203,523		49,376
Accounts payable and accrued expenses		1,574,018		1,563,191		10,827
Other		173,814		84,257		89,557
		2,000,731		1,850,971		149,760
Net Working Capital	$	2,110,874	$	2,471,227	$	(360,353	)
Current Ratio		2.06		2.34

Cash and equivalents decreased in 2005 due to the repurchase of common stock and cash paid for acquisitions and dividends, partially offset by cash flows from operating activities. Other current assets increased primarily due to a 2005 reclassification of tax refunds receivable from current taxes payable.

Debt

Total debt at December 31, 2005 and 2004 was as follows:

							INCREASE
DOLLARS IN THOUSANDS	2005			2004			(DECREASE)
Short-term debt	$	252,899		$	203,523		$	49,376
Long-term debt		958,321			921,098			37,223
Total debt	$	1,211,220		$	1,124,621		$	86,599
Total debt to total capitalization		13.8	%		12.8	%

In 2005, the Company issued a€63.0 million demand note that is due March 28, 2006 and $53.7 million of 4.88% senior notes that are due December 31, 2020.

In 2005, the Company entered into a $600.0 million Line of Credit Agreement with a termination date of June 16, 2006 and a $350.0 million revolving credit facility (“RCF”) with a termination date of June 17, 2010. This debt capacity is for use principally to support any issuances of commercial paper and to fund larger acquisitions.

The Company has cash on hand and additional debt capacity to fund larger acquisitions. As of December 31, 2005, the Company has unused capacity of $950.0 million under its current U.S. debt facilities. In addition, the Company believes that based on its current free operating cash flow and debt-to-capitalization ratios, it could readily obtain additional financing if necessary.

Stockholders’ Equity

The changes to stockholders’ equity during 2005 and 2004 were as follows:

IN THOUSANDS	2005			2004
Beginning balance	$	7,627,610		$	7,874,286
Net income		1,494,869			1,338,694
Cash dividends declared		(346,059	)		(312,286	)
Repurchases of common stock		(1,041,798	)		(1,729,806	)
Stock option and restricted stock activity		103,676			151,490
Currency translation adjustments		(296,248	)		306,653
Other		4,845			(1,421	)
Ending balance	$	7,546,895		$	7,627,610

MANAGEMENT’S DISCUSSION AND ANALYSIS     46

The average exchange rates for the period used for translating the income statements of international businesses were stronger in 2005 than the average period rates in 2004 resulting in a positive foreign currency effect on the income statement. However, the change in foreign currency translation had a negative impact on the balance sheet as the end-of-period rates declined in 2005 versus the 2004 end-of-period rates, primarily driven by the weakening of the euro throughout 2005.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

The Company’s contractual obligations as of December 31, 2005 were as follows:

											2011 AND
											FUTURE
IN THOUSANDS	2006		2007		2008		2009		2010		YEARS
Total debt	$	252,899	$	6,677	$	156,209	$	502,838	$	6,169	$	286,428
Minimum lease payments		101,602		79,424		61,889		43,562		37,286		60,693
Affordable housing capital obligations		14,040		13,703		13,722		14,092		13,344		3,244
Maximum venture capital contribution		9,177		—		—		—		—		—
Preferred stock of subsidiaries		—		—		—		—		—		40,000
Accrued dividends on preferred stock of subsidiaries		13,140		11,680		—		—		—		—
	$	390,858	$	111,484	$	231,820	$	560,492	$	56,799	$	390,365

In 2001, the Company committed to two affordable housing limited partnership investments. In connection with the formation and financing of these limited partnerships, the affordable housing limited partnerships borrowed the full amount of funds necessary for their affordable housing projects from a third party financial institution. The excess cash of $126.8 million was distributed to the Company in 2001 and will be repaid to the limited partnerships via capital contributions as the limited partnerships require the funds for their affordable housing projects. The financing of these limited partnerships was structured in this manner in order to receive the affordable housing tax credits and deductions without any substantial initial cash outlay by the Company.

The Company has provided guarantees related to the debt of certain unconsolidated affiliates of $30.0 million at December 31, 2005. In the event one of these affiliates defaults on its debt, the Company would be liable for the debt repayment. The Company has recorded liabilities related to these guarantees of $14.0 million at December 31, 2005. At December 31, 2005, the Company had open stand-by letters of credit of $68.0 million, substantially all of which expire in 2006. The Company had no other significant off-balance sheet commitments at December 31, 2005.

MARKET RISK

Interest Rate Risk

The Company’s exposure to market risk for changes in interest rates relates primarily to the Company’s long-term debt.

The Company has no cash flow exposure on its long-term obligations related to changes in market interest rates, other than $100.0 million of debt which has been hedged by the interest rate swap discussed below. The Company primarily enters into long-term debt obligations for general corporate purposes, including the funding of capital expenditures and acquisitions. In December 2002, the Company entered into an interest rate swap with a notional value of $100.0 million to hedge a portion of the fixed rate debt. Under the terms of the interest rate swap, the Company receives interest at a fixed rate of 5.75% and pays interest at a variable rate of LIBOR plus 1.96%. The maturity date of the interest rate swap is March 1, 2009. The carrying value of the notes has been adjusted to reflect the fair value of the interest rate swap.

47     2005 ANNUAL REPORT

The following table presents the Company’s financial instruments for which fair value is subject to changing market interest rates:

					6.55%
	4.88%		5.75%		PREFERRED DEBT		6.875%
	NOTES DUE		NOTES DUE		SECURITIES DUE		NOTES DUE
IN THOUSANDS	DECEMBER 31, 2020		MARCH 1, 2009		DECEMBER 31, 2011		NOVEMBER 15, 2008
As of December 31, 2005:
Estimated cash outflow by year of principal maturity
2006	$	9,548	$	—	$	—	$	—
2007		5,369		—		—		—
2008		5,473		—		—		150,000
2009		5,679		500,000		—		—
2010		5,713		—		—		—
2011 and thereafter		21,953		—		250,000		—
Estimated fair value		53,563		512,015		267,205		157,742
Carrying value		53,735		496,687		249,739		149,947
As of December 31, 2004:
Total estimated cash outflow	$	—	$	500,000	$	250,000	$	150,000
Estimated fair value		—		533,895		282,693		165,903
Carrying value		—		499,343		249,705		149,929

Foreign Currency Risk

The Company operates in the United States and 47 other countries. In general, the Company’s products are primarily manufactured and sold within the same country. The initial funding for the foreign manufacturing operations was provided primarily through the permanent investment of equity capital from the U.S. parent company. Therefore, the Company and its subsidiaries do not have significant assets or liabilities denominated in currencies other than their functional currencies. As such, the Company does not have any significant derivatives or other financial instruments that are subject to foreign currency risk at December 31, 2005 or 2004.

CRITICAL ACCOUNTING POLICIES

The Company has four accounting policies which it believes are important to the Company’s financial condition and results of operations, and which require the Company to make estimates about matters that are inherently uncertain.

These critical accounting policies are as follows:

Realizability of Inventories—Inventories are stated at the lower of cost or market. Generally, the Company’s operating units perform an analysis of the historical sales usage of the individual inventory items on hand and a reserve is recorded to adjust inventory cost to market value based on the following usage criteria:

USAGE CLASSIFICATION	CRITERIA	RESERVE %
Active	Quantity on hand is less than prior 6 months’ usage		0%
Slow-moving	Some usage in last 12 months, but quantity on hand exceeds prior 6 months’ usage		50%
Obsolete	No usage in the last 12 months		90%

In addition, for the majority of U.S. operations, the Company has elected to use the last-in, first-out (“LIFO”) method of inventory costing. Generally, this method results in a lower inventory value than the first-in, first-out (“FIFO”) method due to the effects of inflation.

MANAGEMENT’S DISCUSSION AND ANALYSIS     48

Collectibility of Accounts Receivable—The Company estimates the allowance for uncollectible accounts based on the greater of a specific reserve for past due accounts or a reserve calculated based on the historical write-off percentage over the last two years. In addition, the allowance for uncollectible accounts includes reserves for customer credits and cash discounts, which are also estimated based on past experience.

Depreciation of Plant and Equipment—The Company’s U.S. businesses compute depreciation on an accelerated basis, as follows:

Buildings and improvements	150% declining balance
Machinery and equipment	200% declining balance

The majority of the international businesses compute depreciation on a straight-line basis to conform to their local statutory accounting and tax regulations.

Income Taxes—The Company provides deferred income tax assets and liabilities based on the estimated future tax effects of differences between the financial and tax bases of assets and liabilities based on currently enacted tax laws. The Company’s tax balances are based on management’s interpretation of the tax regulations and rulings in numerous taxing jurisdictions. Income tax expense recognized by the Company also reflects its best estimates and assumptions regarding, among other things, the level of future taxable income and effect of the Company’s various tax planning strategies. Future tax authority rulings and changes in tax laws, changes in projected levels of taxable income and future tax planning strategies could affect the actual effective tax rate and tax balances recorded by the Company.

The Company believes that the above critical policies have resulted in past actual results approximating the estimated amounts in those areas.

FORWARD-LOOKING STATEMENTS

This annual report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including, without limitation, statements regarding the Company’s 2006 forecasts and assumptions, the adequacy of internally generated funds, the recoverability of the Company’s investments in mortgage entities, future cash flows and income from the Company’s mortgage investments, equipment leases, the meeting of dividend payout objectives, the impact of the repeal of the ETI benefit on the Company’s future U.S. tax payments, the impact of the AJCA including the amount of U.S. pre-tax manufacturing income that would qualify as eligible income, payments under guarantees, the Company’s portion of future benefit payments related to pension and postretirement benefits, the availability of additional financing and the outcome of outstanding legal proceedings. These statements are subject to certain risks, uncertainties, and other factors, which could cause actual results to differ materially from those anticipated. Important risks that may influence future results include (1) a downturn in the construction, automotive, general industrial, food institutional and retail, or real estate markets, (2) deterioration in global and domestic business and economic conditions, particularly in North America, the European Community, Asia or Australia, (3) the unfavorable impact of foreign currency fluctuations and costs of raw materials, (4) an interruption in, or reduction in, introducing new products into the Company’s product lines, (5) an unfavorable environment for making acquisitions, domestic and international, including adverse accounting or regulatory requirements and market values of candidates, and (6) unfavorable tax law changes and tax authority rulings. The risks covered here are not all inclusive and given these and other possible risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

ITW practices fair disclosure for all interested parties. Investors should be aware that while ITW regularly communicates with securities analysts and other investment professionals, it is against ITW’s policy to disclose to them any material non-public information or other confidential commercial information. Shareholders should not assume that ITW agrees with any statement or report issued by any analyst irrespective of the content of the statement or report.

49

MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of Illinois Tool Works Inc. (“ITW”) is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). ITW’s internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

ITW management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) inInternal Control—Integrated Framework.Based on our assessment we believe that, as of December 31, 2005, the Company’s internal control over financial reporting is effective based on those criteria.

Our Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their attestation report which is included herein.

/s/ David B. Speer	/s/ Ronald D. Kropp
David B. Speer	Ronald D. Kropp
President and Chief Executive Officer	Vice President & Controller, Financial Reporting
February 24, 2006	February 24, 2006

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM     50

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Illinois Tool Works Inc.:

We have audited the accompanying statements of financial position of Illinois Tool Works Inc. and Subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related statements of income, income reinvested in the business, comprehensive income and cash flows for each of the three years in the period ended December 31, 2005. We also have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, dated February 24, 2006 that the Company maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management’s assessment, and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, a company’s principal executive and principal financial officers, or persons performing similar functions, and effected by a company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of a company are being made only in accordance with authorizations of management and directors of a company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of a company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the criteria established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Chicago, Illinois
February 24, 2006

51     2005 ANNUAL REPORT

Statement of Income
Illinois Tool Works Inc. and Subsidiaries

	FOR THE YEARS ENDED DECEMBER 31
IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS	2005			2004			2003
Operating Revenues	$	12,921,792		$	11,731,425		$	10,035,623
Cost of revenues		8,363,881			7,591,246			6,527,692
Selling, administrative, and research and development expenses		2,214,865			2,024,445			1,850,197
Amortization and impairment of goodwill and other intangible assets		83,842			59,121			24,276
Operating Income		2,259,204			2,056,613			1,633,458
Interest expense		(86,998	)		(69,234	)		(70,672	)
Other income		9,363			12,026			13,328
Income from Continuing Operations Before Income Taxes		2,181,569			1,999,405			1,576,114
Income taxes		686,700			659,800			535,900
Income from Continuing Operations		1,494,869			1,339,605			1,040,214
Loss from Discontinued Operations		—			(911	)		(16,534	)
Net Income	$	1,494,869		$	1,338,694		$	1,023,680
Income Per Share from Continuing Operations:
Basic		$5.24			$4.43			$3.39
Diluted		$5.20			$4.39			$3.37
Loss Per Share from Discontinued Operations:
Basic		$   —			$   —			$(0.05	)
Diluted		$   —			$   —			$(0.05	)
Net Income Per Share:
Basic		$5.24			$4.43			$3.33
Diluted		$5.20			$4.39			$3.32

Statement of Income Reinvested in the Business
Illinois Tool Works Inc. and Subsidiaries

	FOR THE YEARS ENDED DECEMBER 31
IN THOUSANDS	2005			2004			2003
Beginning Balance	$	7,963,518		$	6,937,110		$	6,202,263
Net income		1,494,869			1,338,694			1,023,680
Cash dividends declared		(346,059	)		(312,286	)		(288,833	)
Ending Balance	$	9,112,328		$	7,963,518		$	6,937,110

Statement of Comprehensive Income
Illinois Tool Works Inc. and Subsidiaries

	FOR THE YEARS ENDED DECEMBER 31
IN THOUSANDS	2005			2004			2003
Net Income	$	1,494,869		$	1,338,694		$	1,023,680
Other Comprehensive Income:
Foreign currency translation adjustments		(296,248	)		306,653			407,811
Minimum pension liability adjustments		4,640			(5,009	)		6,124
Income tax related to minimum pension liability adjustments		205			1,960			(1,748	)
Comprehensive Income	$	1,203,466		$	1,642,298		$	1,435,867

The Notes to Financial Statements are an integral part of these statements.

STATEMENT OF FINANCIAL POSITION     52

Statement of Financial Position
Illinois Tool Works Inc. and Subsidiaries

	DECEMBER 31
IN THOUSANDS EXCEPT SHARES	2005			2004
Assets
Current Assets:
Cash and equivalents	$	370,417		$	667,390
Trade receivables		2,098,276			2,054,624
Inventories		1,203,063			1,281,156
Deferred income taxes		168,739			147,416
Prepaid expenses and other current assets		271,110			171,612
Total current assets		4,111,605			4,322,198
Plant and Equipment:
Land		156,975			160,649
Buildings and improvements		1,210,133			1,236,541
Machinery and equipment		3,235,571			3,272,144
Equipment leased to others		155,565			150,412
Construction in progress		92,934			117,366
		4,851,178			4,937,112
Accumulated depreciation		(3,044,069	)		(3,060,237	)
Net plant and equipment		1,807,109			1,876,875
Investments		896,487			912,483
Goodwill		3,009,011			2,753,053
Intangible Assets		669,927			440,002
Deferred Income Taxes		45,269			233,172
Other Assets		906,235			814,151
	$	11,445,643		$	11,351,934
Liabilities and Stockholders’ Equity
Current Liabilities:
Short-term debt	$	252,899		$	203,523
Accounts payable		560,078			603,811
Accrued expenses		1,013,940			959,380
Cash dividends payable		92,620			81,653
Income taxes payable		81,194			2,604
Total current liabilities		2,000,731			1,850,971
Noncurrent Liabilities:
Long-term debt		958,321			921,098
Other		939,696			952,255
Total noncurrent liabilities		1,898,017			1,873,353
Stockholders’ Equity:
Common stock:
Issued—312,043,289 shares in 2005 and 311,373,558 shares in 2004		3,120			3,114
Additional paid-in-capital		1,082,611			978,941
Income reinvested in the business		9,112,328			7,963,518
Common stock held in treasury		(2,773,176	)		(1,731,378	)
Accumulated other comprehensive income		122,012			413,415
Total stockholders’ equity		7,546,895			7,627,610
	$	11,445,643		$	11,351,934

The Notes to Financial Statements are an integral part of this statement.

53     2005 ANNUAL REPORT

Statement of Cash Flows
Illinois Tool Works Inc. and Subsidiaries

	FOR THE YEARS ENDED DECEMBER 31
IN THOUSANDS	2005			2004			2003
Cash Provided by (Used for) Operating Activities:
Net income	$	1,494,869		$	1,338,694		$	1,023,680
Adjustments to reconcile net income to cash provided by operating activities:
Loss from discontinued operations		—			911			16,534
Depreciation		299,232			294,162			282,277
Amortization and impairment of goodwill and other intangible assets		83,842			59,121			24,276
Change in deferred income taxes		69,745			143,214			203,958
Provision for uncollectible accounts		7,156			391			8,875
Loss on sale of plant and equipment		4,289			4,710			6,883
Income from investments		(126,278	)		(142,621	)		(145,541	)
Non-cash interest on nonrecourse notes payable		—			—			18,696
(Gain) loss on sale of operations and affiliates		8,548			(8	)		(5,109	)
Stock compensation expense		64,144			32,514			17,777
Other non-cash items, net		(1,875	)		9,740			17,951
Change in assets and liabilities:
(Increase) decrease in—
Trade receivables		(58,902	)		(128,868	)		(22,239	)
Inventories		104,419			(177,052	)		108,180
Prepaid expenses and other assets		(82,280	)		(123,532	)		(186,714	)
Net assets of discontinued operations		—			—			30,736
Increase (decrease) in—
Accounts payable		(39,216	)		31,947			(10,104	)
Accrued expenses and other liabilities		35,491			35,056			47,070
Income taxes payable		(16,647	)		153,457			(68,497	)
Other, net		(1	)		195			52
Net cash provided by operating activities		1,846,536			1,532,031			1,368,741
Cash Provided by (Used for) Investing Activities:
Acquisition of businesses (excluding cash and equivalents) and additional interest in affiliates		(626,922	)		(587,783	)		(203,726	)
Additions to plant and equipment		(293,102	)		(282,560	)		(258,312	)
Purchases of investments		(120,240	)		(64,442	)		(133,236	)
Proceeds from investments		220,082			85,412			59,509
Proceeds from sale of plant and equipment		33,860			23,378			29,489
Proceeds from sale of operations and affiliates		1,475			6,495			21,421
Other, net		448			8,173			994
Net cash used for investing activities		(784,399	)		(811,327	)		(483,861	)
Cash Provided by (Used for) Financing Activities:
Cash dividends paid		(335,092	)		(304,581	)		(285,399	)
Issuance of common stock		24,563			79,108			40,357
Repurchases of common stock		(1,041,798	)		(1,729,806	)		—
Net proceeds (repayments) of short-term debt		44,406			134,019			(68,159	)
Proceeds from long-term debt		58,661			97			931
Repayments of long-term debt		(9,941	)		(6,629	)		(28,538	)
Tax benefits related to stock options and restricted stock		12,879			—			—
Repayment of preferred stock of subsidiary		(20,000	)		—			—
Other, net		—			—			12
Net cash used for financing activities		(1,266,322	)		(1,827,792	)		(340,796	)
Effect of Exchange Rate Changes on Cash and Equivalents		(92,788	)		89,995			82,712
Cash and Equivalents:
Increase (decrease) during the year		(296,973	)		(1,017,093	)		626,796
Beginning of year		667,390			1,684,483			1,057,687
End of year	$	370,417		$	667,390		$	1,684,483
Cash Paid During the Year for Interest	$	99,115		$	73,393		$	73,250
Cash Paid During the Year for Income Taxes	$	622,451		$	339,334		$	351,156
Liabilities Assumed from Acquisitions	$	270,726		$	150,913		$	120,825

The Notes to Financial Statements are an integral part of this statement. See the Investments note for information regarding non-cash transactions.

NOTES TO FINANCIAL STATEMENTS     54

Notes to Financial Statements

The Notes to Financial Statementsfurnish additional information on items in the financial statements. The notes have been arranged in the same order as the related items appear in the statements.

Illinois Tool Works Inc. (the “Company” or “ITW”) is a worldwide manufacturer of highly engineered products and specialty systems. The Company primarily serves the construction, automotive, food institutional and retail, and general industrial markets.

Significant accounting principles and policies of the Company are in italics. Certain reclassifications of prior years’ data have been made to conform to current year reporting.

The preparation of the Company’s financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the notes to financial statements. Actual results could differ from those estimates. The significant estimates included in the preparation of the financial statements are related to inventories, trade receivables, plant and equipment, income taxes, goodwill and intangible assets, product liability matters, litigation, product warranties, pensions, other postretirement benefits, environmental matters and stock options.

Consolidation and Translation—The financial statementsinclude the Company and substantially all of its majority-owned subsidiaries. All significant intercompany transactions are eliminated from the financial statements. Substantially all of the Company’s foreign subsidiaries outside North America have November 30 fiscal year-ends to facilitate inclusion of their financial statements in the December 31 consolidated financial statements.

Foreign subsidiaries’ assets and liabilities are translated to U.S. dollars at end-of-period exchange rates. Revenues and expenses are translated at average rates for the period. Translation adjustments are reported as a component of accumulated other comprehensive income in stockholders’ equity.

Acquisitions—Summarized information related to acquisitions during 2005, 2004 and 2003 is as follows:

IN THOUSANDS EXCEPT NUMBER OF ACQUISITIONS		2005		2004		2003
Number of acquisitions		22		24		28
Net cash paid during the year	$	626,922	$	587,783	$	203,726
Premium recorded as:
Goodwill	$	299,825	$	219,750	$	100,611
Intangible assets	$	283,867	$	219,576	$	55,400

The acquisitions in these years, individually and in the aggregate, did not materially affect the Company’s results of operations or financial position. The Company anticipates subsequent purchase accounting adjustments will change the initial amounts recorded for goodwill and intangible assets.

Operating Revenuesare recognized when the risks and rewards of ownership are transferred to the customer,which is generally at the time of product shipment. Operating revenues for the Leasing and Investments segment include income from mortgage investments, leases of equipment and other investments that is recognized based on the applicable accounting method for each type of investment. See the Investments note for the detailed accounting policies related to the Company’s significant investments.

No single customer accounted for more than 5% of consolidated revenues in 2005, 2004 or 2003.

Research and Development Expensesare recorded as expense in the year incurred.These costs were $127,871,000 in 2005, $123,486,000 in 2004 and $106,777,000 in 2003.

Rental Expensewas $119,054,000 in 2005, $108,450,000 in 2004 and $102,447,000 in 2003. Future minimum lease payments for the years ending December 31 are as follows:

IN THOUSANDS
2006	$	101,602
2007		79,424
2008		61,889
2009		43,562
2010		37,286
2011 and future years		60,693
	$	384,456

55     2005 ANNUAL REPORT

Advertising Expensesare recorded as expense in the year incurred.These costs were $80,059,000 in 2005, $81,113,000 in 2004 and $74,760,000 in 2003.

Interest Expenserelated to debt has been recorded in the statement of income as follows:

IN THOUSANDS	2005		2004		2003
Cost of revenues	$	3,479	$	4,202	$	22,687
Interest expense		86,998		69,234		70,672
Loss from discontinued operations		—		—		25
	$	90,477	$	73,436	$	93,384

The interest expense recorded as cost of revenues relates to the Leasing and Investment segment and includes interest expense related to both the direct debt of the segment and general corporate debt allocated to the segment based on the after-tax cash flows of the investments. The allocation of interest expense from general corporate debt to the segment was $3,479,000, $4,202,000 and $3,990,000 in 2005, 2004 and 2003, respectively.

Other Income (Expense)consisted of the following:

IN THOUSANDS	2005			2004			2003
Interest income	$	27,861		$	25,614		$	26,171
Gain (loss) on sale of operations and affiliates		(8,548	)		8			5,109
Loss on sale of plant and equipment		(4,289	)		(4,710	)		(6,883	)
Loss on foreign currency transactions		(3,447	)		(9,810	)		(5,077	)
Other, net		(2,214	)		924			(5,992	)
	$	9,363		$	12,026		$	13,328

The interest income above primarily relates to general corporate short-term investments. Interest income related to the investments of the Leasing and Investments segment is included in the operating income of that segment.

Income Taxes—The Company utilizes the asset and liability method of accounting for income taxes. Deferred income taxes are determined based on the estimated future tax effects of differences between the financial and tax bases of assets and liabilities given the provisions of the enacted tax laws.The components of the provision for income taxes on continuing operations were as shown below:

IN THOUSANDS	2005			2004			2003
U.S. federal income taxes:
Current	$	399,629		$	250,887		$	170,040
Deferred		63,144			92,526			239,618
Tax cost of dividend repatriation		17,427			25,000			—
Benefit of net operating loss carryforwards		(54,248	)		(4,204	)		(33,816	)
Tax benefit related to stock recorded through equity		13,740			36,322			19,139
	$	439,692		$	400,531		$	394,981
Foreign income taxes:
Current	$	160,545		$	226,699		$	201,136
Deferred		36,170			51,129			(47,769	)
Benefit of net operating loss carryforwards		(7,047	)		(51,425	)		(38,161	)
	$	189,668		$	226,403		$	115,206
State income taxes:
Current	$	53,901		$	43,297		$	33,116
Deferred		9,685			(2,719	)		20,407
Benefit of net operating loss carryforwards		(7,476	)		(11,014	)		(29,355	)
Tax benefit related to stock recorded through equity		1,230			3,302			1,545
		57,340			32,866			25,713
	$	686,700		$	659,800		$	535,900

NOTES TO FINANCIAL STATEMENTS     56

Income from continuing operations before income taxes for domestic and foreign operations was as follows:

IN THOUSANDS	2005		2004		2003
Domestic	$	1,402,767	$	1,354,301	$	1,066,575
Foreign		778,802		645,104		509,539
	$	2,181,569	$	1,999,405	$	1,576,114

The reconciliation between the U.S. federal statutory tax rate and the effective tax rate was as follows:

	2005			2004			2003
U.S. federal statutory tax rate		35.0	%		35.0	%		35.0	%
State income taxes, net of U.S. federal tax benefit		1.7			1.5			1.1
Differences between U.S. federal statutory and foreign tax rates		(1.1	)		(0.6	)		(1.0	)
Nontaxable foreign interest income		(2.4	)		(1.6	)		(2.7	)
Tax effect of foreign dividends		1.0			0.1			1.0
Other, net		(2.7	)		(1.4	)		0.6
Effective tax rate		31.5	%		33.0	%		34.0	%

In October 2004, the American Jobs Creation Act of 2004 (“AJCA”) was enacted in the United States. One of the provisions of the AJCA was to allow a special one-time dividends-received deduction of 85% on the repatriation of certain foreign earnings to U.S. taxpayers, provided certain criteria regarding the sources and uses of the repatriated funds are met.

In 2004, the Company recorded a deferred tax liability of $25,000,000 to reflect the estimated tax cost of the minimum foreign dividends expected to be repatriated under the AJCA during 2005. During 2005, the Company repatriated foreign dividends of $1,404,000,000 and incurred an additional tax cost of $17,400,000.Deferred U.S. federal income taxes and foreign withholding taxes have not been provided on the remaining undistributed earnings of certain international subsidiaries of $2,000,000,000 and $2,300,000,000 as of December 31, 2005 and 2004, respectively, as these earnings are considered permanently invested. Upon repatriation of these earnings to the United States in the form of dividends or otherwise, the Company may be subject to U.S. income taxes and foreign withholding taxes. The actual U.S. tax cost would depend on income tax laws and circumstances at the time of distribution. Determination of the related tax liability is not practicable because of the complexities associated with the hypothetical calculation.

The components of deferred income tax assets and liabilities at December 31, 2005 and 2004 were as follows:

	2005						2004
IN THOUSANDS	ASSET			LIABILITY			ASSET			LIABILITY
Goodwill and intangible assets	$	125,758		$	(279,206	)	$	83,392		$	(117,471	)
Inventory reserves, capitalized tax cost and LIFO inventory		34,945			(18,693	)		41,159			(15,327	)
Investments		109,356			(301,276	)		114,517			(247,954	)
Plant and equipment		13,181			(89,532	)		36,345			(98,585	)
Accrued expenses and reserves		128,044			—			196,195			—
Employee benefit accruals		257,709			—			229,572			—
Foreign tax credit carryforwards		66,749			—			11,540			—
Net operating loss carryforwards		252,663			—			270,908			—
Capital loss carryforwards		104,786			—			114,920			—
Allowances for uncollectible accounts		10,794			—			10,176			—
Prepaid pension assets		—			(93,770	)		—			(87,654	)
Other		94,046			(26,758	)		43,057			(44,152	)
Gross deferred income tax assets (liabilities)		1,198,031			(809,235	)		1,151,781			(611,143	)
Valuation allowances		(174,788	)		—			(160,050	)		—
Total deferred income tax assets (liabilities)	$	1,023,243		$	(809,235	)	$	991,731		$	(611,143	)

57     2005 ANNUAL REPORT

Valuation allowances are established when it is estimated that it is more likely than not that the tax benefit of the deferred tax asset will not be realized. The valuation allowances recorded at December 31, 2005 and 2004 relate primarily to certain net operating loss carryforwards and capital loss carryforwards. The Company expects to generate adequate taxable income in the applicable tax jurisdictions in future years to utilize the net deferred income tax assets of $214,008,000 and $380,588,000 at December 31, 2005 and 2004, respectively.

At December 31, 2005, the Company had net operating loss carryforwards available to offset future taxable income in the United States and certain foreign jurisdictions, which expire as follows:

IN THOUSANDS	GROSS NET OPERATING LOSS CARRYFORWARDS
2006		$	4,498
2007			2,580
2008			20,451
2009			3,708
2010			7,667
2011			4,104
2012			8,172
2013			8,651
2014			3,263
2015			3,954
2016			1,370
2017			1,761
2018			—
2019			—
2020			1,534
2021			3,170
2022			4,094
2023			24,119
2024			165,765
2025			8,286
Do not expire			399,992
		$	677,139

Income from Continuing Operations Per Shareis computed by dividing income from continuing operations by the weighted average number of shares outstanding for the period. Income from continuing operations per diluted share is computed by dividing income from continuing operations by the weighted average number of shares assuming dilution for stock options and restricted stock. Dilutive shares reflect the potential additional shares that would be outstanding if the dilutive stock options outstanding were exercised and the unvested restricted stock vested during the period. The computation of income from continuing operations per share was as follows:

IN THOUSANDS EXCEPT PER SHARE AMOUNTS	2005		2004		2003
Income from continuing operations	$	1,494,869	$	1,339,605	$	1,040,214
Income from continuing operations per share—Basic:
Weighted average common shares		285,529		302,376		307,069
Income from continuing operations per share—Basic		$5.24		$4.43		$3.39
Income from continuing operations per share—Diluted:
Weighted average common shares		285,529		302,376		307,069
Effect of dilutive stock options and restricted stock		2,188		2,475		1,681
Weighted average common shares assuming dilution		287,717		304,851		308,750
Income from continuing operations per share—Diluted		$5.20		$4.39		$3.37

NOTES TO FINANCIAL STATEMENTS     58

Options that had exercise prices greater than the average market price of the common shares are considered antidilutive and were not included in the computation of diluted income from continuing operations per share. The antidilutive options outstanding as of December 31, 2005, 2004 and 2003 were as follows:

	2005		2004		2003
Weighted average shares issuable under antidilutive options		2,393,312		191,975		26,085
Weighted average exercise price per share		$94.24		$94.15		$79.35

Discontinued Operationsrepresents the Company’s former Consumer Products segment which was comprised of the following businesses: Precor specialty exercise equipment, West Bend small appliances and premium cookware, and Florida Tile ceramic tile. The Company’s net loss on disposal of the segment was $911,000 in 2004 and $16,534,000 in 2003.

As of December 31, 2005 and 2004, there were no assets or liabilities remaining from the discontinued operations.

Cash and Equivalentsincluded interest-bearing instruments of $143,306,000 at December 31, 2005 and $203,796,000 at December 31, 2004.Interest-bearing instruments have maturities of 90 days or less and are stated at cost, which approximates market.

Trade Receivableswere net of allowances for uncollectible accounts. The changes in the allowances for uncollectible accounts during 2005, 2004 and 2003 were as follows:

IN THOUSANDS	2005			2004			2003
Beginning balance	$	(56,205	)	$	(62,364	)	$	(66,158	)
Provision charged to expense		(7,156	)		(391	)		(8,875	)
Write-offs, net of recoveries		14,392			14,236			17,987
Acquisitions and divestitures		(5,931	)		(4,285	)		(2,851	)
Other		3,722			(3,401	)		(2,467	)
Ending balance	$	(51,178	)	$	(56,205	)	$	(62,364	)

Inventoriesat December 31, 2005 and 2004 were as follows:

IN THOUSANDS	2005		2004
Raw material	$	340,748	$	385,036
Work-in-process		136,557		118,052
Finished goods		725,758		778,068
	$	1,203,063	$	1,281,156

Inventories are stated at the lower of cost or market and include material, labor and factory overhead. The last-in, first-out (“LIFO”) method is used to determine the cost of the inventories of a majority of the U.S. operations.Inventories priced at LIFO were 33% and 34% of total inventories as of December 31, 2005 and 2004, respectively.The first-in, first-out (“FIFO”) method, which approximates current cost, is used for all other inventories.If the FIFO method was used for all inventories, total inventories would have been approximately $135,848,000 and $126,774,000 higher than reported at December 31, 2005 and 2004, respectively.

Plant and Equipmentare stated at cost less accumulated depreciation. Renewals and improvements that increase the useful life of plant and equipment are capitalized. Maintenance and repairs are charged to expense as incurred.

Depreciation was $299,232,000 in 2005, $294,162,000 in 2004 and $282,277,000 in 2003, and was reflected primarily in cost of revenues.Depreciation of plant and equipment for financial reporting purposes is computed principally on an accelerated basis.

The range of useful lives used to depreciate plant and equipment is as follows:

Buildings and improvements	10—50 years
Machinery and equipment	3—20 years
Equipment leased to others	Term of lease

59     2005 ANNUAL REPORT

Investmentsas of December 31, 2005 and 2004 consisted of the following:

IN THOUSANDS	2005		2004
Leases of equipment	$	309,437	$	302,487
Mortgage investments		292,370		380,465
Affordable housing limited partnerships		131,827		93,200
Venture capital limited partnership		91,522		75,333
Prepaid forward contract		28,376		27,040
Properties held for sale		26,920		22,868
Property developments		16,035		11,090
	$	896,487	$	912,483

Leases of Equipment

The components of the investment in leases of equipment at December 31, 2005 and 2004 were as shown below:

IN THOUSANDS	2005			2004
Leveraged, direct financing and sales-type leases:
Gross lease contracts receivable, net of nonrecourse debt service	$	156,393		$	166,646
Estimated residual value of leased assets		248,119			255,119
Unearned income		(108,389	)		(121,482	)
		296,123			300,283
Equipment under operating leases		13,314			2,204
	$	309,437		$	302,487

Deferred tax liabilities related to leveraged and direct financing leases were $295,064,000 and $245,723,000 at December 31, 2005 and 2004, respectively.

The investment in leases of equipment at December 31, 2005 and 2004 relates to the following types of equipment:

IN THOUSANDS	2005		2004
Telecommunications	$	196,348	$	193,306
Air traffic control		68,268		61,757
Aircraft		43,480		44,020
Manufacturing		1,341		3,404
	$	309,437	$	302,487

In 2003, the Company entered into a leveraged lease transaction related to air traffic control equipment in Australia with a cash investment of $48,763,000. In 2002, the Company entered into leveraged leasing transactions related to mobile telecommunications equipment with two major European telecommunications companies with a cash investment of $144,676,000. Under the terms of the telecommunications and air traffic control lease transactions, the lessees have made upfront payments to creditworthy third party financial institutions that are acting as payment undertakers. These payment undertakers are obligated to make the required scheduled payments directly to the nonrecourse debt holders and to the lessors, including the Company. In the event of default by the lessees, the Company can recover its net investment from the payment undertakers. In addition, the lessees are required to purchase residual value insurance from a creditworthy third party at a date near the end of the lease term.

The components of the income from leveraged, direct financing and sales-type leases for the years ended December 31, 2005, 2004 and 2003 were as shown below:

IN THOUSANDS	2005			2004			2003
Lease income before income taxes	$	13,890		$	24,326		$	27,059
Investment tax credits recognized		250			296			612
Income tax expense		(5,197	)		(9,014	)		(10,077	)
	$	8,943		$	15,608		$	17,594

Unearned income is recognized as lease income over the life of the lease based on the effective yield of the lease. The residual values of leased assets are estimated at the inception of the lease based on market appraisals and reviewed for impairment at least annually.

NOTES TO FINANCIAL STATEMENTS     60

Mortgage Investments

In 1995, 1996 and 1997, the Company, through its investments in separate mortgage entities, acquired three distinct pools of mortgage-related assets in exchange for aggregate nonrecourse notes payable of $739,705,000, preferred stock of subsidiaries of $60,000,000 and cash of $240,000,000. The mortgage-related assets acquired in these transactions related to office buildings, apartment buildings and shopping malls located throughout the United States. In conjunction with these transactions, the mortgage entities simultaneously entered into ten-year swap agreements and other related agreements whereby a third party receives the portion of the interest and net operating cash flow from the mortgage-related assets in excess of specified semi-annual amounts and a portion of the proceeds from the disposition of the mortgage-related assets and principal repayments, in exchange for the third party making the contractual principal and interest payments on the nonrecourse notes payable. In addition, in the event that the pools of mortgage-related assets do not generate interest and net operating cash flow greater than the specified amounts, the Company has the right to receive the shortfall from the cash flow generated by separate pools of mortgage-related assets (owned by third parties in which the Company has minimal interests), which the swap counter party has estimated to have a total fair value of approximately $600,000,000 at December 31, 2005. The mortgage entities entered into the swaps and other related agreements in order to reduce their real estate, credit and interest rate risks relative to the mortgage-related assets and related nonrecourse notes payable.

In December 2005, in accordance with the 10-year term of the transaction, all remaining mortgage-related assets related to the 1995 mortgage investment transaction (the “First Mortgage Transaction”) were sold. The Company received $150,800,000 for its share of the disposition proceeds and paid $32,000,000 for the redemption of preferred stock of a subsidiary and related accrued dividends. As of December 31, 2005, there are no remaining assets or liabilities related to the First Mortgage Transaction.

As of December 31, 2005 and 2004, the book value of the assets held by the mortgage entities was as follows:

IN THOUSANDS	2005		2004
Cash on hand from dispositions	$	350,308	$	459,470
Real estate (12 and 24 properties, respectively)		180,507		348,004
Mortgage loans (1 and 4 loans, respectively)		17,713		78,766
Other assets		17,207		8,389
	$	565,735	$	894,629

Assuming all assets become worthless and the swap counterparty defaults, the Company’s maximum exposure to loss related to the mortgage entities is limited to its investment of $292,370,000 at December 31, 2005.

On July 1, 2003, the Company adopted FASB Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”) relative to its investments in the mortgage entities. FIN 46 requires consolidation of variable interest entities in which a company has a controlling financial interest, even if it does not have a majority voting interest. A company is deemed to have a controlling financial interest in a variable interest entity if it has either the majority of the risk of loss or the majority of the residual returns. Upon its adoption of FIN 46 for the mortgage investments as of July 1, 2003, the Company deconsolidated its investments in the mortgage entities as the Company neither bears the majority of the risk of loss nor enjoys the majority of any residual returns. No gain or loss was recognized in connection with this change in accounting.

In 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (“FIN 46R”). The adoption of FIN 46R had no impact on the Company.

Starting in the third quarter of 2003 and for subsequent periods,the Company accounts for its net investments in the mortgage entities using the equity method of accounting as provided in Statement of Position 78-9, Accounting for Investments in Real Estate Ventures. Under this method, the net mortgage investments are adjusted through income for changes in the Company’s share of the net assets of the mortgage entities. The excess of the liquidation value of the investments in the mortgage entities over their net book value as of July 1, 2003 of $178,333,000 is being recognized as income over the remaining term of each of the investments.The remaining amount of this excess liquidation value over book value at December 31, 2005 and 2004 was as follows:

IN THOUSANDS	2005		2004
Mortgage transaction ending December 31, 2005	$	—	$	25,243
Mortgage transaction ending December 31, 2006		20,449		35,307
Mortgage transaction ending February 28, 2008		14,861		28,964
	$	35,310	$	89,514

61     2005 ANNUAL REPORT

Prior to the adoption of FIN 46 for the mortgage investments as of July 1, 2003, the principal mortgage-related assets were accounted for as follows:

Commercial mortgage loans —Interest income was recorded based on the effective yield determined at the inception of the commercial mortgage transactions. The Company evaluated whether the commercial mortgage loans had been impaired by reviewing the discounted estimated future cash flows of the loans versus the carrying value of the loans. If the carrying value exceeded the discounted cash flows, an impairment loss was recorded through the operating income of the Leasing and Investments segment. Interest income was recognized on impaired mortgage loans based on the original effective yield of the loans. Loans that were foreclosed were transferred to commercial real estate at carrying value.

Commercial real estate —Recorded at cost and depreciated on a straight-line basis over an estimated useful life of 39 years. At least annually, the real estate assets were evaluated for impairment by comparing estimated future undiscounted cash flows to the carrying values. If the undiscounted future cash flows were less than the carrying value, an impairment loss was recorded equal to the difference between the estimated fair value and the carrying value of the impaired asset. Gains and losses were recorded on the sale of the real estate assets through the operating income of the Leasing and Investments segment based on the proceeds of the sale compared with the carrying value of the asset sold.

Net swap receivables —Recorded at fair value, based on the estimated future cash flows discounted at current market interest rates. All estimated future cash flows were provided by the swap counter party, who also is the servicer of the mortgage loans and real estate. Market interest rates for the swap inflows were based on the current market yield of a bond of the swap counter party. Discount rates for the swap outflows were based on an estimate of risk-adjusted rates for real estate assets. Any adjustments to the carrying value of the net swap receivables due to changes in expected future cash flows, discount rates or interest rates were recorded through the operating income of the Leasing and Investment segment.

Other Investments

The Company has entered into several affordable housing limited partnerships primarily to receive tax benefits in the form of tax credits and tax deductions from operating losses.These affordable housing investments are accounted for using the effective yield method, in which the investment is amortized to income tax expense as the tax benefits are received. The tax credits are credited to income tax expense as they are allocated to the Company.

The Company entered into a venture capital limited partnership in 2001 that invests in late-stage venture capital opportunities. The Company has committed to total capital contributions to this partnership of $100,000,000 over a five-year period. The Company has a 25% limited partnership interest andaccounts for this investment using the equity method, whereby the Company recognizes its proportionate share of the partnership’s income or loss. The partnership’s financial statements are prepared on a mark-to-market basis.

The Company’s investment in the prepaid forward contract was initially recorded at cost.Interest income is being accrued for this contract based on the effective yield of the contract.

Properties held for sale are former manufacturing or office facilities located primarily in the United States that are no longer used by the Company’s operations and are currently held for sale. These propertiesare recorded at the lower of cost or market.

The Company has invested in property developments with a residential construction developer through partnerships in which the Company has a 50% interest.These partnership investments are accounted for using the equity method, whereby the Company recognizes its proportionate share of the partnerships’ income or loss.

The property development partnerships and affordable housing limited partnerships in which the Company has invested are considered variable interest entities under FIN 46R. Because the Company neither bears the majority of the risk of loss nor enjoys the majority of any residual returns relative to these variable interest entities, the Company does not consolidate those entities. The Company accounts for the property development investments using the equity method and the affordable housing investments using the effective yield method as described above. The Company’s maximum exposure to loss related to the property development investments and affordable housing investments is $23,660,000 and $131,827,000, respectively, as of December 31, 2005.

NOTES TO FINANCIAL STATEMENTS     62

Cash Flows and Non-Cash Transactions

Cash flows related to investments during 2005, 2004 and 2003 were as follows:

IN THOUSANDS	2005			2004			2003
Cash used to purchase investments:
Affordable housing limited partnerships	$	(80,822	)	$	(28,449	)	$	(53,581	)
Leases of equipment		—			(449	)		(48,763	)
Venture capital limited partnership		(27,242	)		(28,007	)		(26,069	)
Property developments		(11,976	)		(3,918	)		(3,830	)
Other		(200	)		(3,619	)		(993	)
	$	(120,240	)	$	(64,442	)	$	(133,236	)
Cash proceeds from investments:
Mortgage investments	$	172,288		$	26,187		$	26,000
Property developments		13,805			13,810			19,584
Venture capital limited partnership		22,683			19,428			—
Leases of equipment		8,685			8,041			9,767
Properties held for sale		2,600			17,888			3,929
Other		21			58			229
	$	220,082		$	85,412		$	59,509

There were no material non-cash transactions in 2005 and 2004. The Company’s only material non-cash transactions during 2003 relate to the debt service on the nonrecourse notes payable of the mortgage entities, which was paid by the mortgage swap counter party, as follows:

IN THOUSANDS	2003
Payments by mortgage swap counter party—
Principal	$	20,803
Interest		19,295
	$	40,098
Non-cash interest expense	$	18,696

Goodwill and Intangible Assets—Goodwill represents the excess cost over fair value of the net assets of purchased businesses.The Company does not amortize goodwill and intangible assets that have indefinite lives. In the first quarter of each year, the Company performs an annual impairment assessment of goodwill and intangible assets with indefinite lives based on the fair value of the related reporting unit or intangible asset.

As of January 1, 2005, the Company had assigned its recorded goodwill and intangible assets to approximately 340 of its then 650 reporting units. When performing its annual impairment assessment, the Company compares the fair value of each reporting unit to its carrying value. Fair values are determined by discounting estimated future cash flows at the Company’s estimated cost of capital of 10%. Estimated future cash flows are based either on current operating cash flows or on a detailed cash flow forecast prepared by the relevant operating unit. If the fair value of an operating unit is less than its carrying value, an impairment loss is recorded for the difference between the implied fair value of the unit’s goodwill and the carrying value of the goodwill.

Amortization and impairment of goodwill and other intangible assets for the years ended December 31, 2005, 2004 and 2003 were as follows:

IN THOUSANDS	2005		2004		2003
Goodwill:
Impairment	$	9,650	$	11,492	$	702
Intangible Assets:
Amortization		69,143		37,409		19,813
Impairment		5,049		10,220		3,761
	$	83,842	$	59,121	$	24,276

63     2005 ANNUAL REPORT

In 2005, the Company recorded goodwill and intangible asset impairment charges of $14,699,000. The goodwill impairment charges of $9,650,000 were primarily related to a Canadian stretch packaging equipment business and a U.S. welding components business, and resulted from lower estimated future cash flows than previously expected. Also in 2005, intangible asset impairments of $5,049,000 were recorded to reduce to estimated fair value the carrying value of trademarks, patents, and customer-related intangible assets related to a U.S. business that manufactures clean room mats in the Engineered Products—North America segment.

In 2004, the Company recorded goodwill impairment charges of $11,492,000, which were primarily related to a European automotive components business and a U.S. electrical components business, and resulted from lower estimated future cash flows than previously expected. Also in 2004, intangible asset impairments of $10,220,000 were recorded to reduce to estimated fair value the carrying value of trademarks and brands related primarily to several U.S. welding components businesses, a U.S. industrial packaging business in the Specialty Systems—North America segment and a U.S. business that manufactures clean room mats in the Engineered Products—North America segment.

In 2003, the Company recorded a goodwill impairment charge of $702,000 related to a U.S. welding components business and primarily resulted from lower estimated future cash flows than previously expected. Also in 2003, intangible asset impairment charges of $3,761,000 were recorded to reduce to estimated fair value the carrying value of trademarks and brands related to several U.S. welding components businesses in the Specialty Systems—North America segment and a U.S. business that manufactures clean room mats in the Engineered Products—North America segment.

The changes in the carrying amount of goodwill by segment for the years ended December 31, 2005 and 2004 were as follows:

	ENGINEERED			ENGINEERED			SPECIALTY			SPECIALTY
	PRODUCTS			PRODUCTS			SYSTEMS			SYSTEMS
IN THOUSANDS	NORTH AMERICA			INTERNATIONAL			NORTH AMERICA			INTERNATIONAL			TOTAL
Balance, December 31, 2003	$	527,160		$	483,056		$	836,811		$	664,254		$	2,511,281
2004 activity:
Acquisitions		103,300			93,762			17,348			20,842			235,252
Impairment write-offs		(3,000	)		(8,492	)		—			—			(11,492	)
Foreign currency translation		468			15,998			137			1,409			18,012
Intersegment goodwill transfers		(7,000	)		7,754			(5,083	)		4,329			—
Balance, December 31, 2004		620,928			592,078			849,213			690,834			2,753,053
2005 activity:
Acquisitions		85,934			20,559			79,967			101,823			288,283
Impairment write-offs		—			(80	)		(9,559	)		(11	)		(9,650	)
Foreign currency translation		102			(13,192	)		178			(9,763	)		(22,675	)
Intersegment goodwill transfers		17,889			(17,889	)		(2,283	)		2,283			—
Balance, December 31, 2005	$	724,853		$	581,476		$	917,516		$	785,166		$	3,009,011

Intangible assets as of December 31, 2005 and 2004 were as follows:

	2005							2004
			ACCUMULATED							ACCUMULATED
IN THOUSANDS	COST		AMORTIZATION			NET		COST		AMORTIZATION			NET
Amortizable Intangible Assets:
Customer lists and relationships	$	219,879	$	(30,865	)	$	189,014	$	112,315	$	(14,015	)	$	98,300
Patents and proprietary technology		167,887		(66,392	)		101,495		117,285		(55,021	)		62,264
Trademarks and brands		113,402		(14,613	)		98,789		68,353		(8,489	)		59,864
Software		101,562		(18,972	)		82,590		51,123		(5,472	)		45,651
Noncompete agreements		87,977		(59,335	)		28,642		80,562		(47,115	)		33,447
Other		56,693		(45,750	)		10,943		97,686		(38,597	)		59,089
Indefinite-lived Intangible Assets:
Trademarks and brands		158,454		—			158,454		81,387		—			81,387
Total Intangible Assets	$	905,854	$	(235,927	)	$	669,927	$	608,711	$	(168,709	)	$	440,002

Intangible assets are being amortized primarily on a straight-line basis over their estimated useful lives of three to 20 years.

NOTES TO FINANCIAL STATEMENTS     64

The estimated amortization expense of intangible assets for the future years ending December 31 is as follows:

IN THOUSANDS
2006	$	77,011
2007		72,178
2008		65,751
2009		57,674
2010		47,365

Other Assetsas of December 31, 2005 and 2004 consisted of the following:

IN THOUSANDS	2005		2004
Prepaid pension assets	$	430,862	$	402,045
Cash surrender value of life insurance policies		298,190		266,581
Investment in unconsolidated affiliates		23,733		21,720
Other		153,450		123,805
	$	906,235	$	814,151

Retirement Plans and Postretirement Benefits—The Company has both funded and unfunded defined benefit pension plans. The major domestic plan covers substantially all of its U.S. employees and provides benefits based on years of service and final average salary. The Company also has other postretirement benefit plans covering substantially all of its U.S. employees. The primary postretirement health care plan is contributory with the participants’ contributions adjusted annually. The postretirement life insurance plans are noncontributory.

The Company has various defined benefit pension plans in foreign countries, predominantly the United Kingdom, Germany, Canada and Australia.

The Company uses a September 30 measurement date.

Summarized information regarding the Company’s significant defined benefit pension and postretirement health care and life insurance benefit plans is as follows:

	PENSION									OTHER POSTRETIREMENT BENEFITS
IN THOUSANDS	2005			2004			2003			2005			2004			2003
Components of net periodic benefit cost:
Service cost	$	84,929		$	78,991		$	70,168		$	12,945		$	13,471		$	12,613
Interest cost		85,713			82,518			77,606			30,293			34,666			31,302
Expected return on plan assets		(124,382	)		(118,024	)		(102,536	)		(5,754	)		(3,466	)		(1,280	)
Amortization of prior service cost (income)		(2,277	)		(2,304	)		(2,345	)		6,736			6,736			6,601
Amortization of actuarial loss		8,591			5,074			3,555			1,246			5,595			926
Amortization of transition amount		(18	)		(139	)		(893	)		—			—			—
Settlement/curtailment loss		195			59			381			—			—			—
Net periodic benefit cost	$	52,751		$	46,175		$	45,936		$	45,466		$	57,002		$	50,162

65     2005 ANNUAL REPORT

	PENSION						OTHER POSTRETIREMENT BENEFITS
IN THOUSANDS	2005			2004			2005			2004
Change in benefit obligation as of September 30:
Benefit obligation at beginning of period	$	1,589,256		$	1,447,024		$	546,112		$	587,256
Service cost		84,929			78,991			12,945			13,471
Interest cost		85,713			82,518			30,293			34,666
Plan participants’ contributions		2,583			2,244			15,565			13,983
Amendments		1,306			(15	)		(16,212	)		—
Medicare subsidy impact		—			—			—			(30,465	)
Actuarial (gain) loss		125,819			32,428			64,880			(33,238	)
Acquisitions		119,080			4,442			—			9,145
Benefits paid		(112,287	)		(97,053	)		(47,561	)		(48,706	)
Liabilities (to) from other plans		24,326			(777	)		—			—
Foreign currency translation		(41,064	)		39,454			—			—
Benefit obligation at end of period	$	1,879,661		$	1,589,256		$	606,022		$	546,112
Change in plan assets as of September 30:
Fair value of plan assets at beginning of period	$	1,491,574		$	1,200,435		$	65,204		$	36,192
Actual return on plan assets		220,829			158,133			4,321			2,360
Acquisitions		86,619			1,228			—			—
Company contributions		103,157			205,223			65,999			61,375
Plan participants’ contributions		2,583			2,244			15,565			13,983
Benefits paid		(112,287	)		(97,053	)		(47,561	)		(48,706	)
Assets (to) from other plans		8,400			(4,456	)		—			—
Foreign currency translation		(27,301	)		25,820			—			—
Fair value of plan assets at end of period	$	1,773,574		$	1,491,574		$	103,528		$	65,204
Funded status	$	(106,087	)	$	(97,682	)	$	(502,494	)	$	(480,908	)
Unrecognized net actuarial loss		367,932			352,439			131,316			66,924
Unrecognized prior service cost (income)		(6,435	)		(10,819	)		36,050			58,998
Unrecognized net transition amount		2,341			2,220			—			—
Contributions after measurement date		2,460			8,171			35,895			43,515
Other immaterial plans		(17,262	)		(12,228	)		(2,169	)		(2,028	)
Net amount recognized	$	242,949		$	242,101		$	(301,402	)	$	(313,499	)
The amounts recognized in the statement of financial position as of December 31 consisted of:
Prepaid benefit cost	$	424,165		$	379,909		$	—		$	—
Accrued benefit liability		(235,625	)		(212,296	)		(301,402	)		(313,499	)
Intangible asset for minimum pension liability		6,697			22,136			—			—
Accumulated other comprehensive loss for minimum pension liability		47,712			52,352			—			—
Net amount recognized	$	242,949		$	242,101		$	(301,402	)	$	(313,499	)
Accumulated benefit obligation for all significant defined benefit pension plans	$	1,653,854		$	1,399,725
Plans with accumulated benefit obligation in excess of plan assets as of September 30:
Projected benefit obligation	$	349,916		$	288,393
Accumulated benefit obligation	$	324,128		$	268,836
Fair value of plan assets	$	137,669		$	94,263
Increase (decrease) in minimum liability included in other comprehensive income	$	(4,640	)	$	5,009

NOTES TO FINANCIAL STATEMENTS     66

Assumptions

The weighted-average assumptions used in the valuations of pension and other postretirement benefits were as follows:

	PENSION									OTHER POSTRETIREMENT BENEFITS
	2005			2004			2003			2005			2004			2003
Weighted-average assumptions used to determine benefit obligation at September 30:
Discount rate		5.30	%		5.67	%		5.90	%		5.50	%		5.75	%		6.00	%
Rate of compensation increases		4.20			4.35			4.32			—			—			—
Weighted-average assumptions used to determine net cost for years ended December 31:
Discount rate		5.67	%		5.90	%		6.44	%		5.75	%		6.00	%		6.60	%
Expected return on plan assets		7.99			7.99			8.06			7.00			7.00			7.00
Rate of compensation increases		4.35			4.32			4.43			—			—			—

The expected long-term rate of return for pension plans was developed using historical returns while factoring in current market conditions such as inflation, interest rates and equity performance. The expected long-term rate of return for the postretirement health care plans was developed from the major domestic pension plan rate less 100 basis points.

Assumed health care cost trend rates have an effect on the amounts reported for the postretirement health care benefit plans. The assumed health care cost trend rates used to determine the postretirement benefit obligation at September 30 were as follows:

	2005			2004			2003
Health care cost trend rate assumed for the next year		10.00	%		10.00	%		10.00	%
Ultimate trend rate		5.00	%		5.00	%		5.00	%
Year that the rate reaches the ultimate trend rate		2010			2009			2008

A one-percentage-point change in assumed health care cost trend rates would have the following effects:

IN THOUSANDS	1-PERCENTAGE- POINT INCREASE		1-PERCENTAGE- POINT DECREASE
Effect on total of service and interest cost components for 2005	$	1,326	$	(2,188	)
Effect on postretirement benefit obligation at September 30, 2005	$	22,498	$	(27,705	)

Plan Assets

The target asset allocation and weighted-average asset allocations for the Company’s significant pension plans at September 30, 2005 and 2004 were as follows:

				PERCENTAGE OF PLAN
				ASSETS AT SEPTEMBER 30
ASSET CATEGORY	TARGET ALLOCATION			2005			2004
Equity securities		60 - 75	%		67	%		67	%
Debt securities		20 - 35			29			30
Real estate		0 -   1			1			1
Other		0 - 10			3			2
					100	%		100	%

The Company’s overall investment strategy for the assets in the pension funds is to achieve a balance between the goals of growing plan assets and keeping risk at a reasonable level over a long-term investment horizon. In order to reduce unnecessary risk, the pension funds are diversified across several asset classes, securities and investment managers with a focus on total return. The use of derivatives for the purpose of speculation, leverage, circumventing investment guidelines or taking risks that are inconsistent with specified guidelines is prohibited.

67     2005 ANNUAL REPORT

The assets in the Company’s postretirement health care plans are invested in life insurance policies. The Company’s overall investment strategy for the assets in the postretirement healthcare fund is to invest in assets that provide a reasonable rate of return while preserving capital and which are exempt from U.S. federal income taxes.

Cash Flows

The Company generally funds its pension plans to the extent such contributions are tax deductible. The Company expects to contribute $38,700,000 to its pension plans and $62,400,000 to its other postretirement benefit plans in 2006.

The Company’s portion of the benefit payments that are expected to be paid during the years ending December 31 is as follows:

			OTHER
			POSTRETIREMENT
IN THOUSANDS	PENSION BENEFITS		BENEFITS
2006	$	153,843	$	34,348
2007		157,990		35,753
2008		162,395		36,927
2009		168,449		38,350
2010		174,722		39,599
Years 2011-2015		918,740		213,029

In addition to the above pension benefits, the Company sponsors defined contribution retirement plans covering the majority of its U.S. employees. The Company’s contributions to these plans were $26,543,000 in 2005, $27,220,000 in 2004 and $24,745,000 in 2003.

Short-Term Debtas of December 31, 2005 and 2004 consisted of the following:

IN THOUSANDS	2005		2004
Bank overdrafts	$	53,487	$	33,937
Commercial paper		94,488		134,982
European demand note		74,283		—
Current maturities of long-term debt		12,090		4,149
Other borrowings by foreign subsidiaries		18,551		30,455
	$	252,899	$	203,523

Commercial paper is issued at a discount and generally matures 30 to 90 days from the date of issuance. The weighted average interest rate on commercial paper was 4.3% at December 31, 2005 and 2.4% at December 31, 2004.

In December 2005, the Company issued a€63,000,000 demand note in order to obtain cash for dividend repatriation to the United States. The demand note has an interest rate of 2.7% and is due March 28, 2006.

The weighted average interest rate on other borrowings by foreign subsidiaries was 3.1% at December 31, 2005 and 2.0% at December 31, 2004.

In 2005, the Company entered into a $600,000,000 Line of Credit Agreement with a termination date of June 16, 2006. No amounts were outstanding under this facility at December 31, 2005.

Accrued Expensesas of December 31, 2005 and 2004 consisted of accruals for:

IN THOUSANDS	2005		2004
Compensation and employee benefits	$	367,804	$	363,929
Deferred revenue and customer deposits		119,505		82,854
Rebates		111,589		101,248
Warranties		70,882		79,020
Current portion of postretirement benefit obligation		34,348		38,111
Current portion of affordable housing capital obligations		14,040		20,017
Other		295,772		274,201
	$	1,013,940	$	959,380

NOTES TO FINANCIAL STATEMENTS     68

The changes in accrued warranties during 2005, 2004 and 2003 were as follows:

IN THOUSANDS	2005			2004			2003
Beginning balance	$	79,020		$	69,415		$	58,861
Charges		(52,258	)		(47,760	)		(49,423	)
Provision charged to expense		44,120			57,365			59,977
Ending balance	$	70,882		$	79,020		$	69,415

Long-Term Debtat December 31, 2005 and 2004 consisted of the following:

IN THOUSANDS	2005			2004
6.875% notes due November 15, 2008	$	149,947		$	149,929
5.75% notes due March 1, 2009		496,687			499,343
6.55% preferred debt securities due December 31, 2011		249,739			249,705
4.88% preferred debt securities due December 31, 2020		53,735			—
Other borrowings		20,303			26,270
		970,411			925,247
Current maturities		(12,090	)		(4,149	)
	$	958,321		$	921,098

In 1998, the Company issued $150,000,000 of 6.875% notes at 99.228% of face value. The effective interest rate of the notes is 6.9%. The quoted market price of the notes exceeded the carrying value by approximately $7,795,000 at December 31, 2005 and $15,974,000 at December 31, 2004.

In 1999, the Company issued $500,000,000 of 5.75% redeemable notes at 99.281% of face value. The effective interest rate of the notes is 5.8%. The quoted market price of the notes exceeded the carrying value by approximately $15,328,000 at December 31, 2005 and $34,552,000 at December 31, 2004. In December 2002, the Company entered into an interest rate swap with a notional value of $100,000,000 to hedge a portion of the fixed-rate debt. Under the terms of the swap, the Company receives interest at a fixed rate of 5.75% and pays interest at a variable rate of LIBOR plus 1.96%. The variable interest rate under the swap was 6.37% at December 31, 2005 and 4.36% at December 31, 2004. The maturity date of the interest rate swap is March 1, 2009. The carrying value of the 5.75% notes has been adjusted to reflect the fair value of the interest rate swap.

In 2002, a subsidiary of the Company issued $250,000,000 of 6.55% preferred debt securities at 99.849% of face value. The effective interest rate of the preferred debt securities is 6.7%. The estimated fair value of the securities exceeded the carrying value by approximately $17,466,000 at December 31, 2005 and $32,988,000 at December 31, 2004.

In 2005, the Company issued $53,735,000 of 4.88% senior notes at 100% of face value. The effective interest rate of the notes is 4.88%. The carrying value of the notes exceeded the estimated fair value by approximately $172,000 at December 31, 2005.

In 2003, the Company entered into a $350,000,000 revolving credit facility (“RCF”) with a termination date of June 20, 2008. This RCF was replaced on June 17, 2005 by a $350,000,000 RCF with a termination date of June 17, 2010. No amounts were outstanding under this facility at December 31, 2005.

The Company’s debt agreements’ financial covenants limit total debt, including guarantees, to 50% of total capitalization. The Company’s total debt, including guarantees, was 14% of total capitalization as of December 31, 2005, which was in compliance with these covenants.

Other debt outstanding at December 31, 2005, bears interest at rates ranging from 2.2% to 11.0%, with maturities through the year 2029.

69     2005 ANNUAL REPORT

Scheduled maturities of long-term debt for the years ending December 31 are as follows:

IN THOUSANDS
2007	$	6,677
2008		156,209
2009		502,838
2010		6,169
2011 and future years		286,428
	$	958,321

In connection with forming joint ventures, the Company has provided debt guarantees of $30,000,000 at December 31, 2005 and $32,000,000 at December 31, 2004. The Company has recorded liabilities related to these guarantees of $14,000,000 at December 31, 2005 and $16,000,000 at December 31, 2004.

At December 31, 2005, the Company had open stand-by letters of credit of $68,000,000, substantially all of which expire in 2006. At December 31, 2004, the Company had open stand-by letters of credit of $97,000,000, substantially all of which expired in 2005.

Other Noncurrent Liabilitiesat December 31, 2005 and 2004 consisted of the following:

IN THOUSANDS	2005		2004
Postretirement benefit obligation	$	267,054	$	275,388
Pension benefit obligation		235,625		212,296
Affordable housing capital obligations		58,105		74,640
Preferred stock of subsidiaries		40,000		60,000
Accrued dividends on preferred stock of subsidiaries		24,820		32,700
Other		314,092		297,231
	$	939,696	$	952,255

In connection with each of the three commercial mortgage transactions, various subsidiaries of the Company issued $20,000,000 of preferred stock. Dividends on this preferred stock are cumulative and accrue at a rate of 6% on the first $20,000,000 issuance and 7.3% on the second and third $20,000,000 issuances. The accrued dividends are recorded as an operating expense of the Leasing and Investments segment. In 2005, the Company redeemed the first preferred stock issuance for $20,000,000 and paid accrued dividends of $12,000,000. The mandatory redemption dates for the remaining two issuances are December 12, 2016 and December 23, 2017, respectively.

In 2001, the Company committed to two new affordable housing limited partnership investments. In connection with the formation and financing of these limited partnerships, the affordable housing limited partnerships borrowed the full amount of funds necessary for their affordable housing projects from a third party financial institution. The excess cash of $126,760,000 was distributed to the Company in 2001 and will be repaid to the limited partnerships via capital contributions as the limited partnerships require the funds for their affordable housing projects.

The noncurrent portion of the Company’s capital contributions to the affordable housing limited partnerships are expected to be paid as follows:

IN THOUSANDS
2007	$	13,703
2008		13,722
2009		14,092
2010		13,344
2011 and future years		3,244
	$	58,105

Other than the capital contributions above, the Company has no future obligations, guarantees or commitments to the affordable housing limited partnerships.

NOTES TO FINANCIAL STATEMENTS     70

Commitments and Contingencies—The Company is subject to various legal proceedings and claims that arise in the ordinary course of business, including those involving environmental, tax, product liability (including toxic tort) and general liability claims.The Company accrues for such liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated.Such accruals are based on developments to date, the Company’s estimates of the outcomes of these matters and its experience in contesting, litigating and settling other similar matters. The Company believes resolution of these matters, individually and in the aggregate, will not have a material adverse effect on the Company’s financial position, liquidity or future operations.

Among the toxic tort cases in which the Company is a defendant, the Company as well as its subsidiaries Hobart Brothers Company and Miller Electric Mfg. Co., have been named, along with numerous other defendants, in lawsuits alleging injury from exposure to welding consumables. The plaintiffs in these suits claim unspecified damages for injuries resulting from the plaintiffs’ alleged exposure to asbestos, manganese and/or toxic fumes in connection with the welding process. Based upon the Company’s experience in defending these claims, the Company believes that the resolution of these proceedings will not have a material adverse effect on the Company’s financial position, liquidity or future operations. The Company has not recorded any significant reserves related to these cases.

Wilsonart International, Inc. (“Wilsonart”), a wholly owned subsidiary of ITW, is a defendant in a consolidated class action lawsuit filed in 2000 in U.S. federal district court in White Plains, New York on behalf of purchasers of high-pressure laminate. The complaint alleges that Wilsonart participated in a conspiracy with competitors to fix, raise, maintain or stabilize prices for high-pressure laminate between 1994 and 2000 and seeks injunctive relief and treble damages. Indirect purchasers of high-pressure laminate filed similar purported class action cases under various state antitrust and consumer protection statutes in 13 states and the District of Columbia, all of which cases have been stayed pending the outcome of the consolidated class action. These lawsuits were brought following the commencement of a federal grand jury investigation into price-fixing in the high-pressure laminate industry, which investigation was subsequently closed by the Department of Justice with no further proceedings and with all documents being returned to the parties. Plaintiffs are seeking damages of $470,000,000 before trebling. Without admitting liability, Wilsonart’s co-defendants, International Paper Company and Panolam International, Inc., have settled the federal consolidated class action case for $31,000,000 and $9,500,000, respectively. The plaintiffs’ claims against Formica Corporation, the remaining co-defendant in the case, were dismissed with prejudice on September 27, 2004 as a result of its bankruptcy proceedings. As a result, Wilsonart is the sole remaining defendant in the consolidated class action lawsuit. While no assurances can be given regarding the ultimate outcome or the timing of the resolution of these claims, the Company believes that the plaintiffs’ claims are without merit and intends to continue to defend itself vigorously in this action and all related actions that are now pending or that may be brought in the future. The Company has not recorded any reserves related to this case.

Preferred Stock, without par value, of which 300,000 shares are authorized, is issuable in series. The Board of Directors is authorized to fix by resolution the designation and characteristics of each series of preferred stock. The Company has no present commitment to issue its preferred stock.

71     2005 ANNUAL REPORT

Common Stock, with a par value of $.01,Additional Paid-In-CapitalandCommon Stock Held in Treasurytransactions during 2005, 2004 and 2003 are shown below:

							ADDITIONAL
	COMMON STOCK						PAID-IN-CAPITAL			COMMON STOCK HELD IN TREASURY
IN THOUSANDS EXCEPT SHARES	SHARES			AMOUNT			AMOUNT			SHARES			AMOUNT
Balance, December 31, 2002		306,825,627		$	3,068		$	747,778			(242,736	)	$	(1,662	)
During 2003—
Shares issued for stock options		1,369,741			14			47,896			(8,911	)		(644	)
Shares surrendered on exercise of stock options and vesting of restricted stock		(97,554	)		(1	)		(7,552	)		8,911			644
Stock compensation expense		—			—			17,777			—			—
Tax benefits related to stock options and restricted stock		—			—			18,767			—			—
Net shares issued for restricted stock grants		790,508			8			5			1,996			14
Restricted stock forfeitures		(2,250	)		—			—			—			—
Escrow shares returned from prior acquisitions		(8,847	)		—			(664	)		—			—
Tax benefits related to defined contribution plans		—			—			1,917			—			—
Balance, December 31, 2003		308,877,225			3,089			825,924			(240,740	)		(1,648	)
During 2004—
Shares issued for stock options		2,146,718			22			97,607			(27,867	)		(2,568	)
Shares surrendered on exercise of stock options and vesting of restricted stock		(201,639	)		(2	)		(18,518	)		27,867			2,568
Stock compensation expense		—			—			32,514			—			—
Tax benefits related to stock options and restricted stock		—			—			37,747			—			—
Shares issued for acquisitions		19,257			—			1,628			—			—
Net shares issued for restricted stock grants		553,981			5			162			11,019			76
Restricted stock forfeitures		(21,984	)		—			—			—			—
Tax benefits related to defined contribution plans		—			—			1,877			—			—
Repurchases of common stock		—			—			—			(18,915,473	)		(1,729,806	)
Balance, December 31, 2004		311,373,558			3,114			978,941			(19,145,194	)		(1,731,378	)
During 2005—
Shares issued for stock options		850,033			8			37,858			—			—
Shares surrendered on exercise of stock options and vesting of restricted stock		(148,642	)		(2	)		(13,302	)		—			—
Stock compensation expense		—			—			64,144			—			—
Tax benefits related to stock options and restricted stock		—			—			12,879			—			—
Restricted stock forfeitures		(31,660	)		—			—			—			—
Tax benefits related to defined contribution plans		—			—			2,091			—			—
Repurchases of common stock		—			—			—			(12,084,527	)		(1,041,798	)
Balance, December 31, 2005		312,043,289		$	3,120		$	1,082,611			(31,229,721	)	$	(2,773,176	)
Authorized, December 31, 2005		350,000,000

On April 19, 2004 the Company’s Board of Directors authorized a stock repurchase program, which provided for the buyback of up to 31,000,000 shares. The Company completed the stock repurchase program in 2005.

Cash Dividendsdeclared were $1.22 per share in 2005, $1.04 per share in 2004 and $.94 per share in 2003. Cash dividends paid were $1.17 per share in 2005, $1.00 per share in 2004 and $.93 per share in 2003.

NOTES TO FINANCIAL STATEMENTS     72

Comprehensive Incomeis defined as the changes in equity during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. The Company’s components of other comprehensive income are shown below:

				MINIMUM			TOTAL ACCUMULATED
	CUMULATIVE			PENSION			OTHER
IN THOUSANDS	TRANSLATION ADJUSTMENTS			LIABILITY, NET OF TAX			COMPREHENSIVE INCOME
Balance, January 1, 2003	$	(266,781	)	$	(35,595	)	$	(302,376	)
Current period change		407,811			4,376			412,187
Balance, December 31, 2003		141,030			(31,219	)		109,811
Current period change		306,653			(3,049	)		303,604
Balance, December 31, 2004		447,683			(34,268	)		413,415
Current period change		(296,248	)		4,845			(291,403	)
Balance, December 31, 2005	$	151,435		$	(29,423	)	$	122,012

Stock-Based Compensation—Stock options and restricted stock have been issued to officers and other management employees under ITW’s 1996 Stock Incentive Plan. The stock options generally vest over a four-year period and have a maturity of ten years from the issuance date. Restricted stock generally vests over a three-year period. The restricted shares vest only if the employee is actively employed by the Company on the vesting date, and unvested shares are forfeited upon retirement, death, or disability, unless the Compensation Committee of the Board of Directors determines otherwise. The restricted shares carry full voting and dividend rights unless the shares are forfeited. To cover the exercise of vested options, the Company generally issues new shares from its authorized but unissued share pool. At December 31, 2005, 17,462,676 shares of ITW common stock were reserved for issuance under this plan. Option exercise prices are equal to the common stock fair market value on the date of grant.

Effective January 1, 2005, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which requiresthe Company to measure the cost of employee services received in exchange for equity awards based on the grant date fair value. Starting in 2005, the Company records compensation cost related to the amortization of the unamortized grant date fair value of stock awards unvested as of December 31, 2004 over the remaining service periods of those awards.SFAS 123R supersedes Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation and Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”).

Prior to 2005, the Company accounted for stock-based compensation in accordance with APB 25, using the intrinsic value method, which did not require that compensation cost be recognized for the Company’s stock options. The Company’s net income and net income per share for 2004 and 2003 would have been reduced if compensation cost related to stock options had been determined based on fair value at the grant dates. Pro forma net income as if the fair value-based method had been applied to all awards is as follows:

IN THOUSANDS EXCEPT PER SHARE AMOUNTS	2005			2004			2003
Net income as reported	$	1,494,869		$	1,338,694		$	1,023,680
Add: Restricted stock and stock options recorded as expense, net of tax		46,556			24,114			11,789
Deduct: Total stock-based compensation expense, net of tax		(46,556	)		(61,639	)		(35,569	)
Pro forma net income	$	1,494,869		$	1,301,169		$	999,900
Net income per share:
Basic—as reported		$5.24			$4.43			$3.33
Basic—pro forma		5.24			4.30			3.26
Diluted—as reported		5.20			4.39			3.32
Diluted—pro forma		5.20			4.27			3.24

73     2005 ANNUAL REPORT

The following table summarizes the components of the Company’s stock-based compensation programs recorded as expense:

IN THOUSANDS	2005			2004			2003
Restricted Stock:
Pretax compensation expense	$	33,105		$	32,514		$	17,777
Tax benefit		(8,699	)		(8,400	)		(5,988	)
Restricted stock expense, net of tax	$	24,406		$	24,114		$	11,789
Stock Options:
Pretax compensation expense	$	31,039	��	$	—		$	—
Tax benefit		(8,889	)		—			—
Stock option expense, net of tax	$	22,150		$	—		$	—
Total Stock-Based Compensation:
Pretax compensation expense	$	64,144		$	32,514		$	17,777
Tax benefit		(17,588	)		(8,400	)		(5,988	)
Total restricted stock and stock options recorded as expense, net of tax	$	46,556		$	24,114		$	11,789

The following table summarizes unvested restricted stock and stock options activity for the year ended December 31, 2005:

				WEIGHTED-AVERAGE
	NUMBER			GRANT-DATE FAIR
	OF SHARES			VALUE
Unvested Restricted Stock
Unvested, January 1, 2005		612,482			$   76.35
Vested		(433,010	)		73.99
Forfeited		(31,660	)		76.05
Unvested, December 31, 2005		147,812			83.32
Unvested Options
Unvested, January 1, 2005		3,378,542			$    21.98
Vested		(1,620,705	)		21.76
Forfeited		(22,739	)		21.76
Unvested, December 31, 2005		1,735,098			22.19

The following table summarizes option activity under the Plan for the year ended December 31, 2005:

						WEIGHTED-AVERAGE
	NUMBER			WEIGHTED-AVERAGE		REMAINING	AGGREGATE INTRINSIC
OPTIONS	OF SHARES			EXERCISE PRICE		CONTRACTUAL LIFE	VALUE
Under option at beginning of year		11,156,827		$	65.79
Granted		—			—
Exercised		(850,033	)		44.55
Cancelled or expired		(21,412	)		73.85
Under option at end of year		10,285,382			67.53	5.78 years	$	225,407,000
Exercisable at end of year		8,550,284			62.57	5.17 years	$	222,727,000

The Compensation Committee of the Board of Directors approved an option grant of 1,755,780 shares at an exercise price of $84.16 effective February 1, 2006. The estimated fair value of the options granted during 2004 and 2006 was calculated using a binomial option pricing model. Previous grants were valued using the Black-Scholes option-pricing model. The following table summarizes the assumptions used in the models:

	2006			2004			2003
Risk-free interest rate		4.5-4.7	%		2.6-4.3	%		4.2	%
Expected stock volatility		15.5-26.5	%		15.5-25.4	%		27.6	%
Weighted average volatility		23.0	%		24.6	%	NA
Dividend yield		1.3	%		1.2	%		1.1	%
Expected years until exercise		4.2-6.7			2.6-6.3			6.0

NOTES TO FINANCIAL STATEMENTS     74

Lattice-based option valuation models, such as a binomial option pricing model, incorporate ranges of assumptions for inputs. The risk-free rate of interest for periods within the contractual life of the option is based on a zero-coupon U.S. government instrument over the contractual term of the equity instrument. Expected volatility is based on implied volatility from traded options on the Company’s stock and historical volatility of the Company’s stock. The Company uses historical data to estimate option exercise timing and employee termination rates within the valuation model. Separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected term of options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding. The ranges presented result from separate groups of employees assumed to exhibit different behavior.

The weighted-average grant-date fair value of options granted during 2006, 2004 and 2003 was $23.73, $21.99 and $25.65 per share, respectively. The aggregate intrinsic value of options exercised during the years ended December 31, 2005, 2004 and 2003, was $36,754,000, $95,253,000 and $50,002,000, respectively. Exercise of options during the years ended December 31, 2005, 2004, and 2003, resulted in cash receipts of $24,563,000, $79,108,000 and $40,357,000, respectively. As of December 31, 2005, there was $32,675,000 of total unrecognized compensation cost related to non-vested equity awards. That cost is expected to be recognized over a weighted-average period of 2.0 years.

Segment Information—Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information, requires that segment information be reported based on the way the segments are organized within the Company for making operating decisions and assessing performance.

The Company has approximately 700 operations in 48 countries, which are aggregated and organized for internal reporting purposes in 2005 into the following five segments:

Engineered Products—North America:Businesses in this segment are located in North America and manufacture a variety of short lead-time plastic and metal components and fasteners, as well as specialty products for a diverse customer base. These commercially oriented, value-added products become part of the customers’ products and typically are manufactured and delivered in a time period less than 30 days.

Engineered Products—International:Businesses in this segment are located outside North America and manufacture a variety of short lead-time plastic and metal components and fasteners, as well as specialty products for a diverse customer base. These commercially oriented, value-added products become part of the customers’ products and typically are manufactured and delivered in a time period less than 30 days.

Specialty Systems—North America:Businesses in this segment are located in North America and design and manufacture longer lead-time machinery and related consumables, as well as specialty equipment for a diverse customer base. These commercially oriented, value-added products become part of the customers’ processes and typically are manufactured and delivered in a time period of more than 30 days.

Specialty Systems—International:Businesses in this segment are located outside North America and design and manufacture longer lead-time machinery and related consumables as well as specialty equipment for a diverse customer base. These commercially oriented, value-added products become part of the customers’ processes and typically are manufactured and delivered in a time period of more than 30 days.

Leasing and Investments:Businesses in this segment make investments in mortgage entities; leases of telecommunications, aircraft, air traffic control and other equipment; properties; affordable housing and a venture capital fund.

75     2005 ANNUAL REPORT

Segment information for 2005, 2004 and 2003 was as follows:

IN THOUSANDS	2005			2004			2003
Operating revenues:
Engineered Products—North America	$	3,766,417		$	3,377,373		$	3,118,404
Engineered Products—International		2,727,922			2,491,908			1,897,951
Specialty Systems—North America		4,168,305			3,776,100			3,300,776
Specialty Systems—International		2,582,346			2,349,238			1,943,447
Leasing and Investments		132,080			148,791			152,585
Intersegment revenues		(455,278	)		(411,985	)		(377,540	)
	$	12,921,792		$	11,731,425		$	10,035,623
Operating income:
Engineered Products—North America	$	659,222		$	573,175		$	504,071
Engineered Products—International		403,507			372,368			263,464
Specialty Systems—North America		776,094			668,114			534,384
Specialty Systems—International		304,288			311,354			214,602
Leasing and Investments		116,093			131,602			116,937
	$	2,259,204		$	2,056,613		$	1,633,458
Depreciation and amortization and impairment of goodwill and intangible assets:
Engineered Products—North America	$	126,245		$	106,975		$	96,583
Engineered Products—International		94,134			95,749			69,210
Specialty Systems—North America		89,908			85,725			86,297
Specialty Systems—International		72,422			64,569			54,400
Leasing and Investments		365			265			63
	$	383,074		$	353,283		$	306,553
Plant and equipment additions:
Engineered Products—North America	$	78,413		$	71,436		$	82,421
Engineered Products—International		91,613			76,881			64,584
Specialty Systems—North America		70,479			79,042			57,114
Specialty Systems—International		52,597			55,201			54,193
	$	293,102		$	282,560		$	258,312
Identifiable assets:
Engineered Products—North America	$	2,287,068		$	2,083,296		$	1,784,894
Engineered Products—International		2,083,767			2,243,432			1,778,277
Specialty Systems—North America		2,530,921			2,303,782			2,154,155
Specialty Systems—International		2,210,231			2,108,891			1,899,075
Leasing and Investments		704,596			778,381			735,202
Corporate		1,629,060			1,834,152			2,841,718
	$	11,445,643		$	11,351,934		$	11,193,321

Identifiable assets by segment are those assets that are specifically used in that segment. Corporate assets are principally cash and equivalents and other general corporate assets.

NOTES TO FINANCIAL STATEMENTS     76

Enterprise-wide information for 2005, 2004 and 2003 was as follows:

IN THOUSANDS	2005		2004		2003
Operating Revenues by Product Line:
Engineered Products—North America—
Fasteners and Components	$	2,708,967	$	2,581,945	$	2,444,042
Specialty Products		1,057,450		795,428		674,362
	$	3,766,417	$	3,377,373	$	3,118,404
Engineered Products—International—
Fasteners and Components	$	2,162,643	$	2,074,394	$	1,673,315
Specialty Products		565,279		417,514		224,636
	$	2,727,922	$	2,491,908	$	1,897,951
Specialty Systems—North America—
Equipment and Consumables	$	2,624,832	$	2,371,003	$	1,945,063
Specialty Equipment		1,543,473		1,405,097		1,355,713
	$	4,168,305	$	3,776,100	$	3,300,776
Specialty Systems—International—
Equipment and Consumables	$	1,714,517	$	1,537,700	$	1,234,475
Specialty Equipment		867,829		811,538		708,972
	$	2,582,346	$	2,349,238	$	1,943,447
Operating Revenues by Geographic Region:
United States	$	7,236,830	$	6,608,900	$	5,915,456
Europe		3,836,375		3,521,832		2,844,333
Asia		629,614		555,916		410,191
Australia		599,783		557,513		425,831
Other		619,190		487,264		439,812
	$	12,921,792	$	11,731,425	$	10,035,623

Operating revenues by geographic region are based on the location of the business unit that recorded the revenues.

Total noncurrent assets excluding deferred tax assets and financial instruments were $6,435,000,000 and $5,918,000,000 at December 31, 2005 and 2004, respectively. Of these amounts, approximately 56% and 54% was attributed to U.S. operations for 2005 and 2004, respectively. The remaining amounts were attributed to the Company’s foreign operations, with no single country accounting for a significant portion.

77     2005 ANNUAL REPORT

Quarterly and Common Stock Data

Quarterly Financial Data (Unaudited)

	THREE MONTHS ENDED
IN THOUSANDS	MARCH 31				JUNE 30				SEPTEMBER 30				DECEMBER 31
EXCEPT PER SHARE AMOUNTS	2005		2004		2005		2004		2005		2004		2005		2004
Operating revenues	$	3,074,291	$	2,710,349	$	3,295,644	$	3,002,271	$	3,257,600	$	2,967,168	$	3,294,257	$	3,051,637
Cost of revenues		2,022,337		1,750,343		2,156,602		1,929,803		2,081,272		1,934,831		2,103,670		1,976,269
Operating income		477,889		447,642		566,854		561,536		619,220		512,238		595,241		535,197
Income from continuing operations		312,306		290,025		373,782		360,350		408,202		330,051		400,579		359,179
Income (loss) from discontinued operations		—		171		—		—		—		—		—		(1,082	)
Net income		312,306		290,196		373,782		360,350		408,202		330,051		400,579		358,097
Income per share from continuing operations:
Basic		1.07		.94		1.30		1.17		1.44		1.10		1.43		1.22
Diluted		1.06		.93		1.29		1.16		1.43		1.09		1.42		1.21
Net income per share:
Basic		1.07		.94		1.30		1.17		1.44		1.10		1.43		1.22
Diluted		1.06		.93		1.29		1.16		1.43		1.09		1.42		1.21

Common Stock Price and Dividend Data—The common stock of Illinois Tool Works Inc. is listed on the New York Stock Exchange and the Chicago Stock Exchange. Quarterly market price and dividend data for 2005 and 2004 were as shown below:

		MARKET PRICE PER SHARE			DIVIDENDS DECLARED
	HIGH		LOW		PER SHARE
2005
Fourth quarter	$	91.10	$	79.33	$	.33
Third quarter		87.53		78.50		.33
Second quarter		91.52		78.99		.28
First quarter		94.64		85.56		.28
2004
Fourth quarter	$	96.62	$	87.48	$	.28
Third quarter		96.68		86.20		.28
Second quarter		96.70		78.52		.24
First quarter		85.00		74.51		.24

The approximate number of holders of record of common stock as of February 1, 2006 was 11,801. This number does not include beneficial owners of the Company’s securities held in the name of nominees.