Illinois Tool Works (ITW) 10-K 2006 FY Annual report

Exhibit 13

MANAGEMENT’S DISCUSSION AND ANALYSIS     32

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 750 operations in 49 countries which are aggregated and organized for internal reporting purposes in 2006 into the following four segments: Engineered Products—North America; Engineered Products—International; Specialty Systems—North America; and Specialty Systems—International. 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, restructuring costs, goodwill and intangible impairment charges and currency translation 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 750 operations utilize the 80/20 process in various aspects of their business. Common applications of the 80/20 business process include:

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

• Segmenting the customer base by focusing on the 80/20 customers separately and finding alternative ways to serve the 20/80 customers.

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

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

The result of the application of this 80/20 business process is that the Company has consistently improved its operating and financial performance. These 80/20 efforts can 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 2006, 2005 and 2004 are summarized as follows:

DOLLARS IN THOUSANDS	2006			2005			2004
Operating revenues	$	14,055,049		$	12,790,294		$	11,583,250
Operating income		2,420,936			2,140,931			1,923,125
Margin %		17.2	%		16.7	%		16.6	%

33     2006 ANNUAL REPORT

In 2006 and 2005, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

	2006 COMPARED TO 2005									2005 COMPARED TO 2004
	% INCREASE (DECREASE)						% POINT INCREASE (DECREASE)			% INCREASE (DECREASE)						% POINT INCREASE (DECREASE)
	OPERATING			OPERATING			OPERATING			OPERATING			OPERATING			OPERATING
	REVENUES			INCOME			MARGINS			REVENUES			INCOME			MARGINS
Base business:
Revenue change/Operating leverage		3.8	%		9.1	%		0.9	%		4.6	%		11.1	%		1.0	%
Changes in variable margins and overhead costs		—			0.9			0.2			—			(3.2	)		(0.5	)
		3.8			10.0			1.1			4.6			7.9			0.5
Acquisitions and divestitures		6.9			1.8			(0.9	)		4.9			2.7			(0.4	)
Restructuring costs		—			1.4			0.2			—			(1.1	)		(0.2	)
Impairment of goodwill and intangibles		—			(0.1	)		—			—			0.4			0.1
Translation		—			—			—			1.3			1.4			—
Intercompany		(0.8	)		—			0.1			(0.4	)		—			0.1
		9.9	%		13.1	%		0.5	%		10.4	%		11.3	%		0.1	%

Operating Revenues

Revenues increased by 9.9% in 2006 over 2005 primarily due to revenues from acquisitions and an increase in base revenues. The base business revenues increased in 2006 versus 2005 primarily related to a 4.8% increase in international base business revenues. European economic growth and market demand improved starting in the second quarter of 2006 and continued through the remainder of the year. In addition, strong growth in Asia Pacific markets contributed to the base business increase. North American base business revenues increased 2.9% primarily due to reasonably strong end market demand during the first half of 2006. North American base business revenues decreased in the last half of 2006 due to declines in the construction and automotive end markets and the slowing of industrial production.

Revenues increased 10.4% in 2005 versus 2004, primarily related to a 5.9% increase in North American base business revenues and revenues from acquired companies. 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 a result of slow European economic growth.

Operating Income

Operating income in 2006 improved over 2005 primarily due to leverage from the growth in base business revenues, income from acquired companies and lower restructuring expenses. Operating margins are negatively affected by lower margins of acquired businesses, including amortization expense.

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

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 of less than 30 days.

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

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

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

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

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

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

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

• plastic fasteners for automotive, appliance, electronics and general industrial applications.

MANAGEMENT’S DISCUSSION AND ANALYSIS     34

In the specialty products category, products include:

• reclosable packaging for consumer food and storage applications;

• 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;

• automotive aftermarket maintenance and appearance products; and

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

In 2006, this segment primarily served the construction (45%), automotive (20%) and consumer durables (9%) markets.

The results of operations for the Engineered Products — North America segment for 2006, 2005 and 2004 were as follows:

DOLLARS IN THOUSANDS	2006			2005			2004
Operating revenues	$	4,118,494		$	3,766,134		$	3,377,373
Operating income		713,779			659,222			573,175
Margin %		17.3	%		17.5	%		17.0	%

In 2006 and 2005, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

	2006 COMPARED TO 2005									2005 COMPARED TO 2004
	% INCREASE (DECREASE)						% POINT INCREASE (DECREASE)			% INCREASE (DECREASE)						% POINT INCREASE (DECREASE)
	OPERATING			OPERATING			OPERATING			OPERATING			OPERATING			OPERATING
	REVENUES			INCOME			MARGINS			REVENUES			INCOME			MARGINS
Base business:
Revenue change/Operating leverage		0.4	%		1.0	%		0.1	%		2.8	%		6.8	%		0.6	%
Changes in variable margins and overhead costs		—			2.8			0.5			—			3.0			0.5
		0.4			3.8			0.6			2.8			9.8			1.1
Acquisitions and divestitures		8.6			3.8			(0.8	)		8.4			5.1			(0.6	)
Restructuring costs		—			0.4			—			—			(0.4	)		(0.1	)
Impairment of goodwill and intangibles		—			(0.1	)		—			—			0.3			0.1
Translation		0.4			0.4			—			0.3			0.2			—
		9.4	%		8.3	%		(0.2	)%		11.5	%		15.0	%		0.5	%

Operating Revenues

Revenues increased in 2006 over 2005 primarily due to revenues from acquisitions and a small increase in base business revenues. Acquisition revenue was primarily related to the acquisition of a truss business, an aerosol anti-static business and two polymers businesses. Construction base business revenues decreased 1.2% mainly due to the dramatic decline in the residential construction market in the second half of 2006. Automotive base revenues decreased 3.7% due to a 6.0% decline in automotive production at the Detroit 3 automotive manufacturers. Base revenues from the other industrial-based businesses in this segment grew 5.0% due to increased demand in a broad array of end markets these businesses serve, particularly in the industrial plastics and metals businesses, the reclosable packaging businesses and the polymers businesses.

Revenues increased in 2005 over 2004 primarily due to revenues from acquisitions and higher base business revenues. 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 only 1.4% in 2005 due to a slowing residential construction market as well as a decline in revenues at the Wilsonart businesses. Automotive base revenues increased 1.5% despite a 4% decline in automotive production at the Detroit 3 automotive manufacturers, as increased product penetration 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 businesses.

35     2006 ANNUAL REPORT

Operating Income

Operating income increased in 2006 over 2005 primarily due to income from acquired companies, leverage from the growth in base business revenues, lower operating expenses and lower restructuring expenses. Variable margins increased 40 basis points primarily due to cost control efforts despite the declining automotive and construction markets. In 2006, an impairment charge of $5.6 million was recorded primarily related to the goodwill and intangibles of a U.S. construction joist business and the intangibles of a U.S. contamination control business.

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 higher 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 was higher in 2005 due to a $9.0 million charge in 2004 associated with warranty issues related to a discontinued product at the Wilsonart laminate business.

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 of less than 30 days.

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

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

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

• 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, electronics and general industrial applications; and

• plastic fasteners for automotive, appliance, electronics and general industrial applications.

In the specialty products category, products include:

• reclosable packaging for consumer food applications;

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

• 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;

• automotive aftermarket maintenance and appearance products; and

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

In 2006, this segment primarily served the construction (40%), automotive (25%) and consumer durables (11%) markets.

The results of operations for the Engineered Products—International segment for 2006, 2005 and 2004 were as follows:

DOLLARS IN THOUSANDS	2006			2005			2004
Operating revenues	$	2,914,713		$	2,743,882		$	2,500,243
Operating income		430,609			406,189			372,832
Margin %		14.8	%		14.8	%		14.9	%

MANAGEMENT’S DISCUSSION AND ANALYSIS     36

In 2006 and 2005, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

	2006 COMPARED TO 2005									2005 COMPARED TO 2004
	% INCREASE (DECREASE)						% POINT INCREASE (DECREASE)			% INCREASE (DECREASE)						% POINT INCREASE (DECREASE)
	OPERATING			OPERATING			OPERATING			OPERATING			OPERATING			OPERATING
	REVENUES			INCOME			MARGINS			REVENUES			INCOME			MARGINS
Base business:
Revenue change/Operating leverage		3.9	%		10.4	%		0.9	%		0.3	%		0.9	%		0.1	%
Changes in variable margins and overhead costs		—			(6.1	)		(0.9	)		—			(1.9	)		(0.3	)
		3.9			4.3			—			0.3			(1.0	)		(0.2	)
Acquisitions and divestitures		2.9			0.7			(0.3	)		6.6			4.6			(0.3	)
Restructuring costs		—			2.1			0.3			—			(0.7	)		(0.1	)
Impairment of goodwill and intangibles		—			(0.4	)		—			—			2.3			0.3
Translation		(0.6	)		(0.7	)		—			2.8			3.7			0.2
		6.2	%		6.0	%		0.0	%		9.7	%		8.9	%		(0.1	)%

Operating Revenues

Revenues increased in 2006 over 2005 primarily due to an increase in base business revenues and revenues from acquisitions. Base business construction revenues increased 5.7% due to strong demand across the European and Asia Pacific markets. Automotive base revenues only increased 0.9% due to weak European automotive car builds. Base revenues from the other businesses in this segment increased 3.8% as they benefited from stronger demand in a broad array of industrial and commercial end markets that they serve. The revenues from acquisitions increased primarily due to the acquisition of a European construction business, a European laminate business, a European fluids business and a European reclosable packaging business. Currency translation had a slightly unfavorable impact on 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.

Operating Income

Operating income increased in 2006 over 2005 primarily due to the positive leverage effect from the increase in base revenues described above and lower restructuring expenses, partially offset by higher operating expenses. Variable margins decreased 30 basis points in 2006 due to higher growth in lower margin construction businesses. In addition, increased operating expenses and higher overhead expenses negatively impacted base business income. Currency translation reduced operating income by 0.7%. Income was negatively affected by a $1.7 million impairment charge related to two Asian construction businesses.

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 10 basis points primarily due to increases in raw material costs.

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 and systems 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, metal consumables and related accessories for a variety of end market users;

• 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;

37     2006 ANNUAL REPORT

• marking tools and inks for various end users;

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

• solder materials, services and equipment for the electronic and microelectronic assembly industry.

In the specialty equipment and systems category, products include:

• commercial food equipment such as dishwashers, refrigerators, cooking equipment and food machines for use by restaurants, institutions and supermarkets and related service;

• 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;

• airport ground power generators for commercial and military applications; and

• supply chain management software for the industrial, aerospace and health care markets.

In 2006, this segment primarily served the general industrial (24%), food institutional and service (23%), maintenance, repair and operations (“MRO”)/metals (9%) and food and beverage (9%) markets.

The results of operations for the Specialty Systems—North America segment for 2006, 2005 and 2004 were as follows:

DOLLARS IN THOUSANDS	2006			2005			2004
Operating revenues	$	4,627,627		$	4,168,305		$	3,776,100
Operating income		874,429			773,914			666,228
Margin %		18.9	%		18.6	%		17.6	%

In 2006 and 2005, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

	2006 COMPARED TO 2005									2005 COMPARED TO 2004
	% INCREASE (DECREASE)						% POINT INCREASE (DECREASE)			% INCREASE (DECREASE)						% POINT INCREASE (DECREASE)
	OPERATING			OPERATING			OPERATING			OPERATING			OPERATING			OPERATING
	REVENUES			INCOME			MARGINS			REVENUES			INCOME			MARGINS
Base business:
Revenue change/Operating leverage		5.1	%		11.2	%		1.1	%		8.4	%		19.5	%		1.8	%
Changes in variable margins and overhead costs		—			0.6			0.1			—			(4.5	)		(0.7	)
		5.1			11.8			1.2			8.4			15.0			1.1
Acquisitions and divestitures		5.6			0.9			(0.9	)		1.5			1.1			—
Restructuring costs		—			(0.3	)		(0.1	)		—			—			—
Impairment of goodwill and intangibles		—			0.2			0.1			—			(0.5	)		(0.1	)
Translation		0.3			0.4			—			0.5			0.6			—
		11.0	%		13.0	%		0.3	%		10.4	%		16.2	%		1.0	%

Operating Revenues

Revenues increased in 2006 over 2005 primarily due to revenues from acquisitions and higher base business revenues. The acquired revenues were primarily related to the acquisition of two materials and structural testing businesses, two businesses supplying the electronic and microelectronic assembly industry, an industrial packaging business, a decorating business and a supply chain management software business. Base business revenues grew primarily due to increased demand for machinery and consumables in many of the end markets that this segment serves. Welding base revenues increased 16.8% due to high demand in the energy, heavy fabrication and general industrial markets. Total packaging base revenues remained virtually flat in 2006 versus 2005 due to the slowing of the metals and construction markets in the second half of 2006. Food equipment base revenues increased 3.0% due to growth in the restaurant and institutional sector as well as the service business. Base business revenue from the other businesses in this segment, including the marking, decorating and finishing businesses, increased 1.3% in 2006 versus 2005.

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 energy and construction markets. Food equipment and industrial packaging base revenues increased 5.0% and 3.3%, respectively, in 2005. Base revenues from 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.

MANAGEMENT’S DISCUSSION AND ANALYSIS     38

Operating Income

Operating income increased in 2006 versus 2005 primarily due to leverage from base business revenue increases and income from acquisitions. Variable margins increased 30 basis points mainly due to operating efficiency gains. Operating income was also higher due to lower goodwill and intangible impairment charges versus the prior year. Goodwill and intangible asset impairment charges of $8.0 million were recorded in 2006 related to the goodwill of a U.S. thermal transfer ribbon business and a Canadian stretch packaging equipment business and the goodwill and intangibles of a U.S. welding components business.

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 U.S. welding components business and a Canadian stretch packaging equipment business.

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 stretch film and related packaging equipment for various industrial purposes;

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

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

• solder materials, services and equipment for the electronic and microelectronic assembly industry.

In the specialty equipment category, products include:

• commercial food equipment such as dishwashers, refrigerators and cooking equipment for use by restaurants, institutions and supermarkets and related service;

• 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 2006, this segment primarily served the general industrial (26%), food institutional and service (16%), food and beverage (14%) and MRO/metals (11%) markets.

The results of operations for the Specialty Systems—International segment for 2006, 2005 and 2004 were as follows:

DOLLARS IN THOUSANDS	2006			2005			2004
Operating revenues	$	2,947,570		$	2,566,386		$	2,340,902
Operating income		402,119			301,606			310,890
Margin %		13.6	%		11.8	%		13.3	%

39     2006 ANNUAL REPORT

In 2006 and 2005, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

	2006 COMPARED TO 2005									2005 COMPARED TO 2004
	% INCREASE (DECREASE)						% POINT INCREASE (DECREASE)			% INCREASE (DECREASE)						% POINT INCREASE (DECREASE)
	OPERATING			OPERATING			OPERATING			OPERATING			OPERATING			OPERATING
	REVENUES			INCOME			MARGINS			REVENUES			INCOME			MARGINS
Base business:
Revenue change/Operating leverage		5.8	%		19.3	%		1.5	%		4.2	%		12.2	%		1.0	%
Changes in variable margins and overhead costs		—			7.4			0.8			—			(12.9	)		(1.6	)
		5.8			26.7			2.3			4.2			(0.7	)		(0.6	)
Acquisitions and divestitures		9.7			1.0			(1.1	)		3.0			(0.5	)		(0.4	)
Restructuring costs		—			7.4			0.8			—			(5.1	)		(0.6	)
Impairment of goodwill and intangibles		—			(0.8	)		(0.1	)		—			0.1			—
Translation		(0.6	)		(1.0	)		(0.1	)		2.4			3.2			0.1
		14.9	%		33.3	%		1.8	%		9.6	%		(3.0	)%		(1.5	)%

Operating Revenues

Revenues increased in 2006 versus 2005 primarily due to revenues from acquired companies and base business revenue growth. The contribution from acquired revenues was primarily related to the acquisition of two materials and structural testing businesses, two businesses supplying the electronic and microelectronic assembly industry, an aircraft ground power business and a European welding business. Food equipment base revenues increased 2.4% due primarily to growth in European institutional demand. Packaging base revenues increased 2.4% with strong growth in the multi-pack carrier business. Other base business revenues, including the welding and finishing businesses, increased 13.8% led by strong welding equipment and consumable sales in Asia and Europe and growth in the structural testing businesses.

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 materials and structural testing business.

Operating Income

Operating income increased in 2006 versus 2005 primarily as a result of leverage from the revenue increases described above, reduced operating costs and lower restructuring expenses. Variable margins increased 60 basis points due to operating efficiency gains, primarily in the materials and structural testing businesses and Asian welding businesses. In addition, income was favorably impacted by lower overhead expenses stemming from 2005 restructuring projects in the food equipment, industrial packaging and decorating businesses. Income was also positively affected by a nonrecurring 2005 charge of $8.7 million to resolve accounting issues at a European food equipment business.

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.

SEGMENT REPORTING CHANGE

In 2006, the Company announced that given the run-off of assets in the Leasing and Investments portfolio and the general intention to utilize free cash flow for core manufacturing investments and acquisitions rather than to make additional financial investments, the internal reporting has been revised to eliminate the reporting of Leasing and Investments as an operating segment. Leasing and Investments results have been reclassified to nonoperating investment income in the prior years’ income statement to conform to the current year presentation.

MANAGEMENT’S DISCUSSION AND ANALYSIS     40

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, 2006, the Company had assigned its recorded goodwill and intangible assets to approximately 375 of its then 700 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, 2006, 2005 and 2004 were as follows:

IN THOUSANDS	2006		2005		2004
Goodwill:
Impairment	$	14,793	$	9,650	$	11,492
Intangible Assets:
Amortization		106,766		69,143		37,409
Impairment		2,985		5,049		10,220
	$	124,544	$	83,842	$	59,121

Amortization expense increased by $37.6 million in 2006 versus 2005 and by $31.7 million in 2005 over 2004 due primarily to the amortization of newly acquired intangibles.

Total goodwill and intangible asset impairment charges by segment for the years ended December 31, 2006, 2005 and 2004 were as follows:

IN THOUSANDS	2006		2005		2004
Engineered Products – North America	$	5,550	$	5,049	$	7,007
Engineered Products – International		1,682		80		8,492
Specialty Systems – North America		8,004		9,559		5,937
Specialty Systems – International		2,542		11		276
	$	17,778	$	14,699	$	21,712

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

INTEREST EXPENSE

Interest expense decreased to $85.6 million in 2006 versus $94.6 million in 2005 primarily as a result of lower borrowings at international operations and lower average borrowings of short-term commercial paper during 2006. Interest expense increased to $94.6 million in 2005 versus $77.6 million in 2004 primarily as a result of higher average borrowings of 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 borrowings at international operations.

INVESTMENT INCOME

Investment income by investment category for the periods ended December 31, 2006, 2005 and 2004 were as follows:

IN THOUSANDS	2006		2005		2004
Mortgage investments	$	40,146	$	84,193	$	81,028
Venture capital limited partnership		23,001		11,629		19,267
Leases of equipment		4,898		15,468		25,762
Property developments		900		6,774		7,445
Other		9,663		8,214		9,119
	$	78,608	$	126,278	$	142,621

41     2006 ANNUAL REPORT

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. In conjunction with these transactions, the mortgage entities simultaneously entered into 10-year swap agreements and other related agreements whereby a third party received a 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.

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 assumed the majority of the real estate and credit risk related to the commercial mortgage loans and real estate, and 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 pertaining to the 1995 mortgage investment transaction (the “First Mortgage Transaction”) were sold and the swap and other related agreements were terminated. 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 were no remaining assets or liabilities related to the First Mortgage Transaction.

In November 2006, in accordance with the 10-year term of the transaction, all remaining mortgage-related assets pertaining to the 1996 mortgage investment transaction (the “Second Mortgage Transaction”) were sold and the swap and other related agreements were terminated. In December 2006, the Company received $157.1 million for its share of the disposition proceeds related to the Second Mortgage Transaction and in January 2007, the Company paid $34.6 million for the redemption of preferred stock of a subsidiary and related accrued dividends.

In December 2006, all remaining mortgage-related assets pertaining to the 1997 mortgage investment transaction (the “Third Mortgage Transaction”) were sold and the swap and other related agreements were terminated. In December 2006, the Company received $168.6 million for its share of the disposition proceeds related to the Third Mortgage Transaction and in January 2007, the Company paid $34.6 million for the redemption of preferred stock of a subsidiary and related accrued dividends. After the January 2, 2007 preferred stock payments there are no remaining assets or liabilities related to the Second or Third Mortgage Transactions.

Mortgage investment income declined to $40.1 million in 2006 as compared with $84.2 million in 2005. Of this decline, $34.4 million resulted from the 2005 completion of the First Mortgage Transaction. The remaining decline of $9.6 million was primarily due to lower gains in 2006 versus 2005 related to the remaining two mortgage transactions.

In 2005, mortgage investment 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.

Leases of Equipment

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.

In 2006 and 2005, lease income was lower than the previous year due to the scheduled decline in leveraged lease income. The 2005 decline was partially offset by a $2.9 million gain on the sale of a United Airlines bankruptcy claim.

Other Investments

Operating income from the venture capital limited partnership increased to $23.0 million in 2006 versus $11.6 million in 2005 due to higher mark-to-market gains. Operating income from the venture capital limited partnership was $11.6 million in 2005 versus $19.3 million in 2004 due to higher mark-to-market gains in 2004.

MANAGEMENT’S DISCUSSION AND ANALYSIS     42

Income from property developments declined to $0.9 million in 2006 versus $6.8 million in 2005 as 93 fewer properties were sold in 2006 than 2005.

OTHER INCOME

Other income was $31.3 million in 2006 versus $9.0 million in 2005. The increase was primarily due to gains on the sale of operations, lower losses on the sale of plant and equipment and higher interest income. This was partially offset by higher losses on foreign currency transactions in 2006. Other income was $9.0 million in 2005 versus $11.2 million in 2004.

INCOME TAXES

The effective tax rate was 29.75% in 2006, 31.5% in 2005 and 33.0% in 2004. The effective tax rate differs from the U.S. federal statutory rate primarily due to state taxes, lower foreign tax rates, non-taxable foreign interest income, taxes on foreign dividends and tax relief provided to U.S. manufacturers under the American Jobs Creation Act of 2004. See the Income Taxes note for a reconciliation of the U.S. federal statutory rate to the effective tax rate.

INCOME FROM CONTINUING OPERATIONS

Income from continuing operations in 2006 of $1.7 billion ($3.01 per diluted share) was 14.9% higher than 2005 income of $1.5 billion ($2.60 per diluted share). Income from continuing operations in 2005 was 11.6% higher than 2004 income of $1.3 billion ($2.20 per diluted share).

FOREIGN CURRENCY

Foreign currency fluctuations had no significant impact on revenues or earnings in 2006. The weakening of the U.S. dollar against foreign currencies increased operating revenues by approximately $150 million in 2005 and $430 million in 2004, and increased income from continuing operations by approximately 6 cents per diluted share in 2005 and 15 cents per diluted share in 2004.

NEW ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106 and 132(R), (“SFAS 158”). On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS 158. This statement requires employers to recognize the overfunded or underfunded status of defined benefit pension and postretirement plans as an asset or liability in its statement of financial position and previously unrecognized changes in that funded status through accumulated other comprehensive income. The Company recorded an after-tax charge to accumulated other comprehensive income of $180.0 million in 2006 to recognize the funded status of its benefit plans. Effective for the 2008 fiscal year, SFAS 158 requires plan assets and liabilities to be measured as of year-end, rather than the September 30 measurement date that the Company presently uses.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in tax returns, and provides guidance on derecognition, classification, and interest and penalties, related to uncertain tax positions. FIN 48 will be effective for the Company on January 1, 2007, with any cumulative effect of the change in accounting principle recorded as an adjustment to retained earnings. The Company does not anticipate that the adoption of FIN 48 will materially affect the Company’s financial position or results of operations.

In July 2006, the FASB issued FASB Staff Position No. FAS 13-2, Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction (“FSP 13-2”). FSP 13-2 addresses how a change or projected change in the timing of cash flows relating to income taxes generated by a leveraged lease transaction affects the accounting by a lessor for that lease. FSP 13-2 will be effective for the Company on January 1, 2007, with any cumulative effect of the change in accounting principle recorded as an adjustment to retained earnings. The adoption of FSP 13-2 is not expected to have a material effect on the Company’s financial position or results of operations.

2007 FORECAST

The Company is forecasting full-year 2007 income from continuing operations to be in a range of $3.27 to $3.39 per diluted share. The following key assumptions were used for this forecast:

• base business revenue growth in a range of 2.5% to 4.5%;

• foreign exchange rates holding at year-end 2006 levels;

• annualized revenues from 2007 acquired companies in a range of $800 million to $1.2 billion;

43     2006 ANNUAL REPORT

• share repurchases of $500 million to $700 million for the year;

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

• nonoperating investment income of $25 million to $30 million, which is lower than 2006 by $50 million to $55 million;

• estimated impairment of goodwill and intangible assets of $15 million to $25 million; and

• an effective tax rate of 29.75%.

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

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 guideline of 25% to 35% of the last two years’ average net income. In addition, free operating cash flow is expected to be adequate to finance internal growth, acquisitions and share repurchases.

The Company uses free operating cash flow to measure normal cash flow generated by its operations that is available for dividends, acquisitions, share repurchases 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.

On August 4, 2006, the Company’s Board of Directors authorized a stock repurchase program which provides for the buyback of up to 35.0 million shares. Under this program, the Company repurchased 9.7 million shares of its common stock during 2006 for $446.9 million at an average price of $46.16 per share. In 2004, the Company’s Board of Directors authorized a stock repurchase program, which provided for the buyback of up to 31.0 million shares (on a pre-split basis) and which was completed in 2005.

Summarized cash flow information for the three years ended December 31, 2006, 2005 and 2004 was as follows:

IN THOUSANDS	2006			2005			2004
Net cash provided by operating activities	$	2,066,028		$	1,851,543		$	1,536,797
Additions to plant and equipment		(301,006	)		(293,102	)		(282,560	)
Free operating cash flow	$	1,765,022		$	1,558,441		$	1,254,237
Acquisitions	$	(1,378,708	)	$	(626,922	)	$	(587,783	)
Purchases of investments		(25,347	)		(120,240	)		(64,442	)
Proceeds from investments		367,365			220,082			85,412
Cash dividends paid		(398,846	)		(335,092	)		(304,581	)
Repurchases of common stock		(446,876	)		(1,041,798	)		(1,729,806	)
Net proceeds of debt		178,441			93,126			127,487
Other		158,739			(44,570	)		202,383
Net increase (decrease) in cash and equivalents	$	219,790		$	(296,973	)	$	(1,017,093	)

Return on Invested Capital

The Company uses return on average invested capital (“ROIC”) to measure the effectiveness of its operations’ use of invested capital to generate profits. ROIC for the three years ended December 31, 2006, 2005 and 2004 was as follows:

DOLLARS IN THOUSANDS	2006			2005			2004
Operating income after taxes of 29.75%, 31.5%, and 33.0%, respectively	$	1,700,708		$	1,466,538		$	1,288,494
Invested Capital:
Trade receivables	$	2,471,273		$	2,098,276		$	2,054,624
Inventories		1,482,508			1,203,063			1,281,156
Net plant and equipment		2,053,457			1,807,109			1,876,875
Investments		595,083			896,487			912,483
Goodwill and intangible assets		5,138,687			3,678,938			3,193,055
Accounts payable and accrued expenses		(2,173,863	)		(1,747,832	)		(1,647,448	)
Other, net		278,487			451,657			414,096
Total invested capital	$	9,845,632		$	8,387,698		$	8,084,841
Average invested capital	$	9,160,712		$	8,277,715		$	7,603,773
Return on average invested capital		18.6	%		17.7	%		16.9	%

MANAGEMENT’S DISCUSSION AND ANALYSIS     44

The 90 basis point increase in ROIC in 2006 versus 2005 was due primarily to a 16.0% 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 29.75% in 2006 from 31.5% in 2005. The positive impact was partially offset by an increase of 10.7% in average invested capital, primarily from acquisitions.

The 80 basis point increase in ROIC in 2005 versus 2004 was due primarily to a 13.8% 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 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.

Working Capital

Net working capital at December 31, 2006 and 2005 is summarized as follows:

					INCREASE
DOLLARS IN THOUSANDS	2006		2005		(DECREASE)
Current Assets:
Cash and equivalents	$	590,207	$	370,417	$	219,790
Trade receivables		2,471,273		2,098,276		372,997
Inventories		1,482,508		1,203,063		279,445
Other		662,417		439,849		222,568
		5,206,405		4,111,605		1,094,800
Current Liabilities:
Short-term debt		462,721		252,899		209,822
Accounts payable and accrued expenses		1,895,182		1,574,018		321,164
Other		278,681		173,814		104,867
		2,636,584		2,000,731		635,853
Net Working Capital	$	2,569,821	$	2,110,874	$	458,947
Current Ratio		1.97		2.06

Cash and equivalents increased in 2006 primarily due to increased cash flow from operating activities, partially offset by cash paid for acquisitions and the repurchase of common stock. Other current assets increased primarily due to higher tax refund receivables in the United States. Short-term debt increased due to an increase in short-term commercial paper to fund acquisition activity and stock repurchases in 2006 and a net increase in international debt. Trade receivables, inventories, accounts payable and accrued expenses increased primarily as a result of currency translation and acquisitions.

Debt

Total debt at December 31, 2006 and 2005 was as follows:

							INCREASE
DOLLARS IN THOUSANDS	2006			2005			(DECREASE)
Short-term debt	$	462,721		$	252,899		$	209,822
Long-term debt		955,610			958,321			(2,711	)
Total debt	$	1,418,331		$	1,211,220		$	207,111
Total debt to total capitalization		13.6	%		13.8	%

In 2006, the Company borrowed €140.0 million under five European short-term credit facilities with combined maximum available borrowings of€188.7 million. As of December 31, 2006, the Company has unused debt capacity of€48.7 million under these facilities.

In June 2006, the Company entered into a $600 million Line of Credit Agreement with a termination date of June 15, 2007. In November 2006, the Company exercised a provision which provided for an increase in the aggregate commitment by $200 million to a total of $800 million. In 2006, the Company entered into a $350 million revolving credit facility (“RCF”) with a termination date of June 16, 2011. 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, 2006, the Company has unused capacity of approximately $1.2 billion under its current U.S. debt facilities and approximately $300 million under international 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.

45     2006 ANNUAL REPORT

Stockholders’ Equity

The changes to stockholders’ equity during 2006 and 2005 were as follows:

IN THOUSANDS	2006			2005
Beginning balance	$	7,546,895		$	7,627,610
Net income		1,717,746			1,494,869
Cash dividends declared		(423,563	)		(346,059	)
Shares issued for acquisitions		162,898			—
Repurchases of common stock		(446,876	)		(1,041,798	)
Stock option and restricted stock activity		135,781			103,676
Adjustment to initially apply SFAS 158, net of tax		(180,037	)		—
Currency translation adjustments		495,697			(296,248	)
Minimum pension liability		8,967			4,845
Ending balance	$	9,017,508		$	7,546,895

The average exchange rates for the period used for translating the income statements of international businesses were essentially flat in 2006 with the average period rates in 2005, resulting in minimal foreign currency effect on the income statement. However, the change in foreign currency translation had a positive impact on the balance sheet as the end-of-year rates were higher in 2006 than the 2005 end-of-year rates, primarily driven by the strengthening of the euro during 2006.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

The Company’s contractual obligations as of December 31, 2006 were as follows:

											2012 AND
											FUTURE
IN THOUSANDS	2007		2008		2009		2010		2011		YEARS
Total debt	$	462,721	$	158,248	$	503,326	$	6,250	$	255,586	$	32,200
Interest payments on notes and preferred debt securities		57,594		57,332		32,377		17,725		17,446		2,856
Minimum lease payments		115,519		91,468		65,569		45,125		30,934		64,169
Affordable housing capital obligations		14,092		13,612		13,978		13,262		3,244		—
Preferred stock of subsidiaries and related accrued dividends		69,200		—		—		—		—		—
Maximum venture capital contribution		11,677		—		—		—		—		—
	$	730,803	$	320,660	$	615,250	$	82,362	$	307,210	$	99,225

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 $24.0 million at December 31, 2006. 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 $16.0 million at December 31, 2006. At December 31, 2006, the Company had open stand-by letters of credit of $127.0 million, substantially all of which expire in 2007. The Company had no other significant off-balance sheet commitments at December 31, 2006.

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.

MANAGEMENT’S DISCUSSION AND ANALYSIS     46

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, 2006:
Estimated cash outflow by year of principal maturity
2007	$	10,630	$	—	$	—	$	—
2008		5,472		—		—		150,000
2009		5,679		500,000		—		—
2010		5,713		—		—		—
2011		5,351		—		250,000		—
2012 and thereafter		16,603		—		—		—
Estimated fair value		53,047		505,200		262,118		154,050
Carrying value		49,448		497,048		249,776		149,966
As of December 31, 2005:
Total estimated cash outflow	$	53,735	$	500,000	$	250,000	$	150,000
Estimated fair value		53,563		512,015		267,205		157,742
Carrying value		53,735		496,687		249,739		149,947

Foreign Currency Risk

The Company operates in the United States and 48 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, 2006 or 2005.

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.

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.

47     2006 ANNUAL REPORT

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 2007 forecasts and assumptions, the adequacy of internally generated funds, future cash flows and income from equipment leases, the meeting of dividend payout objectives, payments under guarantees, the Company’s portion of future benefit payments related to pension and postretirement benefits, the availability of additional financing, the outcome of outstanding legal proceedings and the impact of adopting FSP 13-2 and FIN 48. 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, general industrial, automotive or food institutional and service markets, (2) deterioration in global and domestic business and economic conditions, particularly in North America, Europe, 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.

MANAGEMENT’S DISCUSSION AND ANALYSIS     48

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, 2006. 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, 2006, 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, 2006 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which is included herein.

/s/ David B. Speer	/s/ Ronald D. Kropp
Chairman & Chief Executive Officer	Senior Vice President & Chief Financial Officer
February 23, 2007	February 23, 2007

49     2006 ANNUAL REPORT

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, 2006 and 2005, 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, 2006. We also have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, dated February 23, 2007, that the Company maintained effective internal control over financial reporting as of December 31, 2006, 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, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the 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 the 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, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, 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, 2006, 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, 2006, 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 23, 2007

STATEMENT OF INCOME     50

Statement of Income

Illinois Tool Works Inc. and Subsidiaries

	FOR THE YEARS ENDED DECEMBER 31
IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS	2006			2005			2004
Operating Revenues	$	14,055,049		$	12,790,294		$	11,583,250
Cost of revenues		9,077,321			8,350,372			7,576,343
Selling, administrative, and research and development expenses		2,432,248			2,215,149			2,024,661
Amortization and impairment of goodwill and other intangible assets		124,544			83,842			59,121
Operating Income		2,420,936			2,140,931			1,923,125
Interest expense		(85,607	)		(94,597	)		(77,556	)
Investment income		78,608			126,278			142,621
Other income		31,309			8,957			11,215
Income from Continuing Operations Before Income Taxes		2,445,246			2,181,569			1,999,405
Income taxes		727,500			686,700			659,800
Income from Continuing Operations		1,717,746			1,494,869			1,339,605
Loss from Discontinued Operations		—			—			(911	)
Net Income	$	1,717,746		$	1,494,869		$	1,338,694
Net Income Per Share:
Basic	$	3.04		$	2.62		$	2.21
Diluted	$	3.01		$	2.60		$	2.20

Statement of Income Reinvested in the Business

Illinois Tool Works Inc. and Subsidiaries

	FOR THE YEARS ENDED DECEMBER 31
IN THOUSANDS	2006			2005			2004
Beginning Balance	$	9,112,328		$	7,963,518		$	6,937,110
Net income		1,717,746			1,494,869			1,338,694
Cash dividends declared		(423,563	)		(346,059	)		(312,286	)
Ending Balance	$	10,406,511		$	9,112,328		$	7,963,518

Statement of Comprehensive Income

Illinois Tool Works Inc. and Subsidiaries

	FOR THE YEARS ENDED DECEMBER 31
IN THOUSANDS	2006			2005			2004
Net Income	$	1,717,746		$	1,494,869		$	1,338,694
Other Comprehensive Income:
Foreign currency translation adjustments		495,697			(296,248	)		306,653
Minimum pension liability adjustments		14,650			4,640			(5,009	)
Income tax related to minimum pension liability adjustments		(5,683	)		205			1,960
Comprehensive Income	$	2,222,410		$	1,203,466		$	1,642,298

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

51     2005 ANNUAL REPORT

Statement of Financial Position
Illinois Tool Works Inc. and Subsidiaries

	DECEMBER 31
IN THOUSANDS EXCEPT SHARES	2006			2005
Assets
Current Assets:
Cash and equivalents	$	590,207		$	370,417
Trade receivables		2,471,273			2,098,276
Inventories		1,482,508			1,203,063
Deferred income taxes		196,860			168,739
Prepaid expenses and other current assets		465,557			271,110
Total current assets		5,206,405			4,111,605
Plant and Equipment:
Land		193,328			156,975
Buildings and improvements		1,374,926			1,210,133
Machinery and equipment		3,594,057			3,235,571
Equipment leased to others		149,682			155,565
Construction in progress		96,853			92,934
		5,408,846			4,851,178
Accumulated depreciation		(3,355,389	)		(3,044,069	)
Net plant and equipment		2,053,457			1,807,109
Investments		595,083			896,487
Goodwill		4,025,053			3,009,011
Intangible Assets		1,113,634			669,927
Deferred Income Taxes		116,245			45,269
Other Assets		770,562			906,235
	$	13,880,439		$	11,445,643
Liabilities and Stockholders’ Equity
Current Liabilities:
Short-term debt	$	462,721		$	252,899
Accounts payable		707,656			560,078
Accrued expenses		1,187,526			1,013,940
Cash dividends payable		117,337			92,620
Income taxes payable		161,344			81,194
Total current liabilities		2,636,584			2,000,731
Noncurrent Liabilities:
Long-term debt		955,610			958,321
Deferred income taxes		259,159			—
Other		1,011,578			939,696
Total noncurrent liabilities		2,226,347			1,898,017
Stockholders’ Equity:
Common stock:
Issued—630,900,742 shares in 2006 and 624,086,578 shares in 2005		6,309			3,120
Additional paid-in-capital		1,378,587			1,082,611
Income reinvested in the business		10,406,511			9,112,328
Common stock held in treasury		(3,220,538	)		(2,773,176	)
Accumulated other comprehensive income		446,639			122,012
Total stockholders’ equity		9,017,508			7,546,895
	$	13,880,439		$	11,445,643

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

STATEMENT OF CASH FLOW     52

Statement of Cash Flows

Illinois Tool Works Inc. and Subsidiaries

	FOR THE YEARS ENDED DECEMBER 31
IN THOUSANDS	2006			2005			2004
Cash Provided by (Used for) Operating Activities:
Net income	$	1,717,746		$	1,494,869		$	1,338,694
Adjustments to reconcile net income to cash provided by operating activities:
Loss from discontinued operations		—			—			911
Depreciation		319,362			299,232			294,162
Amortization and impairment of goodwill and other intangible assets		124,544			83,842			59,121
Change in deferred income taxes		167,003			69,745			143,214
Provision for uncollectible accounts		8,727			7,156			391
Loss on sale of plant and equipment		1,149			4,289			4,710
Income from investments		(78,608	)		(126,278	)		(142,621	)
(Gain) loss on sale of operations and affiliates		(16,795	)		8,548			(8	)
Stock compensation expense		34,781			64,144			32,514
Other non-cash items, net		510			(1,875	)		9,740
Change in assets and liabilities:
(Increase) decrease in—
Trade receivables		(45,581	)		(58,902	)		(128,868	)
Inventories		(60,204	)		104,419			(177,052	)
Prepaid expenses and other assets		(63,930	)		(82,280	)		(123,532	)
Increase (decrease) in—
Accounts payable		10,941			(39,216	)		31,947
Accrued expenses and other liabilities		1,314			35,491			35,056
Income taxes receivable and payable		(55,261	)		(16,647	)		153,457
Other, net		330			5,006			4,961
Net cash provided by operating activities		2,066,028			1,851,543			1,536,797
Cash Provided by (Used for) Investing Activities:
Acquisition of businesses (excluding cash and equivalents) and additional interest in affiliates		(1,378,708	)		(626,922	)		(587,783	)
Additions to plant and equipment		(301,006	)		(293,102	)		(282,560	)
Purchases of investments		(25,347	)		(120,240	)		(64,442	)
Proceeds from investments		367,365			220,082			85,412
Proceeds from sale of plant and equipment		14,190			33,860			23,378
Proceeds from sale of operations and affiliates		40,303			1,475			6,495
Other, net		8,788			(4,559	)		3,407
Net cash used for investing activities		(1,274,415	)		(789,406	)		(816,093	)
Cash Provided by (Used for) Financing Activities:
Cash dividends paid		(398,846	)		(335,092	)		(304,581	)
Issuance of common stock		78,969			24,563			79,108
Repurchases of common stock		(446,876	)		(1,041,798	)		(1,729,806	)
Net proceeds of short-term debt		194,896			44,406			134,019
Proceeds from long-term debt		177			58,661			97
Repayments of long-term debt		(16,632	)		(9,941	)		(6,629	)
Excess tax benefits from share-based compensation		13,086			12,879			—
Repayment of preferred stock of subsidiary		—			(20,000	)		—
Net cash used for financing activities		(575,226	)		(1,266,322	)		(1,827,792	)
Effect of Exchange Rate Changes on Cash and Equivalents		3,403			(92,788	)		89,995
Cash and Equivalents:
Increase (decrease) during the year		219,790			(296,973	)		(1,017,093	)
Beginning of year		370,417			667,390			1,684,483
End of year	$	590,207		$	370,417		$	667,390
Cash Paid During the Year for Interest	$	75,026		$	99,115		$	73,393
Cash Paid During the Year for Income Taxes	$	646,647		$	622,451		$	339,334
Liabilities Assumed from Acquisitions	$	448,561		$	270,726		$	150,913

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

53      2006 ANNUAL REPORT

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, general industrial, automotive and food institutional and service 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—The Company accounts for acquisitions under the purchase method, in which assets acquired and liabilities assumed are recorded at fair value as of the date of acquisition. The operating results of the acquired companies are included in the Company’s consolidated financial statements from the date of acquisition.Acquisitions in the following years, individually and in the aggregate, did not materially affect the Company’s results of operations or financial position. Summarized information related to acquisitions is as follows:

IN THOUSANDS EXCEPT NUMBER OF ACQUISITIONS	2006		2005		2004
Number of acquisitions		53		22		24
Net cash paid during the year	$	1,378,708	$	626,922	$	587,783
Value of shares issued for acquisitions	$	162,898	$	—	$	1,628

The Company’s only significant non-cash transaction during 2006 related to the exchange of the Company’s common stock as consideration for an acquisition. There were no significant non-cash transactions in 2005 and 2004.

The premium over tangible net assets recorded for acquisitions based on purchase price allocations during 2006, 2005 and 2004 were as follows:

	2006				2005				2004
	WEIGHTED				WEIGHTED				WEIGHTED
	AVERAGE		PREMIUM		AVERAGE		PREMIUM		AVERAGE			PREMIUM
IN THOUSANDS EXCEPT FOR WEIGHTED-AVERAGE LIVES (YEARS)	LIFE		RECORDED		LIFE		RECORDED		LIFE			RECORDED
Goodwill			$	774,661			$	296,311				$	219,010
Amortizable Intangible Assets:
Customer lists and relationships		10.1		287,371		12.0		112,328		11.9			83,643
Patents & proprietary technology		11.0		90,730		10.5		29,079		7.2			16,738
Trademarks and brands		15.6		75,040		14.4		50,174		17.1			26,933
Software		6.2		78,432		7.1		24,006		4.7			50,906
Noncompete agreements		4.1		19,081		2.0		6,424		4.2			10,181
Other		1.2		9,414		1.0		7,268		2.6			2,005
Total Amortizable Intangible Assets		10.1		560,068		11.2		229,279		9.8	��		190,406
Indefinite-lived Intangible Assets:
Trademarks and brands				4,170				30,980					29,170
Total Premium Recorded			$	1,338,899			$	556,570				$	438,586

NOTES TO FINANCIAL STATEMENTS     54

Of the total goodwill recorded for acquisitions, the Company expects goodwill of $78,923,000 in 2006, $77,005,000 in 2005 and $102,301,000 in 2004 will be tax deductible. The Company anticipates subsequent purchase accounting adjustments will change the initial amounts recorded for goodwill and intangible assets, primarily due to the completion of valuations.

Operating Revenuesare recognized when the risks and rewards of ownership are transferred to the customer,which is generally at the time of product shipment. No single customer accounted for more than 5% of consolidated revenues in 2006, 2005 or 2004.

Research and Development Expensesare recorded as expense in the year incurred.These costs were $144,914,000 in 2006, $127,871,000 in 2005 and $123,486,000 in 2004.

Rental Expensewas $120,842,000 in 2006, $117,585,000 in 2005 and $108,450,000 in 2004. Future minimum lease payments for the years ending December 31 are as follows:

IN THOUSANDS
2007	$	115,519
2008		91,468
2009		65,569
2010		45,125
2011		30,934
2012 and future years		64,169
	$	412,784

Advertising Expensesare recorded as expense in the year incurred.These costs were $98,660,000 in 2006, $80,059,000 in 2005 and $81,113,000 in 2004.

Investment Incomeby investment category for the periods ended December 31, 2006, 2005 and 2004 were as follows:

IN THOUSANDS	2006		2005		2004
Mortgage investments	$	40,146	$	84,193	$	81,028
Venture capital limited partnership		23,001		11,629		19,267
Leases of equipment		4,898		15,468		25,762
Property developments		900		6,774		7,445
Other		9,663		8,214		9,119
	$	78,608	$	126,278	$	142,621

Other Income (Expense)consisted of the following:

IN THOUSANDS	2006			2005			2004
Interest income	$	30,900		$	27,861		$	25,614
Gain (loss) on sale of operations and affiliates		16,795			(8,548	)		8
Loss on sale of plant and equipment		(1,149	)		(4,289	)		(4,710	)
Loss on foreign currency transactions		(9,741	)		(3,447	)		(9,810	)
Other, net		(5,496	)		(2,620	)		113
	$	31,309		$	8,957		$	11,215

55     2006 ANNUAL REPORT

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	2006			2005			2004
U.S. federal income taxes:
Current	$	363,233		$	399,629		$	250,887
Deferred		77,391			80,571			117,526
Benefit of net operating loss carryforwards		—			(54,248	)		(4,204	)
Tax benefit related to stock recorded through equity		20,551			13,740			36,322
	$	461,175		$	439,692		$	400,531
Foreign income taxes:
Current	$	275,070		$	160,545		$	226,699
Deferred		9,617			36,170			51,129
Benefit of net operating loss carryforwards		(58,273	)		(7,047	)		(51,425	)
	$	226,414		$	189,668		$	226,403
State income taxes:
Current	$	42,330		$	53,901		$	43,297
Deferred		(3,898	)		9,685			(2,719	)
Benefit of net operating loss carryforwards		—			(7,476	)		(11,014	)
Tax benefit related to stock recorded through equity		1,479			1,230			3,302
		39,911			57,340			32,866
	$	727,500		$	686,700		$	659,800

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

IN THOUSANDS	2006		2005		2004
Domestic	$	1,494,242	$	1,402,767	$	1,354,301
Foreign		951,004		778,802		645,104
	$	2,445,246	$	2,181,569	$	1,999,405

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

	2006			2005			2004
U.S. federal statutory tax rate		35.0	%		35.0	%		35.0	%
State income taxes, net of U.S. federal tax benefit		1.1			1.7			1.5
Differences between U.S. federal statutory and foreign tax rates		(1.1	)		(1.1	)		(0.6	)
Nontaxable foreign interest income		(2.3	)		(2.4	)		(1.6	)
Tax effect of foreign dividends		0.2			1.0			0.1
Tax relief for U.S. manufacturers		(0.5	)		(0.4	)		—
Other, net		(2.6	)		(2.3	)		(1.4	)
Effective tax rate		29.8	%		31.5	%		33.0	%

In 2004, the Company recorded a deferred tax liability of $25,000,000 to reflect the estimated tax cost of the minimum foreign dividends repatriated under the American Jobs Creation Act 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 approximately $2,900,000,000 and $2,000,000,000 as of December 31, 2006 and 2005, 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.

NOTES TO FINANCIAL STATEMENTS     56

The components of deferred income tax assets and liabilities at December 31, 2006 and 2005 were as follows:

	2006						2005
IN THOUSANDS	ASSET			LIABILITY			ASSET			LIABILITY
Goodwill and intangible assets	$	132,906		$	(497,597	)	$	125,758		$	(279,206	)
Inventory reserves, capitalized tax cost and LIFO inventory		41,500			(18,636	)		34,945			(18,693	)
Investments		45,163			(220,360	)		109,356			(301,276	)
Plant and equipment		16,550			(95,896	)		13,181			(89,532	)
Accrued expenses and reserves		129,250			—			128,044			—
Employee benefit accruals		303,579			—			257,709			—
Foreign tax credit carryforwards		76,855			—			66,749			—
Net operating loss carryforwards		345,531			—			252,663			—
Capital loss carryforwards		67,092			—			104,786			—
Allowances for uncollectible accounts		12,439			—			10,794			—
Prepaid pension assets		—			(29,776	)		—			(93,770	)
Other		71,403			(38,650	)		94,046			(26,758	)
Gross deferred income tax assets (liabilities)		1,242,268			(900,915	)		1,198,031			(809,235	)
Valuation allowances		(287,407	)		—			(174,788	)		—
Total deferred income tax assets (liabilities)	$	954,861		$	(900,915	)	$	1,023,243		$	(809,235	)

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, 2006 and 2005 relate primarily to certain net operating loss carryforwards and capital loss carryforwards. Included in the total valuation allowances at December 31, 2006 were allowances of $90,395,000 that relate to acquired net operating loss carryforwards that, if adjusted in the future, would reduce goodwill.

At December 31, 2006, 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
2007	$	3,637
2008		19,627
2009		7,161
2010		11,196
2011		9,707
2012		14,291
2013		8,506
2014		519
2015		1,534
2016		3,759
2017		—
2018		6,438
2019		23,479
2020		69,029
2021		87,699
2022		39,600
2023		64,228
2024		65,453
2025		14,331
Do not expire		536,611
	$	986,805

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in tax returns, and provides guidance on derecognition, classification, and interest and penalties, related to uncertain tax positions. FIN 48 will be effective for the Company on January 1, 2007, with any cumulative effect of the change in accounting principle recorded as an adjustment to retained earnings. The Company does not anticipate the adoption of FIN 48 will materially affect the Company’s financial position or results of operations.

57     2006 ANNUAL REPORT

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	2006		2005		2004
Income from continuing operations	$	1,717,746	$	1,494,869	$	1,339,605
Income from continuing operations per share—Basic:
Weighted average common shares		565,632		571,058		604,752
Income from continuing operations per share—Basic		$3.04		$2.62		$2.22
Income from continuing operations per share—Diluted:
Weighted average common shares		565,632		571,058		604,752
Effect of dilutive stock options and restricted stock		4,260		4,376		4,950
Weighted average common shares assuming dilution		569,892		575,434		609,702
Income from continuing operations per share—Diluted		$3.01		$2.60		$2.20

Options that were considered antidilutive were not included in the computation of diluted income from continuing operations per share.The antidilutive options outstanding as of December 31, 2006, 2005 and 2004 were as follows:

IN THOUSANDS EXCEPT PER SHARE AMOUNTS	2006		2005		2004
Weighted average shares issuable under antidilutive options		7,759		4,787		384
Weighted average exercise price per share		$45.14		$47.12	$	47.08

Cash and Equivalentsincluded interest-bearing instruments of $234,310,000 at December 31, 2006 and $143,306,000 at December 31, 2005.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 2006, 2005 and 2004 were as follows:

IN THOUSANDS	2006			2005			2004
Beginning balance	$	(51,178	)	$	(56,205	)	$	(62,364	)
Provision charged to expense		(8,727	)		(7,156	)		(391	)
Write-offs, net of recoveries		10,465			14,392			14,236
Acquisitions and divestitures		(8,658	)		(5,931	)		(4,285	)
Other		(3,551	)		3,722			(3,401	)
Ending balance	$	(61,649	)	$	(51,178	)	$	(56,205	)

Inventoriesat December 31, 2006 and 2005 were as follows:

IN THOUSANDS	2006		2005
Raw material	$	470,032	$	340,748
Work-in-process		166,946		136,557
Finished goods		845,530		725,758
	$	1,482,508	$	1,203,063

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 29% and 33% of total inventories as of December 31, 2006 and 2005, 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 $154,928,000 and $135,848,000 higher than reported at December 31, 2006 and 2005, respectively.

NOTES TO FINANCIAL STATEMENTS     58

Prepaid Expenses and Other Current Assetsas of December 31, 2006 and 2005 were as follows:

IN THOUSANDS	2006		2005
Income tax refunds	$	261,792	$	108,242
Insurance		44,271		45,753
Value-added-tax receivables		40,177		27,379
Other		119,317		89,736
	$	465,557	$	271,110

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 $319,362,000 in 2006, $299,232,000 in 2005 and $294,162,000 in 2004, and was reflected primarily in cost of revenues.Depreciation of plant and equipment for financial reporting purposes is computed on an accelerated basis for U.S. businesses and on a straight-line basis for a majority of the international businesses.

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

Investmentsas of December 31, 2006 and 2005 consisted of the following:

IN THOUSANDS	2006		2005
Leases of equipment	$	310,598	$	309,437
Mortgage investments		—		292,370
Affordable housing limited partnerships		114,594		131,827
Venture capital limited partnership		91,365		91,522
Prepaid forward contract		29,778		28,376
Properties held for sale		29,039		26,920
Property developments		19,709		16,035
	$	595,083	$	896,487

Leases of Equipment

The components of the investment in leases of equipment at December 31, 2006 and 2005 were as shown below:

IN THOUSANDS	2006			2005
Leveraged, direct financing and sales-type leases:
Gross lease contracts receivable, net of nonrecourse debt service	$	155,774		$	156,393
Estimated residual value of leased assets		248,119			248,119
Unearned income		(105,914	)		(108,389	)
		297,979			296,123
Equipment under operating leases		12,619			13,314
	$	310,598		$	309,437

Deferred tax liabilities related to leveraged and direct financing leases were $213,267,000 and $295,064,000 at December 31, 2006 and 2005, respectively.

The investment in leases of equipment at December 31, 2006 and 2005 relates to the following types of equipment:

IN THOUSANDS	2006		2005
Telecommunications	$	196,348	$	196,348
Air traffic control		70,280		68,268
Aircraft		43,033		43,480
Manufacturing		937		1,341
	$	310,598	$	309,437

59      2006 ANNUAL REPORT

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, 2006, 2005 and 2004 were as shown below:

IN THOUSANDS	2006			2005			2004
Lease income before income taxes	$	2,567		$	13,890		$	24,326
Investment tax credits recognized		133			250			296
Income tax expense		(948	)		(5,197	)		(9,014	)
	$	1,752		$	8,943		$	15,608

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.

In July 2006, the FASB issued FASB Staff Position No. FAS 13-2, Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction (“FSP 13-2”). FSP 13-2 addresses how a change or projected change in the timing of cash flows relating to income taxes generated by a leveraged lease transaction affects the accounting by a lessor for that lease. FSP 13-2 will be effective for the Company on January 1, 2007, with any cumulative effect of the change in accounting principle recorded as an adjustment to retained earnings. The adoption of FSP 13-2 is not expected to have a material effect on the Company’s financial position or results of operations.

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 10-year swap agreements and other related agreements whereby a third party received 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. 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 pertaining to the 1995 mortgage investment transaction (the “First Mortgage Transaction”) were sold and the swap and other related agreements were terminated. 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.

In November 2006, in accordance with the 10-year term of the transaction, all remaining mortgage-related assets pertaining to the 1996 mortgage investment transaction (the “Second Mortgage Transaction”) were sold and the swap and other related agreements were terminated . In December 2006, the Company received $157,115,000 for its share of the disposition proceeds related to the Second Mortgage Transaction and in January 2007, the Company paid $34,600,000 for the redemption of preferred stock of a subsidiary and related accrued dividends.

In December 2006, all remaining mortgage-related assets pertaining to the 1997 mortgage investment transaction (the “Third Mortgage Transaction”) were also sold and the swap and other related agreements were terminated. In December 2006, the Company received $168,567,000 for its share of the disposition proceeds related to the Third Mortgage Transaction and in January 2007, the Company paid $34,600,000 for the redemption of preferred stock of a subsidiary and related accrued dividends. After the January 2, 2007 preferred stock payments, there are no remaining assets or liabilities related to the Second or Third Mortgage Transactions.

NOTES TO FINANCIAL STATEMENTS     60

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 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 FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (“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’s maximum exposure to loss related to the property development investments and affordable housing investments is $27,334,000 and $114,594,000, respectively, as of December 31, 2006.

Cash Flows

Cash flows related to investments during 2006, 2005 and 2004 were as follows:

IN THOUSANDS	2006			2005			2004
Cash used to purchase investments:
Affordable housing limited partnerships	$	(17,814	)	$	(80,822	)	$	(28,449	)
Property developments		(4,885	)		(11,976	)		(3,918	)
Venture capital limited partnership		(1,926	)		(27,242	)		(28,007	)
Other		(722	)		(200	)		(4,068	)
	$	(25,347	)	$	(120,240	)	$	(64,442	)
Cash proceeds from investments:
Mortgage investments	$	333,976		$	172,288		$	26,187
Venture capital limited partnership		25,085			22,683			19,428
Leases of equipment		4,467			8,685			8,041
Property developments		2,073			13,805			13,810
Properties held for sale		1,698			2,600			17,888
Other		66			21			58
	$	367,365		$	220,082		$	85,412

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, 2006, the Company had assigned its recorded goodwill and intangible assets to approximately 375 of its then 700 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.

61     2006 ANNUAL REPORT

Amortization and impairment of goodwill and other intangible assets for the years ended December 31, 2006, 2005 and 2004 were as follows:

IN THOUSANDS	2006		2005		2004
Goodwill:
Impairment	$	14,793	$	9,650	$	11,492
Intangible Assets:
Amortization		106,766		69,143		37,409
Impairment		2,985		5,049		10,220
	$	124,544	$	83,842	$	59,121

In 2006, the Company recorded impairment charges of $17,778,000. The goodwill impairment charges of $14,793,000 were primarily related to a U.S. construction joist business, a Canadian stretch packaging equipment business, a European food equipment business, a U.S. thermal transfer ribbon business and an Asian construction business, and resulted from lower estimated future cash flows than previously expected. Also in 2006, intangible asset impairments of $2,985,000 were recorded to reduce to the estimated fair value the carrying value of trademarks, patents and customer-related intangible assets primarily related to a U.S. welding components business in the Specialty Systems—North America segment and a U.S. contamination control business in the Engineered Products—North America segment.

In 2005, the Company recorded goodwill impairment charges of $9,650,000, which 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.

The changes in the carrying amount of goodwill by segment for the years ended December 31, 2006 and 2005 were as follows:

	ENGINEERED			ENGINEERED			SPECIALTY			SPECIALTY
	PRODUCTS			PRODUCTS			SYSTEMS			SYSTEMS
IN THOUSANDS	NORTH AMERICA			INTERNATIONAL			NORTH AMERICA			INTERNATIONAL			TOTAL
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
2006 activity:
Acquisitions and divestitures		230,737			45,837			395,586			88,554			760,714
Impairment write-offs		(4,504	)		(1,682	)		(6,344	)		(2,263	)		(14,793	)
Foreign currency translation		(2,084	)		103,854			22,416			145,935			270,121
Intersegment goodwill transfers		3,146			17,643			(3,146	)		(17,643	)		—
Balance, December 31, 2006		$952,148			$747,128			$1,326,028			$999,749		$	4,025,053

NOTES TO FINANCIAL STATEMENTS     62

Intangible assets as of December 31, 2006 and 2005 were as follows:

	2006							2005
			ACCUMULATED							ACCUMULATED
IN THOUSANDS	COST		AMORTIZATION			NET		COST		AMORTIZATION			NET
Amortizable Intangible Assets:
Customer lists and relationships		$540,802		$(63,394	)		$477,408		$219,879		$(30,865	)	$	189,014
Patents and proprietary technology		239,237		(80,788	)		158,449		167,887		(66,392	)		101,495
Trademarks and brands		192,871		(25,104	)		167,767		113,402		(14,613	)		98,789
Software		182,895		(62,747	)		120,148		101,562		(18,972	)		82,590
Noncompete agreements		109,563		(70,758	)		38,805		87,977		(59,335	)		28,642
Other		71,669		(60,771	)		10,898		56,693		(45,750	)		10,943
Total Amortizable Intangible Assets		1,337,037		(363,562	)		973,475		747,400		(235,927	)		511,473
Indefinite-lived Intangible Assets:
Trademarks and brands		140,159		—			140,159		158,454		—			158,454
Total Intangible Assets	$	1,477,196		$(363,562	)	$	1,113,634		$905,854		$(235,927	)	$	669,927

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

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

IN THOUSANDS
2007	$	133,791
2008		121,689
2009		109,924
2010		101,246
2011		96,238

Other Assetsas of December 31, 2006 and 2005 consisted of the following:

IN THOUSANDS	2006		2005
Cash surrender value of life insurance policies	$	318,771	$	298,190
Prepaid pension assets		257,537		430,862
Customer tooling		47,520		45,602
Noncurrent receivables		41,788		27,609
Other		104,946		103,972
	$	770,562	$	906,235

Retirement Plans and Postretirement Benefits—The Company has both funded and unfunded defined benefit pension plans. The major domestic plan covers a substantial portion of its U.S. employees and provides benefits based on years of service and final average salary. Beginning January 1, 2007, the major domestic defined benefit plan was closed to new participants. Newly hired employees and employees from acquired businesses that are not participating in this plan will be eligible for additional Company contributions under the existing defined contribution retirement plan.

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.

63     2006 ANNUAL REPORT

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106 and 132(R), (“SFAS 158”). On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS 158. This statement requires employers to recognize the overfunded or underfunded status of defined benefit pension and postretirement plans as an asset or liability in its statement of financial position and previously unrecognized changes in that funded status through accumulated other comprehensive income. The Company recorded an after-tax charge to accumulated other comprehensive income of $180,037,000 in 2006 to recognize the funded status of its benefit plans. As a result, the Company recognized the following adjustments in the statement of financial position at December 31, 2006:

	BEFORE					AFTER
	APPLICATION OF					APPLICATION OF
IN THOUSANDS	SFAS 158		ADJUSTMENTS			SFAS 158
Current deferred income tax assets	$	203,342	$	(6,482	)	$	196,860
Noncurrent deferred income tax assets		138,083		(21,838	)		116,245
Other noncurrent assets		978,147		(207,585	)		770,562
Accrued expenses		1,198,426		(10,900	)		1,187,526
Noncurrent deferred income tax liabilities		421,192		(162,033	)		259,159
Other noncurrent liabilities		894,513		117,065			1,011,578
Accumulated other comprehensive income		626,676		(180,037	)		446,639

Effective for the 2008 fiscal year, SFAS 158 requires plan assets and liabilities to be measured as of year-end, rather than the September 30 measurement date that the Company presently uses.

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

	PENSION									OTHER POSTRETIREMENT BENEFITS
IN THOUSANDS	2006			2005			2004			2006			2005			2004
Components of net periodic benefit cost:
Service cost	$	107,335		$	84,929		$	78,991		$	16,747		$	12,945		$	13,471
Interest cost		97,044			85,713			82,518			32,330			30,293			34,666
Expected return on plan assets		(137,866	)		(124,382	)		(118,024	)		(7,982	)		(5,754	)		(3,466	)
Amortization of actuarial loss		25,036			8,591			5,074			21,126			1,246			5,595
Amortization of prior service cost (income)		(2,170	)		(2,277	)		(2,304	)		6,269			6,736			6,736
Amortization of transition amount		64			(18	)		(139	)		—			—			—
Settlement/curtailment loss		2,624			195			59			—			—			—
Net periodic benefit cost	$	92,067		$	52,751		$	46,175		$	68,490		$	45,466		$	57,002

The estimated cost (income) from the items below that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2007 are as follows:

				OTHER
				POSTRETIREMENT
IN THOUSANDS	PENSION			BENEFITS
Net loss	$	19,966		$	2,022
Prior service cost (income)	$	(2,350	)	$	6,261
Net transition obligation	$	29		$	—

NOTES TO FINANCIAL STATEMENT     64

	PENSION						OTHER POSTRETIREMENT BENEFITS
IN THOUSANDS	2006			2005			2006			2005
Change in benefit obligation as of September 30:
Benefit obligation at beginning of period	$	1,879,661		$	1,589,256		$	606,022		$	546,112
Service cost		107,335			84,929			16,747			12,945
Interest cost		97,044			85,713			32,330			30,293
Plan participants’ contributions		5,606			2,583			15,850			15,565
Amendments		2,685			1,306			—			(16,212	)
Actuarial (gain) loss		(18,494	)		125,819			(70,765	)		64,880
Acquisitions		7,309			119,080			—			—
Benefits paid		(130,078	)		(112,287	)		(44,972	)		(47,561	)
Medicare subsidy received		—			—			2,612			—
Liabilities (to) from other plans		2,813			24,326			(480	)		—
Foreign currency translation		73,755			(41,064	)		—			—
Benefit obligation at end of period	$	2,027,636		$	1,879,661		$	557,344		$	606,022
Change in plan assets as of September 30:
Fair value of plan assets at beginning of period	$	1,773,574		$	1,491,574		$	103,528		$	65,204
Actual return on plan assets		193,206			220,829			13,771			4,321
Acquisitions		—			86,619			—			—
Company contributions		89,382			103,157			61,063			65,999
Plan participants’ contributions		5,606			2,583			15,850			15,565
Benefits paid		(130,078	)		(112,287	)		(44,972	)		(47,561	)
Assets from other plans		1,975			8,400			—			—
Foreign currency translation		52,751			(27,301	)		—			—
Fair value of plan assets at end of period	$	1,986,416		$	1,773,574		$	149,240		$	103,528
Funded status	$	(41,220	)	$	(106,087	)	$	(408,104	)	$	(502,494	)
Unrecognized net actuarial loss		—			367,932			—			131,316
Unrecognized prior service cost (income)		—			(6,435	)		—			36,050
Unrecognized net transition amount		—			2,341			—			—
Contributions after measurement date		49,694			2,460			30,214			35,895
Other immaterial plans		(18,244	)		(17,262	)		(7,579	)		(2,169	)
Net asset (liability) at end of year	$	(9,770	)	$	242,949		$	(385,469	)	$	(301,402	)
The amounts recognized in the statement of financial position as of December 31 consisted of:
Noncurrent assets	$	257,537		$	424,165		$	—		$	—
Current liabilities		(13,111	)		—			(11,139	)		(34,348	)
Noncurrent liabilities		(254,196	)		(235,625	)		(374,330	)		(267,054	)
Intangible asset for minimum pension liability		—			6,697			—			—
Accumulated other comprehensive loss for minimum pension liability		—			47,712			—			—
Net asset (liability) at end of year	$	(9,770	)	$	242,949		$	(385,469	)	$	(301,402	)
The pre-tax amounts recognized in accumulated other comprehensive income consist of:
Net loss	$	279,500					$	27,427
Prior service cost (income)		(1,289	)					38,788
Net transition obligation		2,386						—
	$	280,597					$	66,215
Accumulated benefit obligation for all significant defined benefit pension plans	$	1,778,146		$	1,653,854
Plans with accumulated benefit obligation in excess of plan assets as of September 30:
Projected benefit obligation	$	334,142		$	349,916
Accumulated benefit obligation	$	300,697		$	324,128
Fair value of plan assets	$	102,609		$	137,669

65     2006 ANNUAL REPORT

Assumptions

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

	PENSION									OTHER POSTRETIREMENT BENEFITS
	2006			2005			2004			2006			2005			2004
Weighted-average assumptions used to determine benefit obligations at September 30:
Discount rate		5.50	%		5.30	%		5.67	%		5.95	%		5.50	%		5.75	%
Rate of compensation increases		4.26			4.20			4.35			—			—			—
Weighted-average assumptions used to determine net cost for years ended December 31:
Discount rate		5.30	%		5.67	%		5.90	%		5.50	%		5.75	%		6.00	%
Expected return on plan assets		8.33			7.99			7.99			7.00			7.00			7.00
Rate of compensation increases		4.20			4.35			4.32			—			—			—

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 primary postretirement health care plan was developed from similar factors as the pension plans less insurance costs and mortality charges.

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:

	2006			2005			2004
Health care cost trend rate assumed for the next year		11.00	%		10.00	%		10.00	%
Ultimate trend rate		5.00	%		5.00	%		5.00	%
Year that the rate reaches the ultimate trend rate		2014			2010			2009

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 2006	$	1,551	$	(1,757	)
Effect on postretirement benefit obligation at September 30, 2006	$	20,793	$	(21,611	)

Plan Assets

The target asset allocation and weighted-average asset allocations for the Company’s significant pension plans at September 30, 2006 and 2005 were as follows:

				PERCENTAGE OF PLAN
				ASSETS AT SEPTEMBER 30
ASSET CATEGORY	TARGET ALLOCATION			2006			2005
Equity securities		60 - 75	%		67	%		67	%
Debt securities		20 - 35			29			29
Real estate		0 -   1			1			1
Other		0 - 10			3			3
					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. Additionally, the Company does not use derivatives for the purpose of speculation, leverage, circumventing investment guidelines or taking risks that are inconsistent with specified guidelines.

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 health care fund is to invest in assets that provide a reasonable rate of return while preserving capital and are exempt from U.S. federal income taxes.

NOTES TO FINANCIAL STATEMENT     66

Cash Flows

The Company generally funds its pension plans to the extent such contributions are tax deductible. The Company expects to contribute $82,400,000 to its pension plans and $61,700,000 to its other postretirement benefit plans in 2007.

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

IN THOUSANDS	PENSION		OTHER POSTRETIREMENT BENEFITS
2007	$	158,426	$	37,654
2008		160,085		38,757
2009		165,262		40,985
2010		171,268		43,372
2011		174,942		45,817
Years 2012-2016		924,462		238,922

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 expense for these plans was $44,698,000 in 2006, $37,367,000 in 2005 and $37,231,000 in 2004.

Short-Term Debtas of December 31, 2006 and 2005 consisted of the following:

IN THOUSANDS	2006		2005
Bank overdrafts	$	45,259	$	53,487
Commercial paper		200,340		94,488
European facilities		184,996		—
European demand note		—		74,283
Current maturities of long-term debt		16,684		12,090
Other borrowings by foreign subsidiaries		15,442		18,551
	$	462,721	$	252,899

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 5.3% at December 31, 2006 and 4.3% at December 31, 2005.

The Company had five European short-term credit facilities with combined maximum available borrowings of €188,700,000 as of December 31, 2006. The facilities had a weighted average interest rate of 3.9% at December 31, 2006.

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 had an interest rate of 2.7% and was repaid in 2006.

The weighted average interest rate on other borrowings by foreign subsidiaries was 2.4% at December 31, 2006 and 3.1% at December 31, 2005.

In June 2006, the Company entered into a $600,000,000 Line of Credit Agreement with a termination date of June 15, 2007. In November 2006, the Company exercised a provision which provided for an increase in the aggregate commitment by $200,000,000 to a total of $800,000,000. No amounts were outstanding under this facility at December 31, 2006.

Accrued Expensesas of December 31, 2006 and 2005 consisted of accruals for:

IN THOUSANDS	2006		2005
Compensation and employee benefits	$	416,124	$	367,804
Deferred revenue and customer deposits		173,036		119,505
Rebates		125,715		111,589
Warranties		70,119		70,882
Preferred stock of subsidiaries and related accrued dividends		69,200		—
Current portion of pension and other postretirement benefit obligations		24,250		34,348
Current portion of affordable housing capital obligations		14,092		14,040
Other		294,990		295,772
	$	1,187,526	$	1,013,940

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 7.3% on the second and third $20,000,000 issuances. The accrued dividends are included in interest expense. In 2005, the Company redeemed the first preferred stock issuance for $20,000,000 and paid accrued dividends of $12,000,000. The Company redeemed the second and third preferred stock issuances and paid accrued dividends on January 2, 2007.

67     2006 ANNUAL REPORT

The changes in accrued warranties during 2006, 2005 and 2004 were as follows:

IN THOUSANDS	2006			2005			2004
Beginning balance	$	70,882		$	79,020		$	69,415
Charges		(51,300	)		(52,258	)		(47,760	)
Provision charged to expense		45,418			42,276			55,065
Acquisitions and divestitures		3,176			3,646			705
Foreign currency translation		1,943			(1,802	)		1,595
Ending balance	$	70,119		$	70,882		$	79,020

Long-Term Debtat December 31, 2006 and 2005 consisted of the following:

IN THOUSANDS	2006			2005
6.875% notes due November 15, 2008	$	149,966		$	149,947
5.75% notes due March 1, 2009		497,048			496,687
6.55% preferred debt securities due December 31, 2011		249,776			249,739
4.88% preferred debt securities due December 31, 2020		49,448			53,735
Other borrowings		26,056			20,303
		972,294			970,411
Current maturities		(16,684	)		(12,090	)
	$	955,610		$	958,321

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 $4,084,000 at December 31, 2006 and $7,795,000 at December 31, 2005.

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 $8,152,000 at December 31, 2006 and $15,328,000 at December 31, 2005. 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 7.33% at December 31, 2006 and 6.37% at December 31, 2005. 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 $12,342,000 at December 31, 2006 and $17,466,000 at December 31, 2005.

In 2005, the Company issued $53,735,000 of 4.88% senior notes at 100% of face value. The estimated fair value of the securities exceeded the carrying value by approximately $3,599,000 at December 31, 2006. The carrying value of the notes exceeded the estimated fair value by approximately $172,000 at December 31, 2005.

In 2005, the Company entered into a $350,000,000 revolving credit facility (“RCF”) with a termination date of June 17, 2010. This RCF was replaced on June 16, 2006 by a $350,000,000 RCF with a termination date of June 16, 2011. No amounts were outstanding under this facility at December 31, 2006.

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 15% of total capitalization as of December 31, 2006, which was in compliance with these covenants.

Other debt outstanding at December 31, 2006, bears interest at rates ranging from 2.6% to 12.6%, with maturities through the year 2029.

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

IN THOUSANDS
2008	$	158,248
2009		503,326
2010		6,250
2011		255,586
2012 and future years		32,200
	$	955,610

NOTES TO FINANCIAL STATEMENTS     68

In connection with forming joint ventures, the Company has provided debt guarantees of $24,000,000 at December 31, 2006 and $30,000,000 at December 31, 2005. The Company has recorded liabilities related to these guarantees of $16,000,000 at December 31, 2006 and $14,000,000 at December 31, 2005.

At December 31, 2006, the Company had open stand-by letters of credit of $127,000,000, substantially all of which expire in 2007. At December 31, 2005, the Company had open stand-by letters of credit of $107,000,000, substantially all of which expired in 2006.

Other Noncurrent Liabilitiesat December 31, 2006 and 2005 consisted of the following:

IN THOUSANDS	2006		2005
Postretirement benefit obligation	$	374,330	$	267,054
Pension benefit obligation		254,196		235,625
Affordable housing capital obligations		44,096		58,105
Preferred stock of subsidiaries and related accrued dividends		—		64,820
Other		338,956		314,092
	$	1,011,578	$	939,696

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
2008	$	13,612
2009		13,978
2010		13,262
2011		3,244
	$	44,096

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

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 the Company, was a defendant in a consolidated class action lawsuit filed in 2000 in federal district court in White Plains, New York on behalf of direct purchasers of high-pressure laminate. The complaint alleged that Wilsonart participated in a conspiracy with competitors to fix, raise, maintain or stabilize prices for high pressure laminate between 1994 and 2000 and sought injunctive relief and treble damages. On May 24, 2006, after a two month trial, a federal jury unanimously rendered a verdict in favor of Wilsonart. Judgment was entered on the verdict, and that judgment is now final. Indirect purchasers of high-pressure laminate had filed similar purported class action cases under various state antitrust and consumer protection laws in 13 states and the District of Columbia, all of which cases have been voluntarily dismissed by the plaintiffs.

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.

69     2006 ANNUAL REPORT

Common Stock, with a par value of $.01,Additional Paid-In-CapitalandCommon Stock Held in Treasurytransactions during 2006, 2005 and 2004 are shown below. On May 5, 2006, the stockholders approved an amendment to the Restated Certificate of Incorporation changing the number of authorized shares of common stock from 350,000,000 shares to 700,000,000 shares in order to affect a two-for-one split of the Company’s common stock, with a distribution date of May 25, 2006, at a rate of one additional share for each common share held by stockholders of record on May 18, 2006. All per share data in this report has been restated to reflect the stock split.

							ADDITIONAL
	COMMON STOCK						PAID-IN-CAPITAL			COMMON STOCK HELD IN TREASURY
IN THOUSANDS EXCEPT SHARES	SHARES			AMOUNT			AMOUNT			SHARES			AMOUNT
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	)
During 2006—
Adjustment to reflect May 2006 stock split		312,043,289			3,151			(3,151	)		(31,229,721	)		—
Shares issued for stock options		3,096,786			19			85,033			—			—
Shares surrendered on exercise of stock options and vesting of restricted stock		(125,568	)		—			(6,082	)		—			—
Stock compensation expense		—			—			34,781			—			—
Tax benefits related to stock options and restricted stock		—			—			20,198			—			—
Restricted stock forfeitures		(10,610	)		—			—			—			—
Tax benefits related to defined contribution plans		—			—			1,832			—			—
Shares issued for acquisitions		3,853,556			19			163,365			(11,011	)		(486	)
Repurchases of common stock		—			—			—			(9,680,731	)		(446,876	)
Balance, December 31, 2006		630,900,742		$	6,309		$	1,378,587			(72,151,184	)	$	(3,220,538	)
Authorized, December 31, 2006		700,000,000

On August 4, 2006 the Company’s Board of Directors authorized a stock repurchase program, which provided for the buyback of up to 35,000,000 shares. As of December 31, 2006, the Company had repurchased 9,680,731 shares of its common stock for $446,876,000 at an average price of $46.16 per share.

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 (on a pre-split basis) and which was completed in 2005.

Cash Dividendsdeclared were $0.75 per share in 2006, $0.61 per share in 2005 and $0.52 per share in 2004. Cash dividends paid were $0.705 per share in 2006, $0.585 per share in 2005 and $0.50 per share in 2004.

NOTES TO FINANCIAL STATEMENTS     70

Accumulated Other Comprehensive Income—Comprehensive income is 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 stockholders and distributions to stockholders. The changes in accumulated other comprehensive income during 2006, 2005 and 2004 were as follows:

IN THOUSANDS	2006			2005			2004
Beginning balance	$	122,012		$	413,415		$	109,811
Foreign currency translation adjustments		495,697			(296,248	)		306,653
Minimum pension liability, net of tax		8,967			4,845			(3,049	)
Adjustment to initially apply SFAS 158, net of tax		(180,037	)		—			—
Ending balance	$	446,639		$	122,012		$	413,415

As of December 31, 2006, the ending balance of accumulated comprehensive income consisted of cumulative translation adjustment income of $647,132,000 and unrecognized service costs and actuarial losses for postretirement and pension of $200,493,000.

Stock-Based Compensation—Stock options and restricted stock have been issued to officers and other management employees under ITW’s 1996 and 2006 Stock Incentive Plans, as amended in 2006. 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, 2006, 69,222,795 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 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 records compensation cost related to the amortization of the unamortized grant date fair value of stock awards unvested as of December 31, 2004, and any subsequent awards, over the remaining service periods of those awards.

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 would have been reduced if compensation cost related to stock options had been determined based on fair value at the grant date. 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	2004
Net income as reported	$	1,338,694
Add: Restricted stock and stock options recorded as expense, net of tax		24,114
Deduct: Total stock-based compensation expense, net of tax		(61,639	)
Pro forma net income	$	1,301,169
Net income per share:
Basic—as reported		$2.21
Basic—pro forma		2.15
Diluted—as reported		2.20
Diluted—pro forma		2.13

71     2006 ANNUAL REPORT

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

IN THOUSANDS	2006			2005			2004
Restricted Stock:
Pretax compensation expense	$	12,185		$	33,105		$	32,514
Tax benefit		(4,145	)		(8,699	)		(8,400	)
Restricted stock expense, net of tax	$	8,040		$	24,406		$	24,114
Stock Options:
Pretax compensation expense	$	22,596		$	31,039		$	—
Tax benefit		(6,165	)		(8,889	)		—
Stock option expense, net of tax	$	16,431		$	22,150		$	—
Total Stock-Based Compensation:
Pretax compensation expense	$	34,781		$	64,144		$	32,514
Tax benefit		(10,310	)		(17,588	)		(8,400	)
Total restricted stock and stock options recorded as expense, net of tax	$	24,471		$	46,556		$	24,114

The following table summarizes activity related to unvested restricted stock during 2006:

				WEIGHTED-AVERAGE
	NUMBER			GRANT-DATE
	OF SHARES			FAIR VALUE
Unvested Restricted Stock
Unvested, January 1, 2006		295,624		$	41.66
Vested		(285,014	)		41.96
Forfeited		(10,610	)		41.66
Unvested, December 31, 2006		—			—

The following table summarizes stock option activity under the Plan as of December 31, 2006, and changes during the year then ended:

OPTIONS	NUMBER OF SHARES			WEIGHTED-AVERAGE EXERCISE PRICE		WEIGHTED-AVERAGE REMAINING CONTRACTUAL TERM		AGGREGATE INTRINSIC VALUE
Under option, January 1, 2006		20,570,764		$	33.76
Granted		3,511,560			42.08
Exercised		(3,096,786	)		27.46
Cancelled or expired		(92,077	)		39.66
Under option, December 31, 2006		20,893,461			36.07		5.76 years	$	215,890,490
Exercisable, December 31, 2006		17,124,981			34.42		5.15 years	$	204,857,919

On February 9, 2007, the Compensation Committee of the Board of Directors approved an option grant of 3,699,075 shares at an exercise price of $51.60 per share. The estimated fair value of the options granted during 2006 and 2004 were calculated using a binomial option pricing model. Previous grants were valued using the Black-Scholes option-pricing model. The following summarizes the assumptions used in the models:

	2007			2006			2004
Risk-free interest rate		4.7-5.1	%		4.5-4.7	%		2.6-4.3	%
Expected stock volatility		17.0-25.9	%		15.5-26.5	%		15.5-25.4	%
Weighted-average volatility		22.0	%		23.0	%		24.6	%
Dividend yield		1.65	%		1.3	%		1.2	%
Expected years until exercise		6.7-7.0			4.2-6.7			2.6-6.3

Lattice-based option valuation models, such as the 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 the 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.

NOTES TO FINANCIAL STATEMENTS     72

The weighted-average grant-date fair value of options granted during 2007, 2006 and 2004 was $14.39, $11.87 and $11.00 per share, respectively. The aggregate intrinsic value of options exercised during the years ended December 31, 2006, 2005 and 2004, was $63,255,000, $36,754,000 and $95,253,000, respectively. Exercise of options during the years ended December 31, 2006, 2005 and 2004, resulted in cash receipts of $78,969,000, $24,563,000 and $79,108,000, respectively. As of December 31, 2006, there was $39,055,000 of total unrecognized compensation cost related to non-vested equity awards. That cost is expected to be recognized over a weighted-average period of 2.6 years. The total fair value of options vested during the year ended December 31, 2006 was $35,505,000.

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.

In 2006, the Company announced that given the run-off of assets in the Leasing and Investments portfolio and the general intention to utilize free cash flow for core manufacturing investments and acquisitions rather than to make additional financial investments, the internal reporting has been revised to eliminate the reporting of Leasing and Investments as an operating segment. Leasing and Investments’ results have been reclassified to nonoperating investment income in the 2005 and 2004 statements of income to conform to the current year’s presentation, as follows:

	TWELVE MONTHS ENDED						TWELVE MONTHS ENDED
	DECEMBER 31, 2005			INVESTMENTS			DECEMBER 31, 2005
IN THOUSANDS	AS PREVIOUSLY REPORTED			RECLASSIFICATION			AS CURRENTLY REPORTED
Operating Revenues	$	12,921,792		$	(131,498	)	$	12,790,294
Cost of revenues		8,363,881			(13,509	)		8,350,372
Selling, administrative, and research and development expenses		2,214,865			284			2,215,149
Amortization and impairment of goodwill and intangibles		83,842			—			83,842
Operating Income		2,259,204			(118,273	)		2,140,931
Interest expense		(86,998	)		(7,599	)		(94,597	)
Investment income		—			126,278			126,278
Other income		9,363			(406	)		8,957
Income from Continuing Operations before Income Taxes	$	2,181,569		$	—		$	2,181,569

	TWELVE MONTHS ENDED						TWELVE MONTHS ENDED
	DECEMBER 31, 2004			INVESTMENTS			DECEMBER 31, 2004
IN THOUSANDS	AS PREVIOUSLY REPORTED			RECLASSIFICATION			AS CURRENTLY REPORTED
Operating Revenues	$	11,731,425		$	(148,175	)	$	11,583,250
Cost of revenues		7,591,246			(14,903	)		7,576,343
Selling, administrative, and research and development expenses		2,024,445			216			2,024,661
Amortization and impairment of goodwill and intangibles		59,121			—			59,121
Operating Income		2,056,613			(133,488	)		1,923,125
Interest expense		(69,234	)		(8,322	)		(77,556	)
Investment income		—			142,621			142,621
Other income		12,026			(811	)		11,215
Income from Continuing Operations before Income Taxes	$	1,999,405		$	—		$	1,999,405

The Company has approximately 750 operations in 49 countries, which are aggregated and organized for internal reporting purposes in 2006 into the following four 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 of 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 of less than 30 days.

73     2006 ANNUAL REPORT

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.

Segment information for 2006, 2005 and 2004 was as follows:

IN THOUSANDS	2006			2005			2004
Operating revenues:
Engineered Products—North America	$	4,118,494		$	3,766,134		$	3,377,373
Engineered Products—International		2,914,713			2,743,882			2,500,243
Specialty Systems—North America		4,627,627			4,168,305			3,776,100
Specialty Systems—International		2,947,570			2,566,386			2,340,902
Intersegment revenues		(553,355	)		(454,413	)		(411,368	)
	$	14,055,049		$	12,790,294		$	11,583,250
Operating income:
Engineered Products—North America	$	713,779		$	659,222		$	573,175
Engineered Products—International		430,609			406,189			372,832
Specialty Systems—North America		874,429			773,914			666,228
Specialty Systems—International		402,119			301,606			310,890
	$	2,420,936		$	2,140,931		$	1,923,125
Depreciation and amortization and impairment of goodwill and intangible assets:
Engineered Products—North America	$	147,379		$	126,246		$	106,975
Engineered Products—International		100,257			94,142			95,749
Specialty Systems—North America		109,486			90,273			85,990
Specialty Systems—International		86,784			72,413			64,569
	$	443,906		$	383,074		$	353,283
Plant and equipment additions:
Engineered Products—North America	$	99,365		$	78,413		$	71,436
Engineered Products—International		76,376			91,613			76,881
Specialty Systems—North America		75,225			70,479			79,042
Specialty Systems—International		50,040			52,597			55,201
	$	301,006		$	293,102		$	282,560
Identifiable assets:
Engineered Products—North America	$	2,783,101		$	2,287,068		$	2,083,296
Engineered Products—International		2,615,266			2,098,432			2,247,662
Specialty Systems—North America		3,350,957			2,530,921			2,303,782
Specialty Systems—International		2,798,260			2,199,339			2,103,342
Corporate		2,332,855			2,329,883			2,613,852
	$	13,880,439		$	11,445,643		$	11,351,934

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

NOTES TO FINANCIAL STATEMENTS     74

Enterprise-wide information for 2006, 2005 and 2004 was as follows:

IN THOUSANDS	2006		2005		2004
Operating Revenues by Product Line:
Engineered Products—North America—
Fasteners and Components	$	2,877,188	$	2,708,967	$	2,581,945
Specialty Products		1,241,306		1,057,167		795,428
	$	4,118,494	$	3,766,134	$	3,377,373
Engineered Products—International—
Fasteners and Components	$	2,270,675	$	2,162,643	$	2,074,394
Specialty Products		644,038		581,239		425,849
	$	2,914,713	$	2,743,882	$	2,500,243
Specialty Systems—North America—
Equipment and Consumables	$	2,907,664	$	2,624,832	$	2,371,003
Specialty Equipment and Systems		1,719,963		1,543,473		1,405,097
	$	4,627,627	$	4,168,305	$	3,776,100
Specialty Systems—International—
Equipment and Consumables	$	1,893,645	$	1,698,557	$	1,529,364
Specialty Equipment		1,053,925		867,829		811,538
	$	2,947,570	$	2,566,386	$	2,340,902
Operating Revenues by Geographic Region:
United States	$	7,009,600	$	6,854,205	$	6,283,935
Europe		4,039,885		3,766,091		3,461,879
Asia		1,085,910		828,569		699,425
Other North America		944,826		505,108		393,686
Australia/New Zealand		604,103		617,344		574,863
Other		370,725		218,977		169,462
	$	14,055,049	$	12,790,294	$	11,583,250

Operating revenues by geographic region are based on the customers’ location.

Total noncurrent assets excluding deferred tax assets and financial instruments were $8,011,000,000 and $6,435,000,000 at December 31, 2006 and 2005, respectively. Of these amounts, approximately 56% was attributed to U.S. operations in both 2006 and 2005. The remaining amounts were attributed to the Company’s foreign operations, with no single country accounting for a significant portion.

75     2006 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	2006		2005		2006		2005		2006		2005		2006		2005
Operating revenues	$	3,297,036	$	3,051,881	$	3,579,470	$	3,286,061	$	3,538,014	$	3,200,154	$	3,640,529	$	3,252,198
Cost of revenues		2,119,674		2,019,025		2,292,821		2,153,884		2,292,192		2,077,754		2,372,634		2,099,709
Operating income		539,968		458,732		659,764		559,906		626,866		565,216		594,338		557,077
Net income		366,530		312,306		465,854		373,782		446,092		408,202		439,270		400,579
Net income per share:
Basic		.65		.54		.82		.65		.79		.72		.78		.71
Diluted		.65		.53		.81		.64		.78		.72		.77		.71

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 2006 and 2005 were as shown below:

		MARKET PRICE PER SHARE			DIVIDENDS DECLARED
	HIGH		LOW		PER SHARE
2006:
Fourth quarter	$	50.11	$	44.32	$	.21
Third quarter		48.00		42.23		.21
Second quarter		53.54		46.31		.165
First quarter		49.38		41.54		.165
2005:
Fourth quarter	$	45.55	$	39.67	$	.165
Third quarter		43.77		39.25		.165
Second quarter		45.76		39.50		.14
First quarter		47.32		42.78		.14

The approximate number of holders of record of common stock as of February 1, 2007 was 11,349. This number does not include beneficial owners of the Company’s securities held in the name of nominees.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*

*$100 invested on 12/31/01 in stock or index-including reinvestment of dividends. Fiscal year ending December 31.